New York’s Post-Election Tax Environment for Business Owners
November 16, 2020
Something Is Rotten
There’s a gray pall hanging over New York that has clouded the judgement of many politicians, and has left many of its residents feeling anxious and off-balance. No, it’s not the smoke from all the newly lit joints, blunts and pipes drifting across from New Jersey, following the recent approval by that State’s voters of a proposal to legalize the recreational use of cannabis.[i] It’s something far more pernicious than that.
Last month, the Tax Foundation published its “State Business Tax Climate Index.” This Index allows taxpayers to compare their state’s tax system to those of other states. It is derived by scoring a state’s “tax climate” relative to that of other states. Among the factors considered under this methodology are a state’s individual and corporate income taxes, sales taxes, real property taxes, and unemployment insurance taxes.[ii]
According to the Index, New York was ranked 48th for the third straight year.[iii] Would it surprise you if I told you that the State was ranked 49th during the five-year period running from 2014 to 2018?
I didn’t think so.
Notwithstanding its well-deserved position in what may be described as one of the lower circles in the tax version of Dante’s Inferno,[iv] the State has hardly been repentant for its tax policies; rather, New York has continued to act poorly toward the closely held businesses and business owners that make their home within its borders,[v] seemingly confident in its ability to do so without repercussions.
The same may also be said for New York City.
But how much longer will business owners subject themselves to this treatment? At what point will the tax cost of operating in New York – and in the City, in particular – when aggregated with the non-tax business costs of what has always been a very demanding and expensive business environment,[vi] so outweigh the benefits of being located there, that owners are left with little choice but to remove themselves and their businesses from the State?
How will the pandemic and its aftermath – including the economic shutdown imposed earlier this year to prevent its spread, not to mention the one that appears to be on the horizon[vii] – figure into a business owner’s deliberations over whether to maintain, scale back, or abandon their New York presence?
How might the results of the recent federal elections influence a business owner’s thinking on this question?
In order to better appreciate how the closely held New York business may respond to the challenges arising from these developments, and why, it would behoove us to first review conditions as they were before 2020.
The NY Business Environment
Prior to the onset of the pandemic, more than 2 million closely held businesses operated in New York, comprising approximately 99% of all businesses in the State. These businesses employed almost 4 million people, or about half the State’s private sector workforce.[viii]
Let’s consider one of these closely held businesses that may have operated out of New York City and which drew its workforce from the City’s boroughs and neighboring counties.
The cost of living in the City is notorious,[ix] so a business would have to pay more to hire and retain employees. Even at the lower end of the compensation spectrum, the City requires a minimum wage of $15 an hour; beginning in 2021, Nassau, Suffolk and Westchester Counties will require the same minimum wage. Also starting in 2021, qualifying employees will be entitled to 12 weeks of paid family leave.[x]
Then there is the famously outrageous cost of leasing commercial space in the City (at least pre-COVID) and, in particular, Manhattan.
Add to that the State’s and the City’s regulatory environments, which are both complex and pervasive; in other words, the cost of compliance with their rules is not insignificant.
Finally, the pièce de résistance: taxes. New York knows how to tax like nobody’s business.[xi]
Taxes
There was a time we referred to Massachusetts as “Taxachusetts.” The Bay State shed that mantle years ago, leaving “Tax York” as the reigning champion. A quick review of the major taxes imposed upon New York businesses and their owners will demonstrate why the title fits.
Beginning with the City, there is (a)(i) a business corporation tax on C corporations and (ii) a general corporation tax on S corporations, each imposed at a rate of 8.85%; (b) an unincorporated business tax that applies to sole proprietorships and partnerships/LLCs at a rate of 4%[xii]; (c) a commercial rent tax[xiii] on tenants at an effective rate of 3.9%; (d) a real property transfer tax at a maximum rate of 2.625% for nonresidential properties; (e)(i) a sales tax of 4.5%, plus (ii) the Metropolitan Commuter Transportation District surcharge of 0.375%; and (f) a personal income tax at a top rate of 3.876%.
