On January 19, 2021, New York Governor Andrew Cuomo published his Fiscal Year 2022 Executive Budget and related legislation (the "Budget Proposal"). While the Budget Proposal contains a variety of important provisions, this post will cover one of the most notable: the proposed pass-through entity ("PTE") workaround to the $10,000 limitation on Federal state and local tax deductions (the "SALT cap").
This blog has previously discussed PTE workarounds in depth here, so only a high-level review of the current landscape is required for the purposes of this post. To combat the negative impacts of the highly politicized SALT cap, many states enacted workarounds permitting partnerships and S corporations to pay tax at the entity level. The theory behind these workarounds is that, because the SALT cap applies only to individuals, state and local income taxes applied at the entity level should be fully deductible at the Federal level without regard to the individual limitation. Especially given recent IRS approval of PTE workarounds, many ( including the authors) predicted that New York would inevitably work to enact such a workaround in 2021. This prediction seems to be coming true.
The Proposed Legislation
Most importantly, the Budget Proposal would create Article 24-A, providing an elective PTE tax for any taxable year beginning on or after January 1, 2022. First, let's clarify who qualifies. The workaround is only available to partnerships and S corporations that are comprised solely of individual partners or shareholders. Additionally, and similar to the majority of currently existing PTE workarounds, because the regime is elective eligible entities would be required to make an annual election by the first day of the last full month prior to the start of their tax year (December 1 for calendar year entities) in order to participate. For each year the election is in place, the entity must certify its eligibility for the workaround election by attaching a certificate of eligibility to its yearly return.
If the entity validly elects into the PTE workaround, it will be required to pay tax at a rate of 6.85 percent on its partnership taxable income or S corporation taxable income (as defined by the legislation). This generally means that electing entities would be subject to tax on their income allocated or sourced to New York (as well as guaranteed payments for partnerships). The Budget Proposal also amends § 606 of the Tax Law, creating a PTE tax credit for the individual partners or shareholders of electing entities. Each electing entity would be required to provide its partners or shareholders with the amount of PTE tax imposed on and paid by the entity, which the partner or shareholder would then use to calculate their related credit in the amount of 92 percent of his or her proportionate share of the PTE tax paid by the entity.
Additionally, the Budget Proposal adds a resident tax credit by amending § 620 of the Tax Law, which would provide that New York residents are allowed a resident tax credit for 92 percent of their share of "substantially similar" PTE taxes paid by the electing entity to other states. Like the workaround itself, this credit is only available starting in 2022, so New Yorkers are still left to wonder whether credits were or could be legally taken for PTE taxes paid between 2018-2021. Resident credits are a crucial facet of any PTE workaround regime - for further information, please see our post on this issue here.
Finally, the Budget Proposal makes clear that partners and shareholders of electing entities would remain jointly and severally liable for the tax imposed at the entity level pursuant to a PTE workaround election.
While the proposal gives taxpayers some insight into what form New York's PTE workaround might eventually take, there is lingering uncertainty surrounding whether such a workaround will even be useful once enacted. Given that the SALT cap primarily harms high-tax (and typically Democratic) states, Democratic victories in the recent Senate runoff elections could result in a repeal of the SALT cap altogether. Further changes to the Federal tax law (such as the 28 percent cap on itemized deduction for those earning more than $400,000 that President Biden has proposed) could also play into the analysis.
While we cannot say with certainty what the future will bring, the coming year promises to be a busy one for SALT practitioners - stay tuned!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.