Last week, we reviewed some of the tax measures discussed by Governor Cuomo in his report on the State of the State, and how they may affect New York businesses and their owners.[i] Today, we’ll take a look at just a few of the “revenue provisions” included in Mr. Cuomo’s proposed Executive Budget for the Fiscal Year 2022, as released on January 19.
It’s important to bear in mind that the State’s fiscal year begins in just over two months, on April 1, 2021. Now that the Governor has submitted his budget to the Legislature for its approval – along with the related appropriation and revenue bills – the Senate Finance and the Assembly Ways and Means committees will analyze the Governor’s proposals and estimates. After each chamber has completed its review of the budget, a conference committee process will be used to organize the issues identified by each chamber. These will be deliberated, they may be amended and, ultimately, the Legislature will reach an agreement on the budget.
Any changes that the Legislature makes to the Governor’s proposals will be sent to him for approval. The Governor has line item veto authority to reject specific items, though his veto may be overridden by a vote of two-thirds of the members of each chamber – following the 2020 elections, the Democrats (the Governor’s own Party) have a veto-proof supermajority in each chamber.
The foregoing process takes time, but it must be completed before April 1, 2021. In the meantime, New York – like so many other States – continues to wait on the Federal government to deliver funding to help offset the revenue losses from the economic disruption caused by the coronavirus pandemic.
It seems very unlikely, however, that Congress will act quickly enough to relieve the pressure on New York’s fiscal situation. Indeed, last week a number of moderate Republican Senators indicated that it was too soon to consider President Biden’s proposed $1.9 trillion economic stimulus plan, and the financial support it promises to deliver to state and local governments. The Senators did not disagree with the proposition that more financial stimulus will be needed, but they reasoned that Congress enacted a $900 billion relief package only last month, and it should be given time to work before additional fiscal measures are taken.
I imagine that, at some not-too-distant time – perhaps in March[ii] – President Biden and the Democrats will abandon their plan for a bipartisan relief bill, and will instead use the reconciliation process to fast-track economic stimulus and tax increases through Congress.[iii] Indeed, last week, “Treasury Secretary-designate Janet Yellen said she would work with lawmakers to fast-track a series of tax increases on . . . wealthy Americans.”[iv]
The flurry of Executive Orders during Mr. Biden’s first few days in office presages this outcome.[v] The President is pushing his Party’s agenda (and those of its various constituents) on many different fronts. The use of Executive Orders allows him to unilaterally move a number of items. In the end, however, he will need Congress – the power of the purse – including the Senate, to support him. If he cannot achieve a bipartisan consensus on certain items, or if he is frustrated by the prospect of the filibuster, he will turn to the reconciliation process sooner rather than later. Congressional elections will be held in less than two years – the Democrats have some momentum now, and will have to demonstrate that they’ve made progress.
Certainly, New York has not been caught off guard by the foregoing developments – the State had to be prepared to act in the event Mr. Trump were reelected, or in the event the Republicans retained control of the Senate.
In fact, like any “fiscally responsible state,”[vi] New York has taken certain measures to staunch the bleeding, if you will.
For example, New York has chosen to decouple from the more relaxed rules provided under the CARES Act[vii] for the use of NOLs with respect to certain taxable years[viii]; thus, in determining their New York income tax liability for those years, taxpayers must re-compute their Federal NOL deduction using the more restrictive rules that were in place prior to the CARES Act.[ix]
At the same time, however, New York has decided to conform to the Federal treatment of PPP loans. Specifically, if a forgiven loan is excluded from Federal adjusted gross income, it will also be excluded from New York adjusted gross income.
What’s more, New York has also chosen to follow the Federal treatment of business expenses that were paid or incurred with the proceeds from a forgiven PPP loan; if these expenses are deducted in computing Federal adjusted gross income, the same deductions will automatically be allowed in determining New York adjusted gross income.
In other words, New York has chosen to disregard certain business-friendly Federal tax changes made in response to the pandemic, by which it hopes to retain tax revenues by avoiding the payment of refunds, and it has chosen to adopt other business-friendly Federal measures,[x] by which it will lose tax revenues.
So where does that leave New York?
