On April 17, 2018, Governor Andrew Cuomo signed S.B. 7509, New York state’s FY ’19 budget bill (the “Budget Bill” or “reform”), which, among other provisions, reforms New York Tax Law in response to the Tax Cuts and Jobs Act of 2017 (TCJA). The Budget Bill enacts the Employer Compensation Expense Tax System and the Charitable Gifts Trust Fund in an effort to shield individuals from the TCJA’s $10,000 SALT deduction limitation. Additionally, the reform explicitly expands the definition of “exempt CFC income” to include income under Internal Revenue Code (IRC) section 965, the “deemed repatriation transition tax.” However, the budget bill requires the add-back of both the section 965(c) deduction and the IRC section 250 foreign derived intangible income (FDII) deduction related to the new IRC section 951A global intangible low-taxed income provisions.
Employer Compensation Expense Program
While capping SALT deductions for personal income taxes, the TCJA retains SALT deductions for businesses. Leveraging that deductibility for the benefit of New York resident and nonresident individuals, the reform implements the Employer Compensation Expense Program, an optional tax on employers based on the payroll expenses paid to all employees for which the employer is required to withhold New York state income tax. Employers can opt into the program on a year-by-year basis, as long as they make the election before December 1 of the preceding year.
Tax Base, Rate, and Credit
The tax is imposed on the amount of payroll expenses paid per employee in excess of $40,000 during the calendar year. The tax is phased-in over a three-year period, with a tax rate of 1.5 percent for 2019, three percent for 2020, and is entirely phased-in with a five percent rate beginning in 2021.
Pursuant to a statutory formula, employees receive credit towards their New York state personal income tax relative to the amount of tax paid by the employer allocable to that employee. The statute explicitly provides that the employer may not reduce an employee’s wages in any way that represents any tax (or portion thereof) paid.
Charitable Gifts Trust Fund
The New York reform also creates a charitable deduction program for the ostensible purpose to further assist New York resident and nonresident individuals address the TCJA’s SALT deduction limitation. This program authorizes the State to create two charitable accounts. Individual taxpayers who contribute to these accounts are eligible for refundable credits on their New York state tax returns, and the State presumes that these contributions will be eligible for charitable contribution deductions on the taxpayer’s Federal return. Localities are authorized to create similar charitable funds for which donations can be credited against the taxpayer’s real property taxes.
State Charitable Funds
Under the reform, the State is authorized to create two charitable accounts, the Health Charitable Account and the Elementary and the Secondary Education Charitable Account. Contributions to these accounts are unlimited. Additionally, taxpayers may contribute up to $10 million per year to Health Research, Inc., SUNY Impact Foundation, and CUNY Research Foundation.
Contributions to the state charitable funds provide taxpayers with a credit against their New York State personal income tax equal to 85 percent of the amount contributed. The State presumes that the contribution should be deductible as a charitable contribution on a taxpayer’s Federal return.
Local Charitable Funds
The reform also authorizes localities to create similar charitable funds. Contributions to these funds provide individuals with a credit equal to 95 percent of the donation against the taxpayer’s real property tax bill. The credit is allowed in the same year that the donation is made. Again, the State presumes that the contributions will be deductible as charitable contributions on taxpayers’ federal returns.
Response to New Federal Deemed Repatriation Transition Tax Provisions
The reform also responds to a significant TCJA provision that is effective for the 2017 tax year – the DRTT under IRC section 965. As a “rolling conformity” jurisdiction, absent an explicit provision to the contrary, the New York Tax Law would adopt all changes made pursuant to the TCJA, including the amendments to IRC section 965.
New York State Corporate Franchise Tax is imposed on the greatest of three alternate bases: business income, business capital, and the fixed dollar minimum. “Business income” is “entire net income” (federal taxable income with modifications) less “investment income” and “other exempt income.” Because the IRC section 965(a) “inclusion amount” is included in federal gross income, via IRC section 951(a), absent the explicit provision enacted by the New York reform, there was at least some uncertainty whether the IRC section 965(a) “inclusion amount” qualified as “exempt CFC income.”