Turning to New York State, there is (a) a franchise tax on C corporations, generally, at a rate of 6.5%; (b) a real estate transfer tax, generally at 0.40%[xiv]; (c) a sales tax of 4%[xv]; (d) an individual income tax at a top rate of 8.82%[xvi]; and (e) an estate tax of 16%, which features the unconscionable “cliff”[xvii] and its close relative, the 3-year claw-back.[xviii]
The Feds
Of course, one cannot neglect the federal taxes to which the New York business and its owners are also subject.
At least through the end of 2020, the most relevant of these taxes are the following: (a) an income tax on C corporations at a flat rate of 21%; (b) a tax on qualified dividends of 20%; (c) a tax on long-term capital gain of 20% (25% in the case of depreciable real property, to the extent of the depreciation); (d) a 3.8% surtax on the net investment income of individuals; (e) an individual income tax of 37%; (f) a Social Security tax on self-employed individuals, including many partners, of 12.4% up to the first $137,700 of self-employment income, and a Medicare tax of 2.9% on all self-employment income; (g) a 12.4% Social Security tax and a 2.9% Medicare tax on wages paid to employees, with the tax being shared equally between the employee and the employer; and (h) an estate tax, a gift tax, and/or a generation-skipping transfer tax, as applicable, on a taxable transfer of property, at the rate of 40% to the extent the amount transferred exceeds the individual transferor’s exemption amount.
In determining their federal income tax liability, an individual business owner – whether a sole proprietor, a member of a partnership/LLC, a shareholder of an S corporation, or an employee of a corporation of which the individual is a shareholder – may claim an itemized deduction of up to only $10,000 of the New York State and City income taxes paid by them on their share of the taxable income of such business entities (though it should be noted that the IRS last week approved a “state tax cap workaround” for individual owners of partnerships and S corporations).[xix]
“Tax the Rich!”
As if the foregoing barrage of taxes was not enough, “tax the rich” became a rallying cry during the Democratic Party’s presidential primaries.[xx] Its message resonated with New York Democrats, both in Albany and in the City.
But who are these rich people?[xxi]
According to the Tax Policy Center – a nonpartisan think tank based in Washington, D.C. – about 9% of the households in the U.S. have income greater than $200,000, and they receive almost 45% of all pre-tax income; the “really rich,” however, representing the top 0.40% of households, have incomes in excess of $1 million a year and receive 13% of all pre-tax income.
At the same time, the top 20% of households, who received 54% of all income, also paid 69% of federal taxes, while the top 1%, with 6% of the income, paid 25% of all federal taxes.[xxii]
According to the Empire Center – a nonpartisan think tank based in Albany – the highest-earning 1% of New Yorkers pay more City and State income taxes than the combined lowest-earning 90%.[xxiii] In the State, they account for 40%; in the City, the 1% account for 47% of the personal income taxes paid.[xxiv]
COVID
Most objective observers would agree that the imposition of the existing federal, state and city taxes on an individual taxpayer’s business earnings and assets, when viewed in the aggregate, presents a daunting challenge for the business, its owners and the owners’ families, they are made even more so when one considers the non-tax expenses of conducting business in a place like New York or the City.
The politically-driven threat of still higher taxes certainly turned up the anxiety level for business owners (and their employees) who were already on edge.
Into this already challenging tax and economic environment came the COVID-19 virus.
On March 7, 2020, Governor Cuomo declared a state of emergency, which was followed on March 20 by a statewide order that all non-essential workers work from home.
From an economic perspective, the results were not good. The City’s real estate market, for example, took a blow.[xxv] Office buildings and the businesses depending upon them (for example, restaurants and transportation) were suddenly struggling to make ends meet.
The adverse effects upon these and so many other businesses and their employees are translated into reduced tax revenues for the State and the City, thereby placing the government in the position of having to cut back on various programs.
