If a family sets up a tiered limited partnership and LLC structure, run by New York-based employees out of a New York office, purely to trade securities for the family's own account, do the nonresident family members owe New York State income tax or the New York City nonresident earnings tax on their share of the trading income?

Plain-English summary

Petitioner, MSD Capital, L.P., was formed to handle the investments of an individual "M," his spouse "S," their relatives, and trusts for their benefit (collectively, the "M Interests"), none of whom live in New York. The planned structure has several layers. Petitioner itself has M as its sole general partner (1% of capital) and a trust, T1, funded by M and/or S, as its sole limited partner (99% of capital). Petitioner keeps an office in New York City and employs two people, G and J, who manage the investments. Petitioner's own activities are limited to managing its own assets and acting as a passive, non-managing member (87.5% interest) in a set of "Series G" and "Series J" LLCs, each of which has G or J as the managing member (12.5% interest). Petitioner is also the sole general partner of a separate entity, "Portfolio LP," which in turn sets up several fund "series," with other M Interests as limited partners.

None of Petitioner, Portfolio LP, or the Series G/J LLCs is a broker-dealer, and none "makes a market" in securities - they simply buy, hold, and sell securities and other financial instruments, virtually all for their own account, and all are treated as partnerships for federal tax purposes.

The Department addressed two questions. First, is the distributive share of income that M and the other M Interests receive (directly or indirectly through this tiered structure) New York source income for personal income tax purposes? Second, is that same income "net earnings from self-employment" for purposes of the New York City Earnings Tax on Nonresidents? Relying on its own earlier opinions in Kenneth S. Davidson Partners (TSB-A-88(11)I) and Paul E. Singer (TSB-A-92(2)I), the Department concluded that because every entity in the chain is only trading and investing for its own account - with no market-making or broker/dealer activity - none of them is "carrying on a business" in New York under Tax Law § 631(b) and (d). That conclusion held even though Petitioner has a New York City office and New York-based employees managing the investments, and even though the arrangement is tiered (income passes from the Series LLCs and Portfolio LP through Petitioner before reaching the family members). As a result, none of the M Interests has New York source income from these activities under §§ 631(a) and 632(a)(1). Separately, under IRC § 1402(a) (incorporated by NYC Admin. Code § 11-1901(f)), the same income - dividends and interest not received as a securities dealer, capital gains and losses, and a limited partner's distributive share other than guaranteed payments for services - is excluded from "net earnings from self-employment," so it is also not subject to the New York City Earnings Tax on Nonresidents under NYC Admin. Code § 11-1902.

What this means for you

Nonresident family members using a NY-based family office / investment LP structure

If your family's investment vehicle is organized in tiers - an operating partnership, one or more LLC "series," and a top-level portfolio partnership - and every layer of that structure is limited to buying, holding, and selling securities or other financial instruments for the family's own account (no broker-dealer registration, no market-making), the fact that the managing entity has a New York City office and New York-based staff running the investments does not, by itself, turn the family members' distributive shares into New York source income. The same trading gains are also not "net earnings from self-employment" for New York City Earnings Tax on Nonresidents purposes, because IRC § 1402(a) excludes dealer-exempt dividends and interest, capital gains and losses, and a limited partner's distributive share other than guaranteed payments for services.

Advisors structuring tiered LP/LLC investment vehicles with NY-based staff

When designing a multi-entity structure for a client's family office - general partner/limited partner layers, non-managing LLC interests, and a portfolio-level partnership with several fund "series" - the key fact the Department focused on is the character of the activity at every level: trading and investing for the entities' own account, without broker/dealer status or market-making. Confirm and document that no entity in the chain crosses into dealer or market-making activity, since that is what keeps the structure out of "carrying on a business" under Tax Law § 631(b) and (d), regardless of how many tiers the income passes through before reaching the ultimate nonresident owners.

Common questions

Q: Does having a New York City office and New York-based employees (G and J) manage the investments change the analysis?
A: No. The Department found that Petitioner's New York office and its two New York-based employees who manage the investments did not matter to the outcome. What mattered was the character of the activity - trading and investing for the entities' own account, with no broker/dealer activity or market-making - which is what Tax Law § 631(d) excludes from "carrying on a business."

