Iowa to hedge fund industry: go away.

When most people think "Iowa," they think "corn and beans."  They don't think "financial services."  That's a mistake.  Our financial services economy dwarfs our ag economy:

Source: Federal Reserve Bank of Chicago.  Full chart here.

Sadly, the Iowa Department of Revenue hasn't gotten the memo.  An obscure tax policy decision at the Department guarantees that a big part of the financial services industry will stay away from Iowa.

In the last 20 years the financial service industry has embraced investment partnerships (often in the form of Limited Liability Companies) for private equity investments and for private investment pools.  A hedge fund is one brand of investment partnership.  The fund doesn't pay its own taxes; the income passes through to the tax returns of its owners.  Hedge fund income is typically interest, dividends and capital gain.  Very few states try to tax non-resident partners on investment income - so-called "non-business income" -- from partnerships with in-state headquarters.  Unfortunately, Iowa is one of them.

The Iowa Department of Revenue takes the position that investment income of non-resident partners of Iowa investment partnerships is fully taxable in Iowa as "business" income. That means a Florida investor in an Iowa investment partnership is expected to pay Iowa tax of up to 8.98 percent on dividends, interest and capital gains earned through an Iowa partnership - income that would be free of state income taxes if he earned the money directly.

There is nothing in Iowa's tax law that requires the department to take this view.  Iowa's statute that distinguishes "business" and "non-business" income is virtually identical to the New York statute, and New York doesn't try to tax non-resident partners on income earned from New York partnerships.  Not coincidentally, New York has a dynamic financial services industry that includes world-class private equity and hedge funds.  Until the Department of Revenue or the legislature make some changes, Iowa never will.

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[Hedge Fund Search Digest]

This post detailing the responsibilities of a hedge fund tax manager (in neither Iowa nor NY but Texas, which is home to some energy funds) may be of interest:
http://hedgefundblog.jobsearchdigest.com/146/tax-manager-hedge-fund-job-in-dallas-fort-worth/
For instance, it appears that this fund is actually set up in NY, supporting the point made in the post above.