N.Y. SALT Cap Repair Tucked Into Finances Delivers Broader Tax Break

Thousands of additional New York businesses may now be able to seize on a lucrative tax break after policy makers agreed to make a technical fix as part of a $220 billion budget deal signed into law by Gov. Kathy Hochul.

Tucked inside the largest-ever state spending plan, which promises a little less pain at the pump and help for working parents, is also an adjustment to the state and local tax law that will now allow more New York residents to receive the full benefit of a SALT cap workaround passed last year.

“The limitation was really negatively impacting lots of New York residents who own S corporations in New York,” said Timothy Noonan, a tax attorney at Hodgson Russ in New York City.

Single shareholder S corporations, along with S corps that had a mix of resident and nonresident shareholders, received limited tax benefits from last year’s “pass-through entity tax,” which gave partnerships, limited liability companies, and S corporations a way to ease the pain of a $10,000 federal cap on individuals’ deductions for state and local taxes paid.

Tax changes would apply starting in tax year 2022. However, the deadline for firms to elect for the pass-through entity tax for this year closed on March 15.

“We have so many S corporations, in particular, single one-shareholder S corporations that chose to pass on it because maybe they didn’t have a high enough allocation— it just wasn’t worthwhile for them,” said Alan Goldenberg, a state and local tax principal at Anchin, Block & Anchin LLP. “But now they could be getting substantial benefit. It’d be nice if they could elect in.”

A spokesman for the New York Department of Taxation and Finance did not immediately respond to a request for comment on whether the agency is considering extending the deadline following the tax law changes.

Limited Access to Workarounds

New York followed other states, including neighboring New Jersey and Connecticut, that provided the adjustment following guidance from the Internal Revenue Service last November that allows some kinds of workarounds for the cap imposed in the 2017 tax law.

More than 95,000 pass-through entities opted into the work around by the October 15 deadline, representing roughly 10% of eligible businesses, according to the state’s tax department. It’s anticipated under these new changes many more businesses will want to take advantage.

The 2021 SALT cap maneuver allowed pass-through businesses to pay state income taxes at the entity level, instead of having income pass to individual owners or members for taxation. The taxes would be offset by a corresponding individual income tax credit.

However, the relief was limited because unlike partnerships that can have special allocations, S corps are not allowed to have different classes. The state’s tax department was concerned about possible federal tax problems if firms had differential treatment between resident and nonresident shareholders within a single entity. The state’s tax department initial solution was to limit the tax to source income only.

During the recent legislative session, the Business Council of New York State pushed lawmakers and tax department officials, who agreed to revisit the issue, and change the law to create new two classes of S corporations for the purposes of optional tax: the “electing resident S corporation” and the “electing standard S corporation” for residents to reap the tax break.

“The more compelling issue was probably here’s a mechanism to provide real world tax relief without it affecting the state’s budget,” said Ken Pokalsky, vice president of the Business Council of New York State, representing a couple thousand employers.

Pioneering Expansion in NYC

Lawmakers also agreed to a first-of-its-kind pass-through entity tax at the city level in New York for partners and residents of S corporations. The Partnership for New York City had been urging the previous administration under Mayor Bill de Blasio to conform the city’s tax code to the state tax code to keep high-income earners and businesses from fleeing the city.

The legislature can’t change the tax code as it applies to New York City without the mayor’s approval.

However, Mayor Eric Adams “saw right away that this was a tangible way to demonstrate to his commitment to maintaining New York’s tax base, keeping high earners in the city, where they create jobs and contribute to our overall economy in very large ways,” said Kathryn Wylde, president of the Partnership for New York City, which represents the top CEOs.

However, some attorneys argue that the city’s tax code change could have a limited benefit depending on an individual firm. Firms will need to weigh electing into the city pass-through entity tax, which they will need to pay for upfront, versus receiving federal tax savings later. They will also have to make an entirely separate city election next year different from the state election.

“The question then becomes is it worthwhile for the business to have to elect in for New York City?” said Goldenberg. “Is it worthwhile to make that payment because they are not going to have the cash?”