San Francisco’s Proposition Q and its Impact on Hedge Fund Managers

Proposition Q Passes in a Landslide

On November 4, 2008, San Francisco voters approved Proposition Q modifying the city’s Payroll Expense Tax by a resounding 74% of the vote. This little noticed proposition, which went into effect on January 1, 2009, will impact many hedge fund managers and other businesses in San Francisco.

San Francisco’s Payroll Expense Tax

Companies with one or more employees within the City and County of San Francisco and a payroll greater than $250,000 are required to pay a Payroll Expense Tax to the city equal to 1.5 percent of their taxable payroll. In 2007, the Payroll Tax generated over $350 million in revenues for San Francisco. Prior to Proposition Q, the law was unclear about whether compensation for services related to “pass through” entities such as partnerships and limited liability companies was considered “compensation paid to employees” and therefore subject to the Payroll Expense Tax. In reality, for most hedge fund managers in San Francisco, this meant that the distributions made to owners of the company or partnership were not subject to the tax.

Effect of Proposition Q

Proposition Q clarified that such distributions for payments to partners/owners for work done in San Francisco must be included in the calculation of the Payroll Expense Tax. For example, if a hedge fund manager earns $5 million per year, pays $250,000 in salaries to its employees, and distributes $4 million in profits to its partners or owners, prior to Proposition Q only the $250,000 paid to the employees was definitely subject to the Payroll Expense Tax. Beginning in 2009, however, the entire $4 million paid to the partners or owners, will also be subject to the Payroll Expense Tax.

Lack of Guidance and Recommendations

Proposition Q garnered scant attention in the news media, and will no doubt catch many hedge fund managers by surprise this year. The website of the San Francisco Office of the Treasurer and Tax Collector provides almost no information for business owners about the proposition. We advise that hedge fund managers keep Proposition Q and the Payroll Expense Tax in mind when making employment and compensation decisions. In particular, managers should keep in mind the safe harbor provision when determining the owner’s own W2 compensation, as well as the compensation of the top 25% of employees. Managers should also consult with their tax advisors to anticipate the impact of Proposition Q on their 2009 Payroll Expense Taxes, and determine whether they need to adjust their pre-payments of those taxes.

To find out more about Proposition Q and other topics relating to compensation and employment law issues for hedge fund managers, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP (www.colefrieman.com) at 415-352-2300.

****

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and can be reached directly at 415-868-5345.