It has been nearly six months since the enactment of the sweeping Federal Tax Cut and Jobs Act of 2017. With the New York State Legislature nearing the end of its current session, and having enacted limited legislative responses to the federal enactment, here is a summary of where things stand on key federal tax reform provisions and their effect on the New York State and City taxation of corporations, individuals, and pass-through entities:
Interest expense limitation: Limitation of deduction for business interest to 30% of a taxpayer’s “adjusted taxable income,” subject to indefinite carryforward.
• NYS/NYC Impact. The federal interest expense limitation (including the carryforward) should apply for New York State and City tax purposes, since the starting point in computing entire net income is federal taxable income.
• Open Questions:
• Since the New York State and City combined group is considered the “taxpayer” for many purposes, how will the 30% interest expense limitation apply in the case of a New York combined return that includes the corporation whose interest deduction is limited for federal purposes?
• How should the carryforward be apportioned in the year applied — based on the corporation’s apportionment in the year incurred or in the year applied?
• How will the limitation affect the attribution of interest expense to exempt CFC income or investment income?
Immediate expensing: Immediate expensing for qualified property, through 100% bonus depreciation if placed in service between September 27, 2017 and January 1, 2023.
• NYS/NYC Impact. 100% bonus depreciation should not apply because the existing law had already decoupled from bonus depreciation under IRC § 168(k). Tax Law § 208(9)(b)(17); Admin. Code § 11- 652(8)(b)(16).
NOLs: Net operating losses arising after 2017 are limited to 80% of taxable income, with no carryback but with an indefinite carryforward.
• NYS/NYC Impact: The federal NOL limitation should not apply because, for tax years beginning after 2014, the New York State and New York City NOL is defined as the amount of a corporation’s “business loss” multiplied by its apportionment factor. New York law expressly provides that the NOL deduction is not limited by the amount allowed for federal purposes under IRC § 172. Tax Law §210.1(a)(ix); Admin. Code § 11-654.1(3)(a). The carryback limitation and indefinite carryforward also should not apply, since New York law expressly provides NOLs may be carried back for three years and carried forward for up to 20 years. Tax Law § 210.1(a)(ix)(4); Admin. Code § 11-654.1(3)(d)
Repatriation transition tax: One-time repatriation transition tax on foreign-source income that was not previously taxed.
Undoubtedly, the most far-reaching federal changes are in the area of international taxation. In exchange for moving to a more business-friendly, quasi-territorial system of corporate taxation, the new federal tax law provides for a one-time repatriation of foreign income from controlled foreign corporations (“CFCs”) in the transition year. This is effectuated in steps: first by increasing taxable income under IRC § 965(a) to take into account accumulated deferred income from CFCs as of December 31, 2017 (or as of November 2, 2017, whichever is greater); and second by then providing a deduction (“participation exemption”) under IRC § 965(c) that results in a lower effective federal tax rate (either 15.5% or 8%) on that income. The taxpayer may elect to pay the resulting transition tax over eight years.
• NYS/NYC Impact: The recently enacted New York State Budget Bill confirms that the one-time repatriated foreign income under IRC § 965 constitutes “exempt CFC income” for New York State and City corporate tax purposes. However, the federal deduction allowed under IRC § 965(c) must be added back. Tax Law § 208(9)(b)(23); Admin. Code § 11-652.5-a(b). In addition, under existing New York State and City law, corporations must either: (i) attribute interest expenses to the exempt income; or (ii) make a revocable election to reduce exempt income by 40%, which will have the effect of reducing the benefits of the exemption for CFC income. Reflecting the uncertainties of interest expense attribution, the Budget Bill provides that, in computing any underpayment of estimated tax for the transition year, no amount will be added to the tax for the portion of the underpayment relating to the attribution of interest expense or the 40% election.
• Open Question:
• In light of the potentially significant impact of the attribution of interest expenses with respect to repatriated income qualifying as exempt CFC income, will the State and City tax departments permit less onerous indirect attribution methodologies for this one-time item?
GILTI: Inclusion in taxable income of Global Intangible Low-Taxed Income (“GILTI”) from CFCs.