Perhaps more disconcerting, because of its potentially longer-term effects on the City’s economy, was the realization among many employers that their businesses may be operated remotely, without the substantial cost of maintaining a physical presence in the City. As the New York Times put it almost six months ago:[xxvi]
“[A]s the pandemic eases its grip, companies are considering not just how to safely bring back employees, but whether all of them need to come back at all. They were forced by the crisis to figure out how to function productively with workers operating from home — and realized unexpectedly that it was not all bad. If that’s the case, they are now wondering whether it’s worth continuing to spend as much money on Manhattan’s exorbitant commercial rents. They are also mindful that public health considerations might make the packed workplaces of the recent past less viable.”
Just as importantly, many employees have discovered the benefits of telecommuting and, in most cases, their employers are eager to keep them happy.
New York’s Reaction
In typical fashion, the Department of Taxation and Finance went on the attack.
The Department announced that a telecommuter who lives in New Jersey or Connecticut will still be subject to New York income tax if their assigned or primary office is in New York, and their days telecommuting during the pandemic will be considered days worked in New York, unless their New York employer has established a bona fide employer office at the nonresident’s “telecommuting location.”[xxvii]
The City’s Democratic Mayor de Blasio has been going after other telecommuters: those residents with second homes outside the City. The Mayor favors a tax on wealthy New Yorkers to help close the budget gaps resulting from the pandemic. “We do not make decisions based on the wealthy few,” Mr. de Blasio has stated, while Governor Cuomo has been portrayed as “pleading with rich city dwellers” who left the City at the height of the pandemic to come back. According to Mr. Cuomo, raising taxes would make matters worse; it “would cause the wealthy to flee New York.”[xxviii]
Not to be outdone, Democrats in Albany were openly discussing their hopes of securing a supermajority in the State Senate – they already have one in the Assembly – in order to override what they expect will be the veto by Governor Cuomo, a fellow Democrat, of any State legislation that seeks to increase taxes on New York’s “wealthy”[xxix] in order to cover the budget shortfall brought on by the pandemic.[xxx] Among the tax increases being discussed is a tax on pied-à-terres, an increased rate on millionaires, and a tax on the unrealized capital gains of billionaires.[xxxi]
They needed only two seats to secure their veto-proof majority. Unfortunately for New York’s Democrats (excluding Mr. Cuomo), it appears that they will lose, rather than gain, seats in the State Senate.[xxxii]
The National Scene
Although New York business owners may have dodged a bullet in Albany – at least for now – will they dodge a similar bullet out of Washington, D.C.? That remains to be seen.[xxxiii]
If the Democrats win both runoff races in Georgia (on January 5, 2021) for that State’s two U.S. Senate seats, they will have split that chamber evenly with the Republicans, at 50 seats apiece. In that case, Ms. Harris’s vote, as president of the Senate, would break any tie regarding tax legislation.[xxxiv]
Also to be considered is the influence that may be exercised by the Democratic Party’s progressive wing. Its agenda resonated with many voters, including its calls for taxing the rich and redistributing wealth. What’s more, now that Mr. Biden will be sitting in the White House, its members are becoming more vocal about demanding representation in his cabinet and in Congressional committee appointments.
What hangs in the balance? Major tax increases for businesses and their owners, including: (a) an increase in the C corporation tax rate to 28%; (b) an increase in the rate on GILTI to 21%; (c) an increase in the individual income tax rate to 39.6%; (d) an increase in the tax rate on capital gains and qualified dividends to 39.6% for individuals with more than $1 million of income; (e) the extension of the 12.4% Social Security tax to all self-employment income and wages in excess of $400,000; (f) the elimination of the Section 199A deduction for individuals with income in excess of $400,000; (g) the elimination of the like kind exchange for individuals with income in excess of $400,000; (h) the reduction of the federal estate/gift/GST tax basic exclusion amount to $5 million[xxxv]; and (i) the elimination of the basis step-up at death.[xxxvi]
A Glimpse into the Future?
The possibility of an increase in several federal taxes. The uncertain budget situation in Albany and New York City, and what it may mean for state and local taxes. The rise of a “progressive” political agenda at both the national and state levels, and its acceptance by large segments of the population. A tendency to demonize anyone who is perceived as being “successful,” even when they are not “rich” by any stretch. A second wave of the COVID-19 virus, and the strong prospects of a so-called “dark winter.” The likelihood of another economic shutdown, including the physical lockdown of offices and other places of business, and its impact upon businesses, their employees, as well as government. Finally, the mental fatigue caused by all of the foregoing.
