New York enacts sweeping tax reform legislation
Substantial impact for corporations, banks and individuals
TAX ALERT |
On March 31, 2014, New York Governor Andrew Cuomo, faced with ongoing media criticism rating New York as the worst tax climate in the United States and the need to keep state spending increases to a minimum, signed into law S.6359-D/A.8559-D, the Budget Act of 2014-15 (the Act), accomplishing what few thought possible−radical reform of New York’s tax system. The impact of the Act is both broad and deep, putting into place sweeping changes to the state’s taxation of corporations, banks and individuals in the face of substantial inertia in an election year. To put this into perspective, in spite of significant recognized issues, prior to the enactment of the Act, the general corporate franchise tax law had not been substantially modified since 1945, and the banking franchise tax law had not been substantially modified since 1985.
Given the scope of the Act, digesting the changes will be a challenge for most businesses and individuals. For example, there are wholesale changes to New York’s taxation of banks, unitary taxation of corporations, and market-based sourcing provisions for apportionment. Other changes include new net operating loss (NOL) provisions, use of economic nexus standards, new reporting methods for corporate partners, reduction of the corporate franchise tax rate, a real property tax credit, and the elimination of corporate income tax for qualified manufacturers. For individuals, changes include property tax relief for low- and middle-income taxpayers and estate tax reforms, including closing the so-called “residential trust” loophole.
The following discussion provides detail on specific provisions contained in the Act.
Repeal of bank franchise tax
For tax years beginning on or after Jan. 1, 2015, the state has abolished the banking franchise tax (Article 32). Instead, the state will tax banks in accordance with the provisions of the general corporate franchise tax (Article 9-A). Entities that were previously taxed under Article 32 will need to analyze the impact of this change, particularly to the extent that those entities relied upon administrative pronouncements issued under Article 32 in arriving at tax positions.
Rate reductions and increases
The Act cuts the New York corporate franchise tax rate from 7.1 percent to 6.5 percent, effective for tax years beginning on or after Jan. 1, 2016, and increases the rate of the Metropolitan Transit Authority (MTA) surcharge to 25.6 percent, effective for tax years beginning on or after Jan. 1, 2015, and before Jan. 1, 2016. The MTA surcharge will be set based on state financial projections for years thereafter.
Effective for tax years beginning on or after Jan. 1, 2014, the tax rate is 0 percent for a qualified New York manufacturer. A “qualified New York manufacturer” is a manufacturer having property in New York that is eligible for the investment tax credit (see below) and either (1) the fair market value of that property has an adjusted basis for federal income tax purposes of at least $1 million, or (2) all of the manufacturer’s real and personal property is located in New York.
The capital base tax rate will also be phased out by 2021.
The law combines the apportionment factor for business income and capital into a new customer-based single sales factor. Special rules apply to financial institutions, allowing them to make an annual and irrevocable election to use an 8 percent fixed percentage method instead of customer-based sourcing for receipts from qualified financial instruments (e.g., instruments that are mark to market under IRC sec. 475(f) or sec. 1256). The enactment of these rules follows a trend by the New York State Department of Taxation and Finance to attempt to source sales other than sales of tangible personal property using rules that approximate market, such as web-user location or population for sales of internet advertising, instead of the state’s statutory proportional income producing activity test. This change should prove to be a boon for New York-based service companies and a cost to service companies that have New York customers but are based in other states.
Net operating losses
Under the new law, existing NOL provisions have been revised to switch from a pre-apportionment to a post-apportionment computation, terminating the state’s tie to the federal NOL amount. Because of these computational changes, the Act established “prior-year net operating loss” (PNOL) rules and provided transition rules related to the use of NOLs generated before Jan. 1, 2015. A taxpayer’s PNOL corresponds to its NOLs generated under current law, modified to account for the change to calculation on a post-apportionment basis. Taxpayers will be allowed to deduct both PNOL and newly generated NOLs, subject to a 20-year carryforward period, and PNOLs must be applied against the business income base before post-reform NOLs. Additionally, NOLs generated in post-reform tax years may be carried back three years, provided the NOL can be carried back to a tax year beginning before Jan. 1, 2015.
New economic nexus standards
Under the Act, businesses subject to the corporate franchise tax and the metropolitan business tax surcharge include those that derive $1 million or more in gross receipts from activity in New York. A corporation that is part of “combined group” and that has less than $1 million, but more than $10,000, in receipts is deemed to satisfy the receipts threshold if the in-state receipts of all members of the group that separately exceed $10,000 meet the $1 million threshold in the aggregate. Given the change to customer-based sourcing, this provision is likely to impact nexus determinations for many out-of-state businesses. However, given the aggressiveness of this approach, it is likely to be challenged under both the Due Process Clause and the Commerce Clause of the U.S. Constitution.
