On-Demand: Year-End Tax Strategies for Businesses
In this webinar, participants will understand the latest federal, state and local, and international tax laws and how businesses could be affected by the House Ways and Means Committee tax proposals.
Carolyn Dolci:Thank you everyone for joining this afternoon for our presentation. We're going to talk first about some recent changes. We're going to head into federal tax planning, then international and then state and local tax planning.
Carolyn Dolci:So we have a full afternoon of CPE credit today. Starting off, on November 15th, the president signed the Infrastructure and Jobs Act. So one of the most significant items in here that affects our presentation that we're discussing, is going to be the termination of the Employee Retention Credit. And that's effective as of October 1 of 2021. Businesses still can go back and apply for this for earlier quarters, but they are ending it earlier. Now, if you're a business that was eligible to claim the credit in October and November, and you're reduced your payroll taxes, you have to be ready to make those payments because your deposits are going to be considered late. Now, the American Institute of Certified Public Accountants did write to the IRS asking for relief, but as of I looked this morning, I didn't see anything, but hopefully there'll be something coming.
We updated our slides a little bit, but they were done before October 19th, sorry, November 19th, which was Friday when the house passed the Build Back Better. So we're going to cover some of the provisions here. There is an expectation that there will be significant changes made by the Senate, but we're going to talk about items in the current field that we have. First item is Corporate Alternative Minimum Tax, and this would impose a 15% minimum tax on any corporation, which has average annual adjusted financial statement income greater than a billion. And this would be, over an applicable three-year period, and it would be for your tax years beginning after December 31st of 2022. There's also the Qualified Small Business Stock. The way the rules are now, is there are special tax rates on this top of stock if you hold it and you have a gain, and those would go away for people that have income greater than 400,000. Under the current law, the tax rates, they call it on the 75% excluded, are 25% and 7% for AMT. Now, remember we're only paying tax on the 25%, but those would be the rates. There's also on the 100% exclusion, there wouldn't be any tax on that. That's 100% excluded. But under the proposal, these ex-rates would not apply for taxpayers with adjusted gross income of more than 400,000. And this would be effective for sales and exchanges after September 13th of 2021.
Now, if you got worthless, I think we're still on here. Worthless Partnership Interests, or corporate securities, the date for when the worthless securities can be claimed will be the date of the identifiable event. Currently, it's the last day of the taxable year. And this change would apply to taxable years beginning after December 31st of 2021. Now, you may remember, under the Tax Cuts and Jobs Act of '17, research and development expenditures we're supposed to be amortized over five years, starting the taxable years beginning after December 31st, 2021, but the bill has delayed this. And so now it would not be until after December 31st of 2025, which means these course will continue to be expensed. If you came to our earlier session, you may have heard some of the next items here, but I think it's important to mention them, and that's the Net Investment Income Tax. Remember, that's at 3.8% tax, and this would be extended to cover income in the ordinary course of a trader business for individuals of taxable income greater than 400,000. It's 500,000 for individuals filing a joint, 250 for married filing separately. And this would be for tax years, beginning after December 31st of 2021.
Excess Business Losses. These would be permanently disallowed. Now, if you remember, the Cares Act that suspended it for 2018 through 2020, so people could take those losses, and the provision here would losses to be carried forward. Anthony is going to talk about this a little bit more when he does his section, and this would apply to tax figures beginning after 2020, because the difference now is really that it's just making it permanent. There's two other items that are not on these slides that I want to mention. And one, there is a High Income Surcharge. It's 5% on taxpayers with modified adjusted gross income in excess of $10 million, 5 million for married filing separately. And then there's an additional 3% on taxpayers with modified adjusted gross income in excess of 25 million. And that would be for tax years beginning after December 31st of 2021. This is not on our slides.
Probably the one that I think is most interesting to everybody is the Salt Cap increase. Currently, it's at $10,000, and the bill would increase it to 80,000 for years, '21 through 23rd. So that means we would in 2021, have the potential to get an individual state tax deduction up to that limit. So I think that if we do see that happen, there is going to be a big rush for year-end tax planning for individuals. Not to mention that there are many businesses who elected past entity taxes, and we will see how this all plays out. And Mitch is going to talk more about that when he gets to his presentation. So I'm going to pass this on now to Anthony.
