SALT Strategies

New York State Budget Tax Provisions’ Response to Federal Tax Cuts and Jobs Act

On April 12th Governor Cuomo signed the 2018-2019 Fiscal Year budget (Budget). The Budget contains numerous provisions that address the New York tax ramifications arising from the Tax Cuts and Jobs Act (TCJA) passed by the United States Congress late last year. The Budget’s tax provisions pose significant complexities as well as potential pitfalls for New York taxpayers. The Budget’s tax provisions will affect New York corporate as well as individual taxpayers.

It should be noted that New York adopts the Internal Revenue Code {“IRC”} on a “rolling conformity” basis. Therefore, unless the State explicitly “de-couples” from or modifies a provision of the TCJA, the State’s tax treatment will follow the Federal with respect to a TCJA provision.

The following highlights the significant tax provisions contained in the Budget as well as the Budget’s attempt at mitigating some of the TCJA’s provisions that may negatively affect New York individual taxpayers.

1. Corporate Taxpayers With Subpart F Income (Part KK)

The Budget addresses those New York corporate taxpayers with mandatory Repatriation Transition Tax, Foreign Derived Intangible Income or Global Intangible Low-Taxed Income arising from the provisions of TCJA.

Repatriation Transition Tax (RTT)

One of the most significant provisions of the TCJA is the imposition of a one-time “Transition Tax” under IRC § 965 on the deferred foreign earnings of specific foreign corporations (SFC). This is a one-time tax applicable to the last tax year beginning before January 1, 2018. The accumulated deferred foreign earnings of the SFC increase Subpart F income (965(a)) and are also allowed a deduction under IRC § 965(c). The US shareholders of the SFC pick up their share of 965(a) income and 965(c) deductions.

The Budget modifies the New York corporate tax provision’s definition of “Exempt CFC Income” to include the income subject to the TCJA’s RTT. It is noteworthy that the NYS Budget only addressed the RTT as applicable to a Corporate U.S. shareholder. Other NYS guidance is available on the NY treatment of the RTT for non-corporate US shareholders (Please see 2. Individuals with Section 965 Income below).

However, the Budget did not provide for a modification of the calculation of the interest expense attribution provisions related to “Exempt CFC income” or the annual taxpayer “safe harbor” election to reduce total exempt income by 40% in lieu of the interest expense attribution reduction to “Exempt CFC income” under NY Law. (Please see New York State CONSOLIDATED LAWS, CHAPTER 60 TAX LAW, Article 9-A Franchise Tax on Business Corporations Section 208.6-a.(b) and TSB-M-15(8)(c)). Therefore any interest expense attributable to this income must be added back.

Additionally, the Budget provides relief from underpayment of estimated taxes that may arise from the interest expense attribution related to the RTT. This relief applies to taxable years beginning on or after January 1, 2017 and before January 1, 2018.

Foreign Derived Intangible Income (FDII)

The TCJA provides a new special deduction in IRC § 250 for certain foreign-derived intangible income {“FDII”} earned by a US “C” corporation. The deduction is equal to 37.5% of the US corporation’s FDII. FDII is generally defined as income derived from the sales or license of property to foreign persons for foreign use, as well as income from services performed for any person not located within the U.S. To be eligible for the federal deduction, FDII must be in excess of a fixed return on tangible assets of the US corporation.

The Budget specifically requires corporate taxpayers to addback the federal FDII deduction permitted under IRC Section 250(a)(1)(A) in the computation of their New York taxable business income. Please see New York State CONSOLIDATED LAWS, CHAPTER 60 TAX LAW, Article 9-A Franchise Tax on Business Corporations Section 208.9(b)(24).

Global Intangible Low-Taxed Income (GILTI)

The TCJA created new IRC § 951A, that results in the taxation of a US shareholder on its income from controlled foreign corporations (CFCs), to the extent this income is in excess of a fixed return on the tangible assets of such CFCs.

