N.Y. Move Could Double-Tax Hedge Fund Managers
As they grapple with a gaping budget shortfall, Mr. Paterson and the lawmakers plan to enact a tax change that will treat much of the compensation earned by the fund managers who work in New York but live outside the state as ordinary income.
However, industry observers say the move could open up fund managers to double taxation and take some of the shine off New York as a hedge fund destination, The New York Times’s David M. Halbfinger reports.
Many fund managers are paid a flat management fee of 2 percent of assets, plus — as a performance incentive — as much as 20 percent of any profits they generate. The latter amount, known as “carried interest” or “the carry,” has been taxed federally at a rate of 15 percent because it is treated as a capital gain, rather than as ordinary income, which is subject to rates as high as 35 percent.
Democratic leaders in Congress have tried three times so far this year to reclassify that compensation as ordinary income. They have failed each time.
In New York, by contrast, lawmakers over the weekend embraced a proposal by Mr. Paterson to begin taxing nonresident fund managers’ carried interest.
Budget officials in Albany hope to reap about $50 million a year from the change.
But tax lawyers and representatives of investment firms argue that the fund managers could wind up being taxed twice on the same earnings, and warn that those who already live in places like Greenwich, Conn., or Summit, N.J., could decide to move their businesses out of New York altogether and work closer to home.
“It could be one more reason to move,” said Richard S. Zarin, a tax lawyer at the firm Morgan, Lewis who represents a number of investment fund organizers. “Having my office in New York versus Greenwich is now costing the partners who live in Connecticut more money than it used to.”
Under existing state laws, people are generally taxed on their income by the states where they work and on their investment gains by the states where they live. Because carried interest has been treated as investment income, and in New York State is subject to the same tax rate as other income like salary and wages, fund managers who live in the state have already been paying state tax on it.
But the carried interest earned by an estimated 1,000 New York fund managers living in Connecticut or New Jersey has been taxed only by their home states, officials said. (For people earning more than $500,000, the income-tax rate in Connecticut is 6.5 percent; in New York and New Jersey, 8.97 percent.)
By reclassifying carried interest as, essentially, payment for services, New York is seeking to tax nonresident fund managers as if their carried interest is no different from any other kind of fee paid for work performed.
But if Connecticut and New Jersey do not follow New York’s lead in reclassifying carried interest as ordinary income, those fund managers who continue to commute to work in New York could be taxed by two states on the same profits, tax experts said.
“You’ve got this potential for double taxation,” said Edouard S. Markson, a tax lawyer at Chadbourne & Parke with fund-manager clients. “Someone with enough money at stake is likely to bring a federal court challenge.”
Mr. Zarin, of Morgan, Lewis, also raised the question of whether foreign sovereign wealth funds or the pension plans of other states, which often help fund managers start new investment vehicles in return for a share of carried interest, could wind up having to pay state tax in New York. “Those people would never expect to have that happen,” he said.
But he said a more likely effect, at least for investment funds with small outposts in New York, would be “to say, ‘Do we really need that office in New York?’ You’d probably say, ‘I’d rather not have the headache.’ ”
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Senate Said to Scale Back ‘Carried Interest’ Tax
The plan being discussed in the Senate would see “carried interest” — the portion of a fund’s investment gains taken by fund managers as compensation — taxed at about 33 percent for assets held less than seven years and about 31 percent for assets held longer than that, Bloomberg News said.
Under current rules, carried interest is taxed federally at 15 percent because it is treated as a capital gain. That contrasts with the tax rate on ordinary income, which can be as high as 35 percent.
The plan approved by the House on May 28, which overcame strong lobbying pressure from Wall Street, amounted to a compromise that would tax 75 percent of carried interest as ordinary income and 25 percent as capital gains, with no special rates for long-term assets. It is expected to raise more than $17 billion in tax revenue over the next decade.
The measure is part of a broader tax bill, passed by a vote of 215 to 204 in the House, that would extend benefits for unemployed people.
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The Editors: Wall Street Casino
This approach ignores some pretty basic history: that the banks imploded while Republicans held Congress and the White House; that President George W. Bush started the rescue; that many Republicans voted for the bailouts; and that they stabilized a financial system that was perilously close to collapse.
More important, it’s a distraction from the very real reasons the nation needs to tighten the rules governing finance. They were on vivid display on Tuesday in a hearing room just down the hall from the Senate floor where Republicans voted the day before to block debate on a Democratic financial reform bill.
Current and former Goldman Sachs officials tried to defend their practice of trading incomprehensible mortgage-based investments of little demonstrable economic value and enormous destructive capacity. Instead, they underscored why much of this work should be curtailed.
The Securities and Exchange Commission has accused Goldman of defrauding clients by selling them a complex instrument without telling them it was designed so another client could bet against it. Testifying before the Senate subcommittee on investigations, Goldman executives denied withholding information. They insisted there was nothing wrong with selling mortgage-backed products while placing bets against them.
They called it “risk management.” Most people call it stacking the deck.
We do not know whether Goldman broke the law, but we know this gambling is too dangerous. Banks like Goldman turned the financial system into a casino. Like gambling, the transactions mostly just shifted money around. Unlike gambling, they packed an enormous capacity for economic destruction — hobbling banks that made bad bets, freezing credit and economic activity. Society — not the bankers — bore the cost.
That’s why objecting to financial regulation overhaul on the grounds that it might allow future bailouts is such a specious argument.
The bailouts, which many Republicans acknowledged were necessary at the time, cost taxpayers about $87 billion, or 1 percent of gross domestic product. The crisis cost more. Falling tax revenues, unemployment insurance for millions of jobless workers and a fiscal stimulus to stop the economy’s slide is projected to boost the federal debt to more than 65 percent of G.D.P. next year.
Financial reform is needed to try to ensure such a crisis never happens again, and the bill cobbled together by Senate Democrats is reasonably tough. It would ban many — unfortunately not all — of the private, custom-made derivatives at the center of the financial meltdown and force most derivative trading onto open exchanges. Banks trading in custom-made products would have to build larger cushions of capital to protect themselves.
The bill would establish a consumer protection agency to stop predatory lending, impose new oversight on hedge funds and make it possible for regulators to dismantle big banks that were deemed to pose an imminent risk of failure. And it would create a $50 billion fund, by the nation’s largest banks, to cover commitments of a failing institution that was being wound down.
Whatever Republican campaign mailings may say, the fund was designed to avoid bailouts. The bill’s failing is not that it’s too weak. It’s that it could be stronger.
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Democrats Make Final Push on Overhaul
Democrats could bring the sweeping bill up for a vote in the House of Representatives on Wednesday, where it is expected to pass easily.
They hope to pass the measure through the Senate by the end of the week so Mr. Obama can sign it into law by the July 4 holiday, but they could see final action slide into mid-July.
Senator Christopher Dodd, the Democrats’ point man on the issue, said on Tuesday that it was “doubtful” the Senate would act by the end of the week.
Legislative action will be out of the question for much of Thursday as the late Democratic Senator Robert Byrd lies in state in the Senate chamber.
Furthermore, Mr. Dodd and other backers had yet to nail down the support of wavering moderate Republican senators whose support will be needed to overcome a procedural hurdle.
And lawmakers are doubtless eager to get out of town for a weeklong break for the holiday.
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