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New York state budget provides extensive tax reform

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New York Gov. Andrew Cuomo signed the final FY18-19 New York State budget legislation on April 12, 2018.1 The legislation makes significant changes to the New York state tax system in response to federal tax reform provisions contained in H.R. 1, commonly referred to as the Tax Cuts and Jobs Act (TCJA).2 The new provisions are generally effective for tax years beginning on or after Jan. 1, 2018, unless otherwise specified. This legislation, in combination with the New York state tax reform enacted in 2014, represents a significant transformation of the New York state tax system.

Corporate income tax provisions Background

The TCJA modified and added a number of provisions to the Internal Revenue Code (IRC) that impact multinational taxpayers, effectively changing the U.S. tax system from a worldwide territorial system to a quasi-territorial system. As part of this change, the TCJA created a 100% dividends received deduction (DRD) for foreign sourced dividends received from 10%-or-more owned foreign corporations.3 Under IRC Sec. 965, the transition to the quasi-worldwide territorial system subjects repatriated foreign earnings to a one-time transition tax at 15.5% or 8% depending on the type of asset.4 IRC Sec. 250 was added to provide a deduction equal to 37.5% of a domestic corporate taxpayer’s foreign derived intangible income (FDII) for tax years beginning after 2017.5 As part of the TCJA’s effort to create a more territorial regime of taxation, it added IRC Sec. 951A that creates a new class of income, Global Intangible Low-Taxed Income (GILTI), recognized by U.S. shareholders of controlled foreign corporations for tax years beginning after 2017.6

Repatriation transition tax

Under the enacted budget, New York expands its definition of “exempt CFC income” to include income that is received under IRC Sec. 965 from a corporation that is conducting a unitary business with the taxpayer, so long as it is not included in a combined report.7 The exemption amount deducted for federal income tax purposes under IRC Sec. 965(c) must be added back in computing taxable income.8 This rule applies to taxable years beginning on or after Jan. 1, 2017.9 Further, the legislation provides that this provision applies to certain New York City corporations,10 and similar provisions that serve to exclude the income received under IRC Sec. 965 apply for New York state insurance franchise tax purposes as well.11

Foreign dividend gross-up

The subtraction for deemed dividends available under IRC Sec. 78 applies to the extent the dividends are not deducted under IRC Sec. 250 for both New York state and New York City purposes.12

FDII

To compute corporate income, an addback is required for the federal 37.5% FDII deduction in both New York state and New York City, and similar provisions require an addback of the deduction for New York state insurance franchise tax purposes.13

Personal income tax provisions Statutory residency

Beginning April 12, 2018, the budget legislation officially adopts the New York State Department of Taxation and Finance’s audit policy of counting all days that an individual is present in New York to determine statutory residency, regardless of whether an individual is domiciled in the state or New York City for a portion of the taxable year.14

Alimony and moving expenses

The legislation decouples the treatment of alimony payments from the TCJA which generally results in the elimination of a deduction for alimony paid. Specifically, alimony or separate maintenance payments made are subtracted from federal adjusted gross income in computing New York taxable income.15 Qualified moving expense reimbursements or payments received or made by a taxpayer during the taxable year are subtracted from federal adjusted gross income to compute state taxable income.16

Standard and itemized deductions

The legislation restores the single filer standard deduction for both New York state and New York City purposes. Single filers may take the $7,500 standard deduction so long as they are not: (i) claimed as a dependent by another New York State taxpayer; (ii) married; (iii) head of household; or (iv) a surviving spouse.17 Further, the legislation removes the requirement to itemize deductions on the corresponding federal return in order to itemize deductions for New York purposes.18

Sales and use tax provisions The new legislation allows the Commissioner to grant relief to certain minority limited partners of a limited partnership or minority members of a limited liability company from unpaid sales or use taxes.19

Effective June 1, 2018, resale of food or beverages (including alcoholic beverages) by restaurants are exempt from sales tax.20 Additionally, effective April 12, 2018, drugs or medicine sold to veterinarians are exempt from sales tax. This new legislation streamlines the process, as in the past veterinarians were required to take a credit or request a refund on sales tax paid.21 Finally, for purposes of the definition of transportation services subject to sales and use tax, the definition of “limousine” is clarified to include any vehicle which holds between 15 and 20 persons that only has two axles and four tires.22