Anthony Cuti:Good afternoon everybody. My name is Anthony Cuti. I'm a senior tax manager here at Eisner in the Metro Park, New Jersey office. The first topic, some business tax planning notes. Just wanted to mention that for 2021, there's not been any major updates to the current tax rates for corporations that tax rate remains at 21% for this year. For individuals, the top tax rate is 37%, there's also the investment income tax at 3.8%, additional Medicare tax at 0.9%, as well as the self-employment tax, has the social security portion capped at 142,800, that's increasing to 147,000 for 2022. Also, wanted to note that when tax planning, it's important to review multiple years and not specifically just the current tax year. Additionally, specifically for cash-basis taxpayers, expenses are generally deductible when paid, and in a year where proposed regulations appear to favor increased rates in 2022, a business may want to defer some expense payments until then, where it's feasible from a business standpoint. And also wanted to note, and Mitch will get into this further in his section, the new New York State Pass-Through Entity Tax, in New Jersey, Bay Tax and other state tax work arounds. Even accrual-basis taxpayers are required to pay these taxes before year end in order to get a 2021 tax deduction.
Some other items to consider before year end is setting up some qualified retirement plans, and also very important to look at your basis and your at-risk limitations to determine if you can utilize losses. These are important planning opportunity before year end so no surprises come April. The Partnership K-1s in 2020 began reporting your tax, your capital on a tax basis. This will continue through 2021. The S Corporations have a new form, 7203, which will help shareholders track their stock and debt basis. The small business exception, which is important for items which we'll get into a little bit later with the interest expense limitation, inventory, and method of accounting. This is based off of three-year average of gross receipts for 2021, it's 26 million. And that's also increasing to 27 million in 2022. There's also, which Carolyn touched on briefly the R&D credits, which we have webinars that you can register for in the future, which you can also elect to apply these research credits against payroll taxes on form 8974, if you meet the small business exception of 26 million of gross receipts in 2021.
You also have the opportunity before year end to review your entity choice, whether you're a C Corporation or a Pass-Through, which is an S corp or a partnership. The advantages of being an S corp or partnership, you could qualify for the section 199A which is the pass through deduction, which we'll get into further as we proceed through the presentation. That gives you a 20% deduction on your business income, but could also potentially limit your losses if they exceed a certain number. C corporations, which get to utilize net operating losses, which we'll again, talk about a little bit further down the road. Is also important to note that especially given the environment of the pandemic, we may have employees working in some new states, new locations. You want to discuss with your engagement team, as you may require some new filing requirements and some quarterly estimates, which may be due in the coming days.
The next topic is the Paycheck Protection Program Loans. Many taxpayers took advantage of these loans throughout the last year and a half. Many took two rounds and are going through the process of applying for forgiveness now. The loan forgiveness, if you get full forgiveness, is excludable from federal taxable income under the Cares Act. Expenses are also fully deductible. However, wanted to note that there are some states which may exclude the forgiveness from income, but however, they may not allow for the deductions to be deductible. California, for instance, is one of the states that are disallowing the deduction for some businesses.
The Employee Retention Credit, which was used to encourage employers to retain employees and their salaries during the pandemic. This was a fully-refundable tax credit for employers equal to 50% or 70% of qualified wages, this 50% in 2020 and 70% in 2021. The key takeaway here is that no deduction is allowed for the wages equal to the amount of the credit that is claimed. This could result in income in a year that the payroll relates to. And if a 2021 employee retention credit was received, a 2020 amended return will be required. If you still have not applied for the employer retention credit, you still have an opportunity to do so. We do have a task force here at Eisner that can certainly assist you with the process of applying for it. This has been a great windfall for many of our clients, and it does take some time to get the money from the IRS, so we recommend moving forward with this as quickly as you can. Also, as Carolyn mentioned, the credit is available on wages through September 30th, as this was repealed very recently. And the maximum credit for 2021 is 21,000 per employee. So it's $7,000 per quarter on the first $10,000 of qualified wages.
Lexi D’Esposito: Poll #1
Anthony Cuti:That's correct. The maximum 2021 Employee Retention Credit per employee is $21,000 for the year. Our next topic is the Qualified Business Income Deduction or Pass Through deduction. This has been around since the Tax Cuts and Jobs Act 2017, 2018 being the first year that allowed owners of sole proprietorships, partnerships, and S corporations to deduct 20% of income earned by the business. This currently will sunset in 2025. If you do qualify for the section 199A deduction, the top effective tax rate is 29.6%. Also wanted to note, there was some discussion that the QBI deduction would be limited in some of the new provisions and regulations that were out there. But however, at the moment, it's been left untouched.
