United States: Current New York Tax Considerations For Asset Managers—Part 1, Sourcing Fee Income In A Remote Work Model

Asset managers face a complicated tax environment in New York. They must consider not just New York State (NYS) business taxes on their management companies, their funds and themselves, but also parallel New York City (NYC) business taxes. Sometimes these NYS and NYC taxes are aligned, and sometimes they are not. In the case of remote work, they are not. As we discuss below, remote work presents an opportunity to reduce the New York tax burden on fee income, but NYS and NYC each present their own considerations, which must both be addressed to properly capitalize on it.

The pandemic forced many of us into a work-from-home experiment that had no precedent or road map. Many companies then learned that working from home is not only possible but, in some cases, quite efficient. As a result, after leaving NYC in March of 2020, many principals and investment professionals have decided they may stay put and never truly return to their NYC offices. Some will work from home and occasionally visit the NYC office, while others will simply establish new offices closer to their primary residence.

This Legal Update reviews key NYC Unincorporated Business Tax (UBT) and NYS Personal Income Tax (PIT) considerations-and potential savings-that may arise from this shift. It focuses on income sourcing concepts for partnerships under the UBT and PIT. The sourcing regimes largely apply to management fee income, as the UBT and PIT both have exemptions for self-trading income that shelter carried interest income from tax, when structured properly. Based on their current approaches to income sourcing, the UBT automatically adjusts to remote work locations and the PIT does not. NYS's newly enacted "Pass-Through Entity Tax" mirrors the PIT. We have discussed the Pass-Through Entity Tax in a recent Legal Update. The PIT discussion in this Legal Update applies primarily to nonresident partners because resident partners are taxable on all of their income wherever earned.

Part 2 of this Legal Update will address the PIT considerations that residents and nonresidents face at the individual level, including some basics around residency changes, and the effects of those changes on PIT liabilities. It will consider issues such as sourcing carried interest income, bonuses and deferred payments in years that involve residency changes, and establishing bona fide home offices.

I. Some Basics

A. UBT

The UBT is a 4% tax on net income that is allocated and apportioned to NYC. It applies to a base that is generally derived from federal gross income and deductions, but has its own definition of a taxable business-which notably excludes some financial and real estate investment activities-and applies its own modifications to income.¹ The result is a tax that conforms to many aspects of Subchapter K and the Internal Revenue Code, but also has its very own concepts, construction and application.

One mostly thinks of partnerships and limited liability companies in relation to the UBT, but the tax also applies to sole proprietors, trusts, and any other form of unincorporated business.² Whatever the form of business, determining how much income the business earned in NYC is often the most crucial determination. Many UBT filers do business inside and outside NYC and therefore must "allocate" that income to NYC to calculate the tax (most other state and local income taxes use the term "apportion" for income that is attributed by formula and the term "allocate" for income that is attributed by source).³ NYC allocates income by using a formula that results in a "business allocation percentage" that represents the percentage of income a taxpayer must attribute to NYC in any particular year for tax purposes.

Until recently, the NYC allocation formula included three factors-property, payroll, and gross income.⁴ Beginning in 2018, however, the property and payroll factors no longer apply and the NYC business allocation percentage is derived entirely from the gross income factor.⁵ That means a business determines its NYC income solely by reference to the percentage of its gross receipts or sales that are attributable to NYC under the UBT's rules for sourcing gross income. For a services business, such as asset management or law or accounting services, the place of performance generally controls that determination because the gross income factor sources fees for most services to NYC to the extent the services were performed within NYC.⁶ Special industry-specific rules provide a customer-based approach for registered broker-dealers and mutual fund managers⁷ and those exceptions are not addressed by this Legal Update. Further flexibility may exist with respect to "other business receipts" or "other reasonable method[s]," which we have covered, in part, in this prior article.

B. PIT

The PIT is a graduated personal net income tax on residents and nonresidents at the NYS level, and on residents at the NYC level. Remote working has a greater potential impact on nonresidents than residents (except to the extent a person changes their residency as a result of remote work). This is because remote work may affect the amount of both NYS sourced business income (i.e., Form K-1 income) and NYS sourced compensation (i.e., Form W2 income) that nonresidents must report.

In contrast to the UBT, the PIT is more closely tied to federal tax returns, at least for residents. It applies to federal adjusted gross income with certain state-specific modifications.⁸ That means NYS and NYC tax all of a resident's income wherever earned on almost the same basis as the federal government, subject to NYS credits for taxes paid to other state and local jurisdictions.

The analysis is a little more complicated for nonresidents. NYC does not tax nonresidents at all (which is a policy choice that solidifies the UBT's importance in NYC's tax structure), and NYS taxes nonresidents only on income earned within NYS.⁹ Similar to the UBT, the PIT has complicated rules that go into determining how much income is taxable in NYS.

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Footnotes

1. NYC Admin. Code § 11-501(k).

2. NYC Admin. Code § 11-501(m).

3. NYC Admin. Code § 11-508(a).

4. NYC Admin. Code § 11-508(c).

5. NYC Admin. Code § 11-508(i)(1).

6. NYC Admin. Code § 11-508(c).

7. NYC Admin. Code § 11-508(e-3).

8. NY Tax Law § 612(a); 20 NYCRR § 112.1.

9. NY Tax Law § 601(e).

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