New York Adopts Budget / Further Developments August 10, 2010 (revised, August 17, 2010)

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1 Multistate Tax EXTERNAL ALERT New York Adopts Budget / Further Developments August 10, 2010 (revised, August 17, 2010) Overview We are issuing this revised Tax Alert to report on further developments in New York s budget process. On August 10, 2010, we released our original alert discussing A D (same as S C), which included the tax provisions of the New York State budget for fiscal year As stated in our earlier alert, we understood that Governor Paterson had signed A D on August 4, Since the date of our earlier release, it has come to our attention that due to a clerical error, the bill originally presented to the Governor for signature was an earlier version of A D that did not contain the final amendments. Thus, the bill signed by the Governor on August 4, 2010, had not in fact been enacted by the New York Legislature and, consequently, did not effect the intended changes to the New York Tax Law. On August 11, 2010, the Governor signed the enacted version of A D, thus bringing the legislation into effect. We are reissuing this Tax Alert to reflect changes to the applicable effective dates of certain tax provisions as a result of the one week delay in the Governor s signing of A D into law. As stated in our earlier alert, on August 4, 2010, the Governor signed A , which made chapter amendments to A D. Previously, the Governor had signed into law Chapter 59 of the Laws of 2010 (A C), establishing the Excelsior Jobs Program. This Tax Alert summarizes the more significant tax changes contained in these new laws. The law changes described herein pertain to New York State and not to New York City except where noted. However, law changes in the sales tax also apply at the local level (including New York City) unless otherwise noted. Deferral of Tax Credits The new law defers the use of most business tax credits and some personal tax credits in excess of $2 million for taxable years beginning in 2010 through A taxpayer may use a pro rata share of each of its applicable credits up to $2 million during the deferral years. 2 Credits in excess of the $2 million annual limitation will be deferred until The following credits, to the extent available under Article 9 (Certain Regulated Businesses), Article 9-A (General Corporation Franchise Tax), Article 22 (Personal Income Tax), Article 32 (Banking Corporation Tax), or Article 33 (Insurance Company Franchise Tax), are subject to deferral: Investment tax credit Empire Zone employment incentive credit QETC employment credit QETC facilities, operations, and training credit Empire Zone wage tax credit Credit for servicing certain mortgages Credit for purchase of certain defibrillators QEZE tax reduction credit Green building credit / Alternative fuels credit Remediated brownfield credit for real property taxes for qualified sites Security training tax credit Conservation easement tax credit Empire Zone investment tax credit Employment incentive credit QETC capital tax credit Special additional mortgage recording tax credit Empire zone capital tax credit Credit for employment of persons with disabilities QEZE credit for real property taxes Low income housing credit Brownfield redevelopment tax credit Environmental remediation insurance credit Credit for fuel cell electric generating equipment expenditures Empire state commercial production credit 1 Tax Law 33, as added by A9710-D, Part Y, Section 1. 2 Tax Law 33.1(b), as added by A9710-D, Part Y, Section 1. Page 1

2 Biofuel production credit Credit for rehabilitation of historic properties Solar energy system equipment credit Credit for certain investments in certified capital companies Clean heating fuel credit Credit for companies who provide transportation to individuals with disabilities Power for jobs credit Historic homeownership rehabilitation credit Deferred nonrefundable credits are converted into a temporary deferral nonrefundable payout credit. 3 This credit can be used to reduce tax liability starting in 2013, but not to an amount that is less than certain minimum taxes specified in the relevant provisions of the various corporate franchise taxes. 4 Taxpayers are allowed an unlimited carryforward of the unused credits. The deferred refundable credits are converted into a temporary deferral refundable payout credit. 5 The deferred refundable credits may be utilized as follows: 50% in 2013, 75% of the remainder in 2014, and the balance in Bad Debt Reserve Deduction for Banks The new law provides that, for taxable years beginning on or after January 1, 2010, New York State and City will conform to federal tax law with respect to the treatment of bad debt deductions for banking corporations. 