You do need to have a qualified trader business. Trader businesses that are involved in the performance of services and in the field of health, law, accounting, consulting, financial services, broker services, or other trades or business where the principal asset is the reputation or skill of one or more of its employees or owners, unfortunately do not qualify for QBI deduction. However, if your income is below the phase out threshold, which is currently for 2021 set at 329,800 from married filing joint. So taxpayers with income near the threshold for this year, may want to benefit from accelerating deductions or deferring income to the extent possible, so that their taxable income falls below the threshold. This will allow them to benefit from the full 20% deduction in 2021.
Our next topic on the bonus depreciation. Typically, this applies to business assets with less than a 20-year useful life. Some common dis-qualifiers are buildings and its structural framework, which is more like 39 year property or residential property, which is 27 and a half year property. Some planning ideas. If the rates are expected to increase in 2022, you may want to defer deductions by waiting until January of 2022, to place your assets into service or electing out a bonus depreciation in 2021 altogether. Bonus depreciation for through 2022. For 2021 and 2022 is set at 100%, and it is phasing down year over year through 2026 phasing down to 0%.
Next topic, the cousin of Bonus Depreciation in Section 179. It allows you for an annual tax write off of 1,050,000 for 2021. And the phase out begins with additions over 2,620,000 on a dollar for dollar basis. So this completely phases out at 3,670,000. These numbers are increased to 1,000,080 for 2022, and the phase out begins at 2,000,007 for 2022 as well. Also, wanted to note that the Section 179 cannot bring a taxpayer into a loss position. So this is only if there is a taxable income. So if you do have a loss position, you still can utilize the bonus depreciation. And that brings us to the second question.
Lexi D’Esposito: Poll #2
Anthony Cuti:It looks like the majority of you got that right. The maximum 179 deduction for 2021 is 1,050,000. Also, wanted to just make note quickly of the limits for luxury autos for 2021. The first year depreciation cap for a luxury auto is 10,200, and you are allowed an additional $8,000 first year depreciation excuse me, for qualified listed property, which will give you a total first year, maximum depreciation of a qualified auto of 18,200. And other autos trucks and vans that use more than 50% of business will qualify for bonus and Section 179. Some other year-end items to bring to light with regards to fixed assets and depreciation. A cost segregation study could be beneficial to shorten lives on improvements to your real property. This will help accelerate some deductions. If you do place more than 40% of your assets into service in the last quarter of year, the mid-quarter convention would apply. Also, if you do elect the out of bonus depreciation, it's by class of assets. And one other item is to note that these states may not follow the federal bonus depreciation or Section 179 rules, which could result in modifications to your state taxable income, either favorably or unfavorably, depending on how many years you've benefited from 179 of bonus. Also, actually one other item, I apologize, there is the De minimis expensing safe harbor, which is a written policy, which if you have a applicable financial statement will allow you to expense items up to $5,000 each. Again, this helps accelerate deductions for you. If you do not have an applicable financial statement prepared, the limit is 2,500.
The next topic is section 163(j), which is the business interest expense limitation. This applies taxpayers with a three year average gross receipts of 26 million or more in 2021, and 27 million or more in 2022. This is prepared and filed with your tax return on form 8990, and it is essentially limited to 30% of your EBIDA. If you pay a lot of interest expense, you may want to review the limitations with your engagement team before you're in, again, so there are no surprises come April.
Another hot button topic is meals and entertainment. This was relatively new earlier this year that the president signed it. The law that Consolidated Appropriations Act of 2021, this allows for 2021 and 2022 tax years meals purchased from a restaurant will be 100% deductible. Entertainment continues to be 0% deductible, unless it meets certain exceptions. Meals at entertainment events are 50% deductible if they're separately itemized on the invoice. And also this was just recently released on IRS, notice 2021-63, that taxpayers may treat the entire meal portion of their per diem or allowance as being attributable to food or beverages provided by a restaurant, and therefore 100% deductible in 2021 and 2022.
Next topic is on the qualified transportation fringe benefits. This does not allow deductions for employers for qualified transportation fringe, except as necessary for ensuring the safety of the employee. Employees can still exclude employer paid benefits from taxable income, whether they receive transit passes or fund transportation benefits through pretax plans. The final exclusion for 2021 has been increased to $270 per month, and going up to $280 per month for 2022. There were also final regulations issued in December of 2020, which provides for multiple methods of computing at disallowance for qualified parking.
