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New York blazed a trail when its Legislature became the first to revamp its tax code in response to the new federal tax law.
But the state still has a steep climb when it comes to implementing its law, addressing other tax conformity issues, and dealing with intended and unintended consequences of the sweeping changes.
The measures designed to mitigate the impact of the new $10,000 cap on state and local tax (SALT) deductions each face their own unique challenges, tax experts told Bloomberg Tax. Both will require significant outreach and guidance by the state, they said.
The new charitable funds will be relatively easy to implement, but could be dealt a death blow by the IRS if it rules that the contributions aren’t deductible. The new payroll tax, on the other hand, will be more complicated to implement and faces the challenge of selling it to employers and employees.
“There’s not a precedent of a change this size,” said Andrew Rein, director of the Special Committee on Federal Tax Changes for the watchdog group Citizens Budget Commission. “There is a range of work to be done, from fairly easy to fairly significant,” he told Bloomberg Tax.
New York is the first state to respond to the 2017 federal tax act ( Pub. L. No. 115-97) with “workarounds” to mitigate the impact of the SALT deduction cap. Other high-tax states like California and New Jersey currently are considering similar moves.
Gov. Andrew M. Cuomo (D), who has made the workarounds a top priority, hasn’t officially announced his signature of the New York bill (S. 7509), but it was delivered to him April 2.
The Department of Taxation and Finance declined interview requests.
“We’re not in a position right now to provide answers, as there are still details that need to be ironed out,” James Gazzale, a spokesman for the department, told Bloomberg Tax. He said the department, which is developing guidance, would provide more information in the coming weeks.
S. 7509, which passed as part of the state budget, creates two statewide charitable funds to pay for health care and education, and allows local governments to create their own funds to mitigate the impact of the federal law on property taxes.
The big question is: Will the plan pass muster with the IRS, or will the IRS decide that the charitable contributions aren’t deductible from personal income taxes?
Dennis J. Ventry Jr., a tax law professor at the University of California, Davis School of Law, said he expects the IRS to issue “imminent guidance” that will limit the deductibility of the charitable credits.
“It’s a near certainty they’re not going to say these programs are okay,” Ventry told Bloomberg Tax. “They have to walk a very fine line.”
Ventry said there most likely would be a constitutional challenge to the guidance if the IRS “grandfathers” existing programs that provide a 100 percent credit for charitable contributions to private schools, but said a program like New York’s that provides less than 100 percent credit for public schools isn’t deductible.
Ventry, who chairs the IRS Advisory Council, said the guidance will benefit lawmakers in California and other states who haven’t enacted their programs yet because they’ll be able to structure their laws to address IRS concerns.
Peter L. Faber, a partner at McDermott Will & Emery who has been skeptical of the workarounds, said “we don’t know what action the IRS will take with respect to this and similar proposals in other states.”
“My understanding is that the IRS had tentatively decided not to publish generalized guidance before being faced with actual statutes,” he told Bloomberg Tax in an email. “Now that New York has actually enacted a statute, they may want to come out with guidance, but it is possible that they will hold back for political reasons.”
Faber said New York lawmakers may have been hedging their bets with a little-noticed provision (Part EEE) in the budget bill. The provision creates a procedure for individuals to claim reimbursements for interest paid to the IRS on underpayments of federal tax liability for the 2019, 2020, and 2021 tax years.
“The legislators are obviously hedging their bets here, anticipating the possibility of an IRS challenge to the technique,” Faber said. Presumably, one of the tax department’s “projects would be to set up this mechanism for processing reimbursement claims,” he said.
Kenneth Pokalsky, vice president of the Business Council of New York State, told Bloomberg Tax that “it’s hard to imagine” a local government undertaking such a big move without clear indication from the IRS on deductibility.
If local governments do choose to create the funds, New York’s overlapping tax jurisdictions and consolidated property tax bills will present a host of other complications, according to Rein.
The new voluntary payroll tax created by the budget bill has its own set of challenges, not the least of which is convincing employers to opt in and convincing employees that they’re not getting a pay cut. The payroll tax is designed to offset the tax liability for personal income taxes with a deductible employer-paid tax.
So far, employers aren’t very interested in the new tax, according to the Business Council. Employers have until Dec. 1 to decide if they will opt in for 2019.
“We still believe that very few businesses will choose to opt-in to the new system,” Zack Hutchins, a spokesman for the Council, told Bloomberg Tax in an email. “It simply isn’t worth the burden, never mind trying to convince your employees that they’re not losing money while taking a pay cut.”
The payroll tax has limited appeal beyond firms with high-earning professionals, according to E.J. McMahon, research director at the conservative-leaning Empire Center for Public Policy. Moreover, those firms are mostly pass-through entities that aren’t covered.
“The Cuomo Administration’s inability to come up with a version of the payroll tax for these entities suggests that tax officials have found it even more dauntingly complicated than the corporate version,” he said in an April 5 blog post.
The state won’t have to reinvent the wheel when it comes to implementing the new payroll tax, according to Rein. He said the state could model it after the Metropolitan Commuter Transportation Mobility Tax, a payroll tax enacted in 2009 on employers in the New York City Metropolitan area.
The Legislature and governor undertook a major tax overhaul in a short period of time but left some tax conformity issues on the table. They include:
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