According to the State’s Budget Director, Robert Mujica, as set forth in the FY 2022 Executive Budget Briefing Book:
“The State has no choice. Unlike the Federal government we cannot print money and must balance our budget. Every spending decision is zero sum: Any area where we don’t reduce spending means deeper reductions in another. If $15 billion in Federal funding materializes, the tax increases that will make New York less competitive and the spending reductions that hurt New Yorkers go away. If they fail to act, the State’s ability to meet even the most basic funding needs will be cut for universities and affordable college programs, childcare, combatting homelessness, and much more.”
The Governor’s $193 billion[xi] budget plan for fiscal 2022 addresses, to some degree, the need for more revenues, while also acknowledging certain political realities, as described below.
For months, the Legislature, as well as many members of New York’s Congressional delegation,[xii] have been calling for a mark-to-market-based wealth tax.[xiii] The Governor has prudently chosen, instead, to offer a toned-down version of an earlier Senate bill.[xiv]
The proposed budget would impose an income tax surcharge on certain high-income individuals, and would only apply for the 2021, 2022 and 2023 taxable years. The addition of the “temporary” surcharge would effectively increase New York’s highest marginal income tax rate for individuals, which is currently set at 8.82 percent, and which applies to single individuals with taxable income in excess of just over $1 million for 2020.[xv] Specifically, the budget calls for five new rate brackets, based upon taxable income, to which varying surcharge tax rates would be applied. In the case of a taxpayer with taxable income of:
- More than $5 million but not more than $10 million, the income tax surcharge would be 0.50%;
- More than $10 million but not more than $25 million, the surcharge would be 1.0%;
- More than $25 million but not more than $50 million, the surcharge would be 1.50%;
- More than $50 million but not more than $100 million, the surcharge would be 1.75%;
- More than $100 million, the surcharge would be 2.0%.
Yes, these brackets represent significant amounts of income. How many New Yorkers would actually be subject to this surcharge? In New York City,[xvi] over 30,000 residents reported earning $1 million or more in 2018; of these, 2,626 residents reported income of between $5 million and $10 million, and 1,786 (representing 0.05 percent of all filers) reported income in excess of $10 million.[xvii] What if we looked state-wide? New York taxpayers with taxable income of $1 million or more accounted for just 1 percent of all filers in tax year 2016, but they accounted for 37 percent of the total personal income tax liability.[xviii]
Query how many of these taxpayers attributed their multi-million dollar incomes to a one-time event, such as the sale of a business? The addition of the surcharge should certainly be considered by a target company’s owners in determining whether a prospective buyer’s offering price is sufficient; remember, New York does not tax long-term capital gain at a preferred rate relative to ordinary income.
In an interesting twist, the budget also provides that a taxpayer to whom the surcharge will apply may voluntarily prepay their tax year 2022 and tax year 2023 surcharge liability through their tax year 2021 estimated tax payments. If a taxpayer chooses this option, they will receive a “repayment” via tax deductions in tax years 2024 and 2025.
According to the Budget Briefing Book, the temporary surcharge is “an innovative way to address the State’s short-term fiscal challenges while minimizing the impact on taxpayers over the long-term and to help maintain New York’s ability to compete.”
It is worth noting, however, that the 8.82 percent tax rate was enacted in 2009 as a temporary, three-year, surcharge (i.e., an increase) in response to the fiscal crisis brought on by the Great Recession.[xix] Before then, New York’s top rate was 6.85% for individuals with taxable income in excess of $215,400. Since that time, the “temporary” tax surcharge has been extended several times; it is now scheduled to run through 2024.
Would I be surprised if the budget’s proposed “temporary” surcharge follows this pattern?[xx] Not at all – in fact, I expect the tax will be extended (and re-extended), especially if it does not have the adverse effect of prompting taxpayers to leave New York.
SALT Cap Workaround
You may recall that then-candidate Biden promised to restore the itemized deduction for (i) state and local real property taxes; (ii) state and local personal property taxes; and (iii) state and local income taxes.
Prior to the enactment of the TCJA, individual taxpayers were permitted a deduction for these taxes, whether or not incurred in a taxpayer’s trade or business or activity for the production of income.[xxi] Property taxes were allowed as a deduction in computing adjusted gross income if incurred in connection with property used in a trade or business; otherwise they were an itemized deduction. In the case of state and local income taxes, the deduction was an itemized deduction notwithstanding that the tax may be imposed on profits from a trade or business.
