On April 9, New York Governor Kathy Hochul (D) signed tax legislation (A9009-C; S8009-C) as part of the state’s FY23 budget. The legislation amends the state’s pass-through entity tax (PTET) by creating a new S corporation category for entities with all resident shareholders and excluding pass-through entity taxes from the definition of “income taxes” for purposes of the addback to state taxable income. Additionally, and of significant note for New York City (NYC) resident individuals, the legislation establishes a new Tax Law Article 24-B creating a NYC PTET.
The legislation also accelerates certain reduced individual income tax rates and provides for an alternative tax table benefit recapture for certain taxpayers. The legislation expands the definition of “financial institution” for purposes of Tax Law Section 1701 (relating to the financial institution data match system for state tax collection purposes) to include certain “virtual currency businesses.” The legislation also amends or creates new tax credits and makes other changes.
Action item: With the enactment of a new PTET in New York City and the amendments to the state’s PTET, affected businesses may want to model the impact of electing into these taxes to determine the benefit across all partners and shareholders.
Effective for tax years beginning on or after January 1, 2021, New York enacted the PTET allowing partnerships (as defined under IRC Section 7701(a)(2)) and S corporations to make an annual election to pay an entity-level tax at rates ranging from 6.85% to 10.9% on the entity’s taxable income. An offsetting personal income tax credit is allowed for the electing partnership’s direct partners or members or the S corporation’s direct shareholders.
Under the new legislation, effective for tax years beginning on or after January 1, 2022, the definition of an “electing S corporation” is amended to include either an electing resident S corporation or an electing standard S corporation. An “electing resident S corporation” is an electing S corporation that certifies at the time of its election that all of its shareholders are residents of New York. If such a certification is not made, the corporation will be treated as an “electing standard S corporation.”
If an electing entity is an electing resident S corporation, then its taxable income includes the sum of all items of income, gain, loss, or deduction to the extent included in the taxable income of the resident shareholders. If an electing entity is an electing standard S corporation, then its taxable income includes the sum of all items of income, gain, loss, or deduction derived from or connected with New York sources.
Observation: Under the pre-amended version of the PTET, only the New York source S corporation income flowing up to shareholders was subject to the PTET, limiting the possible benefit to resident shareholders. The amendment expands the scope of the PTET base for “electing resident S corporations” to include all taxable income flowing up to the resident shareholders, thereby resulting in a greater benefit for the resident shareholders of an electing resident S corporation. Resident shareholders of an S corporation that also has nonresident shareholders will not be able to avail themselves of this benefit, and such an S corporation will continue to pay PTET on its New York source income.
The legislation amends Section 612(b)(3) of Tax Law Article 22, which requires the addback of income taxes to the extent they are deductible in determining federal adjusted gross income and not credited against federal income tax. The amendment adds a new Subsection 612(b)(3)(C) that addresses the PTET deduction, providing that the term “income taxes” in the case of a partner, member, or shareholder of an electing partnership or electing S corporation does not include the PTET to the extent it is added back under Section 612(b)(43), the PTET deduction addback. The legislation similarly provides that the term “income taxes” does not include other state pass-through entity taxes that are substantially similar to the NYS PTET to the extent otherwise added back under Section 612(b)(43). This amendment is effective retroactively to tax years beginning on or after January 1, 2021.
Observation: This amendment appears intended to clarify that there is no double addback at the individual level (i.e., since under current law there was a general addback of state income taxes under Section 612(b)(3) and a specific addback of the PTET under Section 612(b)(43)). However, it also appears that, as a result of this amendment, there would be no addback of the PTET by an electing partnership in computing its PTET. Taxpayers that made tax payments based on estimates that added back the PTET at the partnership level may have overpaid their tax and may be eligible for a refund. The amendment to Section 612(b)(3) also applies with respect to the NYC PTET (see discussion below).
The budget bill creates a new Tax Law Article 24-B that creates a NYC PTET that is similar to the New York State PTET, with some differences, effective for tax years beginning on or after January 1, 2023.
The annual NYC PTET election may be made by an “eligible city partnership” or an “eligible city resident S corporation;” once made, it is irrevocable. An “eligible city partnership” means any partnership as provided for in IRC Section 7701(a)(2) that has a NYS partnership return filing obligation under Tax Law Section 658(c)(1), where at least one partner or member is a city resident individual. An “eligible city resident S corporation” means any New York S corporation that is subject to tax under Tax Law Section 209 that has only city resident individual shareholders.
Any eligible city partnership that makes the NYS PTET election may make the NYC PTET election for the same taxable year. Any eligible city resident S corporation that makes the NYS PTET as an “electing resident S corporation” may make the NYC PTET election for the same taxable year. The NYC PTET election must be made by the due date for, and in the same manner, as the NYS PTET election.
The NYC PTET is imposed at a flat rate of 3.876% (the highest NYC personal income tax rate). The base includes all items of income, gain, loss, or deduction to the extent they are included in the city taxable income of a partner, member, or resident shareholder of the electing city taxpayer. A credit is available to resident partners, members, or shareholders against their personal income tax equal to their direct share of the NYC PTET.
The NYC PTET is in addition to the New York City Unincorporated Business Tax on partnerships, and the NYC General Corporation Tax on S corporations.
Observation: The New York State Department of Taxation and Finance has been publishing guidance on its website regarding the NYS PTET; please see: https://www.tax.ny.gov/bus/ptet/. Additional guidance may be issued in the coming weeks and months. Taxpayers should model out the impacts of the recent legislation and analyze the benefit of making the NYC PTET election.