The New York State Legislature has passed—and Governor Cuomo is expected to sign—a 2015-2016 Budget Bill (the “Budget Bill”) that contains significant changes to the New York State and City tax law, including important modifications to the corporate income tax reform legislation that was adopted last year. Of equal significance are provisions the governor had proposed in his Executive Budget, but which were rejected by the Legislature.
What’s in the Budget Bill?
1. New York State Corporate Income Tax
Definition of Investment Capital. The definition of “investment capital” is amended to mean investments in stocks that: (i) meet the definition of a capital asset under section 1221 of the Internal Revenue Code (“IRC”) at all times the taxpayer owned the stock during the taxable year; (ii) are held by the taxpayer for investment for more than one year; (iii) would generate or would be treated by the taxpayer as generating long-term capital gains or losses under the IRC if disposed; and (iv) before the close of the day on which the stock was acquired, are clearly identified on the taxpayer’s books and records as stock held for investment in accordance with the requirements of IRC section 1236(a)(1) (or by October 15, 2015 for stocks acquired prior to that date and not subject to IRS section 1236(a)(1)). Stock acquired on or after January 1, 2015, must have never been held for sale in the regular course of business in order to qualify as investment capital.
Clarifications have also been made to the investment capital holding period presumption. The presumption allowed taxpayers to treat stock as meeting the holding period requirement for purposes of qualifying as investment capital if the taxpayer owned the stock on the last day of the taxable year. The Budget Bill amends the presumption to require that the taxpayer own the stock at the time it actually files its original report for the taxable year in which it acquired the stock. This change was presumably made to prevent taxpayers from deferring tax on business income generated by stock purchased and disposed of during the holding period, but prior to the filing of the tax report.
Cap on Investment Income. The amount of investment income a taxpayer may claim is capped. If a taxpayer’s investment income, determined without regard to allowable interest deductions, is more than 8 percent of its entire net income, then investment income determined without regard to the interest deductions must be capped at 8 percent of the taxpayer’s entire net income.
Interest Expense Attribution. The election to reduce investment income and other exempt income by 40 percent (in lieu of computing actual interest expense attribution) is now explicitly revocable. If, however, the election is revoked as applied to investment income, it must also be revoked as applied to other exempt income, and vice versa.
Net Operating Loss Conversion Subtraction Pool. Taxpayers may elect to use not more than one-half of their net operating loss conversion subtraction pool in each of the tax years beginning on or after January 1, 2015, and before January 1, 2017. Any portion of the pool that is unused at the end of the two-year period is forfeited. However, the election is revocable.
Net Operating Loss Deductions. A net operating loss may be carried back three taxable years, and carried forward 20 years from the year of the loss. No loss may be carried back to a year beginning before January 1, 2015. The Budget Bill establishes an ordering rule, such that the net operating loss must first be carried back to the earliest of the three taxable years. If it is not used in its entirety it may be carried to the second taxable year preceding the loss, and so on. Thus, it is not until the net operating loss is carried back that it can be carried forward, beginning first with the taxable year immediately following the loss year, and so on. A taxpayer may make an irrevocable election to waive the entire carryback period with respect to a net operating loss generated in a specific year.
Definition of Qualified Financial Instruments. The definition of a qualified financial instrument (“QFI”) has been amended to include only certain types of instruments that are marked to market under section 475 or 1256 of the IRC. Those instruments generally include certain (i) loans, (ii) federal, state and municipal debt, (iii) asset-backed securities and other government agency debt, (iv) corporate bonds, (v) dividends and net gains from sales of stock or partnership interests, (vi) other financial instruments, and (vii) physical commodities. The types of financial instruments included are determined by reference to section 210-A(5)(2) of the New York Tax Law. In addition, certain loans secured by real property and stock treated as investment capital do not qualify as QFIs.
In order for a financial instrument to qualify as a QFI, it must meet the definition above and have actually been marked to market under section 475 or 1256 of the IRC. This is a change from the proposal in the governor’s Executive Budget, which would have looked to whether the instrument was or was eligible to be marked to market. Additionally, if a financial instrument within one of the enumerated class of assets is marked to market in a taxable year, then all other financial instruments within the same classes of assets must also be treated as a QFI for the taxable year, regardless of whether they have been marked to market.
Apportionment. The Budget Bill provides specific rules for the apportionment of marked to market gains and for receipts from the operation of vessels. It also amends the apportionment rules as applied to “other aviation services” by including a definition of a “qualified air freight forwarder with respect to another corporation.”
