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New York state’s tax code would undergo the most sweeping overhaul in decades under much anticipated legislation proposed by Gov. Andrew M. Cuomo (D) Feb. 15.
The legislation, submitted to the Legislature for approval as part of the FY 2019 state budget, would shift tax liability for many New Yorkers from the personal income tax to a new payroll tax and two charitable funds.
It would also decouple the state tax code from the federal code to address a number of tax conformity issues that would cause the state to reap a $1.5 billion windfall.
The governor also proposed partially decoupling the state’s corporate income tax from the federal law by clarifying that taxpayers can’t take the partial federal deduction on their state returns for foreign income deemed repatriated. Cuomo said he would pursue an unincorporated business tax to preserve deductibility for pass-through businesses, but didn’t include the details of the proposal in his 30-day amendments.
The plan is designed to mitigate the increased state and local tax burdens under the 2017 federal tax act ( Pub. L. No. 115-97). Under the new law, taxpayers who itemize deductions on their federal return may deduct up to $10,000 in state and local sales, individual income, and property taxes (SALT deduction). Previously the SALT deduction was unlimited.
Cuomo said the new SALT deduction cap will raise taxes for New Yorkers by some $14 billion and cause a migration of New Yorkers—particularly high-income taxpayers—to low-tax states.
The tax overhaul is a huge undertaking, considering that the state tax code has 13 volumes and more than 5,600 pages. The state collects about $51 billion from the personal income tax, according to figures from the Division of the Budget (DOB).
The plan faces an uncertain future in the Legislature, particularly in the Republican-controlled state Senate, where Majority Leader John J. Flanagan (R) has expressed doubts over the measures.
Two charitable contribution funds would be created to provide funding for education and health care—the two largest parts of the state’s operating budget.
The state spent $102 billion in Fiscal Year 2018 on health care and education, representing 60 percent of state spending, according to DOB figures.
Under Cuomo’s plan, taxpayers could claim a new tax credit equal to 85 percent of their contributions to the funds. School districts and local governments would have the opportunity to create their own charitable funds.
There’s a looming question, however, of how the Internal Revenue Service will respond to the charitable contribution scheme. Treasury Secretary Steven Mnuchin, during a Jan. 12 talk in Washington, threatened to target tax audits at residents of states allowing deductions for charitable donations to state charities that provide funding for public services.
In addition, IRS Publication 526 says that taxpayers can’t deduct as a charitable contribution any payment for which they receive a benefit in return.
A host of other states likewise are seeking to shield taxpayers from the effects of the SALT deduction cap, including several others in the northeast.
In Connecticut, Gov. Dannel Malloy (D) recently proposed allowing municipalities to create charitable organizations that support town services, in conjunction with a local property tax credit, which “will allow our cities and towns to continue to provide services while reducing individuals’ federal taxes.” And legislation using charitable contributions to mitigate increased tax burdens has been filed or is being considered in California, Illinois, Maryland, Nebraska, New Jersey, and Virginia for income tax, and Washington for sales tax.
Meanwhile, Cuomo’s proposed voluntary payroll tax would be phased in over three years beginning in the 2019 tax year. Employers would pay a 1.5 percent payroll tax in the first year, 3 percent in the second year, and 5 percent in the third and final year.
Nicole Kaeding, director of special projects at the Tax Foundation, said the SALT workarounds are “highly questionable policy.” The payroll tax, for example, will lower Social Security benefits for individuals because the benefits are based largely on taxable wages.
“Although the Cuomo Administration has made some moves to suggest that they’re considering the unintended consequences, there is no indication the governor’s proposal could avoid impacting an individual’s eligibility for federal benefits under Social Security,” Kaeding said in a Feb. 13 blog post.
“This reduction would also be regressive,” she said. “For high-income individuals, Social Security benefits do not grow when incomes exceed a specific level. In 2018, that is $128,400. But for an individual below the contribution and benefit base limit, limiting wages would have a larger impact. It would reduce the wage base that determines their benefits.”
Robert J. Mujica, the state budget director, said “we’re going to do whatever is necessary to protect New Yorkers from whatever programs are tied to their incomes.”
“We want to make the adjustments necessary as a part of this to make sure that individuals are held whole,” he told reporters Feb. 12. “The intent here is to make sure we make all of those fixes. For most programs, we can just make a statutory change that changes what we count. We can just change the definition in most areas.”
The payroll tax is most likely to appeal to “a relatively small group of reliably profitable firms employing highly paid executives and professionals,” according to E.J. McMahon, research director at the Empire Center for Public Policy, a right-leaning think tank. He said high-earning taxpayers in the New York City area lose the most under the SALT deduction cap.
“Even within that group, the payroll tax option is something likely to be considered only by firms whose executives and staff can work out a mutually satisfactory arrangement to restructure their compensation in a way that combines gross pay cuts and shared net tax savings,” McMahon said in a Feb. 12 blog post.
“Clever execs with smart tax advisors will squeeze the maximum deductibility value out of such an arrangement, but still, the company’s workers will never recover the full value of their lost SALT,” he said.
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