TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, September 25, 2018

Connecticut’s SALT Bypass Offers Hidden Perk For Money Managers

Bloomberg, Connecticut’s SALT Bypass Offers Hidden Perk for Money Managers:

Hedge fund and private equity managers in Connecticut may have more to like about the state’s novel workaround for a new cap on state and local tax deductions.

Not only do those who live and work in the state get a break on their property taxes, they can also shave the tax bill for their carried interest profits, a key source of earnings.

Earlier this year, Governor Dannel Malloy signed a law that creates a way for owners of so-called pass-through businesses, such as partnerships, to take bigger federal deductions to absorb the hit from the tax law’s new $10,000 SALT deduction limit. Buried in the provision is a way to further reduce the rate applied to carried interest.

For managers at some of Connecticut’s big funds such as Viking Global Investors, Lone Pine Capital, Stone Point Capital and Silver Point Capital, the measure could translate to hundreds of thousands, or even millions, of dollars in federal tax savings on carried interest. Representatives for the firms didn’t respond to requests for comment.

The new tax “could create a significant benefit,” said Joseph Pacello, a tax partner in the asset management group at BDO USA. Pacello said the carried interest break is currently being discussed by fund managers in Connecticut and their accountants. ...

For fund managers who earn carried interest -- typically 20 percent of a fund’s profits -- the pass-through entity tax has benefits that go beyond SALT.

Carried interest is eligible for the long-term capital gains rate of 20 percent, instead of facing ordinary income tax rates that now top out at 37 percent. (Federal law adds an additional 3.8 percent surcharge tied to Obamacare to the capital gains rate.) Under the old tax regime, assets had to be held for one year to qualify for the lower rate -- the new law sets a three-year holding period.

To compute the Connecticut levy, fund managers can use two methods. The standard way involves tallying up an entity’s income from sales and services within the state, or in the case of fund managers, annual management fees paid by investors who are Connecticut residents.

An alternative method includes any capital gains, dividends and interest earned by Connecticut residents. Managers who choose that method can include carried interest and reduce the long-term capital gains rate of 20 percent by about 1.4 percentage points, according to Bloomberg calculations supported by Michael Spiro, chair of the tax group at Finn Dixon & Herling in Stamford, and Ivan Mitev, a tax lawyer at Pillsbury Winthrop Shaw Pittman.

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