Moving on to net operating losses for corporations. So for years beginning after December 31st, 2017, and before January 1st, 2021, net operating losses could be carried back five years without any limitation. And this was beneficial as the tax rate for corporations had prior to 2018 was higher than 21%. So it was a big benefit there, and you can carry it back with no limitation, and then they can carry forward indefinitely. For NOLs beginning after January 1, 2021, there is no longer allowed carryback, and they carry forward indefinitely. There is however though, an 80% limitation to taxable income.
And our last topic is on the loss limitation rules for taxpayers other than corporations. So this is for 2021. The loss limitation is equal to 524,000 in the case of a joint return, and any net business losses in excess at this amount will be disallowed in 2021 and carry forward. The CARES Act retroactively delayed the implementation of this rule for tax years 2018 and 2020. So if any taxpayers filed a 2018 or 2019 return with this limitation, have received an opportunity to amend and fully claim these business losses.
I will now turn over to Sam for international.
Samantha Guis:Thanks, Anthony. So my name is Samantha Guis. I'm a Senior Manager here at the Metro Park office, and we're going to touch a little bit on international tax considerations. What's being proposed in the Build Back Better, we can see here there's a lot of items that we thought were noteworthy, but as my colleagues were saying, we still expect this to go through the Senate. There could be significant changes to it. This is just what we're seeing off of the initial proposed bill treatments of GILTI, FDII, BEAT rules, all acronyms spelled out there for you. We love our acronyms. Changes to Subpart F, downward attribution items such as that, which we'll go over in more detail as we progress on.
So with the proposed corporate alternative minimum tax, this will hit our high income earners across the board with over a billion average annually over three years, bringing back that lovely additional tax here, but it would allow an indefinite carry forward of the losses to be offset later on. In addition, you'd be able to carry forward any AMT foreign tax credits to offset the income as well.
GILTI. So the big one here, proposed changes. We're seeing an increase in the GILTI, which is our Global Intangible Low Taxed Income. Currently it's at a 10.5% rate, with the changes being proposed in this bill we're looking at a rate of 15% instead, which they're doing through a reduction of the deduction permitted, putting us at that lovely 21% rate that we're factoring in. This is in line with what everybody's doing with the organization for economic cooperation and development.
So across the board, we're seeing a little bit of an adjustment to our benefit also under the QBAI for the GILTI proposal. And the big thing to note here that we're all kind of concentrating on is the country by country basis, as opposed to the netted. So you used to be able to take your income and losses from Singapore, Ireland, UK, and put them all together in your calculations. Now, what they're proposing is you would only be able to take UK against UK income, Singapore against Singapore. So you're looking at more of a tax effect by not being able to use the losses immediately against other income, but they are allowed to be carried forward on a basis to be used at a later date and get a benefit, but not in the current year going country against country, unfortunately.
This ties in with the FDII, which is the Foreign Derived Intangible Income proposal. This is how we're getting to that higher effective tax rate, by reducing this deduction. It's currently at 50%, they're lowering it to 28.5%. You're going to take this with unfortunately a 5% haircut on the GILTI foreign tax credit, reduced from the 20, which is our current law. So this is how they're taking all those different pieces and getting us to a 15.8% tax rate, as opposed to the 10.5% under the current law. This is in effect after December 31st, 2022. So there is time for some tax planning here to take advantage of.
They're making a lot of changes to the deduction eligible income as well, especially in regards to passive income and sale and dispositions of rental and royalty property. This would also remove some other pieces in regards to potential NOLs that you can use under code section 172. So again, a lot of moving pieces in the foreign world. So it's definitely noteworthy to kind of pay attention to the pieces, but we're expecting a lot of changes. So take it all at face value right now.
Lexi D’Esposito:Poll #3
Samantha Guis:About what I expected, though seeing quite a few more at the one to two bracket here for foreign subs that have GILTI income. So foreign tax credits, this one's a little more universal, you see it a little more with credits you're taking from other jurisdiction, proposed changes are no longer having a year carryback for those excess foreign tax credits you generate in a current year, but we are keeping the 10 year carry forward, other than the GILTI income, that's separate. Going forward, again in each of your buckets, your passive, your active, your foreign branches. You know they like splitting it out to reduce what you can take at a different time period.