Under the TCJA – for taxable years beginning after December 31, 2017, and beginning before January 1, 2026[xxii] – in the case of an individual, the itemized deduction for the aggregate of (i) state and local property taxes not paid or accrued in carrying on a trade or business, or in conducting an activity for the production of income,[xxiii] and (ii) state and local income taxes (or sales taxes in lieu of income taxes) paid or accrued in the taxable year, is limited to $10,000 ($5,000 for a married taxpayer filing a separate return).[xxiv]
You may also recall that, shortly after the enactment of the SALT cap, many high-tax states sought to overturn or somehow circumvent the limitation. These early efforts were not successful but, in November of 2020, the IRS approved of an arrangement under which a state would impose a mandatory or elective entity-level income tax on partnerships and S corporations that do business in the state, or that have income derived from sources within the state. According to the IRS, this entity-level income tax would be deductible by partnerships and S corporations in computing their non-separately stated income or loss; in this way, the entity’s tax payment would be reflected in an individual partner’s or shareholder’s distributive or pro-rata share of non-separately stated income or loss reported on a Schedule K-1. This indirect owner-level tax benefit would not be taken into account, the IRS indicated, in applying the SALT deduction limitation to the individual partner or shareholder.[xxv]
Of course, this workaround is limited – it only applies to partners in a partnership and to shareholders of an S corporation. It does nothing, for example, to reduce the impact of the cap on higher-paid employees who live or work in high tax states, including New York.
Campaign promises aside, many observers believe that the elimination or increase of the SALT cap may be difficult to achieve outside the reconciliation process. Moreover, it may not be politically wise to even try to keep that promise, as demonstrated by Treasury Secretary-designate Janet Yellen last week, when she “dodged the question of whether a repeal of the cap on state and local tax deductions, as proposed by Biden, would deliver a big tax cut to wealthy Americans while doing next to nothing for those in the bottom half of income distribution.”[xxvi]
Governor Cuomo must have anticipated these risks and, so, the budget introduces an elective “pass-through entity tax” similar to the workaround approved by the IRS, described above. The tax will be available only to partnerships and S corporations, all the owners of which are individuals. The tax will be imposed at the rate of 6.85 percent[xxvii] upon the adjusted net income of an electing pass-through entity that is doing business in New York, to the extent such income is allocable to New York. The pass-through entity’s partners or shareholders will be entitled to a credit against their New York personal income tax liability based upon their profit percentage of the partnership or their pro rata share of the S corporation, and the amount of entity tax paid by the partnership or S corporation, as the case may be.[xxviii] A similar credit will be available to a resident partner or shareholder for their share of any pass-through entity tax imposed by another state upon the entity’s income derived from that state. In this way, the partners and shareholders will be permitted to indirectly deduct the SALT taxes paid by their pass-through entity.
The revenue provisions of the Governor’s budget proposal are 415 pages long. In addition to the items described above, they include a variety of tax-related changes, some of which will attract greater attention than others; for example, the legalization and taxation of adult-use cannabis.
Two of the provisions of which the owners of a closely held business should be aware are the following:
- the budget bill would mandate conformity to Federal S corporation status by amending the New York Tax Law to provide that all Federal S corporations will be treated as S corporations for State tax purposes – no separate New York election will be required; and
- the budget bill would amend the Tax Law to clarify that the grantor (seller), and only the grantor, is responsible for paying the basic real estate transfer tax, and that the grantor is not allowed to pass through the cost of the transfer tax to the grantee (buyer).
Most of the tax changes in the proposed New York budget seem reasonable. Of course, there is room for disagreement, especially among the more progressive members of the Governor’s party. It remains to be seen, for example, whether they will demand permanent tax increases, or perhaps even insist upon some version of the wealth tax that received much attention last year.
Then there is the status of the Federal stimulus – when will it be forthcoming, and will New York be allocated a sufficient share of it?
Finally – and this is the key issue – in the event the State’s revenues, whether in the form of the hoped-for Federal assistance, the proposed additional taxes, and/or loan proceeds, are not enough to sustain the many programs and social safety nets that New York provides its residents, how will Albany react?
