Tax Lawyers Doubtful on Cuomo Plan to End Hedge Fund Loophole

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By John Herzfeld

A panel of New York tax lawyers cast doubt on a state budget proposal by Gov. Andrew M. Cuomo (D) to close a loophole that allows hedge funds to treat carried interest as capital gains and not ordinary income.

The report, released March 12 by the Tax Section of the New York State Bar Association, came out as the Democrat-controlled state Assembly and the Republican-controlled state Senate began to try to hammer out a budget agreement before the April 1 start of the state’s fiscal year.

The NYSBA Tax Section report took no position on whether carried interest income for state purposes should be treated as business income or given favorable tax treatment. It noted, however, that the Cuomo proposal only would take effect upon enactment of similar legislation by four neighboring states.

The Tax Section deemed as “unlikely” the chances that Connecticut, New Jersey, Massachusetts, and Pennsylvania would all adopt some kind of legislation dealing with carried interest income. It further questioned whether the actions by the other four states would meet the New York proposal’s criteria of providing “substantially the same effect.”

The meaning of that phrase is unclear, the Tax Section lawyers said. The states could take different approaches, such as treating carried interest as business income but not imposing New York’s “punitive” carried interest fairness fee, or imposing only a lower fee.

$1.1 Billion Projected

The fee, called a Fairness Fix by Cuomo, would be imposed on hedge fund managers working in New York and is meant to collect an estimated $1.1 billion in annual revenue. It would stay in effect as long as federal tax law keeps the carried interest loophole, which Congress declined to address in the 2017 federal tax act ( Pub. L. No. 115-97).

Comments in the report questioned the feasibility of Cuomo’s proposed terms, saying it may be difficult to trace how much of a partnership interest was received in exchange for investment management services.

The report further faulted a Cuomo budget proposal that would make it easier for the state to count days of the year toward a part-year resident’s in-state income. Wealthy taxpayers try to minimize their exposure to New York’s comparatively high income tax rates by limiting the number of days they spend in the state.

A 2015 order from the state Division of Tax Appeals ( In re Petition of Sobotka) found that the state can’t satisfy the 183-day aggregate threshold for statutory residency by adding the number of days someone with a permanent place of abode spent in New York when domiciled in the state to the number of days spent when not domiciled.

The Cuomo proposal would amend the law to undo the decision and restore the state’s policy of counting all days someone is present in New York during a tax year—regardless of whether that person is domiciled or makes their home part of the year. Anyone maintaining a permanent place of abode in New York and exceeding the 183-day threshold would be a statutory resident, whether the person had a New York domicile.

Too Wide a Net?

Taking no position on the budget proposal, the Tax Section said it “would have the effect of taxing individuals as full-year residents of New York when they are ‘for all intents and purposes’ only part-year residents.” That would arguably be inconsistent with state Court of Appeals precedent, according to the Tax Section.

If the state is going to amend the definition of statutory resident to address Sobotka, “it ought to consider a comprehensive revision to the statutory residency provisions,” to keep taxpayers who clearly don’t meet the “for all intents and purposes” test from being caught in the statutory residency net, the Tax Section said.

The report also warned against making the change retroactive to years where the statute of limitations is open, saying that it wouldn’t be good policy and would invite constitutional challenges. Generating additional tax revenue would seem to be the only rationale for the change, “which is not, alone, a compelling justification,” the lawyers said.

Other proposals addressed in the report would extend the statute of limitations on amended tax returns, allow warrantless tax debt to be assessed against unclaimed funds, and give the state tax department the right to appeal Division of Tax Appeals tribunal decisions to state court.

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

For More Information

The NYSBA Tax Section report is at http://src.bna.com/w2c.

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