For GILTI specifically, the income you are allowed to be carry forward for five years, which is actually a very good thing. We couldn't usually carry forward anything at the current tax law, so they're giving us a little bit here. And then going forward after December 31st, 2030, they can be carried forward for 10 years, these tax credits. So we are getting a little bit of a benefit with this increased tax rate that we're looking at under this proposed law.
Again, we still have that 5% haircut to the foreign tax credits, which is expected, unfortunately, with this. We're looking again, December 31st, 2022, for some of these things to take effect. So there is time to take a little bit for tax planning, which could be critical depending upon what the final law actually signs into play.
So BEAT proposed changes, which is our Base Erosion and Anti-abuse Tax, this is pretty harsh here. We're seeing a big increase in taxes. They're doing it gradually over years and increments, but we're basically going for our 3% up to by 2024 an 18%. So if this is applicable to you, it's something to watch, definitely. We're seeing a very harsh take on this. There are certain exceptions being contemplated for controlled foreign corporations, something also to consider. But again, most of it is unfortunately not great in this scenario with the BEAT tax.
But a pleasant piece here is the downward attribution rules under the Tax Cut and Jobs Act. It did become a lot more critical, and it created a lot more compliance and forms for people using this downward attribution. Now they're proposing going back to the rules pre TCJA, which could significantly decrease in some cases the reporting requirements and other aspects needed for certain situations. When you have perhaps 100% of a US company and 100% of a foreign company, it would say those foreign shares belong to the US company. Under the current law, TCJA had certain exceptions pre that that would prevent this from happening and reduce some of that compliance needed with this type of reporting.
And then Subpart F. So outside of GILTI, and as we jump into Subpart F, they are looking to make changes here following. It used to be where the organization was created or their documents are in that country. Now we're focusing more on the residency of where the company is, as opposed to that, to kind of cut down and see where the taxes are being paid. So this would be applicable after December 31st, 2021. So this is less time to plan for it, but this could be a boon and a benefit in some cases, depending on your specific scenarios.
Lexi D’Esposito:Poll #4
Samantha Guis:Okay. About what I would expect again. We do have quite a few of you with some Subpart F income though, but mostly not. New topic kind of up and coming, so it's becoming more and more prevalent, and that seems to be the trend we're seeing. So in regards to Dividends Received Deduction, which everyone enjoys, unfortunately here, we're looking at a not so great potential proposal as well, where the Dividends Received Deduction would be limited for the foreign source only from controlled foreign corporations. So currently you get a hundred percent for that when you own 10% or more of the foreign corporation. Again, we're looking at a reduction to it, and it's something to pay attention to, especially with year end planning, depending upon your ownership in these companies, the dividends obviously given, and what their final determinations could be.
Interest expense. Again, another one of our favorite things under consideration. This could be a little more beneficial. You're looking at being able to utilize an interest deduction potentially for 110% of the net book interest expense. And then this limitation does only apply to the domestic corporations here with a three year average, with the net interest expense over 12 million. So again, another December 31st, 2022, which seems to be the predominant trailing theme, except for our couple with the December 31st, 2021 in the international arena. And this does allow you an unlimited carry forward of the disallowed deduction. So you would be able to get them at some point, just not potentially when you really wanted them.
So international is always one of those areas where they're constantly changing things on us, outside of new legislation such as the Build Back Better. I always advise clients, pay attention to your ownership of anything foreign and ask the questions you've got your controlled foreign corporations or foreign corporations in general on your 5471. You've got your partnerships under 8865s for foreign partnerships and your disregarded entities under 8858. We're seeing a lot more forms and schedules being added to all of these, so keep that in mind. We've also got new schedules coming in on K-1s with a K-2 and a K-3 to hopefully help clear up some of the international reporting. And there it should provide you more pieces. So that way, theoretically should make the forms a little easier. We're hoping that's the case. We think more legislation is probably coming. There's a lot of areas on these forms that says reserved for future use, which always makes us all a little nervous, especially with the government.
You've also got your contributions to foreign corporations or foreign businesses on a form 926, which is key. And then you've got passive foreign investments, which is form 8621. Again, you could go on and on with all of these international forms, but many of them also carry heavy penalties of $10,000 or more. So we always urge clients, ask questions. We have a good team here at EisnerAmper who can help with all of these. It's always better to ask the question and not need to file anything, as opposed to three years later, oh, we should have been filing, how do we fix it? I always encourage staff, clients, anyone, ask the question. I'd much rather do a little research up front than fix it last minute or a couple years later.