As the TCJA provides that the income is subject to tax at regular rates, under new IRC § 250, a corporation is allowed a deduction for 50% of the amount included in income under GILTI provisions plus any deemed dividends under Section 78 to the extent such amount is attributable to GILTI, subject to specific limitations.

The Budget does not address GILTI. As a result of the Budget not specifically addressing the GILTI, both GILTI and the 50% GILTI deduction under IRC § 250 are included in the computation of New York taxable income. The Budget did amend the subtraction modification related to IRC § 78 gross ups to limit the subtraction modification to dividends that were not included in the IRC § 250 deduction.

2. Individuals with Section 965 Repatriation Income

For Federal tax purposes New York individual taxpayers may also have mandatory deemed repatriation income under IRC Sec. 965 of the TCJA. To date, the State has provided limited guidance with respect to the New York State ramifications with respect to such income. The most specific guidance is set forth in Important Notice N-18-4 that was issued in mid-April.

The Notice explicitly sets forth that for NYS personal income tax purposes the net IRC Sec. 965 amount that is required to be included in federal adjusted gross income (FAGI) must be included in New York taxable income. The Notice states that there is no New York exemption or deduction for this income for individuals (including S corporation shareholders).

Therefore, unlike the Budget’s partial consistency with the TCJA’S favorable treatment that affords corporations some relief under the Budget’s corporate tax provisions, for individuals the Budget does not provide any relief to New York individual taxpayers with respect to RTT or GILTI included in their Federal Adjusted Gross Income.

Equally important, the Notice states “Unlike the federal law, which allows taxpayers to elect to pay the tax liability from the IRC Sec. 965 amount over 8 years or, in the case of S corporation shareholders, defer the tax liability until specified triggering events happen in the future.”

New York individual taxpayers must pay the additional New York tax generated by the Sec. 965 amount in the tax year it is recognized and included in FAGI.

In an apparent attempt to mitigate the onerous effect arising from the potential significant increase, the Notice provides that If the taxpayer receives a bill for the underpaid tax that includes a late payment penalty, the taxpayer may request a waiver of the late payment penalty and must supply the Department with a copy of the IRC 965 Transition Tax Statement as part of its request.

The aforementioned Budget provision and Important Notice N-18-4 are effective for tax years beginning on or after January 1, 2017.

3. Budget’s Answer to The TCJA’s Limitation on SALT Itemized Deduction

The Budget also contains several provisions that attempt to assist New York individual taxpayers, and their employers, who seek to mitigate the effect of the TCJA’s $10,000 limitation on the state and local tax itemized deduction.

In an attempt to mitigate the TCJA’s $10,000 limitation on the SALT itemized deduction, the Budget adopted an optional ECET for employers. The ECET provides for a new optional tax on specific payroll expense paid by those employers that elect to be subject to the ECET on “covered employees” during the calendar quarter at the rate of 1.5% in 2019, 3% in 2020, and 5% in 2021 and thereafter. Key aspects of the ECET are:

Employer Compensation Expense Tax {“ECET”} (Part MM)
  • ECET applies only to the payroll during the calendar year in excess of $40,000.
  • Employers are prohibited from deducting from an employee’s wages or compensation any amount that represents the ECET tax.
  • ECET payments are due at the same time as withholding payments are remitted.
  • The ECET election must be made by December 1 of the year prior to the year for which the employer wishes the election to be effective. Elections made after December 1 would take effect in the second succeeding calendar year.
  • An electing employer is only subject to the payroll tax on the payroll expense paid to any covered employee during the calendar year that is in excess of $40,000.
  • A “covered employee” is an employee who must have amounts withheld under NY Tax Law Section 671 and receives annual wages from his or her employer in excess of $40,000.

On the personal income tax side, the ECET provides a personal income tax credit for a “covered employee.” The first year that an employer may elect the ECET is 2019. An employer wishing to effect the ECET for 2019 must make the annual election by December 1, 2018.

Charitable Gifts Trust Fund (Part LL)

In addition, the Budget adopted provisions that call for the creation of the Charitable Gifts Trust Fund {“Fund”} to give individual taxpayers tax credits against their New York State personal income tax for 85% of the contributions to the Fund made in the preceding year. The credit for contributions is first available on the 2019 return. However, in order to receive the credit in 2019 the charitable contribution to the Fund must be made in 2018.

