Maryland tax: We’ll have a more in-depth analysis of Maryland’s proposed surtax on management fees and carried interest later today, but a brief run-down and a little update, if you’re not already aware of it, for now.
Maryland’s state House and Senate introduced proposed legislation to apply a 17 percent additional state income tax to carried interest and management fees. It is expansive: even funds located outside the state would be hit by the tax if they invest in Maryland businesses (unless 80% or more of “average fair market value” of the specified assets in the fund are real estate – because real estate always gets excepted).
There are those that think that the breadth of the proposed legislation is a mistake; that whoever drafted it simply doesn’t understand how profound the consequences could be to Maryland businesses and to state tax revenues – one fund manager told me his firm would almost definitely move to DC, where it has another office – if the legislation passed as written.
But it’s just as possible that this is a preemptive tactic by drafters who understand that, should they try to place additional taxes on carry, previously waived management fees will simply be reinstated. Whatever the tactic, it’s clear that Maryland, and other states that have proposed similar legislation, are attempting to do what they think the federal government failed to do with the three-year carry tax rule (which punitively taxes carried interest if an asset is sold before a three-year holding period, and created its own conflict-of-interest problems): they’re saying, “If the federal government won’t close the loophole, we will.”
The real estate exclusion is telling and not just because real estate always gets special treatment. It implies that the drafters are actually trying to get the legislation passed – the question is whether it is nonetheless so broadly applicable as to be un-passable anyway.
Carry is taxed at the same rate as management fees at the state level. What these states are doing is taking advantage of the fact that the federal government is effectively not closing the ‘loophole’, knowing that private equity firms tend to hold investments longer than three years.
Which means: the fight to get the federal government not to kill preferential tax treatment for carry will now, very likely, have to be played out on an increasingly state-by-state basis.
Another important point to highlight is that, while other states have considered or passed laws that would levy similar surtaxes on carry only in the event that other contiguous states also pass similar legislation (to prevent businesses from hopping across state boundaries), Maryland has no such contingent provision.
On Friday, the venture capital industry group National Venture Capital Association was said to be sending a letter to legislators protesting the legislation. NVCA didn’t respond on Friday to inquiries about it.
Email prepared by Graham Bippart