Mobile Telecommunication Excise Tax. A new tax is imposed on the sale of mobile telecommunication services at the rate of 2.9%. The tax is imposed on the gross receipts from any mobile telecommunication service provided by a home service provider when the customer’s place of primary use is within New York. A corresponding tax is also imposed on gross receipts relating to the metropolitan commuter transportation district. These taxes are in lieu of, not in addition to, the comparable excise taxes imposed on telecommunication services.
2. New York State Sales and Use Tax
Partial Exclusion from Tax for Vessels. The Budget Bill provides a $230,000 cap on the value upon which sales and use tax can be imposed on the sale, lease, or use of a vessel in New York. An exemption from use tax is also established for vessels that have not been used in New York for at least 90 consecutive days (unless the date the vessel is required to be registered or is actually registered with the state occurs sooner).
Exemption for Certain Related Persons. An exemption from sales and use tax has been created for certain related persons where the sales are part of a divestiture required by the Dodd–Frank Wall Street Reform and Consumer Protection Act.
3. New York City Corporate Tax Conformity
The Budget Bill adopts a new corporate tax regime for New York City that is substantially aligned with the reforms that were adopted by New York State last year. The most significant changes include:
- Merger of the bank tax into the general corporation tax
- Modification of the classifications of income (business, investment, and other exempt income)
- Elimination of the tax on subsidiary capital
- The addition of an exemption from tax for investment income and other exempt income
- Limited interest expense attribution
- New treatment for net operating losses
- Adoption of water’s-edge unitary combined filing
- Market-based sourcing
The Budget Bill does not, however, fully conform the New York City corporate tax regime to that adopted by the state. The most significant differences are as follows:
Taxation of S Corporations and Unincorporated Businesses. New York City continues to disregard federal and New York State S elections, thereby subjecting federal and state S corporations to the historical general corporation and bank taxes at the entity level. Similarly, unincorporated businesses will continue to be subject to New York City’s unincorporated business tax.
Tax on Capital. Unlike New York State, which is phasing out its alternative tax on allocated capital, New York City has retained its historical capital tax base.
Increased Business Income Tax Rate for Financial Institutions. An increased 9 percent tax rate will apply to financial corporations, as compared with an 8.85 percent tax rate for most other corporations.
Treatment of Qualified New York Manufacturing Corporations. New York City has adopted reduced tax rates (as opposed to a zero percent tax rate adopted by New York State) for qualified New York manufacturing corporations. The reduced rates apply to a potentially broader definition of a “manufacturing corporation” as compared with the definition used for state purposes.
Rejection of Economic Nexus. Unlike New York State, which has adopted an economic nexus standard, New York City will continue to apply its historical nexus standard for corporate tax purposes.
Phase-In (and Out) of Single Sales Factor Apportionment. Under current corporation tax law, the city is phasing in a single sales factor apportionment formula, with the phase-in to be completed for tax years beginning on or after 2017. However, under the Budget Bill, for tax years beginning on or after January 1, 2018, a taxpayer that has $50 million or less of receipts allocated to New York City may make a one-time election to determine its business allocation percentage based on a statutory weighting of the taxpayer’s property, receipts, and payroll factors (3.5%, 93%, and 3.5%, respectively). The election remains in effect until revoked.
What’s Not in the Budget Bill? Governor Cuomo’s 2015-2016 Executive Budget contained a number of proposals that would have significantly changed the Tax Law. Many of these proposals, including the following, were not adopted as part of the final budget legislation.
Expand Sales Tax Collection Requirements for Marketplace Providers. The proposal sought to shift the burden of collecting sales tax from the retailer to any “marketplace provider” that facilitates the retailer’s sales to New York customers. Among other things, it would have required “marketplace providers” that have nexus with New York to collect sales tax on online sales made by out-of-state sellers.
Close Certain Sales and Use Tax Avoidance Strategies. The proposal would have eliminated certain perceived “loopholes” in the sales tax law. Generally, it sought to: (i) limit the nonresident use tax exemption for businesses to situations where the nonresident business was doing business outside of New York for at least six months before using taxable property or services in New York; (ii) treat single member LLCs and their members as one person for sales tax purposes; (iii) require the up-front payment of sales tax on all lease payments for leases of tangible personal property between related entities; and (iv) impose sales and use tax on most intercompany transfers of tangible personal property between related parties.
Authorize a Professional and Business License Tax Clearance. The proposal would have created a new professional and business license tax clearance program. Applicants for such licenses with past-due tax liabilities of more than $5,000 would have had to pay or make arrangements to pay the debt before obtaining or renewing their license.
Lower the Outstanding Tax Debt Threshold Required to Suspect Delinquent Taxpayers’ Drivers’ Licenses. The proposal would have reduced from $10,000 to $5,000 the threshold of past-due tax liability required in order for the delinquent taxpayer’s driver’s license to be suspended