2009-2010 Budget Bill Makes Important Changes to NYS Tax Laws SUMMARY The 2009-2010 New York State Budget Bill which was recently signed into law makes a number of changes to the New York State ( NYS ) taxation of individuals including: an increase in the top personal income tax rate from 6.85% to 8.97%; elimination of most itemized deductions (including deductions for investment interest) for taxpayers with over $1 million in adjusted gross income; modification of the test for NYS residency, making it more likely that an individual domiciled in NYS will be considered a NYS resident for NYS income tax purposes; and taxing non-residents on gains from sales of certain types of entities holding NYS real estate. Some of the more significant tax law changes for corporations are: requiring any overcapitalized captive insurance company to join in its parent s NYS combined Article 9-A or Article 32 return; an expansion of taxing jurisdiction, or nexus, requiring certain out-of-state vendors to collect NYS sales tax on sales to NYS customers; and increasing the minimum first installment payment of franchise tax under Articles 9, 9-A, 32 and 33. All the foregoing provisions are effective for taxable years beginning on or after January 1, 2009, unless otherwise noted below. Certain items in the proposed Executive Budget (released in December 2008) that were not included in the final Budget Bill include: (i) repeal of the private label credit card bad debt sales tax refund law enacted in 2006, (ii) information reporting by banks of all deposits made by sales tax vendors, and (iii) a proposal to classify capital gain income recognized by investment partnerships and allocated to certain non-nys partners as New York source income and thus subject to NYS tax. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
The new legislation implements the 2009-2010 NYS fiscal plan and thus it is referred to as the Budget Bill. 1 The following is a more detailed description of the provisions of the Budget Bill outlined above. CERTAIN CHANGES AFFECTING INDIVIDUALS Increase in Income Tax Rates The Budget Bill increases NYS s highest income tax rate from 6.85% to 8.97% and adds a new rate of 7.85%. 2 Although described as an increase in marginal rates, the higher rates generally apply to all taxable income of affected taxpayers. 3 The following tables highlight these changes. Prior 4 : NYS Tax Rate Married individuals filing jointly Heads of households Unmarried individuals and married individuals filing separately 6.85% New York taxable income over $40,000 over $30,000 over $20,000 Budget Bill: NYS Tax Rate Married individuals filing jointly Heads of households Unmarried individuals and married individuals filing separately 6.85% New York taxable income over $40,000 but not over $300,000 7.85% New York taxable income over $300,000 but not over $500,000 8.97% New York taxable income over $500,000 over $30,000 but not over $250,000 over $250,000 but not over $500,000 over $500,000 over $20,000 but not over $200,000 over $200,000 but not over $500,000 over $500,000 1 2 3 4 2009 N.Y. Laws ch. 57. Budget Bill, Part Z-1, 1. This is because there are two new supplemental taxes. The first, affecting taxpayers earning more than $300,000, results in the taxpayer s entire being taxed at 7.85%, subject to a phase in between $300,000 and $350,000. Budget Bill, Part Z-1, 2. The second, affecting taxpayers earning more than $500,000, results in the taxpayer s entire New York taxable income being taxed at 8.97%, subject to a phase in between $500,000 and $550,000. Budget Bill, Part Z-1, 3. N.Y. Tax Law 601. All citations to N.Y. Tax Law are to the law in effect prior to enactment of the Budget Bill. -2-
Significantly, the Budget Bill also provides that, for purposes of determining the required installments of estimated tax for 2009, the computation of 100% of the tax for the preceding year is to be made as if the new law had been in effect in 2008. 5 Elimination of Itemized Deductions for Taxpayers with Income Over $1 Million Under the pre-budget Bill law, NYS taxpayers who itemize deductions for U.S. federal income tax purposes may elect to take those same deductions (with certain modifications) for NYS tax purposes 6 ; in the case of taxpayers with NYS adjusted gross income of over $525,000, the modifications included a disallowance of 50% of the taxpayer s itemized deductions for U.S. federal income tax purposes. 7 The Budget Bill adds a new rule prohibiting taxpayers with NYS adjusted gross income in excess of $1 million from claiming any itemized deductions (except the charitable contribution deduction). 