Based upon my own practice – and I am certain that other tax practitioners are having the same experience – many New York business owners are very concerned about the threat of increased tax rates at the federal, state and city levels, and the impact these will have upon their future.
A not insignificant number of owners are expressing an interest not only in leaving New York – and especially the City – but in also relocating their business and, where feasible, their employees. As indicated above, these owners have realized that their business may be operated successfully without the cost of a physical footprint in an expensive jurisdiction. Moreover, they have seen that their employees can work efficiently and effectively through telecommuting, and that they are happier doing so. Although these owners may not be able to do much about avoiding federal tax changes, leaving New York for another state is an option that offers the opportunity for substantial savings. “Why pay for the cost of a New York presence?” they say, including the steep tax bill – what better way to protect the bottom line in the face of increased federal taxes?
Others have read the proverbial tea leaves[xxxvii] and don’t like what they see. These owners are considering the sale of their business – in fact, we are being pushed by some to close their deals before the end of this year out of concern over the fate of the federal tax rate on long-term capital gain[xxxviii] – as the first step toward leaving New York.[xxxix]
Then there are those who feel fortunate to have sold their business before the pandemic, but who are still waiting to be paid part of their sale price, whether as an earn-out, a release of funds from escrow, or in the form of installment payments under a note. Unfortunately for them, if a taxpayer is successful in removing themselves from New York while these amounts remain outstanding, the State will the taxpayer to accrue the unpaid amount for their final year as a New Yorker.[xl] What’s more, when these amounts are, in fact, received by the seller-owner, they will be taxed at the federal capital gain rate in effect for the year of receipt, by which time Congress may have raised it.
Finally, there are former business owners who are anxious about their ability to maintain a comfortable lifestyle, while also being able to leave something for their children or grandchildren. These folks are primarily concerned about their estates, and are worried about avoiding New York’s claw-back and cliff, failing which they will be faced with an estate tax of 16% on the value of their taxable estate.
Yes, there is a lot of uncertainty out there, but with one notable exception: regardless of what the business owner does to try to escape New York taxation, the State’s Department of Taxation and Finance is certain to examine the taxpayer-owner’s returns and to challenge, as a matter of course, their claims to have abandoned New York as their home and to have established a new home elsewhere. It is imperative, therefore, that the business owner obtain the assistance of a tax adviser who is experienced both in planning for such moves and in the taxation of closely held businesses and their owners. It is also important that the taxpayer resign themselves to the fact that the inevitable examination and subsequent administrative review will likely be a protracted process.
[i] Speaking of which, on a recent “WAMC’s Roundtable” program, Governor Cuomo stated, in response to a question regarding the New Jersey vote and the prospects of similar success in New York, “I think this year it is ripe because the state is going to be desperate for funding, even with Biden, even with the stimulus. Even with everything else, we’re still going to need funding, and it’s also the right policy. So I think we get there this year.”
https://www.wamc.org/post/gov-cuomo-wamcs-roundtable-11520 .
So, the discussion moves away from outlawing high-sugar soft drinks to legalizing pot. Finally, some clear-headed thinking. Would you pass me the magic mushrooms, please?
[ii] https://taxfoundation.org/2021-state-business-tax-climate-index/ .
[iii] At least we beat California (let them keep the Dodgers and Lakers) and New Jersey, which came in at 49th and 50th, respectively. New Jersey’s showing may explain, at least in part, why the State legalized the recreational use of cannabis.
[iv] The phrase inscribed on the gate of Hell – not to be confused with the City’s Hell Gate Bridge – “Abandon all hope, ye who enter here,” would fit just as well on any of the bridges and tunnels that connect Manhattan and Queens to the mainland, at least insofar as many closely held businesses are concerned. Canto III of the Inferno.
[v] https://www.taxlawforchb.com/2017/03/an-overview-of-the-nyc-business-tax-environment/ .