Q: Does routing income through multiple tiers (Series LLCs, Portfolio LP, and Petitioner) before it reaches the family members change the result?
A: No. The Department relied on Paul E. Singer (TSB-A-92(2)I), which held that a tiered partnership arrangement - where income is funneled through a limited partnership before its ultimate distribution or deemed distribution to the individual - does not change the conclusion that trading-for-own-account income is not New York source income.

Q: What activity would have changed the outcome?
A: The Department's earlier opinion in Kenneth S. Davidson Partners (TSB-A-88(11)I) noted that a partnership would not be considered to be solely trading for its own account, and so could lose this treatment, if it engaged in other activities such as market-making. Here, none of Petitioner, Portfolio LP, or the Series G/J LLCs was a broker/dealer or made a market in any securities.

Q: Why does the New York City Earnings Tax analysis require a separate discussion from the New York State personal income tax analysis?
A: The New York City Earnings Tax on Nonresidents, imposed under NYC Admin. Code § 11-1902, taxes wages and "net earnings from self-employment," which § 11-1901(f) defines by reference to IRC § 1402(a) rather than by reference to Tax Law § 631. Under § 1402(a), the analysis turns on whether the income is dealer-exempt dividends and interest, capital gain or loss, or a limited partner's distributive share other than guaranteed payments for services rendered - a different test from whether a business is being "carried on" in New York.

Q: Would a guaranteed payment to G or J for managing the investments be treated the same way?
A: The opinion's exclusion for limited partners' distributive shares under IRC § 1402(a)(13) specifically does not apply to "guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services" - meaning compensation-like guaranteed payments for services remain outside that exclusion, unlike the trading-based distributive shares addressed in this opinion.

Q: Are the Series G and Series J LLCs treated differently from partnerships for New York tax purposes?
A: No. Because the LLCs are treated as partnerships for federal income tax purposes, Tax Law § 2(5) and (6) and Department guidance in TSB-M-94(6)I and (8)C treat them as partnerships for New York State personal income tax purposes as well.

Citations and references

• Tax Law § 2(5) and (6) - defines "limited liability company" and provides that "partnership and partner" include an LLC and its members
• Tax Law § 631(a) - defines New York source income of a nonresident individual, including a distributive share of partnership income determined under § 632
• Tax Law § 631(b) - includes in New York source income items attributable to a business, trade, profession, or occupation carried on in New York State
• Tax Law § 631(d) - a nonresident (other than a dealer) is not deemed to carry on a business in New York solely by trading property or options for the individual's own account
• Tax Law § 632(a)(1) - determines the New York source portion of a nonresident partner's distributive share consistent with § 631
• TSB-M-94(6)I and (8)C - an LLC treated as a partnership for federal tax purposes is treated as a partnership for New York State tax purposes
• TSB-A-88(11)I, Kenneth S. Davidson Partners - trading options solely for the partnership's own account is not carrying on a business in New York, but market-making activity would change that conclusion
• TSB-A-92(2)I, Paul E. Singer - a partnership trading securities for its own account through a tiered partnership arrangement still is not carrying on a business in New York
• NYC Admin. Code § 11-1902 - imposes the New York City Earnings Tax on Nonresidents on wages and net earnings from self-employment
• NYC Admin. Code § 11-1901(f) - defines net earnings from self-employment by reference to IRC § 1402(a)
• IRC § 1402(a) - defines net earnings from self-employment, excluding dealer-exempt dividends and interest, capital gains and losses, and a limited partner's distributive share other than guaranteed payments for services

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1998.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a98_8i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-98(8)I
Income Tax
September 4, 1998