8 Itemized deductions include the deduction for interest paid on debt incurred with respect to property held for investment (including debt incurred by a partnership in which the individual is a partner). 9 The elimination of this deduction for NYS purposes means that income from leveraged investments that do not constitute a trade or business (including leveraged investment partnerships) will be taxed by NYS essentially on a gross basis (i.e., without any deduction for the interest expense). As indicated above, prior to the Budget Bill, 50% of this interest was deductible. Modification of the NYS Residency Test Prior to the Budget Bill, an individual domiciled in NYS was not considered a NYS resident for tax purposes if within any 548 consecutive day period (i) the individual was out of the country for at least 450 days, (ii) the individual was not present in NYS for more than 90 days, and (iii) the individual s spouse or minor children did not reside at the individual s permanent place of abode in NYS for more than 90 days. 10 5 6 7 8 9 10 Budget Bill, Part W-1, 2. Similar changes were also made to the NYC tax law. Id. 4. See N.Y. Tax Law 615. N.Y. Tax Law 615(f). This threshold is the same for all taxpayers irrespective of filing status. Id. Similar reductions are applicable under NYC tax law. Administrative Code of City of N.Y. 11-1715(f). Budget Bill, Part W-1, 1. This threshold is the same for all taxpayers irrespective of filing status. Id. Similar changes were also made to the NYC tax law. Id. 3. See I.R.C. 163(d)(3). See N.Y. Tax Law 605(b)(1)(A)(ii). -3-
The Budget Bill changes the third requirement so that the spouse s or minor children s presence in NYS no longer needs to be at a permanent place of abode. 11 According to the Executive Memorandum in Support, this change was necessary because individuals were avoiding tax as residents by having their spouses or children stay with relatives or in a hotel. 12 Taxation of Non-Residents on Sales of Interests in Entities Holding NYS Real Estate Individuals not resident in NYS are generally taxed on gains from the sale of real property located in NYS. 13 Prior to the Budget Bill, taxable gains did not include gain from the sale of an interest in an entity that held NYS real estate. 14 The Budget Bill modifies the term real property located in this state to include an interest in a partnership, limited liability corporation, S corporation, or non-publicly traded C corporation with 100 or fewer shareholders, if, in each case, 50% or more of the fair market value of the entity on the date the interest was sold was attributable to real property located in NYS. 15 For this calculation, property is included in the denominator only if owned by the entity for at least two years prior to the sale of the interest. The portion of the gain subject to NYS tax is equal to the total gain multiplied by a percentage equal to the value of NYS real estate held by the entity divided by the value of all the entity s assets. This formula can lead to a non-resident being taxed on gain that is not attributable to the appreciation of NYS real property. For example, X, a non-resident individual, contributes $100x to an entity that purchases $75x in NYS property and $25x in other assets. Three years later, the NYS property has declined in value from $75x to $60x, but the other assets have risen from $25x to $60x (so half of the value of the entity is in NYS real property and half is in other assets). X sells his interest for $120x, recognizing a total gain of $20x. Even though none of that gain is attributable to the NYS property, under the new law, NYS would tax $10x of the gain. This provision is effective for sales occurring on or after May 7, 2009. 16 11 12 13 14 15 16 Budget Bill, Part A-1, 1. Similar changes were made to the definition of resident for NYC and Yonkers tax purposes. Budget Bill, Part A-1, 2-5. 2009-10 New York State Executive Budget Revenue Article VII Legislation Memorandum in Support ( Memo in Support ), Part A. N.Y. Tax Law 631(a), (b)(1)(a). The same rule applies to NYS real property gains recognized by entities that are not NYS residents. Memo in Support, Part H. Budget Bill, Part F-1, 1. Budget Bill, Part E-1, 2 (30 days after the enactment date). -4-