In general, the new GILTI provisions require a U.S. shareholder of a CFC to pay a minimum aggregate U.S. and foreign tax on its share of the CFC’s earnings. This is carried out first by including the taxpayer’s share of GILTI in its taxable income pursuant to new IRC § 951A, and then allowing a deduction of up to 50% of that amount plus any resulting Section 78 gross-up under IRC § 250, thereby resulting in a reduced federal effective tax rate on that income.
• NYS/NYC Impact. Unlike the one-time repatriation income discussed above, the GILTI inclusion likely does not qualify as “exempt CFC income” because that exemption only applies to additions to federal gross income pursuant to IRC § 951(a) (and the GILTI inclusion is instead pursuant to IRC § 951A). Therefore, it should be includable in entire net income. The deductions provided under IRC § 250 should also apply for New York purposes because they should not be subject to any specific add back. (Note: A State Senate proposal to classify GILTI as other exempt income was not enacted by the Legislature.)
• Open Questions:
• Is the GILTI inclusion amount considered a dividend? If so, it may qualify as “exempt unitary corporation dividends” for New York State and City tax purposes. In order to qualify, however, the corporation that generates the income must be unitary with the taxpayer but cannot be included in the taxpayer’s New York combined return. Tax Law § 208.6-a(c); Admin. Code § 11-652.5-a(c).
• If GILTI is includable in the taxpayer’s business income, should the non-U.S. apportionment factor(s) of the foreign corporations generating the income be used to fairly apportion that income?
Itemized deduction limitations: Limitation of itemized deductions, particularly the $10,000 limitation for state and local taxes.
• NYS/NYC Impact. In an attempt to circumvent the federal limitations on the deductibility of state and local taxes, for years beginning after 2018, New York employers may annually elect to be subject to a new employer payroll tax (“Employer Compensation Expense Program”), converting the taxes to presumably deductible employer payroll taxes, and providing a tax credit to covered employees.
The Budget Bill also authorized the creation of New York State–operated charitable funds to which individuals can make donations and claim a NYS tax credit for 85% of the donation made in the preceding year. Although the Governor had touted the donations as being deductible charitable contributions for federal income tax purposes, a just-released Treasury Department pronouncement strongly suggests that the IRS does not agree (and intends to issue proposed regulations to address this issue). I.R.S. Notice 2018-54 (May 23, 2018).
In addition, beginning in 2018, New York residents will be entitled to claim itemized deductions for New York State and City personal income tax purposes as the law existed immediately prior to the enactment of federal tax reform (i.e., allowing without limitation deductions for local real property taxes, but not state and local income taxes). The Budget Bill now also permits itemized deductions to be claimed for State and City purposes, even for individuals who claim the standard deduction for federal tax purposes.
The Tax Department is also considering a State unincorporated business tax, the purpose of which is to preserve the state and local tax deduction for non-wage income. The Tax Department has recently circulated a UBT “Bill Discussion Draft,” and is seeking comments by July 16, 2018 (see article on page 1).
• Open Questions:
• Will employers electing to be subject to the payroll tax be able to recoup the payroll tax costs by adjusting employee compensation?
• Can an employer segregate into a separate payroll company those New York employees who would benefit from the election, and have the election only apply to the separate payroll company employer?
Qualified business income deduction: Non-corporate owners are entitled to a 20% deduction for qualified business income from a partnership, limited liability company treated as a partnership, S corporation or sole proprietorship under IRC § 199A.
• NYS/NYC Impact. Since the calculation of an individual’s New York State and City taxable income starts with federal adjusted gross income, the 20% deduction should not flow through for State and City purposes.
• Open Question:
• Can a taxpayer nonetheless claim the 20% deduction as a New York itemized deduction? Under existing New York law, the 20% deduction may qualify as a New York itemized deduction, and the law allows individuals who itemize their federal deductions a New York deduction for “the total amount of his or her deductions from federal adjusted gross income . . . as provided in the laws of the United States.” Tax Law § 615(a).
In two recently-issued Technical Memoranda summarizing corporate tax and personal income tax changes enacted in the New York State Budget Bill, the Department states that it will be issuing future guidance on interest expense limitations, mandatory repatriation, and GILTI (for corporations), and on contributions to charitable gift fund accounts and decoupling from the IRC provisions (for individuals). Technical Memorandum, TSB-M-18(3)C and TSB-M-18(4)I (N.Y.S. Dep’t of Taxation & Fin., May 25, 2018).