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.
President Donald Trump’s tax overhaul created a $10,000 cap on state and local tax deductions, a pittance for taxpayers in Northeastern states that have high property taxes. Connecticut taxpayers will see an additional $2.8 billion federal income tax liability as a result of the SALT cap in 2018, the state’s estimates show.
Democratic governors in high-tax states, including Malloy, have battled the Republican law’s cap, saying they’re being unfairly targeted, and have approved different workarounds.
Last month, the IRS moved to block the most common strategy -- making charitable donations for property tax payments -- but remained silent on other workarounds, like Connecticut’s pass-through entity tax.
The pass-through tax, signed into law by Malloy in May, set a mandatory 6.99 percent levy -- the state’s top marginal individual income tax rate -- on pass-through entities, whose income is reported on owners’ personal returns and taxed at individual rates. Pass-through owners then get a state credit equal to about 93 percent of the owner’s share of tax paid by the business. They also get a full deduction for the levy as a business expense on their individual federal returns, since those are still unlimited.
The workaround, retroactive to Jan. 1, 2018, effectively assesses a state tax on the business that the owner can turn into a federal deduction.