CERTAIN CHANGES AFFECTING CORPORATIONS Overcapitalized Capital Insurance Companies Subject to Tax under Article 9-A or Article 32 The Budget Bill generally requires any insurance company that meets the definition of an overcapitalized captive insurance company to be included in a combined Article 9-A or 32 return with its direct or indirect NYS controlling shareholder, and, if there is none, to be taxed as a standalone Article 9-A corporation. 17 An overcapitalized captive insurance company is defined as an insurance company (i) licensed under insurance laws as a captive insurance company, (ii) whose stock is more than 50% owned or controlled, directly or indirectly, by a single corporation that is not exempt from U.S. federal income tax, (iii) whose business includes providing, directly and indirectly, insurance or reinsurance covering the risks of its parent or other 50%-connected affiliates, and (d) 50% or less of whose gross receipts for the taxable year consist of premiums (which is intended to demonstrate that the captive is overcapitalized ). According to the Memorandum in Support, this change was needed to prevent Article 9-A or 32 taxpayers from improperly avoiding NYS taxation of the income on their investment assets by transferring those assets to a captive insurance company that would be taxed under Article 33 or not taxed by NYS at all. 18 Another Expansion of Nexus: This Time for Sales Tax Over the past few years, NYS has, like other states, expanded its interpretation of its jurisdiction to tax, or nexus, so as to tax corporations that have no physical presence in NYS but makes sale to or have other types of contracts with NYS residents. Last year s budget bill enacted (i) the Amazon-tax, which generally required an out-of-state retailer to collect NYS sales tax if it has a commission referral agreement with a NYS resident whose website refers customers to the retailer, and (ii) a rule that required credit card issuers and processors to pay NYS bank tax if they meet certain thresholds regarding credit card customers or merchants. 19 This year s Budget Bill adds to this list, enacting a new law requiring outof-state retailers to collect NYS sales tax based upon the presence of an affiliate in NYS. Specifically, the Budget Bill requires an out-of-state retailer to collect NYS sales tax if any affiliate either (i) uses, in NYS, the same trademark, service mark or trade name as the out-of-state retailer, or (ii) engages in activities in NYS that inure to the benefit of the out-of-state retailer in its development or maintenance of a market for its goods or services in NYS (but only, according to the text of the new statute, to the 17 18 19 Id. 1. Memo in Support, Part F. N.Y. Tax Law 1101(b)(8)(vi) and 1451(c)(1). Amazon and Overstock.com both sued NYS asserting that the so-called Amazon tax was unconstitutional, and a court ruled in favor of NYS in January 2009. Amazon.com LLC v. New York State Dep t of Taxation & Fin., 2009 WL 69336 (N.Y. Sup. Ct. Jan. 12, 2009); Overstock.com, Inc. v. New York State Dep t of Taxation & Fin., N.Y. Supreme Court, No. 107581/08 (N.Y. Sup. Ct. Jan. 12, 2009). -5-
extent that those activities of the [NYS] affiliate are sufficient to satisfy the nexus requirement of the United States constitution ). 20 Significantly, the threshold for affiliation here is a more than 5% ownership connection. Other states have enacted similar rules, but generally use a 50% ownership connection threshold. This rule takes effect on June 1, 2009. 21 Increasing the First Installment Payment of Franchise Tax The Budget Bill increases the percentage used to calculate the mandatory first installment due from Article 9, 9-A, 32 and 33 corporations. Prior to the Budget Bill, a corporation with a franchise tax liability of more than $100,000 in the preceding year was required to pay 30% of the prior year s tax liability as the first installment of tax. 22 The Budget Bill increases the mandatory first installment to 40% of the preceding year s tax liability. 23 This new 40% rule applies even if the taxpayer s total liability for the year is expected to be less than that amount; any overpayment is refundable with interest. 24 This change applies to taxable years beginning on or after January 1, 2010. * * * 20 21 22 23 24 See Budget Bill, Part P-1, 1; N.Y. Tax Law 1131(1), 1133(a). An affiliate means any person (i) more than 5% controlling or controlled by (directly or indirectly) the out-of-state seller, or (ii) more than 5% owned by (directly or indirectly) the same person or group of affiliated persons. N.Y. Tax Law 1101(b)(8)(v)(B). See Budget Bill, Part P-1, 2. See N.Y. Tax Law 197-b(1)(a)(ii), 213-b(a)(ii), 1461(a)(ii), 1514(a)(1)(ii). Budget Bill, Part G-1. See N.Y. Tax Law 197-b(5), 213-b(e), 1461(e), 1514(e). Copyright Sullivan & Cromwell LLP 2009-6-
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