April 4, 2018 New York final budget includes optional payroll expense tax to protect state taxpayers from federal income tax increases under the Tax Cuts and Jobs Act The 2018-19 Fiscal Year Revenue Article VII Legislation (S7509-C/A9509-C and hereafter referred to as the Final Bill) passed the New York State (NYS) Legislature on March 30, 2018, was delivered to Governor Cuomo on April 2, 2018 and is awaiting his signature to be signed into law. The Final Bill includes a provision allowing employers to opt into a new Employer Compensation Expense Tax (ECET) that aims to protect New York individual taxpayers from increased federal income taxes resulting from the $10,000 cap on state and local tax (SALT) deductions under the Tax Cuts and Jobs Act (TCJA). The provisions in the Final Bill are revised from the original proposal in the Executive Budget Revenue Article VII Legislation (S7509-A/A9509-A), as amended by the NYS Assembly 2018-19 Revenue Article VII Legislation (A9509-B). (See EY Tax Alert 2018-0371.) The notable revisions in the Final Bill clarify that an employer's decision to elect to be taxed under Article 24 is an annual election, which must be made by December 1 of each calendar year (as opposed to an October 1 election date provided in prior bill versions). Background Effective January 1, 2018 and through December 31, 2025, the TCJA allows an individual taxpayer to claim a deduction for state, local or foreign property or sales taxes only when the taxes were paid or accrued in carrying on a trade or business or an activity described in IRC Section 212 (expenses incurred for the production of income). The TCJA generally limits the ability of individual taxpayers to take federal SALT deductions. Individual taxpayers can claim an itemized deduction of up to $10,000 ($5,000 if married filing separately) for the aggregate amount of state and local property tax, war profits, excess profits tax and income tax or sales taxes.1 (Ernst & Young LLP Tax news update, December 20, 2017.) It was estimated that absent changes to New York's tax code, the TCJA's limitations on the federal deductibility of SALT will cost New York's taxpayers an additional $14.3 billion per year and "risk undermining the progressivity of New York's tax system, the investments and services that the state provides for its residents, and the competitiveness of New York's economy over the long term." (New York State Department of Taxation and Finance-Preliminary Report on the Federal Tax Cuts and Jobs Act, presented to Governor Cuomo January 17, 2018.) Optional ECET intended to reverse impact of lost federal SALT deductions In an effort to benefit those New York individual taxpayers facing an increase in their federal income tax as a result of the $10,000 cap on SALT deductions, the Final Bill adopts a voluntary program under new Article 24 whereby employers can opt into the ECET. At a high level, "covered employees" of an "electing employer" receive a tax credit against their New York personal income tax liability related to the amount paid by the electing employer under the ECET (but not dollar for dollar). The following is a recap of the ECET provisions included in the Final Bill: — Employer and Electing employer. An "employer" for purposes of the ECET is "an employer that is required by [New York Tax Law Section 671] to deduct and withhold tax from wages." An "electing employer" is an employer that has made the annual election to be subject to the ECET. — Covered employee. Covered employees are employees who are employed by an electing employer, are required to have amounts withheld under NY Tax Law Section 671 and receive annual wages and compensation from his or her employer of more than $40,000 annually. — Payroll expense. Payroll expense means wages and compensation as defined in IRC Section 3121and IRC Section 3231, paid to all covered employees, i.e., Medicare wages. — How employers opt in. In order for the employer election to be effective, the annual election must be made as follows: (1) if the employer is not a corporation, by any member, owner, or other individual with authority to bind the entity or sign returns required pursuant to NY Tax Law Section 653; or (2) if the employer is a for-profit or not-for-profit corporation, by any officer or manager of the employer who is authorized under the law of the state where the corporation is incorporated or under the employer's organizational documents to make the election and who represents to having such authorization under penalty of perjury.2 The election must be made by December 1 of the calendar year to be effective for the immediately succeeding calendar year, but if the election is made after December 1 of the calendar year, it will be effective for the 2nd succeeding calendar year. — ECET tax rate. The ECET is imposed on the payroll expense paid by the electing employers to covered employees at a rate of 1.5% of the payroll expense paid during each calendar quarter for 2019, 3% of the payroll expense paid during each calendar quarter for 2020, and 5% of the payroll expense paid during each calendar quarter for 2021 and thereafter. The electing employer is only subject to tax on the payroll expense paid to any covered employee during the calendar year in excess of $40,000. — No deduction from wages allowed. An employer is not allowed to deduct from wages or compensation of an employee any amount that represents all or any portion of the ECET. — Payment of the ECET. The ECET is required to be paid at the same time the electing employer is required to remit payments under NY Tax Law Section 674 (withholdings on payroll), with certain exceptions. The Commissioner may require that all filings of ECET forms or returns be filed electronically and all payments of the ECET be paid electronically. The Commissioner may also prescribe the methods of quarterly filings by electing employers, including, but not limited to, the inclusion of specific employee-level detail. — New York state personal income tax credit for individuals. NY Tax Law Section 606 is amended to add a new subsection (ccc) that includes the calculation of the New York state personal income tax credit available to covered employees. For 2019, the credit is equal to the product of (1) the covered employee's wages and compensation in excess of $40,000 received during the tax year from the electing employer that are subject to tax under Article 22 (personal income tax) and (2) 1.5% and (3) the result of one minus a fraction, the numerator of which is the tax imposed on the covered employee as determined under NY Tax Law Section 601 before the application of any credits for the applicable tax year and the denominator of which is the covered employee's taxable income under Article 22 for the applicable tax year. For 2020, the same formula applies but substitutes 3% for 1.5%. For 2021 and thereafter, the same formula applies but substitutes 5% for 3%. If the credit exceeds the taxpayer's tax for the tax year, the excess may be carried over to the following tax year or years, without carryover limitations. Ernst & Young LLP insights It is anticipated that Governor Cuomo will sign the Final Bill into law, including the ECET contained in Part MM, in the coming days. However, many questions regarding the execution of the ECET remain uncertain. Employers will need to evaluate the applicability of the ECET as it relates to their business. Furthermore, employers will need to determine the impact of the ECET on their employees, specifically those employees working in one state and residing in another or who are working in multiple jurisdictions throughout the year, both of which could have varying impacts depending on, for example, whether bordering states adopt similar provisions. In addition, it remains to be seen how the Internal Revenue Service and the Federal Government will treat the ECET in general from both a personal income tax and corporate income tax perspective.3 ———————————————
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——————————————— 1 In determining whether a tax is an "income tax" — taxpayers should not simply look to whether income, either gross or net, is used as the measure of taxation; instead, taxpayers must look to the purpose and application of the tax at issue. In any event, it appears that state and local taxes that are non-itemized deductions, but yet are imposed on businesses and individuals (such as the New York City Unincorporated Business Tax and the Metropolitan Commuter Transportation Mobility Tax) would probably remain deductible because they never were taxes described in IRC Section 164(a)(3). 2 The Final Bill also includes opt-in procedures for trusts and governmental entities. 3 Highlighting the uncertainty is Part EEE of the Final Bill which provides that the NYS Tax Department is "required to set up an online application system for taxpayers to submit claims for reimbursement of payments of interest on fixed and final determinations of underpayments of federal tax liability for the 2019, 2020, and 2021 tax year that arise from the taxpayer's reliance on amendments to the tax law enacted in tax year 2018." ——————————————— EY Payroll News Flash
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