Other provisions Statute of limitations for amending returns

The new budget extends the statute of limitations for both the New York state and the New York City finance departments to one year after the amended return is filed on changes made to an amended return.23

State charitable contributions

The budget creates a charitable gifts trust fund, which will house two new state-operated charitable contribution funds.24 Taxpayers who make donations to these state-operated funds can claim significant state tax benefits. Donations made to the new “health charitable account” and “elementary and secondary education charitable account” can be claimed by taxpayer donors as itemized deductions on federal and state tax returns, along with a state tax credit equal to 85 percent of the donation amount for the tax year after the donation.25 The credit is available beginning January 1, 2019.26

Further, the bill authorizes the governing board of each electing city or county to establish a “charitable gifts reserve fund.”27 Donations to these funds will provide a reduction in local property taxes (via a local credit) of up to 95 percent (or less as established locally) of the donation.28

Optional employer compensation expense program (ECEP)

The legislation creates an opportunity for employers to opt into ECEP, a new program intended to offset the expected rise in employees’ tax liabilities due to the new cap on state and local tax deductibility due to TCJA.29 Beginning on Jan. 1, 2019, employers who opt into ECEP will be subject to an additional tax on annual payroll expenses in excess of $40,000 per employee. The tax will be applied at the rates of 1.5% in 2019, 3% in 2020 and 5% in 2021 and thereafter.30 The progressive personal income tax system will remain in place, but employees working for an employer with an ECEP in place will receive a tax credit on their wages “corresponding in value” to the payroll tax and are generally not expected to experience a decline in take-home pay on an annual basis.31

Employers are required to make an annual election to opt into the ECEP election by Dec. 1 of any calendar year prior to the election taking effect.32 The Department of Taxation and Finance is expected to publish additional guidance for employers wishing to participate in this program.

Congestion surcharge on for-hire vehicles

Effective Jan. 1, 2019, a surcharge is imposed on all for-hire transportation trips below 96th Street in Manhattan. The amount is broken out as follows:

  • $2.75 on for-hire vehicles;
  • $2.50 for yellow cabs; and
  • $0.75 for pooled vehicle trips.

The surcharge does not apply to services administered by or on behalf of the Metropolitan Transportation Authority (MTA). The surcharge must be passed along to the passenger and must be separately stated on the receipt. The party liable for the surcharge must apply for a certificate of registration and file returns and remit tax on a monthly basis.33

Commentary The FY18-19 Budget Bill addresses the effects of TCJA both in its dramatic actions with respect to the personal income tax system, and its treatment of deemed repatriation amounts under IRC Sec. 965. Due to the potential ripple effects of the TCJA on many aspects of New York state tax, the budget legislation went through several planning and drafting phases in the executive branch alone prior to being presented to the legislature. Governor Cuomo and the Budget Director released the budget briefing book in January.34 Following this release, the New York State Department presented a revised report to Gov. Cuomo stating that the federal $10,000 annual limitation on the state and local tax itemized deduction would cost New York taxpayers $14.3 billion annually, and proposed multiple work arounds to lower taxable income for New York taxpayers.35 The Department held discussions with taxpayers and tax professionals to solicit feedback and guidance on proposed legislative remedies, with many of these proposals becoming part of the adopted 30-day amendments.

Based on the detrimental impact of the $10,000 limitation, which Governor Cuomo labeled an “economic missile … headed our way,” it was not surprising to see New York proactively adopt several possible solutions. The creation of the ECEP is the first of its kind in the U.S., and there are many uncertainties surrounding how the ECEP will work. Specifically, it is unclear how the Department will address the ECEP through regulations, whether the IRS will endorse ECEP as effectively creating a federal tax deduction for individual employees that is not subject to the $10,000 limitation, and whether employers and employees will view the ECEP as an important differentiator in the employment marketplace worthy of employer administrative burden and/or any salary adjustments. Further, the newly created charitable contribution deductions designed to avoid the $10,000 limitation by recharacterizing tax payments as contributions are likely to be subject to IRS scrutiny.36 If such deductions are disallowed at the federal level, underpayment penalties could apply.