7 Previously, New York State and City permitted banking corporations to use a reserve method for accruing bad debt deductions. There is no New York State or City provision in the budget legislation providing for the recapture of previous additions to bad debt reserves as a result of this legislative change. Covenants Not to Compete / Termination Agreements Under the personal income tax, income from covenants not to compete and termination agreements received by a nonresident that relates to a business, trade, profession, or occupation carried on previously in New York (whether or not the income is attributable to the taxpayer s activities as an employee) will be treated as New York source income, effective for taxable years beginning on or after January 1, This amendment overrules a long line of New York cases that treated such income as not sourced to New York. New York S Corporation - IRC Section 338(h)(10) and Installment Sales Gains The new law reverses the Tax Appeals Tribunal decision in Matter of Gabriel S. Baum and Francis B. Baum. 9 In Baum, the gain to a nonresident shareholder of a New York S corporation from an IRC section 338(h)(10) transaction was not subject to New York taxation. The reasoning in Baum was that since the S corporation would not have recognized the IRC section 338(h)(10) gain under the Article 9-A corporation franchise tax, 10 that gain should not be recognized by the S corporation s shareholders. Instead, those shareholders were treated as merely selling shares of stock in the S corporation, and under normal New York sourcing rules the gain from selling stock is not New York source income to a nonresident shareholder. The new law explicitly provides that a nonresident shareholder is subject to tax on his share of the IRC section 338(h)(10) gain, regardless of whether such gain is included in the entire net income of the New York S corporation. The gain is sourced under the existing allocation rules applicable to sourcing New York S corporation income. Furthermore, the new law provides that any gain or loss 3 Tax Law 34.1, as added by A9710-D, Part Y, Section 2. 4 Tax Law 187(o), , 606(qq), 1456(v), and 1511(y), as added by A9710-D, Part Y, Sections 3, 4, 5, 6, and 7. 5 Tax Law 34.2, as added by A9710-D, Part Y, Section 2. 6 Id. 7 Tax Law 1453(b)(11), (12), (e)(13), (14), (15), (h)(2), (3), (i)(1) and (2), as amended by A9710-D, Part Z, Sections 1 to 9. New York City Administrative Code (b)(11), (12), (e)(13), (14), (15), (h)(2), (3), (i)(1) and (i)(2), as amended by A9710, Part Z, Sections 10 to Tax Law 631(b)(1)(F), as added by A9710-D, Part B, Sections 1 and 2. 9 DTA # and # , New York State Tax Appeals Tribunal (Feb. 12, 2009). 10 See Zweig Total Return Advisors, Inc., New York State Division of Tax Appeals, ALJ Unit, DTA Nos , , and (December 16, 2004). Page 2

3 on the deemed liquidation of the S corporation stock will not increase or offset the nonresident s IRC section 338(h)(10) gain. 11 This change is effective for taxable years beginning on or after January 1, 2007, for which the statute of limitations for refund or assessment is still open. When there is a failure to file a return or a report of a federal audit adjustment, the filing of a false or fraudulent return with the intent to evade tax (as defined in New York Tax Law section 683(c)(1)), or a substantial omission of income (as defined in New York Tax Law section 683(d)), this change will apply to all taxable years open to the assessment of additional tax. 12 If a New York S corporation distributes an installment obligation to shareholders, the income is sourced to New York based on the applicable corporate tax sourcing rule for the year in which the asset was sold. 13 This provision is effective for the same taxable years as described above with respect to IRC section 338(h)(10) transactions. 14 Furthermore, if an S corporation has made an installment sale and ceases to do business in New York, the income from the sale is treated as New York source income based upon the sourcing for the year of the installment sale. 15 This provision takes effect for taxable years beginning on or after January 1, Narrowing of Affiliate Nexus Rule The new law narrows New York s definition of the term vendor for purposes of the sales tax by providing that the activities in the state of an affiliate in furnishing: (1) accounting or legal services, or (2) various types of management advice/services to a seller of tangible personal property or services will not result in making the seller a vendor. 