We are seeing a lot of increased scrutiny in form 1042 reporting. So that's the equivalent of our US 1099s, except for foreign individuals. They're getting hot on this. And unfortunately it is the payor's responsibility more so than the payee who's receiving the money as they don't live in the US. So there's less jurisdiction there for them to take over and collect the tax due. So it falls back on the payor to pay out the tax in additional to what they paid, whoever they're funding. So we encourage people to take a look at that, make sure you're paying attention if they're a US citizen or have a US identifier number, or are a foreign person.
And then Puerto Rico repatriation. This has been in the news quite a lot, whether you're living there or you have businesses there, they are definitely paying attention to Puerto Rico, with specific avenues and potentially even a team for that with the IRS, depending on their funding. So any sort of investment there or living there, if personally, make sure you're paying attention to kind of what they're coming out with it. Tying right into that other point there, pay attention to the legislation development. International is complex as it is, we're always getting updates and rulings that clarify things that were passed in TCJA. So adding a whole new regime on top of what's still being clarified adds a lot to different avenues where things could be missed. So those key details are always important here. I always like to say, a the, an a, or an of could completely change an international question. So we're hoping that maybe they cut down on international a little bit, fingers crossed, but no guarantees. So stay tuned, I guess, for what they will actually a pass. And Mitch, over to you.
Mitch Novitsky: Okay. Thank you, Carolyn, Anthony, Samantha, Lexi. I am going to focus my presentation on state and local taxes. I know the general topic of the presentation today is state and local tax planning, which we're going to discuss some different planning opportunities. I know the SALT workaround was mentioned earlier in this training session. But I'm also going to cover some other areas, which one might say doesn't exactly fall into planning, but if you don't address these items, you could wind up in a situation where you could have some significant liability.
And therefore it's all tied together, because COVID really changed the way the world does business. It used to be like myself, everybody came into the office and did their work in the office. But as a result of COVID, there was a period of time where everybody was remote. Now, some people are coming in, some people are not coming in. Some people are coming in one or two days a week. And many of our clients and many companies have gone to permanent telecommuting policies, where their employees are located in many different states. Sometimes they're telecommuting in a state where their office was not previously located, and we see that all the time and it's good that things are changing, but with things changing, everybody needs to be aware of the tax ramifications that go along with it. So I'm also going to be addressing in my presentation items to look at in terms of year end, that may not necessarily save you in dollars, although it could potentially save you in dollars because the more that get sourced to another jurisdiction, the less that may get sourced to the jurisdiction that you're currently in, which could be a jurisdiction like New York, which is the highest tax jurisdiction, incidentally, on the personal income tax level. In the corporate, it's been a long time, but New York has many distinctions as being number one, some favorable, some unfavorable. But if you do business in the state and city, you're looking at a corporate rate which is pretty much the highest in the nation.
And now on an individual rate, California has the highest state rate, but if you're a New York city resident, as well as a New York state resident, you could potentially also be subject to the highest tax rate in the nation, so that's one other thing that New York is number one at.
So I'm going to be addressing the issues related to the SALT Workaround, I'm going to be getting on that topic. And then I'm going to be addressing the topic of telecommuting and how that creates additional filing obligations. I'm also going to be addressing residency changes because what has happened in the last year is that many individuals have changed their residence, individuals have moved from New York to no tax states or lower taxing states. Individuals are telecommuting in other states and that creates various tax ramifications clearly to the individual because they have to determine where they're a resident, and to the employer as well because your individual employees may notify you of changes in residency, and there could be additional withholding obligations in those jurisdictions.
And I'm going to cover this rule in New York, the convenience of the employer rule, which is a very strict rule that even if an individual is somewhere else, if they report to New York, New York can still subject their income to tax. And then we're going to cover last, the unincorporated business tax, New York city, where there is some tax planning opportunities that present themselves as a result of New York city's tax provisions.
Just before I begin, I just wanted to mention we're going to start with the SALT Workarounds that just following up on my colleagues presentations, some points that they noted. I know when Anthony spoke, he talked about certain changes at the federal level. Just be aware that some of those changes at the federal level as Anthony mentioned may or may not have been adopted at the state level. So typically for state purposes. And when I speak, sometimes I may lay out some basic principles because I teach in Rutgers, in the graduate tax program in the law school.