[vi] https://www.inc.com/jared-hecht/the-5-most-expensive-u-s-cities-to-start-a-business.html .
[vii] As I write this, Mr. Biden is making noise about a national shutdown in 2021 (except when he’s denying plans about a shutdown), while some governors are once again issuing targeted stay-at-home orders in response to a significant increase in the number of cases and deaths across the country.
Dr. Fauci has stated that he does not expect a national lockdown but, rather, “surgical-type local restrictions.” https://thehill.com/policy/healthcare/526036-fauci-were-not-going-to-get-a-national-lockdown?rnd=1605452617
Indeed, daily infections have surpassed 150,000, and no federal relief package is in sight. https://thehill.com/policy/finance/economy/525951-fears-of-double-dip-recession-rise-alongside-covid-19-cases .
[viii] https://www.businessnewsdaily.com/8775-doing-business-in-new-york.html .
[ix] As is the cost of living in the contiguous communities; for example, Westchester, Rockland and Nassau Counties are consistently among the top 10 counties with the highest real property taxes in the country; the others are all from New Jersey and Connecticut, except Marin County in California. https://www.cbsnews.com/news/property-tax-which-homeowners-around-the-u-s-pay-the-highest/ .
[x] Up from eight. https://www1.nyc.gov/nycbusiness/description/paid-family-leave .
[xi] I never understood this idiom, and it appears that its origin is unknown.
[xii] This is an “entity-level” tax. However, because of the entity’s pass-through nature for income tax purposes, its income is also subject to the City’s personal income tax in the case of an individual City resident. Thus, in the case of a City resident who is a sole proprietor, or a partner in a partnership, or a member of an LLC, the entity’s income, or the resident’s share thereof, will also be included in the resident-owner’s personal taxable income for purposes of determining their income tax liability to the City. Thankfully, the City allows a credit to a resident-owner or partner against their personal income tax for at least some of the tax paid by the sole proprietorship or partnership. https://www.taxlawforchb.com/2019/03/new-york-citys-unconscionable-unexpected-unincorporated-business-tax-a-glimpse-of-things-to-come/ .
[xiii] Only in Manhattan, generally south of 96th St.
[xiv] For consideration under $2 million; 0.65% if greater. Assuming a taxable transfer below this threshold, the total tax rate in the City is 3.025%.
[xv] For a total sales tax rate in NYC of 8.875%.
[xvi] Add the City’s rate for a total of 12.696%.
[xvii] When most people think about an estate tax exclusion, they reasonably conclude that a decedent’s asses will be subject to estate tax only to the extent they exceed the exclusion amount. Of course, such rational thinking has no place in New York. Under New York’s estate tax rules, if a decedent’s taxable estate exceeds 105% of the exclusion amount, their entire taxable estate becomes taxable in New York, not just the portion in excess of the exclusion amount. Thus, if I die with an ownership interest in my business that generates a taxable estate of 1.05 x $5.85 million (the State’s current estate tax exclusion amount), plus $1, my entire taxable estate will be subject to New York estate tax at the rate of 16%.
[xviii] New York does not impose a gift tax, but the claw-back has a somewhat similar effect. This rule applies to New York residents who die before January 1, 2026, and provides, generally, that taxable gifts made by a decedent within three years of their death will be included in their gross estate for estate tax purposes. (Gifts of real property located outside New York are not captured by this rule.)
[xix] In Notice 2020-75, released last week, the IRS approved of a method by which the individual partners and shareholders of a pass-through business entity may be allowed to claim a deduction for state and local taxes that were previously payable by these individuals on their share of the entity’s income – and, thus, subject to the $10,000 cap – but which state or local law has shifted to the business entity, which is now directly liable for the taxes.
Transparent evasion, yes, but nevertheless blessed by the IRS.
It almost doesn’t matter because Mr. Biden has called for the repeal of the $10,000 cap – ironic, yes? – and it is doubtful that any Republicans would challenge that position. (After all, the cap is otherwise set to expire after 2025.)
[xx] It is being replaced by “Embrace the base” as a progressive rallying cry on social media. https://thehill.com/homenews/administration/525941-the-memo-divided-democrats-search-for-common-ground .
