By Christian J. Burgos, Executive Director and Co-Head of State and Local Tax Services at Friedman LLP
The recently enacted New York Budget Act for 2021–22 introduced a number of significant changes to state income tax that will affect many New York individuals and businesses alike. The law is designed to help boost the state's economy by offering a range of tax breaks and incentives to middle-class families and certain companies in the food and hospitality sectors.
But not everyone is a winner. High-income individuals, and the real estate industry in particular, are likely to shoulder the brunt of Governor Andrew Cuomo's tax plans.
The Comprehensive Budget Act, which came into force in April 2021 and will generally come into effect from the 2021 tax year, contains several changes to the Income Tax Act and the tax laws for companies. When combined with New York City tax rates, it results in some of the highest tax rates in the country.
Real estate is one of the largest businesses after financial services that contribute to New York State's gross domestic product (GDP). Most real estate companies are generally organized as partnerships of individuals, corporations, and institutional investors likely to be affected by the state's tax law changes.
From the 2021 tax year until the end of 2027, high earners will experience an increase in their personal income tax rates. Before the state's tax law change, the top tax rate was limited to 8.82 percent.
However, individuals with incomes greater than $ 1 million are now subject to a minimum of 9.65 percent personal income tax based on their enrollment status (e.g., single, jointly registered marriage, etc.). This is 10.30 percent for people with an income of more than $ 5 million and is capped at a top tax rate of 10.90 percent for income in excess of $ 25 million.
Similarly, the New York franchise tax rate for companies with a business tax base of more than $ 5 million was also increased from 6.5 percent to 7.25 percent. The corporate tax rate remains at 6.5 percent for companies with a business tax base of $ 5 million or less.
Both personal and corporate tax rate increases are temporary, at least for now, with income tax rates phasing out after 2027 and corporation tax rates phasing out after 2023. New York City individuals and corporations generate a significant amount of their income from equity interests in real estate companies – be it rental income, transferred or sponsored interests, or capital gains – are likely to be hardest hit.
To make matters worse, the state is getting rid of the state's Opportunity Zones program, delaying recognition of capital gains for eligible taxpayers making an equity investment in a qualifying opportunity fund. Such funds are typically an investment vehicle organized as a partnership or, in some cases, a corporation.
In principle, taxpayers must now include all capital gains that were otherwise excluded from federal gross income in their state income tax base. Therefore, the income reported on your tax returns for New York State income tax purposes can be significantly higher than the income reported to the Internal Revenue Service.
While the increase in tax rates and the decoupling from the federal opportunity zones program appear to be a direct blow to the higher earners and those in the real estate industry in general, all is not lost.
Under the Treasury Department's recently issued guidelines, budget legislation created a new, optional pass-through tax system (“PTE”). This effectively bypasses the $ 10,000 federal state and local tax ("SALT") limit enacted under the Tax Cuts and Jobs Act of 2017.
Beginning with the current tax year, transit company owners – such as partnerships, limited liability companies (LLCs), and S companies – can make a choice to be taxed at the corporate level, which for federal income tax purposes is not subject to the SALT cap restriction. The electing pass-through entity generally calculates its business income and pays state income tax while retaining certain pass-through functions, including a state tax credit that is used by the owners of the electing PTE when filing and paying their state income tax return .
Tax rates on taxable income of PTE's choice of income range from 6.85 percent to 10.90 percent, generally reflecting the state's new income tax brackets. Eligible transit company owners are granted a refundable credit against their personal income tax based on each holder's distributive share of the PTE tax paid. In addition, PTE owners can claim credits for multiple dialing PTEs.
So while New York taxpayers will generally see their state tax expenditures spike, under the new PTE tax system there will likely be some relief from a federal income tax perspective.
Overall, the new legislation poses new challenges for the real estate industry and taxpayers are encouraged to consult with their tax advisors about the impact of the recent changes on them.
If you have any questions about your obligations under the new New York tax laws, please contact Christian Burgos [email protected] or (332) 216-0760.
This content was originally published on friedmanllp.com.