Back Door Man: New York City UBT Audit Play Is Subterfuge for Carried Interest Tax

In our view, a NYC Department of Finance approach that seeks to deny management company expenses is ill-conceived. Private capital and financial talent are mobile. Private funds do not have to operate from New York City. Ande while the NYC UBT is partially creditable for individuals subject to NYC income tax, the NYC UBT is a tax that does not have a corollary in other states. A local tax enforcement strategy that indirectly reaches for carried-interest economics may raise revenue in particular audits, but it also risks telling one of New York City’s defining industries that future capital, personnel and growth should look for a more predictable home.

UBT Background
New York City’s UBT generally applies to unincorporated businesses carried on wholly or partly in the City. The tax is imposed at a 4% rate on unincorporated business taxable income.^[i]Unincorporated businesses may include trades, professions and certain occupations conducted by individuals, partnerships, limited liability companies, fiduciaries, estates and trusts.^[ii]Most private structures navigate the UBT by creating a “management company” and a “carry company.” The management company earns fees for providing investment management and investment advisory services. That income generally sits inside the UBT regime. The carry company, by contrast, typically receives a share of investment profits and often relies on the UBT exception for trading for one’s own account.

That exception matters. Under the NYC Administrative Code, an individual or unincorporated entity, other than a dealer, generally is not treated as engaged in an unincorporated business solely by reason of purchasing, holding or selling property for its own account.^[iii]The New York City Comptroller’s Office has described the practical consequence for private equity and hedge funds directly, noting that those funds are typically subject to UBT on management fees but not on carried interest.^[iv]That distinction is the planning architecture. Management fees are service income; carry is structured as a share of investment profits.

Sneaking Through the Alley
The City’s reported audit focus does not appear to be a direct assertion that carried interest itself is subject to UBT. The more indirect theory is expense allocation. UBT deductions generally begin with items of loss and deduction that are allowable for federal income tax purposes and are directly connected with, or incurred in, the conduct of the unincorporated business, subject to UBT-specific modifications.^[v]The reported audit question is whether some expenses deducted by the management company are properly allocable to the carry company.

If salaries, rent and other overhead are properly connected to the management company’s services business, they reduce the management company’s UBT base. But under the reported position, if some portion of those expenses are viewed as supporting the carry company, the City would assert that those expenses should not fully reduce the taxable management company’s income. Other shared costs, such as research or technology expenses, may raise similar allocation questions depending on the facts. That is the back door. Under the reported theory, the carry remains outside the tax base, but deductions connected with producing or supporting that carry are moved away from the management company. The result is more UBT without formally taxing the carry company.

Why Documentation Matters
Fund structures often look clean on paper. Fund documentation requires the management company to bear a list of well-defined costs in exchange for being paid the management fee. The harder question is whether the facts follow the documents. Payroll records, partner functions, rent allocations, research expenses, technology charges and intercompany agreements will tell the City who actually incurred the expenses. If the same people, offices, systems and research support both management-fee activity and carried-interest economics, the allocation to the management company method needs to be defensible.

Planning Implications
Fund managers with New York City exposure may want to shore up their expense allocations to match their operating facts, especially for open years or matters already in audit or conciliation. The most important records may include management agreements, general partner agreements, expense-sharing arrangements, payroll records, time or function records, rent and office-use allocations, research and technology charges and documentation supporting any remote-work sourcing positions. The goal is not merely to show that the structure exists. The goal is to show that the deductions claimed by the UBT taxpayer were actually connected with that taxpayer’s business.

Concluding Thoughts
The renewed UBT focus is best understood as a fight over the line between services and investment activity. Management fees sit on one side. Carried interest often sits on the other. No one wants to come home to find that they’ve left the back door open to mischief. Keeping your house in order to keep the tax man at bay is at least as important as keeping the hidden lover away.

(The author thanks Tian Liu for his valuable assistance in the preparation of this white paper.)

^{[i] N.Y.C. Admin. Code § 11-503(a).}

^{[ii] N.Y.C. Admin. Code § 11-502(a); NYC Department of Finance, Unincorporated Business Tax guidance.}

^{[iii] N.Y.C. Admin. Code § 11-502(c)(2).}

^{[iv] NYC Comptroller, Recent Trends in the City’s Business Income Taxes (Feb. 2025).}

^{[v] N.Y.C. Admin. Code § 11-507(a).}