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I980609A

On June 9, 1998, a Petition for Advisory Opinion was received from, MSD
Capital, L.P., c/o McDermott, Will & Emery, 50 Rockefeller Plaza, New York, New
York 10020.
The issue raised by Petitioner, MSD Capital L.P., is whether, based on the
facts presented, the distributive share of income received (or deemed received)
by M and the other M Interests from Portfolio LP, the Series G LLCs, the Series
J LLCs, and Petitioner (1) would be considered New York source income for
purposes of the New York State personal income tax and (2) would be considered
net earnings from self-employment for purposes of the New York City Earnings Tax
on Nonresidents.
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Petitioner has been formed to facilitate the investment activities of M;
his spouse, S; their relatives; and trusts formed by them primarily for the
benefit of their relatives and charities (collectively, the "M Interests"). None
of the M Interests is a resident of New York State. For various reasons, the M
Interest investments will be made pursuant to the structure set forth below. The
investments, virtually all of which will be securities and other financial
instruments and some of which will be traded on public exchanges, will be managed
in New York by two employees of Petitioner, G and J, who are both unrelated to
any of the M Interests.
The planned structure envisions Petitioner having two partners: M, who
would be the sole general partner, and T1, which would be the sole limited
partner (T1, as a trust that would be solely funded by M and/or S, for the
benefit of their descendants, would be an M Interest); M would contribute 1% of
Petitioner's capital and T1 would contribute 99% of its capital; M's and T1's
capital and income interests would reflect those same proportions. Petitioner,
which would maintain its office in New York City, would employ G and J and such
other staff as may be necessary to manage the investments of Portfolio LP, as
described below. Petitioner's activities would be dedicated exclusively to (1)
managing its own assets (which will consist of furniture, fixtures, and equipment
and working capital) and the assets of Portfolio LP and (2) being a passive
invester in the Series G and Series J LLCs (described below). None of the Series
G LLCs, the Series J LLCs, or Portfolio LP will be a broker/dealer or "make a
market" in any securities. All of these partnerships and LLCs will be treated
as partnerships for federal income tax purposes.
The Series G LLCs and the Series J LLCs would each have Petitioner as its
sole non-managing member and G (in the case of the Series G LLCs) or J (in the
case of the Series J LLCs) as its sole managing member.
(Under certain
extraordinary circumstances, Petitioner may become a managing member.)
Petitioner would contribute and have an interest in 87.5% of the capital of each
of the Series LLCs, while the managing member would contribute and have an
interest in the remaining 12.5% of the capital. Each of the two members of each

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TSB-A-98(8)I
Income Tax
September 4, 1998

Series LLC would share in the income from the Series LLC proportionally with
their respective capital investments, to a maximum amount equal to an objectively
determinable floating rate return on their capital annually.
Any income in
excess of that would be shared, with the individual managing member (G or J)
receiving 99% of such excess, and Petitioner receiving 1% of such excess. The
sole activity of the Series G LLCs and the Series J LLCs would be the making,
maintaining, and disposing of investments in securities and other financial
instruments.
Portfolio LP would establish several separate funds (considered "series"
under Delaware partnership law, which is the authority under which Portfolio LP
would be formed). The exact amount and portion of the capital contribution of
each partner may vary depending on the availability of assets; however, it is
envisioned that (1) Petitioner would be the sole general partner in each fund,
contributing 1% of the capital and receiving a 1% capital interest and a 20.8%
interest in profits, and (2) other M Interests would be limited partners in each
fund, collectively contributing 99% of the capital and receiving a 99% capital
interest and a 79.2% interest in profits.
Discussion
Section 2 of the Tax Law provides the definition of certain terms used in
the Tax Law, and was amended by Chapter 576 of the Laws of 1994 which added the
following:

5. The term “limited liability company” means a domestic limited
   liability company or a foreign limited liability company, as defined
   in section one hundred two of the limited liability company law.
6. “Partnership and partner,” unless the context requires otherwise,
   shall include, but shall not be limited to, a limited liability
   company and a member thereof, respectively.
   An LLC that is treated as a partnership for federal income tax purposes,
   is treated as a partnership for New York State tax purposes. (See, Department
   of Taxation and Finance Memorandum, TSB-M-94(6)I and (8)C, October 25, 1994.)
   Accordingly, for New York State personal income tax purposes, the Series G LLCs
   and the Series J LLCs will be treated as partnerships.
   Section 631(a) of the Tax Law provides that the New York source income of
   a nonresident individual includes the net amount of items of income, gain, loss
   and deduction entering into the individual's federal adjusted gross income
   derived from or connected with New York sources, including the individual's
   distributive share of partnership income, gain, loss and deduction, determined
   under section 632 of the Tax Law.
   Section 632(a)(1) of the Tax Law provides that "[i]n determining New York
   source income of a nonresident partner of any partnership, there shall be
   included only the portion derived from or connected with New York sources of such
   partner's distributive share of items of partnership income, gain, loss and
   deduction entering into the individual's federal adjusted gross income. The
   determination of such portion shall be consistent with section 631 of the Tax
   Law.