17 This law change is effective June 1, Corporate Aircraft or Vessels Sales tax exclusions for certain intercorporate transactions involving vessels and aircraft will not apply except in transactions involving a merger or consolidation of two non-affiliated corporations. 19 This change is effective August 11, Tax Return Preparers The new law prohibits tax return preparers or software companies from charging separately for electronic filing of tax documents and prohibits software companies from charging a higher price for a version of the software that supports electronic filing. 21 This prohibition is effective August 11, The new law eliminates the taxpayer opt-out exceptions pertaining to New York State and New York City preparer penalties for failure to file personal income tax returns electronically. 23 These changes are effective for tax returns and other tax documents required to be filed electronically by tax return preparers on or after December 31, The new law also adds certain definitions applicable to the electronic filing of tax returns and tax documents. The definitional changes apply to electronic returns and payments made for taxable years beginning after December 31, Charitable Deduction The new law limits the personal income tax charitable contribution deduction to 25% of the federal 11 Tax Law 632(a)(2), as amended by A9710-D, Part C, Section A9710-D, Part C, Section 4, as amended by A11678, Part B, Section Tax Law 632(a)(2), as amended by A9710-D, Part C, Section A9710-D, Part C, Section 4, as amended by A11678, Part B, Section Tax Law 631(b)(1)(E-1) as added by A9710-D, Part C, Section A9710-D, Part C, Section Tax Law 1101(b)(8)(i)(I), as amended by A9710-D, Part N, Section A9710-D, Part N, Section Tax Law 1111(q), as amended by A9710-D, Part S, Subpart B, Section A9710-D, Part S, Subpart B, Section Tax Law 34, as added by A9710-D, Part G, Section A9710-D, Part G, Section Tax Law 685(u)(5) and New York City Administrative Code (t)(5), as amended by A9710-D, Part G, Sections 4 and 5, respectively. 24 A9710-D, Part G, Section Tax Law section 33, as added by A9710-D, Part G, Sections 2 and 6. Page 3

4 income tax deduction for taxpayers who have New York State or City adjusted gross income exceeding $10 million, effective for tax years beginning after 2009 and ending before New York City may opt out of this change for purposes of the New York City personal income tax. Film Production Credit The new law increases the film production credit by $420 million per year for taxable years 2010 through 2014, makes modifications to the credit, and adds a post-production credit. 27 Empire Zone Provisions The new law provides transitional rules for the expiration of the Empire Zone program. Businesses certified under the program will continue to be treated as certified for purposes of the Empire Zone Employment Investment Tax Credit until April 1, However, businesses that operate qualified investment projects will continue to be treated as certified for purposes of this credit for 10 years. 29 Businesses will continue to be treated as certified for purposes of the Empire Zone Employment Incentive Credit for three years. 30 However, businesses that operate qualified investment projects will continue to be treated as certified for purposes of this credit for 10 years. 31 In order to continue to receive sales tax benefits under the Empire Zone program, qualified Empire Zone enterprises certified prior to April 1, 2009 must be re-certified by the Department of Taxation and Finance before June 30, Taxpayers may continue to claim sales and use tax refunds under the program for the remainder of their sales tax benefit periods. 33 Industrial Development Agencies The new law contains renewed reporting requirements for persons receiving sales and use tax benefits through industrial development agencies. 34 These requirements shall be deemed to have been in effect on and after January 1, Estate Tax Exclusion The budget legislation sets the estate tax exclusion at $1 million, effective for decedents dying on or after January 1, Private Label Credit Cards The rules concerning sales tax refunds and credits applicable to bad debts charged off from private label credit card accounts are repealed effective July 1, Sales Tax Vendor Credit The sales tax vendor credit is eliminated for vendors required to file monthly sales tax returns (sales exceeding $300,000 per quarter) effective June 1, Sales Tax on Hotel Room Occupancy Hotel room remarketers are treated as hotel operators who are required to