(Dow Jones) New York hedge funds are starting to explore the idea of moving to Connecticut to avoid higher taxes on some of their managers.

Publicly, a New York hedge fund organization has said its members don't want to move out of the country's financial capital. But Joan McDonald, commissioner of the Connecticut Department of Economic and Community Development, or DECD, said she has been in touch with a number of the funds, including some that have reached out to her office.

New York lawmakers have proposed raising taxes on out-of-state managers. The legislation, which is in a budget bill in the state Senate, has been criticized by New York City Mayor Michael Bloomberg and Governor David Paterson, who see the risk of driving businesses out of the state.

Connecticut Gov. Jodi Rell says she'll welcome the funds with open arms, and last week invited some fund managers to an Aug. 2 dinner at a waterfront restaurant in Darien. McDonald says her agency decided the funds should "get to know our governor."

McDonald says the state talks regularly with hedge funds as part of a larger effort to attract all kinds of businesses, but the proposed New York tax hike provides a special circumstance that could trigger some moves.

Hedge funds track taxes very closely in states where they practice, and the Connecticut tax on fund managers' compensation is already lower than in New York.

As Bloomberg noted, hedge funds operate largely on computers and can easily pull up stakes and move. Also, many managers of New York hedge funds already reside in Connecticut and are familiar with the state. Those who don't may have relatives or an alma mater here, said Barbara Fernandez, head of the Office of Insurance and Financial Services at DECD.

Many New York hedge funds have satellite offices in Connecticut, so "this is more a reaching out to kissing cousins," Fernandez said.

Right now, hedge-fund managers who live outside New York but work for funds that operate in the state often don't pay New York state tax on carried interest, which is usually treated as a capital gain. The proposal would treat carried interest as services income, which is taxed at ordinary-income rates rather than the lower capital-gains rate. Services would be taxed in New York if they are performed there, and sometimes even if they are not.

The U.S. Congress has been fighting over proposals to tax carried interest as ordinary income rather than as capital gains, at the federal level, but hasn't made such a change.

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