New York state law enacted in response to federal tax reform
On April 12, 2018, New York enacted legislation, Budget Bill SB7509-C/A 9509-C (the bill) designed to mitigate some of the negative effects of the federal Tax Cuts and Jobs Act of 2017 on New York taxpayers.
Employer Compensation Expense Program
Under the new Employer Compensation Expense Program (ECEP), employers can elect to opt into a new payroll tax on annual wages each year. Electing in would impose a maximum 5 percent employer payroll tax on all New York wages paid in excess of $40,000 per employee in a calendar year. The election covers all employees who are subject to income tax withholding and would be made at least one month before the beginning of the year to which it would apply. The first eligible calendar year is 2019. The payroll tax would be gradually phased in and equal 1.5 percent in 2019, 3 percent in 2020 and 5 percent each year after. This tax would be deductible on the employer’s federal business income tax return. The employer would remit the ECEP to the New York State Department of Taxation and Finance with the regular personal income tax withholding.
The affected employee(s) would in turn receive a New York personal income tax return credit for the employer payments made on the employee’s behalf. However, the taxpayer needs to have a New York tax liability to use the credit. Otherwise, the credit is available for a carryforward to future years until utilized.
The credit is calculated as follows:
Employer’s payroll tax deduction attributable to employee
x
(1 - Employee’s NY personal income tax due for calendar year
Employee’s NY taxable income for calendar year)
Employers who elect into the ECEP cannot deduct this payroll tax from the employee’s wages. Additional guidance is available in New York State Technical Memorandum TSB-M-18(1) ECEP.
Charitable gifts trust fund
New York State also recently established a state-operated Charitable Gifts Trust Fund (CGTF). The fund, which will be in the custody of the state comptroller, has two accounts. One account is the “elementary and secondary education account” which is designed to improve New York state education for public school students at the elementary and secondary school levels. The other is the “health charitable account.” Its goal is to enhance New York state healthcare (including primary, preventive, dental, vision, hunger prevention, nutritional assistance and inpatient care). Subject to IRS approval, taxpayers who donate to either of the two accounts could claim a federal tax charitable contribution deduction in the contribution year and a New York charitable contribution deduction that may be subject to New York’s existing itemized deduction limitation. Additionally, taxpayers can take a credit on the New York personal income tax return in the year after the contribution equal to 85 percent of the value of the donation. The credit is only able to offset New York state personal income tax liability (e.g., the credit cannot offset New York City income tax).
For example:
A $100,000 cash donation to the state-operated CGTF during the 2018 calendar year could generate a 2018 federal charitable contribution deduction of $100,000 and a 2019 New York tax return credit of $85,000 (if the 2019 New York tax return has a New York state tax liability of at least $85,000).
For each CGTF contribution made, the donor must apply for a contribution authorization certificate from the organization.
Donations to the following three New York state organizations: Health Research Inc., the State University of New York Impact Foundation, and the Research Foundation of the City University of New York are limited (each of these pre-existing organizations is only able to accept up to $10 million total in qualified charitable donations per year).
The bill authorizes local jurisdictions (counties, cities, towns, villages and school districts) with populations of less than one million to establish similar public purpose charitable contribution funds. Subject to IRS approval, taxpayers who donate to the local funds may have the opportunity to claim a federal charitable tax deduction for each donation made, plus a potential New York real estate tax credit of up to 95 percent of the total value of the donation (note that the local jurisdiction can provide a credit of less than 95 percent). The credit cannot exceed the real estate tax due for the related 12-month period. Currently there is limited information available. We would recommend you check with your local jurisdiction to determine if a local charitable gift trust fund has been set up (e.g., the Village of Rye Brook has already created a charitable gift trust fund).
Federal response
On May 23, 2018, the IRS issued Notice 2018-54, which states it will be releasing proposed regulations to address this matter.
Treasury has also indicated their opposition to these state charitable funds. As such, taxpayers should be advised that the IRS will likely disallow any such deduction upon examination and the taxpayer may need to litigate in order to secure the deduction. Generally, only section 501(c) organizations qualify for a charitable contribution deduction. Historically, these entities must apply for such status. It remains to be seen whether these state government-sponsored charitable funds can receive IRS-approved determination letters to accept tax-deductible donations. In addition, a tax-deductible charitable contribution must be made without any expectation of a return benefit. If taxpayers do not make the contribution to these state-sponsored funds, they likely remain obligated to pay their income tax liability to the state government. Therefore, a donation in exchange for a tax credit appears to be a quid pro quo, potentially limiting the amount of the actual tax deduction to the net 15 percent of the amount paid to the respective funds.
However, there is case law and administrative guidance, known as the “full deduction rule,” whereby the amount of a donor’s charitable contribution deduction for federal purposes is not reduced by the value of any state tax benefits received. There appears to be no clear legal basis for differentiating between the New York style state charitable tax credits with varying credit percentages and treating all charitable tax credits as a quid pro quo, requiring the donor to reduce the amount of their federal deduction by the value of the credit. This would not only be inconsistent with the legal precedent but would also entail considerable complexity, both for taxpayers and tax administrators. Therefore, we believe that current law supports the full deduction rule in the case of donations where the donor qualifies for state charitable tax credits equal to less than 100 percent of the donation.
Conclusion
It has not yet been determined whether the IRS will formally recognize these payments as a federally tax-deductible charitable contribution or will reclassify as nondeductible.
Our firm currently believes there is substantial authority for claiming a charitable contribution deduction for these payments provided there is a statement formally disclosing this position on the tax return. However, this could change depending upon subsequent developments from the IRS.
If the IRS does issue regulations disallowing these types of deductions, taxpayers claiming such deductions will likely have it denied upon IRS examination and would have to challenge the authority of the regulation in either tax or district court.
The bill directs the New York State Department of Taxation and Finance to provide a method for taxpayers to submit claims online for reimbursement of federal interest attributable to a final determination disallowing the charitable deduction. The reimbursement would only apply to interest paid on fixed and determinable underpayments made to the IRS for the 2019-2021 tax years.
For more information on this topic, or to learn how Baker Tilly state and local tax specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
