Illinois Could Be First State to Specifically Target Carried Interest

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

Tax Policy

Bloomberg BNA regularly spotlights the insights of state and local tax attorneys at KPMG LLP. In this installment, Dan De Jong discusses recent legislation in Illinois that taxes carried interest at the partnership level.

Dan De Jong

By Dan De Jong

Dan De Jong is a senior manager in the State and Local Tax group of KPMG LLP's Washington National Tax practice.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Despite much discussion over the federal tax treatment of carried interest income earned by managers of investment funds, no changes at the federal level appear imminent. The issue may have more traction at the state level. Some state legislators have proposed legislation that would impose a tax roughly equal to the “gap” between the federal ordinary income tax rate and preferential capital gains tax rate on carried interest income earned by fund managers who reside in those states. Proposed legislation moving quickly in one state would create a new tax on pass-through entities through which fund managers often conduct their operations.

On May 23, the Illinois Senate passed Senate Bill 1719, which would impose a new 20 percent privilege tax on the carried interest income of partnerships engaged in “investment management services.” These services are defined to encompass the activities of a typical asset manager. Rather than imposing this new tax on the individuals who own those partnerships, SB 1719 would tax the partnership entity itself on the carried interest income it receives (defined as “fees calculated by reference to the performance of the investment portfolio funds and not from the investment itself”). Partners would continue to be subject to Illinois income tax on their share of the carried interest income.

An earlier version of the bill delaying its effective date until Connecticut, New Jersey, and New York passed laws with similar effect was removed during Senate deliberations. In the version of the bill now pending in the Illinois House, this new tax would become effective beginning July 1.

Interestingly, the Department of Revenue's Fiscal Note on the bill observes that “constitutional issues may prevent the state from collecting any new revenue from the surcharge.” The deadline for final action on this bill was extended until June 30, 2017, which gives the House additional time to consider the issue during the current legislative session.

Pundits give good odds to the bill passing through the Democrat-controlled House, but consider its prospects uncertain if it reaches the desk of Republican governor Bruce Rauner. With Illinois mired in long-term fiscal difficulties, the prospect for raising additional revenue from this bill make it one worth watching for those in the financial services industry.

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