Depending on how you count, New York residents appear to face the highest tax burden in the nation. Between state and local taxes, approximately 12.7% of a New Yorker’s income goes to taxes. President Trump signed a tax reform bill on December 22, 2017. For income earned prior to December 31, 2017, all state and local income and property taxes were deductible as an itemized deduction on one’s federal income tax return. Under the new tax law, deductions for state and local income and real property taxes are limited to $10,000.00 each year. According to IRS data, heretofore New York residents took the highest average deductions for state and local taxes with an average deduction of just over $21,000.00. Consequently, the new law will reduce the average deductions taken by a New York taxpayer who itemizes deductions by $11,000.00.
In an attempt to offset this anticipated loss, Governor Cuomo has included a series of proposals in his latest budget proposal. Whether these proposals will pass the legislature and whether they will be accepted by the Internal Revenue Service, remains to be seen. However, the proposals are interesting.
First the Governor proposes a new voluntary Employer Compensation Expense Tax (“ECET”). The Governor reasons, that even though the new tax law eliminates from itemized deductions a large portion of the state income taxes, employer-side payroll taxes remain deductible. The proposed legislation will phase in a plan over three years beginning on January 1, 2019. When fully functional, the plan will allow employers to voluntarily enter into a system in which the employer pays 5% of all annual payroll expenses in excess of $40,000 per employee. The New York income tax will remain in place. The employees of an employer that pays into the ECET system would receive a corresponding tax credit on her wages. From a New York State point of view, the proposal is revenue neutral. The employer pays the tax and the employee gets the credit.
The summary of the proposed tax reform states, “When fully phased in, the new system could generate up to roughly $4 billion in federal tax savings for New Yorkers per year. The Department of Taxation and Finance estimates that a taxpayer (married filing jointly) making $150,000 in wage income would see a federal income tax reduction of roughly $1,200 as a result of the ECET.”
However, what is not explained in the proposal is what benefit there is for an employer to opt into such a system or how the system helps with the employee’s federal income taxes. An employer that opts into the plan has a new expense and a corresponding deduction. The employee does not receive a credit against her federal income taxes, only her state taxes, so her state taxes go down, but her income remains the same as does her federal tax burden. It appears that unspoken in the plan is that the employer will reduce the employee’s overall compensation by 5%. The employee will then have a lower federal income tax because she has lower income. The credit against her state and local taxes will reduce state taxes paid by the employee. Assuming all of this is worth the time and attention of the employer and employee, there is still a question as to whether the IRS will consider the employer’s voluntary payment “ordinary and necessary.” The Internal Revenue Code requires an expense to be “ordinary and necessary” for it to be deductible for federal tax purposes. The IRS could find that a voluntary payment of this kind of this kind is not ordinary and necessary. In addition, the IRS could determine that such a system results in a benefit to the employee. Only time will tell.
The Governor also proposes two new state operated Charitable Contribution Funds that will accept donations for the purposes of improving health care and education in New York. The hope is that taxpayers who itemize deductions would be permitted to claim these charitable contributions as deductions on their federal and state tax returns. New York State would then give any taxpayer making a donation a state tax credit equal to 85 percent of the donation amount thereby converting a tax into a charitable donation. The legislation would also allow school districts and local municipalities to create charitable funds for education, health care and other charitable purposes. Donations to the fund would be offset by a credit against local property taxes. Here, the idea is to convert non-deductible state and local taxes into deductible charitable donations. This too may run into opposition from the IRS. In order to be considered a charitable deduction under the Internal Revenue Code, a gift must be made out of “disinterested generosity.” A gift given to a charity that results in an almost corresponding real estate tax credit can hardly be said to be given out of disinterested generosity. The IRS may well take the position that only the 15% that does not result in a credit is deductible from the donor’s income taxes. Again, only time will tell.