Given the veto-proof majority that the Democrats have in both chambers of the Legislature, will the State decide in favor of increasing the tax burden imposed on a greater number of its “wealthy” residents than proposed by the Governor, notwithstanding his concern over prompting these individuals and their families, along with their businesses, to leave New York? After all, there are over 500,000 millionaire households in the State.[xxix]
[i] https://www.taxlawforchb.com/2021/01/new-york-deficits-taxes-and-2021/ .
[ii] Former President Trump’s impeachment trial in the Senate is scheduled to begin the week of February 8, 2021.
[iii] I don’t see bipartisanship in our immediate future. After all, we have members of Congress publicly stating that they fear for their safety when in the presence of some of their colleagues. We have other members making accusations that their colleagues informed the mob of their whereabouts prior to and during the January 6 violation of the U.S. Capitol. We have the impeachment trial of a former President whose supporters still number in the tens of millions. And Trump aside – I don’t think he is capable of persuading a rock to sit still – those same citizens, and their elected representatives, fundamentally disagree with so many of the policies articulated by those from across the aisle. Finally, let’s not forget that the Democrats lost seats in the House in 2020, and that the Parties are split 50-50 in the Senate; the 2022 elections will be here before you know it – why would the Republicans play nice?
[iv] https://www.bloomberg.com/news/articles/2021-01-21/yellen-says-administration-will-fight-currency-manipulation . That doesn’t sound like bipartisanship to me.
[v] Of whom does it remind you? Query whether Mr. Biden, like his predecessor, will seek funding by “repurposing” (i.e., diverting) resources from their committed task to another.
[vi] https://www.taxlawforchb.com/2021/01/new-york-deficits-taxes-and-2021/#_ednref20 .
[vii] You will recall this is the $2.2 trillion economic relief legislation enacted in March of 2020; the “Coronavirus Aid, Relief, and Economic Security Act,” P.L. 116-136.
[viii] For example, the CARES Act allows the taxpayer to carry back certain NOLs, which may result in the refund of taxes paid by the taxpayer in a carryback year.
[ix] These more restrictive rules were enacted by the Tax Cuts and Jobs Act (“TCJA”); P.L. 115-97. https://www.tax.ny.gov/pit/cares-act-faq.htm .
[x] Inconsistent? Somewhat, but New York is also fighting to keep taxpayers and their businesses in New York – it has to pick its poison.
[xi] Second only to California, among the states. California’s GDP is double New York’s (and the 5th largest in the world), while New York’s budget per capita is almost double California’s.
[xii] Especially “She Who Must Not Be Named.”
[xiii] https://www.taxlawforchb.com/2020/12/new-yorks-proposed-billionaires-tax-bad-idea/ .
[xv] For married taxpayers with taxable income above $2,155,350.
[xvi] Don’t forget to add New York City’s top rate of 3.876 percent for resident individuals.
[xvii] https://www.thecity.nyc/2020/10/13/21515162/proposals-to-tax-the-rich-new-york .
[xviii] https://cbcny.org/research/personal-income-tax-revenues-new-york-state-and-city .
[xix] It was referred to as the “millionaires’ tax.”
[xx] Think of a “temporary” surcharge as a fiscal gateway drug.
[xxi] In determining an individual’s alternative minimum taxable income, no itemized deduction for property, income, or sales tax was allowed.
[xxii] Yes, this is yet another of the TCJA changes that sunsets after 2025.
[xxiii] Thus, under the provision, in the case of an individual, state and local property taxes, and state and local sales taxes, are not subject to the SALT cap limitation when paid or accrued in carrying on a trade or business, or an activity for the production of income.
[xxiv] Sec. 11042 of the TCJA and sec. 164 of the Code. The “State and Local Tax,” or SALT, Cap.
[xxv] IRS Notice 2020-75.
[xxvi] https://www.bloomberg.com/news/articles/2021-01-21/yellen-says-administration-will-fight-currency-manipulation .
[xxvii] The highest New York tax rate applicable to individuals, disregarding the “temporary” surcharge taxes.
[xxviii] The electing pass-through entity will be liable for the tax in the first instance; in addition, the partners or shareholders of the pass-through entity will be jointly and severally liable for the tax.
[xxix] https://patch.com/new-york/new-york-city/many-millionaires-live-new-york .