collect sales tax, and charges imposed by remarketers to the users of hotel rooms are subject to sales tax. 39 A bundling rule is applied to charges for hotel rooms that are sold along with other goods or services, requiring 26 Tax Law 615(g)(2) and New York City Administrative Code (g)(2), as amended by A9710-D, Part HH, Sections 3 and 7. The new law also adds charitable deduction limitations applicable to taxpayers who have New York State or City adjusted gross income of less than $10 million. See, new subsections (g)(1) added to both Tax Law 615 and New York City Administrative Code by A9710-D, Part HH, Sections 3 and See A9710-D, Part Q for amendments and the related effective date provision. 28 Tax Law B(h) and 606(j)(7), as amended by A9710-D, Part R, Sections Tax Law B(g), as amended by A9710-D, Part R, Section Tax Law C(e), 606(j-1), as amended by A9710-D, Part R, Sections Tax Law C(d), as amended by A9710-D, Part R, Section Tax Law 14(h)(1), as amended by A9710-D, Part R, Section Tax Law 14(h)(2), as amended by A9710-D, Part R, Section Pub. Auth. Law , as amended by A9710-D, Part S, Subpart C, Section A9710-D, Part S, Subpart C, Section 4(b). 36 Tax Law 951(a), as amended by A9710-D, Part T, Sections Tax Law 1132(e-1), repealed by A9710-D, Part W, Sections Tax Law 1137(f)(1), as amended by A9710-D, Part X, Section Tax Law 1101(c)(4), (6), as amended by A9710-D, Part AA, Sections 1-3. Page 4

5 that tax be imposed on the entire charge unless the amount applicable to rent for occupancy of the hotel room is separately stated and reasonable. 40 The new law also amends New York City s hotel room occupancy tax to conform it to the New York State tax with regard to room remarketers. 41 These changes are effective September 1, New York City Personal Income Tax Rate The top New York City personal income tax rate (applicable to taxable income in excess of $500,000) is increased from 3.2 to 3.4%. 43 This change is effective for tax years beginning on or after January 1, Sales Tax Clothing Exemption The current state sales tax exemption (regarding clothing and footwear under $110) is suspended from October 1, 2010 through March 31, The exemption will be restored in stages. From April 1, 2011 through March 31, 2012, the exemption will be restored for clothing and footwear under $55. Beginning April 1, 2012, the exemption once again will apply to clothing and footwear under $110. Local governments may choose whether to follow these new exemption rules or to continue their current exemption practices in accordance with the rules governing such options by local jurisdictions. 45 Captive REITs/RICs The provisions requiring combined filing for captive REITs and RICs are made permanent. 46 As originally enacted, these provisions were scheduled to sunset for taxable years beginning on or after January 1, In addition, the definition of a captive REIT was amended to provide that ownership of the REIT by any entity treated as a corporation (e.g., a check-the-box entity) will potentially cause captive REIT status. The tax law was also amended to provide that an Australian Property Trust and a qualified foreign entity would not be associations for purposes of the captive REIT provisions. A qualified foreign entity is one that: (1) has 75% of its total assets in real estate (including holdings in other REITs, cash equivalents, and US Government securities); (2) is not subject to tax on amounts distributed to its shareholders or is exempt from entity level taxation; (3) distributes at least 85% of its taxable income to holders of its shares or certificates of beneficial interest on an annual basis; (4) not more than 10% of the voting power or value in the entity is held (directly, indirectly or constructively) by a single entity or individual, or the shares or beneficial interests of the entity are regularly traded on an established securities market; and (5) is organized in a country that has a tax treaty with the U.S. 47 This change is effective August 11, Credit Card Reporting Persons required to file with the Internal Revenue Service (under Internal Revenue Code 6050W) reports of credit card and third party network transactions must also file with the New York State Department of Taxation and Finance a copy of the federal information related to New York residents. 49 This change is effective August 11, Excelsior Jobs Program Credit The Excelsior Jobs Program provides an Excelsior Jobs Program Credit ( EJPC ) for taxpayers who qualify for the program. 