With respect to the treatment of IRC Sec. 965 repatriation income, C corporations now have clarification as to how such amounts can be exempt. On the other hand, individuals, including S corporation shareholders, have an inclusion event. They must recognize IRC Sec. 965 income as New York State taxable income for the year it is recognized and included in federal adjusted gross income, rather than being provided an election to pay such liability over an eight-year period or, for S corporation shareholders, being provided the ability to defer the tax liability until specified triggering events happen in the future.37 Such treatment may result in substantially higher taxable income at the New York State level than at the federal level in the year in which IRC Sec. 965 income is recognized. Further, provided that taxpayers elect to pay such liability over an extended time for federal purposes, New Yok State liability may be based on lower taxable incomes in future years. It is also important to note that the Department has released guidance explaining that due to the enactment date of the TCJA being so late in the calendar year, the Department has determined that reasonable cause exists for taxpayers to underpay their portion of liability attributable to IRC Sec. 965 repatriation income and, as such, late payment penalties related to same will be waived.38 However, interest will not be waived, including if the liability is paid on an installment basis.39 This situation illustrates the importance of entity choice, as an entity taxable as a corporation under Article 9-A, for example, in New York State receives different treatment than an individual or even an entity electing to be an S corporation under Article 22.

The New York City Department has also released instructions explaining a divergence from the TCJA regarding the treatment of IRC Sec. 965 repatriation income.40 Specifically, the guidance explains that there are no specific modifications for IRC Sec. 965 repatriation income for taxpayers subject to the general corporation tax (GCT), banking corporation tax (BTX), or unincorporated business tax (UBT).41 Therefore, this income must be classified as business income, investment income, or income from subsidiary capital and deductions must be attributed to that income.42 Similar to the New York State treatment of IRC Sec. 965 repatriation income for individuals, there is no available election to defer tax liability associated with such income for taxpayers subject to the GCT, BTX, or UBT.43 Further, the New York City Department is offering a reasonable cause abatement for underpayment penalties attributable to IRC Sec. 965 repatriation income.44 While New York City does not recognize S corporation elections, the New York City Department’s treatment of IRC Sec. 965 repatriation income is very different for taxpayers under the GCT, BTX, and UBT regimes compared to treatment under the business corporation tax (BCT).

Finally, several proposals that did not make it into the final legislation, but should continue to be monitored, include the proposed imposition of a sales tax on Internet sales; a proposed 17 percent tax on carried interest income; a proposed 14 percent tax imposed on health insurers based on net underwriting gains from New York State customers; providing the New York State Department the right to appeal adverse decisions from the New York State Tax Appeals Tribunal; and additional detail regarding the treatment of GILTI. As evidenced by the recent proposal to reenact a New York State Unincorporated Business Tax,45 NY is likely not through with making legislative changes in response to federal tax reform. In particular, the imposition of sales tax on Internet sales is a possible hot button issue (which could become even more important depending on the U.S. Supreme Court’s pending ruling in South Dakota v. Wayfair).46 It is uncertain whether a ruling in favor of South Dakota would result in the proposal of additional legislation being considered by New York. In addition, the silence on the treatment of carried interest is particularly interesting from a political standpoint, as there is a significant amount of competition between states such as Connecticut, Massachusetts, New Jersey, New York, and Pennsylvania in the Northeast alone to be the domicile of hedge funds, and certain states may be waiting to act on this issue in concert.
 

