The New York Legislature passed its 2018-2019 Fiscal Year budget on March 30, 2018 (Budget), which is expected to be signed into law by Governor Cuomo. The starting point for determining New York taxable income is federal Line 28 taxable income before net operating losses and special deductions. Thus, if New York does not deviate from the federal tax changes, New York will conform to many of the significant provisions in the Tax Cuts and Jobs Act (TCJA) passed by the United States Congress late last year. While the New York budget excludes IRC § 965 repatriated income from New York taxable income, it did not exclude other TCJA provisions, such as the tax on global intangible low-taxed income (GILTI) and the interest expense limitation under IRC § 163(j). Thus, New York will adopt these federal tax changes.
The provisions in the Budget are effective immediately upon signing by the Governor, although varying effective dates are provided for certain provisions. The provisions related to the Repatriation Transition Tax are applicable to tax years beginning on or after January 1, 2017. Provisions related to the $10,000 SALT cap workarounds are effective immediately but only apply to tax years beginning January 1, 2019 and later, as noted below.
Budget Provisions Responding to the TCJA
Repatriation Transition Tax (RTT)
Under the TCJA, a one-time transition tax is imposed under IRC § 965 on the deferred foreign earnings of foreign subsidiaries. Such deferred foreign earnings are taxed as Subpart F income, subject to a deduction under IRC § 965(c).
The Budget provides that amounts received under IRC § 965 from a corporation that is not included in a combined report1 with the taxpayer will be considered “exempt CFC income” for New York purposes, similar to New York’s treatment of other Subpart F income. As a result, such income is excluded from New York taxable income. However, any interest expense attributable to this income must be added back.2
Additionally, the Budget provides relief from underpayment of estimated taxes that may arise from the interest expense attribution related to the RTT. This relief applies to taxable years beginning on or after January 1, 2017 and before January 1, 2018.
Global Intangible Low-Taxed Income (GILTI)
The TCJA created new IRC § 951A, which taxes a US shareholder on its income from controlled foreign corporations (CFCs), to the extent this income is in excess of a fixed return on the tangible assets of such CFCs. Although the income is subject to tax at regular rates, under new IRC § 250, a deduction is allowed for 50% of the amount included in income, effectively taxing GILTI at a 10.5% tax rate for federal purposes. Further, foreign tax credits (FTCs) are available to offset GILTI at the federal level at a rate of 80%. As a result, for federal purposes no GILTI tax will be due where the CFC income is taxed in the foreign jurisdiction at a rate of at least 13.125%.
The Budget does not address GILTI. Therefore, unlike the RTT, both GILTI and the 50% GILTI deduction under IRC § 250 are included in the computation of New York taxable income.
Additionally, the Budget amends the subtraction modification related to IRC § 78 gross ups to limit the subtraction modification to dividends that were not included in the IRC § 250 deduction. Since New York is conforming to GILTI and the related deduction under IRC § 250, limiting the subtraction modification is necessary to prevent taxpayers from obtaining a double benefit.
Foreign Derived Intangible Income (FDII)
The TCJA provides a new special deduction in IRC § 250 for certain foreign-derived income earned by a US corporation. The deduction is for 37.5% of the US corporation’s FDII. FDII is broadly defined as income from the sales (including licenses) of property to foreign persons, as well as income from services performed for foreign persons. To be eligible for the federal deduction, FDII must be in excess of a fixed return on tangible assets of the US corporation.
The Budget specifically excludes the FDII deduction from the computation of New York taxable business income.
Eversheds Sutherland Observation: FDII and GILTI under the TCJA act as a carrot and stick to discourage corporations from locating intangibles in low tax foreign jurisdictions and encourage corporations to locate these intangibles in the US instead. By decoupling from the carrot (FDII) while conforming to the stick (GILTI), New York taxpayers may face an additional burden from these new provisions beyond what is provided for at the federal level. Further, by including GILTI in the state tax base, while not allowing offset of FTCs as allowed at the federal level, New York’s GILTI inclusion is much broader than the federal inclusion and will affect taxpayers with CFCs in high-tax foreign jurisdictions and those with CFCs in low-tax foreign jurisdictions.
The Budget does not address questions of factor representation related to inclusion of GILTI. Taxpayers will need to consider to what extent, if any, activities related to the production of GILTI should be included in their New York allocation factors. To the extent that factor representation is not allowed, inclusion of GILTI in the state tax base could cause unconstitutional distortion. State taxation of GILTI creates further constitutional concerns under the Foreign Commerce Clause and the US Supreme Court’s decision in Kraft v. Iowa, 505 US 71 (1992).
Foreign Dividends Received Deduction
The TCJA provides for a 100% dividend received deduction (DRD) for foreign source dividends received from 10% or more owned foreign corporations on a going forward basis, under IRC § 245A.
The Budget does not address the Foreign DRD provision. As noted in the Department of Taxation and Finance’s Preliminary Report on the Federal Tax Cuts and Jobs Act (Jan. 2018), this dividend income would be considered Subpart F income or investment income and therefore not included in New York taxable income, similar to amounts received under the RTT. Further paralleling treatment of the RTT, any interest expense attributable to this foreign dividend income must be added back.
Interest Deduction Limitation
The TCJA significantly expands the interest deduction limitation under IRC § 163(j). The TCJA limits the deductibility of interest paid or accrued to net interest income plus 30% of adjustable taxable income. Any disallowed interest may be carried forward indefinitely.
The Budget does not address the interest deduction limitation under IRC § 163(j). As a result, New York will conform to this federal limitation.
Workarounds for the TCJA $10,000 Cap on Individual SALT Deductions
The TCJA caps an individual’s state and local tax deductions at $10,000 per year. The Budget includes new provisions designed to ameliorate the impact of the $10,000 cap on individual New York taxpayers. The Budget includes a new optional Employer Compensation Expense Tax (ECET). New Article 24 allows employers to make an annual election to pay a tax on the payroll expense to certain “covered employees" earning more than $40,000 annually. For 2019, the tax rate will be 1.5%. The tax rate will increase to 3% in 2020 and 5% in 2021 and subsequent years. An electing employer is only subject to the payroll tax on the payroll expense paid to any covered employee during the calendar year that is in excess of $40,000.
On the personal income tax side, a credit is provided for the covered employee to offset a portion of the employee’s New York personal income tax liability. Thus, the optional ECET shifts the individual’s capped state income tax deduction to a fully deductible expense of the employer.
The Budget also creates the Charitable Gifts Trust Fund to give individuals tax credits against their New York State personal income tax for 85% of the contributions to the Fund made in the preceding year. The credit for contributions is first available on the 2019 return. Charitable contributions, which are also federal itemized deductions, are not subject to the TCJA $10,000 cap. Although it is not known how the IRS will respond, the goal of the legislation is to convert a state tax payment to a charitable contribution to avoid the TCJA $10,000 cap. Additionally, the Budget gives localities the option to create similar funds to accept contributions that will generate corresponding credits against individual real property tax liabilities.
Eversheds Sutherland Observation: The Budget omits several provisions that were included in the Governor’s Executive budget and earlier versions of the Assembly and Senate bills. Notably absent are: (1) an amendment that would allow the Department of Taxation and Finance to appeal decisions of the Tax Appeals Tribunal; (2) a proposal to close the “carried interest loophole;” and (3) a requirement that marketplace providers collect sales and use tax on sales by marketplace sellers.