The New York State Department of Taxation and Finance has released a “discussion draft” of a bill that would implement a New York State unincorporated business tax (“UBT”) as a way to mitigate the effects of the $10,000 cap on state and local tax deductions for certain non-wage income. Unincorporated Business Tax, Bill Discussion Draft, Article 24-A (released May 15, 2018). Although New York City imposes a UBT, there has not been a State-level UBT since 1981. The goal of the State UBT would be to shift non-deductible individual State income taxes to a deductible unincorporated business tax on pass-through entities, and to credit the value of the UBT paid by the business to the individual owners against their personal income taxes.
Overview of the Draft UBT
Imposition and Tax Rate. The draft bill would impose a 5% tax on the unincorporated business taxable income (“UBTI”) of every partnership (including limited liability companies treated as partnerships) doing business in the State, effective for tax years commencing after 2018. The tax would be imposed on all partnerships regardless of the amount of their taxable income, but would not apply to S corporations, sole proprietorships, or single-member limited liability companies that are owned by individuals.
An entity’s UBTI would be calculated by taking its unincorporated business net income, which is equal to its “federal ordinary business income” as described in IRC § 702(a)(8), with addbacks for guaranteed payments to partners and the State UBT deducted in computing federal ordinary income, and then applying a three-factor apportionment formula consisting of the partnership’s property, payroll, and receipts within and without the State. A significant difference from the New York City UBT is that, as currently drafted, the State UBT would not explicitly exempt from the tax those partnerships whose activities are limited solely to trading for their own account or owning or managing real property for their own account.
Significantly, and unlike the receipts factor under Article 9-A, the UBT receipts factor would not employ market-based sourcing, but would instead generally source service receipts based on the office to which the partnership’s employee performing the services is chiefly connected. The State UBT receipts factor also would not contain special registered broker-dealer sourcing provisions providing for the market-based sourcing of services. This could negatively impact New York–based broker-dealer partnerships whose customers are worldwide, but whose employees primarily work out of New York State.
The Department has indicated that it welcomes comments on several variations that it is considering, including whether the UBT should: (i) be made optional; (ii) only apply to partnerships with taxable income above a certain level; and/or (iii) also apply to S corporations and single member LLCs owned by individuals. In addition, although the draft bill would set the UBT rate at 5% — presumably based on a blend of the State personal income tax and Article 9-A tax rates — the Department has also indicated that it seeks feedback on whether the tax rate should be set higher or lower.
Unincorporated Business Tax Credits
There would be three separate UBT credits. The first credit, called the Unincorporated Business Credit (“UBC”), would be available to a partnership that is also a partner in a lower-tier partnership for use against its State UBT liability. Any partnership that receives a distributive share of income from a lower-tier partnership that has itself paid UBT would claim the UBC credit to offset its own UBT liability. This is modeled after the City “UBT Paid Credit,” and is intended to prevent the State from collecting the UBT twice on the same income.
The other two credits — one available to individual partners against their State personal income tax liability and the other available to corporate partners against their Article 9-A liability — are calculated in exactly the same way. The credit would generally be equal to 93% of the individual or corporate partner’s proportionate share of the partnership’s UBT and could be used to offset the partner’s personal income tax or Article 9-A tax liability, respectively. Excess credits for any taxable year could be carried forward indefinitely.
In its comments on the draft bill, the Department notes that it chose the 93% “discount factor . . . to ensure revenue neutrality for the State.” However, it is unclear how the Department arrived at this number, or whether it will in fact ensure revenue neutrality.
As a practical matter, limiting the credit to 93% likely would not fully compensate corporate partners subject to the 6.5% Article 9-A tax on income — which are unaffected by the federal limitation on itemized state and local tax deductions, but which would be bearing a portion of the State UBT through the partnership — for their share of the State UBT. This is because a corporation’s distributive share of partnership income would not only be subject to the State UBT (at the partnership level), but would also be included in calculating the corporate partner’s own Article 9-A liability, but without the partner receiving a credit that entirely offsets that liability. To its credit, the Department recognizes that using 93% may be an imperfect method of offsetting income tax liability, and has indicated that a method that adjusts the discount factor based on a partner’s own individual tax rate is also under consideration.
It is also unlikely that the State UBT credits against New York income taxes would provide complete relief to a non-resident individual partner who must not only pay New York State income tax (on his or her distributive share of the partnership’s income allocable to the State), but must also pay state income tax to his or her state of residence (on the individual’s distributive share of unapportioned partnership income). In that case, the individual’s state of residence may not allow a nonresident tax credit where the State UBT credit effectively eliminates all (or most of) the individual’s New York State tax on that income. This is in contrast to cases in which the individual pays his or her New York State income tax directly. The draft State UBT would result in a tax increase in the individual’s state of residence, even though the State UBT credit should substantially offset the individual’s New York State income tax on the partnership income.
The Department states that its purpose in releasing the draft bill for discussion is to provide interested parties a chance to comment and provide feedback on both the general concept of a statewide UBT, and the proposed design and implementation details of this tax. It has asked that all such comments be submitted by email to email@example.com by July 16, 2018.