Under the New York Tax Law, as it existed prior to the reform, “exempt CFC income” (a subcategory of “other exempt income”) encompassed income of a unitary CFC that was included in a U.S. shareholder’s federal gross income pursuant to IRC section 951(a). While the IRC section 965(a) income “inclusion amount” should otherwise be construed to constitute an amount included in a CFC’s U.S. shareholder’s federal gross income under IRC section 951(a) and qualify as “exempt CFC income,” the reform expands the definition of “exempt CFC income” to explicitly reference IRC section 965(a) income. However, the reform also explicitly requires the add-back of the IRC section 965(c) participation exemption deduction.
Nonetheless, the New York reform does not expand the definition of “exempt CFC income” with respect to global intangible low-taxed income (GILTI) determined under IRC section 951A. GILTI is another new class of foreign income of a CFC taxable to a U.S. shareholder, which is subject to a lower federal rate of tax. Like DRTT, the lower federal rate is the result of a new FDII deduction under IRC section 250. The reform does not include IRC section 951A in “exempt CFC income.” Since GILTI is included in federal gross income under IRC section 951A, and not under IRC section 951(a), it does not qualify as “exempt CFC income.” Similar to the IRC section 965(c) deduction, the Budget Bill also requires that the FDII deduction is added back to federal taxable income for New York entire net income purposes. Therefore, GILTI remains taxable in New York without the benefit of the corresponding FDII deduction.
Similar changes with respect to IRC section 965(a) income as “exempt CFC income” and the add-back of the IRC section 965(c) and section 250 deductions were also enacted by the New York reform for insurance franchise tax purposes.
New York State and City DRTT Guidance
In April 2018, the New York State Department of Taxation and Finance released Notice N-18-4, which advised individual taxpayers and S corporation shareholders regarding the New York treatment of the IRC section 965 provisions of the TCJA. First, the Notice established that the “net amount” of IRC section 965(a) income (less the IRC section 965(c) deduction), as included in federal adjusted gross income of an individual, is includible as New York taxable income for individuals and S corporation shareholders. Second, unlike the federal law, New York does not allow an individual to elect to pay the DRTT in eight annual installments, or for an S corporation shareholder to defer the tax liability until the occurrence of a specific “triggering event,” as permitted for federal purposes. (The Notice does not address the State’s treatment of a similar installment payment election under IRC section 965 for corporations or the election to defer inclusion in federal gross income of IRC section 965(a) income by a REIT.) Finally, the State determined that because the TCJA was enacted so late in the 2017 taxable year, reasonable cause exists for the Department to waive late payment penalties associated with an underpayment of tax liability attributable to IRC section 965, if the taxpayer includes a copy of its federal IRC 965 Transition Tax Statement together with a late payment penalty waiver request.
On April 20, 2018, the New York City Department of Finance released Finance Memorandum 18-4, which addresses the City’s treatment of IRC section 965 by taxpayers subject to the City’s general corporation tax (on S corporations), the banking corporation tax, and the unincorporated business tax (on partnerships/LLCs). The tax regimes addressed in the City’s memorandum do not provide for a subtraction modification for “except CFC income,” because the City’s recent tax reform, effective in 2015, that created that term applies only to C corporations. The Memorandum provides that the “net amount” of IRC section 965(a) income (less the IRC section 965(c) deduction) is included in income subject to the General Corporation Tax (GCT), Banking Corporation Tax (BCT), and Unincorporated Business Tax (UBT). Like the State’s notice, the Finance Memorandum indicates that the City will not follow the federal deferral of tax payment elections, but also declares there is reasonable cause for penalty abatements relating to underpayment of City GCT, BCT, and UBT because of the late date in which the TCJA was enacted. Regarding the IRC section 965(a) inclusion, the memorandum requires such income to be classified as either business income, investment income, or income from subsidiary capital, as applicable.