As contributions to the Budget’s newly created Charitable Gifts Trust Funds are in theory charitable contributions that may also be federal itemized deductions, such “gifts” in theory are not subject to the TCJA $10,000 limitation.

For tax years beginning on or after January 1, 2019, individuals may claim a credit against their personal income for an amount equal to 85% of the sum of the amounts contributed by the individual in the preceding taxable year, i.e. in 2018, to any or all of the specific accounts within the Fund as set forth in §4 of Part LL of the Budget. The Budget also provides for localities to create similar funds to accept contributions that will generate corresponding credits against individual real property tax liabilities.

To date, the State has provided scarce additional administrative guidance as to how individual taxpayers may effect such charitable contributions. Over the next several months, this area will require additional monitoring with respect to the specific administrative procedures to effect such contributions.

Federal Response To The Budget’s ECET and Charitable Gifts Trust Fund

To date, the Treasury has not issued guidance or formally responded with respect to either of the aforementioned Budget provisions. As the Budget’s objective is to convert state and local tax itemized deductions to either employer deductible payroll taxes or to a charitable contribution to avoid the TCJA $10,000 limitation, Treasury may act imminently and decisively to thwart the attempt by these Budget provisions to circumvent the TCJA’s $10,000 limitation on SALT itemized deductions.

Decoupling From TCJA Standard Deduction Requirement

The Budget adopted another modification in its attempt to mitigate the TCJA’s $10,000 limitation on SALT itemized deductions. Prior to the Budget, state residents were permitted to itemize deductions to determine their New York State Personal Income Tax only if they also itemized deductions on their federal return. The Budget decouples from the IRC to permit itemized deductions for New York State and City personal income tax purposes even if the taxpayer takes the standard deduction to determine Federal Adjusted Gross Income.

4. Non-TCJA Budget Tax Provisions

Statutory Residency “More Than 183 Day” Test Clarification

The Budget codifies the Department of Taxation and Finance’s {“DTF”} previous policy that counted days an individual is present in the State for the entire year, including the domicile period, in determining whether the “More Than 183 Day” test is satisfied. This provision will become effective beginning January 1, 2019.

Statute of Limitations-Assessments Re: Amended Returns (Part H)

Prior to the Budget modification, the State generally had three years from the original filing date of the original tax return to audit and assess additional tax. An amended return did not extend the statute of limitations except with respect to determining reductions or offsets to refunds or credits claimed on the amended returns. As a result of the Budget, except as otherwise provided by New York Tax Law and the New York City Administrative Code, now if a taxpayer files an amended return, the State may assess additional tax including recovery of a previously paid refund, which is attributable to a change or correction on the amended return, within one year. This is also applicable to amended New York City Personal Income Tax returns. This provision is effective immediately and applies to all amended returns filed on or after the effective date.

Responsible Person Sales Tax Relief for Minority LLC Owners (Part X)

Responsible persons of a business are jointly and severally liable, with the business entity or any other responsible person of the business, for sales tax liabilities owed to the State. Prior to the Budget becoming law all LLC members and partners in a partnership were considered responsible persons. The Budget provides certain members of an LLC and limited partners in a limited partnership are liable only for their pro-rata share of the business’s original liability, if such parties can demonstrate that: (i) they were not under a duty to act for the LLC or limited partnership in complying with the requirements of the sales tax; and (ii) their ownership interest and the percentage of their distributive share of the profits and losses of the LLC or limited partnership are each less than 50%. This provision is effective immediately.

The Budget’s “Bottom Line”

So what is the Budget’s Bottom Line? In a word, “WARNING”!!! The Governor’s enacted Budget contains numerous significant complexities as well as pitfalls for New York taxpayers that will require close monitoring over the next several months. This WARNING is especially applicable to New York individual taxpayers that will have Subpart F repatriation income under TCJA!

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