1 Ch. 59 (A9509-C/S7509-C), Laws 2018.
2 P.L. 115-97. For a discussion of this Act, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
3 IRC § 245A. Domestic corporations must hold the foreign stock for 365 days to be eligible for the DRD. IRC § 246(c)(5).
4 IRC § 965. The transition tax is imposed by using the Subpart F rules to require applicable U.S. shareholders to include their pro rata share of post-1986 earnings and profits (E&P) in income to the extent such E&P has not been previously subject to U.S. tax. The income included in federal taxable income is reduced utilizing an exclusion provision in IRC § 965(c).
5 IRC § 250. FDII is broadly defined to include income received from the sale of property for foreign use or services rendered to persons outside the U.S. While GILTI is taxed at regular rates, IRC § 250 allows a deduction of 50 percent of the amount included in income (this amount drops to 37.5% for tax years beginning after 2025). IRC § 250(a)(1)(B).
6 IRC § 951A. GILTI is the excess of the aggregated “tested income” over a routine return on certain tangible assets.
7 N.Y. TAX LAW § 208.6-a(b).
8 N.Y. TAX LAW § 208.9(b)(23).
9 N.Y. TAX LAW § 208.6-a(b).
10 N.Y.C. ADMIN. CODE § 11-652(5-a)(b). Specifically, the provision applies to corporations subject to Chapter 6 City Business Taxes, Subchapter 3-A Corporate Tax of 2015.
11 N.Y. TAX LAW § 1503(b)(1)(S), (b)(2)(B), (b)(2)(W).
12 N.Y. TAX LAW § 208.6(a); N.Y.C. ADMIN. CODE § 11-652(8)(a)(2-a).
13 N.Y. TAX LAW §§ 208.9(b)(24); 1503(b)(2)(W).
14 N.Y. TAX LAW §§ 605(b)(1)(B); 1305(a)(2); N.Y.C. ADMIN. CODE § 11-1705(b)(1)(B).
15 N.Y TAX LAW § 612(w)(1)(A); N.Y.C. ADMIN. CODE § 11-1712(u)(1)(A). Alimony or separate maintenance payments received are added to federal adjusted gross income. N.Y TAX LAW § 612(w)(1)(B); N.Y.C. ADMIN. CODE § 11-1712(u)(1)(B).
16 N.Y TAX LAW § 612(x)(1); N.Y.C. ADMIN. CODE § 11-1712(v)(1).
17 N.Y. TAX LAW § 614(a); N.Y.C. ADMIN. CODE § 11-1714(a).
18 N.Y. TAX LAW § 615(a); N.Y.C. ADMIN. CODE § 11-1715(a).
19 N.Y TAX LAW § 1133(a)(2). To qualify, the partner or member must demonstrate that there was no duty to act in complying with sales and use tax collection and remittance laws.
20 N.Y TAX LAW § 1105(d)(1).
21 N.Y TAX LAW § 1115(f).
22 N.Y TAX LAW § 1101(b)(34).
23 N.Y. TAX LAW §§ 683(c)(12); 1083(c)(12); N.Y.C. ADMIN. CODE § 11-1783(c)(9).
24 N.Y. FIN. LAW § 92-gg.
25 N.Y. FIN. LAW § 92-gg.4; N.Y. TAX LAW § 606(iii). The health charitable account will be used to fund services related to primary, preventive, and inpatient health care, dental and vision care, hunger prevention and nutritional assistance and any other services that ensure that New York state residents have access to quality health care and other related services. N.Y. FIN. LAW § 92-gg.4.a. The elementary and secondary education charitable accounts are created by electing school districts and other local governments and contributed amounts may only be used for elementary and secondary education-related expenditures. N.Y. FIN. LAW § 92-gg.4.b. The credit is also available for contributions of up to $10 million to Health Research, Inc., SUNY Impact Foundation, and CUNY Research Foundation. A9509-C/S7509-C, Laws 2018, Part LL, §§ 2, 3; N.Y. TAX LAW § 606(iii).
26 N.Y. FIN. LAW § 92-gg.
27 N.Y. TAX LAW § 2590-h.54; N.Y. MUN. LAW §§ 6-t, 6-u. The funds are for use by each associated school district for the purpose of public education.
28 N.Y. TAX LAW § 980-a(b).
29 N.Y. TAX LAW §§ 850-857 (new Article 24).
30 N.Y. TAX LAW § 852.
31 N.Y. TAX LAW §§ 606(ccc); 855.
32 N.Y. TAX LAW § 851.
33 N.Y TAX LAW § 1299.
34 Gov. Andrew M. Cuomo & Budget Dir. Robert F. Mujica, Jr., Stand United to Fight for New York, FY 2019 Executive Budget (Jan. 16, 2018).
35 New York State Dep’t of Taxation and Fin., Preliminary Report on the Federal Tax Cuts and Jobs Act, (rev’d Jan. 23, 2018).
36 IRS Notice 2018-54 informs taxpayers that Treasury and the IRS intend to propose regulations concerning the tax treatment of payments taxpayers make to receive a credit against their state and local taxes.
37 New York State Dep’t of Taxation and Fin., New York’s Treatment of IRC § 965 Repatriation Income for Individuals for Tax Year 2017, N-18-4, (April 13, 2018).
38 Id.
39 Id.
40 New York City Dep’t of Fin., Deemed Repatriation Income under the General Corporation Tax, the Banking Corporation Tax, and the Unincorporated Business Tax, Finance Memorandum 18-4, (April 20, 2018).
41 Id.
42 Id.
43 Id.
44 Id.
45 The New York Department of Revenue has issued a discussion draft of this legislation, for which input is requested by July 16, 2018.
46 Docket No. 17-494, oral argument heard on April 17, 2018.




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