Taxing Hedge Fund Managers Just Like Regular Folks - A Matter Of Fair Play?

Performance fees earned by hedge fund managers are taxed at a far lower rate than personal income. The difference to NJ: as much as $100M annually.

Lawmakers in the state Assembly gave their final approval yesterday to a bill that would establish a new tax in New Jersey to make up for what many consider to be a federal loophole that delivers a huge break to Wall Street fund managers.

Portrayed by supporters as an issue of basic fairness, the legislation would levy a hefty new tax on performance fees earned by managers of hedge funds and private-equity funds that are commonly referred to as “carried interest.”

The performance fees, under current federal rules, are generally taxed as capital gains instead of as individual income. The difference can provide huge savings for fund managers because of the higher tax rates that the federal government levies on personal income compared with the rates on capital gains.

New Jersey could generate $100 million or more in new revenue according to some estimates by establishing a state tax on the performance fees. The legislation, however, would also need to be passed in several other neighboring states to go into effect in New Jersey. If it were enacted only in New Jersey, it would be an open invitation for fund managers to move to a nearby state with a friendlier tax environment.

Simply another salary

The primary sponsor of the bill, Assemblyman Troy Singleton (D-Burlington), argued during the floor debate yesterday that the measure would simply treat the income earned by the fund managers no differently than the salaries earned by those in other careers, including “many of the people in this room.” But the bill was opposed by Assembly Minority Leader Jon Bramnick (R-Union), who questioned the message that New Jersey would be sending to the business community about taxes if the bill were to become law.

“People are very mobile, people can easily move from this state,” Bramnick said. “That is a bad message, a dangerous message.”

The effort to adopt the new state tax policy comes several weeks after President Donald Trump — who previously signaled his support for changing the federal tax rules for Wall Street fund managers — put forward a series of proposed federal tax reforms that included calling for lower federal income- and corporate-tax rates. But it’s unclear right now whether his plan would directly take on the issue of carried interest.

And at the state level, the legislation seeking to levy the new tax on Wall Street performance fees is being embraced by Democratic gubernatorial candidate Phil Murphy, a former Goldman Sachs executive who earlier this week won his party’s general election nomination. By contrast, his GOP opponent, Lt. Gov. Kim Guadagno, has made a firm, no new-taxes pledge.

The fairness fee

Under the bill, which was first introduced a year ago, New Jersey would establish a 19 percent “carried-interest fairness fee” to bridge the gap between the federal capital gains rate, which is 20 percent, and the top-end marginal income-tax rate, which is 39.6 percent. And to discourage fund managers from simply relocating to other states to escape the proposed state surcharge, the new fee would not go into effect in New Jersey until Connecticut, Massachusetts, and New York adopted the same change. None have done so thus far.

The legislation also includes a provision that would stop the proposed state-level surcharge from going into effect if the federal government eventually enacts a measure that fully addresses the tax-fairness issue.

The proposed federal tax reforms that were put forward by the Trump administration in late April called for reducing the top-end personal income-tax rate from 39.6 percent to 35 percent, and also for slashing the corporate-tax rate from 35 percent to 15 percent, all in an effort to grow revenues by expanding the overall tax base. But it wasn’t immediately clear whether Trump planned to also ensure that Wall Street performance fees would be taxed as income, something he repeatedly called for as a candidate in 2016. Administration officials have since said that he still intends to close the loophole.

Asked yesterday about the impact the proposed federal tax-policy changes could have on the effort to adopt the carried-interest legislation in New Jersey, Singleton suggested Trump’s tax-reform proposal was just the beginning of a lengthy legislative process, with the final product now subject to input from members of Congress.

‘Getting away with murder’

“What’s the president’s intention, and what ultimately ends up happening, is not the same thing,” Singleton said. He also said he hopes Trump will “harken back to Donald Trump the candidate,” who once bemoaned that the “hedge fund guys are getting away with murder.”

The nonpartisan New Jersey Office of Legislative Services didn’t specify in a fiscal note that was prepared for the state exactly how much additional revenue New Jersey could collect from taxing carried interest as income, except to say that the windfall could be “significant.” But other estimates suggest the state could generate between $80 million and $113 million by enacting the surcharge.

A Senate version of the legislation has yet to be introduced, but Singleton said he’s hopeful that a colleague in the upper house will take an interest in the issue. He also said he wasn’t certain what Gov. Chris Christie’s position is on the issue of carried interest, through Christie as a 2016 presidential candidate called for simplifying the federal tax code and eliminating all loopholes.

But Murphy, the Democratic gubernatorial candidate, has frequently pointed to the proposed new tax as a way to generate revenue that could help fund his policy priorities, which include eventual full funding of the state’s obligation to the public-employee pension system and its school-aid law. And early public-opinion polls indicate Murphy is the gubernatorial contest’s frontrunner.

“I’m encouraged that (Murphy) has looked at this as I have and feels it’s an issue of tax fairness,” Singleton said.

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