Further, the Act transfers the Article 32 nexus threshold for credit card companies to Article 9-A, and such companies will be deemed to have New York nexus for corporate income tax purposes if they have (1) issued credit cards to 1,000 or more customers with New York mailing addresses, (2) 1,000 or more locations in New York covered by merchant contracts to which the business remitted payments, or (3) a combined total of 1,000 or more New York customers and merchant locations. However, the Act does repeal the nexus rule for fulfillment services.
Combined reporting provisions
Applicable to tax years beginning on or after Jan. 1, 2015, the Act replaces the existing confusing and difficult to apply “substantial intercorporate” transaction rules with a full water’s-edge unitary combined reporting with an ownership test of 50 percent. The Act does provide for a seven-year irrevocable election to permit combined filing for certain commonly owned groups, which is automatically renewed for an additional seven years unless affirmatively revoked. This reform may drive substantial changes in some taxpayers’ reporting groups but should make the group determination much clearer than the current method.
Reporting methods for corporate partners
The Act requires corporate partners to compute tax under an “aggregate” method (as opposed to an “entity” method). Under the new method, a corporate partner is deemed to have an undivided interest in the assets, liabilities, and items of receipts, income, gain, loss and deduction of the partnership, and the corporate partner is treated as participating in the partnership’s activities and transactions. Accordingly, if the partnership has “nexus” with New York, all of its corporate partners have nexus as well, making any corporate partner in the partnership subject to the franchise tax. As with the adoption of the new economic nexus provisions described above, this change is likely to impact nexus determinations for many out-of-state businesses but may, once again, be subject to challenge, particularly by corporate partners that are not unitary with the partnerships in which they own an interest.
Real property tax credit for New York manufacturers
The Act provides for a refundable real property tax credit for "qualified New York manufacturers" equal to 20 percent of real property tax paid on property used for manufacturing during the taxable year. The definition of “qualified New York manufacturers" mirrors that used to determine whether a business qualifies to use the 0 percent corporate tax rate.
Property tax relief
The Act creates a new $85 million progressively structured “circuit breaker” tax relief program, under which qualifying homeowners and renters will be eligible to receive a refundable tax credit against personal income tax when their property tax or rent exceeds a certain percentage of their income.
Additionally, the Act includes a new property tax credit that addresses the “outsized number of local governments.” The new credit is intended to encourage local governments to share services by allowing for property tax relief to taxpayers in the first year of the plan if their local governments stay within the property tax cap. The tax cuts will be extended for a second year if jurisdictions comply with the tax cap and have a plan to save 1 percent of their tax levy per year, over three years. The program is intended to provide over $1.5 billion in property tax relief over three years.
The Act aims to bring New York's version of the estate tax into conformity with the federal estate tax. While the top rate will remain at 16 percent, the exemption will be raised to $5.25 million in yearly phases ending April 1, 2017. Additionally, the law closes the "residential tax loophole." Effective with respect to income earned on or after June 1, 2014, trusts will be treated as grantor trusts if they are structured to avoid federal gift tax on contributions of property to the trust. This provision also applies to New York City income tax.
The Act has numerous other provisions that can impact the taxation of corporations, banks and individuals, including:
- The creation of a new investment tax credit and expansion and extension of other credit programs
- The implementation of a requirement that overcapitalized captive insurance companies be included in combined reports
- Elimination of the tax on subsidiary capital
- Exemption of investment capital and investment income and the implementation of limitations on the definitions of each
- Repeal of the generation-skipping tax
The effective date of most of the tax reforms is Jan. 1, 2015. However, since the bill was signed into law on March 31, 2014, it is considered a first quarter financial statement event for calendar-year taxpayers. Because of the breadth and depth of changes, the financial statement impact of the Act may be significant.
Further, the New York State Department of Taxation and Finance has a long road ahead in terms of updating regulations, rulings and other administrative pronouncements. Taxpayers that have relied upon administrative pronouncements in taking a tax position should consider reviewing whether a particular pronouncement is rendered ineffective by the Act.
Please be aware that New York City has yet to comment on any of these new tax changes. Differences between New York State tax and New York City tax will place compliance burdens on those companies that conduct business within New York City.