[xxi] I recall having coming across an article many years ago that asked how Americans identify the “rich” among them. One response: “anyone who makes more money than me.” Funny, right? But also dangerous – what is the starting point for making that determination? Mr. Biden et al say $400,000. The arbitrariness of that decision should make everyone very nervous.
[xxii] https://www.brookings.edu/policy2020/votervital/who-are-the-rich-and-how-might-we-tax-them-more/ .
[xxiii] https://www.empirecenter.org/publications/nycs-high-income-tax-habit/
[xxiv] https://ibo.nyc.ny.us/fiscalhistory.html#taxliability ; https://www.cnbc.com/2020/09/25/taxes-are-likely-to-go-up-for-the-wealthy-in-these-nine-states-.html
[xxv] https://www.taxlawforchb.com/2020/09/nyc-real-estate-post-virus-tax-planning-can-help/#_edn16
[xxvi] https://www.nytimes.com/2020/05/12/nyregion/coronavirus-work-from-home.html
[xxvii] https://www.taxlawforchb.com/2020/10/new-york-business-nonresident-telecommuters-and-the-taxation-of-wages-earned-remotely/
[xxviii] https://www.politico.com/states/new-york/albany/story/2020/08/06/de-blasio-splits-with-cuomo-on-taxing-the-rich-and-luring-them-back-to-nyc-1305410
[xxix] https://www.gothamgazette.com/state/9856-democrats-supermajority-republicans-regain-seats-2020-battle-state-senate-elections-new-york
[xxx] https://www.democratandchronicle.com/story/news/politics/albany/2020/07/30/tax-rich-nys-top-lawmakers-say-yes-andrew-cuomo-says-no/5544324002/ ; https://wskg.org/news/as-new-york-budget-crisis-looms-democrats-seek-alternatives/ .
[xxxi] https://www.nytimes.com/2020/09/07/nyregion/wealth-tax-budget-billionaires.html
[xxxii] That’s right. The counting continues.
[xxxiii] https://www.taxlawforchb.com/2020/11/the-2020-elections-are-almost-over-what-now/
[xxxiv] It would also make Mr. Schumer the majority leader, with all the authority that entails. It may even enable the Democrats to abolish the filibuster.
[xxxv] The pre-2018 amount, though some in the Biden camp have talked about reinstating the pre-2010 estate tax exemption of $3.5 million and the $1 million gift tax exemption.
[xxxvi] https://www.taxlawforchb.com/2020/08/bidens-tax-proposals-for-capital-gain-like-kind-exchanges-basis-step-up-the-estate-tax-tough-times-ahead/ ; https://www.taxlawforchb.com/2020/10/the-election-the-democrats-tax-proposals-and-year-end-tax-planning-caught-between-scylla-and-charybdis/ ; https://www.taxlawforchb.com/2020/08/responding-to-the-democratic-partys-tax-plans/ .
[xxxvii] I believe these are legal in New York.
[xxxviii] Mr. Biden’s $1 million income threshold demonstrates either extreme ignorance of business, extreme animosity for business owners, or extreme stupidity. Not a good sign any which way.
Yes, some pundits are predicting that the Republicans will take at least one of Georgia’s Senate seats, which should alleviate concerns about tax increases. Query then why both political parties are pouring millions into these races and ramping up their public outreach?
Would you trust anything these ding-a-lings say? As I see it, they now qualify as entertainers, along with pollsters, gameshow hosts, actors, athletes, sports “analysts,” television news and reality-TV personalities, and the like.
[xxxix] https://www.taxlawforchb.com/2020/07/out-of-new-york-but-still-being-taxed-by-new-york-look-to-the-source/ ; https://www.taxlawforchb.com/2019/10/statutory-resident-selling-your-new-york-business-welcome-to-double-taxation/ ; https://www.taxlawforchb.com/2019/07/escape-from-new-york-it-will-cost-you/ .
[xl] https://www.taxlawforchb.com/2017/09/withdrawing-your-business-from-new-york-did-you-pay-the-exit-tax/ .