51 The EJPC is available for five taxable years. This recently adopted credit consists of four components: (1) jobs credit equal to a sliding scale percentage of wages up to $5,000 per job, (2) 2% investment credit, (3) 10% research and development credit, and (4) real 40 Tax Law 1105(e)(2), as amended by A9710-D, Part AA, Section New York City Administrative Code (a)(4) and (5), as amended by A9710-D, Part AA, Sections A9710-D, Part AA, Section New York City Administrative Code (a), as amended by A9710-D, Part EE, Sections A9710-D, Part EE, Section Tax Law 1115(a)(30), as amended by A9710-D, Part GG. 46 A9710-D, Part MM, Section 1-2, amending Chapter 57, Part FF-1 of the Laws of Tax Law 2.9, as amended by A-9710-D, Part NN, Section Tax Law 2.9, as amended by A-9710-D, Part NN, Section Tax Law 1703, as added by A9710-D, Part E, Section A9710-D, Part E, Section Tax Law 31, as added by Part MM, Section 2, of Chapter 59 of the Laws of Page 5

6 property tax credit equal to a percentage of property taxes paid with respect to certain projects that had qualified for Empire Zone benefits. 52 The EJPC is provided through a discretionary program administered by the New York State Department of Economic Development. The aggregate amount of credits is capped at $50 million for taxable years beginning in The annual cap rises in $50 million increments to a maximum of $250 million for taxable years beginning in 2015 and then shrinks in $50 million increments until expiration of the program after The EJPC is limited to certain types of operations as follows: (1) financial services data centers or back office operations, (2) manufacturing, (3) software development and new media, (4) scientific research and development, (5) agriculture, (6) creation or expansion of back office operations, (7) distribution centers, and (8) other industries to be identified by the Commissioner of Economic Development. 54 Eligible taxpayers must meet specified jobs requirements. 55 Additionally, taxpayers must apply to participate in the program and, if accepted, are provided with a preliminary schedule of the tax credits to which they will be entitled based on projected jobs and investment. To qualify, taxpayers must be subject to tax under the corporate franchise tax (Article 9-A), the bank tax (Article 32), the insurance company tax (Article 33), or the personal income tax (Article 22). 56 To receive the credits, taxpayers must demonstrate annually that they have met the jobs and investment targets. 57 Certain industries are specifically excluded from the EJPC, namely, (1) not-for-profits; and (2) service business, including those engaged in business and professional services, utilities, retail, entertainment, electrical generation or distribution, natural gas distribution, or production of steam associated with production of electricity. 58 The EJPC is refundable to the extent it exceeds tax liability. 59 Neither the investment tax credit nor the brownfields credit may be claimed for property for which the investment credit portion of the EJPC is claimed. 60 The New York State Department of Taxation and Finance is instructed to publish a report annually providing, among other things, the names of taxpayers claiming the EJPC. 61 Contacts If you have questions regarding these tax law changes or other New York tax matters, please contact any of the following Deloitte Tax LLP professionals or your Lead Multistate Professional: James W. Wetzler Director Deloitte Tax LLP, New York, NY jwetzler@deloitte.com Jay M. Rosen Director Deloitte Tax LLP, New York, NY jarosen@deloitte.com Russell W. Banigan Director Deloitte Tax LLP, Jericho, NY rbanigan@deloitte.com Tax Law 31(a), as added by Part MM, Section 2, of Chapter 59 of the Laws of Ec. Dev. Law 355, as added by Part MM, Section 1, of Chapter 59 of the Laws of Ec. Dev. Law 359, as added by Part MM, Section 1, of Chapter 59 of the Laws of Ec. Dev. Law 353.1(a)-(h), as added by Part MM, Section 1, of Chapter 59 of the Laws of Ec. Dev. Law , as added by Part MM, Section 1, of Chapter 59 of the Laws of Tax Law 31(a), as added by Part MM, Section 2, of Chapter 59 of the Laws of Ec. Dev. Law 354.2, 3 and 5, as added by Part MM, Section 1, of Chapter 59 of the Laws of Ec. Dev. Law 353.4, as added by Part MM, Section 1, of Chapter 59 of the Laws of This list of excluded industries appears to overlap with the activities that are specifically included in the program. 59 Tax Law , 606(qq), 1456(u) and 1511(y), as added by Part MM, Sections 3, 4,6 and 7, of Chapter 59 of the Laws of Tax Law 31(c), as added by Part MM, Section 2, of Chapter 59 of the Laws of Tax Law 31(e), as added by Part MM, Section 2, of Chapter 59 of the Laws of Page 6

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