The Federal Opportunity Zone Program (26 USC Sec. 1400Z ff., The “OZ program”) Controls tax breaks to encourage private investment in economically disadvantaged areas. More than 8,700 census areas in all states, Washington, DC and five US territories have been designated as opportunity zones. Proponents hoped that investing in these communities would fuel economic development and job creation in needy communities. Many states and municipalities, including New York City and New York State, have adjusted their tax codes to reflect the incentives provided as part of the OZ program.
However, critics have noted that some projects have failed to deliver the social benefits promised by the OZ program. New York lawmakers have eliminated some of the benefits of the OZ program for New York residents and some non-residents with profits from New York real estate. This blog post provides a brief overview of the benefits of the OZ program and how those benefits have been incorporated into New York Tax Law. It then describes how new laws remove some of these benefits for New York and New York City state taxes while retaining others.
Tax benefits of the OZ program
By and large, the OZ program offers three benefits to taxpayers who invest qualified profits in an opportunity zone and hold their investment for at least ten years. First, under 26 USC Secs. 1400Z-2 (a) and (b) (1), the recognition of qualifying winnings is postponed until December 31, 2026 (the “Deferral advantage”). Second, under 26 USC Secs. 1400Z-2 (a) and (b) (2) (B), from this year the taxable profit is reduced by 10% (the “Reduction advantage”). No reduction benefits are available for investments made after 2021.
Finally, a gain from investments in opportunity zones that have been held for at least ten years is completely tax excluded from gross income due to 26 USC Secs. 1400Z-2 (a) and (c) (the “Exclusion advantage”). In order to be able to use the OZ program, investments are generally made in qualified opportunity zone funds (“QOFs”) Established as corporations or partnerships to enable taxpayers to take advantage of the OZ program by investing in opportunity zones and following certain rules.
For example, if a person sold stocks in 2021 that were held for at least a year and made $ 1 million in profits, those profits were typically taxable. If instead the individual invested their profits in a QOF in 2021, did not sell the investment for at least ten years, and then sold the investment in 2031 for an additional profit of $ 3 million, the individual would (i) receive recognition of their 1st Deferred $ million capital gains through December 31, 2026 through application of deferred benefit; (ii) pay tax down to just $ 900,000 (ie, $ 1 million, 10% off) due to the discount benefit; and (iii) pay no tax on the subsequent $ 3 million gain due to the Foreclosure Benefit.
New York Compliance
In the past, New York automatically tracked changes in federal tax law by using the federal adjusted gross income as the starting point for determining New York taxable income for personal income tax purposes and federal taxable income for determining the franchise’s income base in New York used. This “ongoing compliance” typically makes filing applications easier for New York taxpayers and therefore enables New York taxpayers to make favorable changes to their federal and New York taxes immediately. As a result, before the new law is passed, New York taxpayers could get the same benefits of deferment, reduction and exclusion for tax purposes in New York, as state income would be deferred, cut or excluded by the same amount under federal law.
However, New York may choose to deviate from its ongoing compliance policy by selectively “decoupling” from federal tax regulations. Such decoupling changes the way federal rules apply to taxes levied by New York. The New York State Assembly, through its power to amend the New York Administrative Act, can decouple income definitions at both the state and city levels.
Decoupling according to new legislation
New York’s budget for fiscal year 2022 (the “budget”), Which was incorporated into law on April 19, decouples part of the OZ program for the purposes of New York State and New York City taxpayers. This decoupling was achieved by defining certain key provisions of the New York State Tax Law (“NYSTL”) And the New York City Administrative Code (the“NYCAC”).
In Sections 208 (9), 612 and 1503 of the NYSTL, “total net income” and “adjusted gross New York income” are defined as generally equivalent to total taxable income and adjusted gross income, respectively, as calculated under federal law, in accordance with New York’s general rolling compliance policy. Equivalent provisions can be found in NYCAC sections 11-602, 11-652, and 11-1712. However, each of these sections also provides for further adjustments in New York State or New York City, which can decouple New York State and / or New York City from federal tax law in certain areas.
The budget will amend each of these sections of the NYSTL and NYCAC so that (1) any amounts accrued or reduced with the deferment or reduction benefit for New York corporate tax purposes will be added to total net income, adjusted gross income, all income who would otherwise have qualified for New York State and New York City Personal Income Tax for the deferral or reduction benefit, and (3) require the inclusion of amounts accrued with the deferral benefit or reduced with the benefit in the calculation of all net income for corporate income tax purposes in New York City. Finally, the budget clarifies that these changes will apply to tax years beginning on or after January 1, 2021.
The budget changes to the NYSTL and NYCAC effectively decouple New York and New York City state tax policies from federal tax policies, at least in terms of deferral and reducible benefit. In the future, a resident of New York State and / or New York City cannot defer payment of New York State and / or New York City taxes on capital gains through the OZ program even if those funds are invested in a QOF in accordance with federal law. Nor would such a resident be able to use the OZ program to lower taxes on capital gains owed to New York State or New York City.
It should also be noted that these rules may apply even to non-residents of New York State or New York City. If the source of the profits a non-resident sought to invest under the OZ program came from the sale of real estate or property, plant and equipment in New York or from doing business in New York. The changes made by the budget are far-reaching in scope and application, and non-residents of New York State or New York City should also be aware of them.
Even so, residents of New York State or New York City also retain some key benefits of the OZ program. First, the exclusion benefit from the budget is not changed. This means that a New York State or New York City resident who invests Qualifying Profits in a QOF will hold the investment in the QOF for a minimum of ten years and follow any other applicable rules he may continue to apply for the purposes of his future Income may exclude New York State and / or New York City taxes, the capital gains from the sale of its stake in the QOF. The exclusion advantage is arguably the most important advantage for investors who use the OZ program, as investments in opportunity zones naturally offer the possibility of high returns on exit and these returns would be completely tax-free at the federal, state and local level. Second, New York City residents, who would lose the most from the budget changes, also continue to benefit from the deferment and reduction benefits on their federal taxes.
Because a taxpayer’s federal tax burden is often much greater than the state or local tax burden, this means that most of the benefits of the OZ program will still be available to New York State or New York City residents. However, these taxpayers should be aware that the budget decoupling is likely to add complexity to their tax returns, and should work with their tax advisors to ensure that city, state, and state regulations are properly followed. However, if Congress passes the tax increases proposed by President Biden, which, among other things, drastically increase tax rates on capital gains and eliminate the increase in the post-death base, the tax benefits of the OZ program could be much more attractive even after the changes discussed in this post.