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Income Tax
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Section 631(b) of the Tax Law provides that items of income, gain, loss and
deduction derived from or connected with New York sources include those items
attributable to a business, trade, profession or occupation carried in New York
State. However, section 631(d) of the Tax Law provides that a nonresident, other
than a dealer holding property primarily for sale to customers in the ordinary
course of the individual's trade or business, shall not be deemed to carry on a
business, trade, profession or occupation in this state solely by reason of the
purchase and sale of property or the purchase, sale or writing of stock option
contracts, or both, for the individual's own account.
In Kenneth S. Davidson Partners, Adv Op Comm T&F, June 28, 1988, TSB-A­
88(11)I, it was held that the purchase and sale by the partnership of options on
indexes, foreign currencies, debt obligations and futures contracts and the
exercise, closing out or expiration of such options solely for its own account
did not constitute the carrying on of a business, trade, profession or occupation
in New York State. However, the opinion noted that the partnership would not be
considered to be solely trading for its own account if it engaged in certain
other activities such as market making activities.
In Paul E. Singer, Adv Op Comm T&F, June 4, 1992, TSB-A-92(2)I, a
partnership with its principal office in New York engaged in trading securities
for its own account.
It had two general partners, one was a nonresident
individual and the other was a limited partnership. The opinion held that the
partnership was not carrying on a trade or business in New York because it was
engaged solely in trading for its own account, thus the income attributable to
the partnership was not New York source income, and this did not change despite
the existence of a tiered partnership arrangement, where the partnership's income
is funneled through the limited partnership before its ultimate distribution, or
deemed distribution to the individual.
In this case, pursuant to sections 631 and 632 of the Tax Law and following
the Davidson, supra, and Singer, supra, opinions, the activities of Petitioner,
Portfolio LP, the Series G LLCs and Series J LLCs constitute trading for their
own accounts. Accordingly, the distributive share of income that M or any of the
other M Interests receive, or are deemed to receive, from Portfolio LP (whether
directly or indirectly through Petitioner), from the Series G LLCs and Series J
LLCs (indirectly through Petitioner), and/or from Petitioner is not deemed to be
attributable to a trade or business carried on in New York State. Therefore, M
and the other M Interests will not have New York source income from these
activities under section 631 of the Tax Law.
The New York City Earnings Tax on Nonresidents is authorized under Article
30 of the Tax Law, and is administered by New York State. Section 11-1902 of the
Administrative Code for the City of New York ("Admin. Code") imposes the tax on
wages earned and net earnings from self-employment, within the City, of
nonresident individuals, estates and trusts. Net earnings from self-employment
is defined, in section 11-1901(f) of the Admin. Code, to be the same as net
earnings from self-employment as defined in section 1402(a) of the Internal
Revenue Code ("IRC"), with some variations not relevant herein. A trust shall
be deemed to have net earnings from self-employment determined in the same manner
as if it were an individual subject to the tax on self-employment income.

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TSB-A-98(8)I
Income Tax
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Section 1402(a) of the IRC defines net earnings from self-employment as:
gross income derived by an individual from any trade or business
carried on by such individual, less the deductions allowed by this
subtitle which are attributable to such trade or business, plus his
distributive share (whether or not distributed) of income or loss
described in section 702(a)(8) from any trade or business carried on
by a partnership of which he is a member; except that in computing
such gross income and deductions and such distributive share of
partnership ordinary income or loss -­
...
(2) there shall be excluded dividends on any share of stock,
and interest on any bond, debenture, note, or certificate, or other
evidence of indebtedness ... unless such dividends and interest are
received in the course of a trade or business as a dealer in stock
or securities;
(3) there shall be excluded any gain or loss —
(A) which is considered as gain or loss from the sale or
exchange of a capital asset;
...
(13) there shall be excluded the distributive share of any
item of income or loss of a limited partner, as such, other than
guaranteed payments described in section 707(c) to that partner for
services actually rendered to or on behalf of the partnership to the
extent that those payments are established to be in the nature of
remuneration for those services.
In this case, the distributive share of income that M or any of the other
M Interests receive, or are deemed to receive, from Portfolio LP (whether
directly or indirectly through Petitioner), from the Series G LLCs and Series J
LLCs (indirectly through Petitioner), and/or from Petitioner, would not be
considered net earnings from self-employment for purposes of the New York City
Earnings Tax on Nonresidents.

DATED:

NOTE:

September 4, 1998

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.