And I know that on this phone call, there's people from all backgrounds, technically in terms of tax. So typically from a state perspective, both from corporate and an individual perspective, you start in terms of determining what your state taxable income, by looking at your federal taxable income, and then you make certain adjustments to get to your state taxable income. So certain items that change from a federal perspective, the paycheck protection, loan forgiveness will the states adopt the federal provisions on that? They may decouple. They may have something saying that they don't. And I can tell you that having done state taxes for many years, states are all over the place on these things. Some conform, some don't conform. Another issue is the NOL changes. Some states conform, some states don't conform. Some conform on the corporate side, some don't on the individual side, some vice versa.
Bonus depreciation is another example. Some states conform, some states don't conform. Some states had their in place before COVID and they may either apply, or the states may have addressed and said, "We'll accept the COVID exceptions." 163J, 461, the list goes on and on. So one thing I tell my students is whenever I prepare a tax return, I know we have this rush to get things done, and we're all very busy, but I like to look at the instructions to the form because when you look at the instructions to the form, you can see where there may be differences between federal and state and adjust accordingly. And of course, when you make estimates during the year, you should be aware of these differences. So preferably don't wait till the last minute to look at the state instructions, but always look, see where the state may conform or may not conform.
Another tip I always give is always look at last year's return because if something was there last year and it's not there this year, it maybe there's a law change, it maybe the company moved, but you should always look and see if something's not appearing this year. Or on an apportionment perspective. If a company is 70% in New York, one year and 20% the next year is there reason for that? Well, there could be due to COVID, but it could be that there's a mistake. So it's worth taking that extra time when you file a return to look at these items.
Just another note following up on Samantha, just on the international side and the federal side, there are no treaties with any states generally, there're treaties with the federal government and other countries. So I have had over the years, you could have situations, for income tax some may follow what the federal does, many states don't, they have their own filing provisions. They look at the term nexus or do you have certain contacts with the jurisdiction, which would require you to file. So from an income tax perspective, I see it from the sales tax perspective. I see it even from a withholding tax perspective, just be aware that what may apply for federal purposes may not apply for state purposes.
So when we say planning, sometimes I bring you potential exposure areas, but that is very important to address because if not, you could wind up paying much more in taxes at a later date. So I wanted to begin with the SALT Workaround and how did this workaround originate? So for federal purposes in the TCJA, your itemized deduction for state and local taxes is $10,000. Now for most of us, $10,000 are property taxes alone. Certainly in New York and New Jersey are going to be higher than $10,000. And then you get zero deduction for your income taxes.
So what happened is there was a notice issued by the IRS and there were different planning ideas, states had different SALT Workarounds, New York had where you could potentially make a charitable contribution deduction. And that would get around this $10,000 limitation. There was a payroll tax that you could pay. None of that really worked, and no one really followed along with it. But then along came the IRS and basically they issued this pronouncement notice 202075. And in essence what happens is if you are a pass through entity, an S Corp or a partnership, and each state has its own specific rules, they can pay the tax on behalf of the partners or the shareholders' behalf. And they will get a deduction for the state taxes that they pay.
So even though an individual will only get a maximum $10,000 deduction, if you are a partner in a partnership that does business in the state generally, but each state has its own rules, or if you are a shareholder in an S Corp, you may be able to have the entity pay the taxes in your behalf. They'll get a deduction, they'll pass through that credit to you. And you will get a credit on your personal tax return for the taxes paid by the entity on your behalf. But the key thing is you're getting a benefit of the federal deduction that you would not otherwise get.
Now, a bunch of states jumped on the bandwagon, particularly after this IRS notice, New York was one of those states, Jersey actually was before New York, Connecticut has it. Although if you see in my slides in Connecticut, the pass through entity tax is actually mandatory. Most of the other states it's all elective. New York state for the pass through entity tax, they made the entity make the election by October 15th. You don't have to file the return until following year, but the election must be made by October 15th. And in order to get the benefit for federal purposes, following up on Anthony's point, whether cash basis or not tax payer, you have to make the payment by year end.
I'm just showing you on this slide all the different states that have SALT Workarounds, and each one works different when you have to make the election by what tax needs to be paid. In New York for example, on the SALT Workaround the entity pays the tax based on all the income. That's how the rate is determined. Some states it's just a flat rate. New York, as an example for partnerships, you can make the election on behalf of resident partners on all their income. Non-resident partners, income source to the state.
S Corporations generally is just income source to the state of New York, each and every state has its own provisions on that. New York also still required individuals to make their own estimated tax payments during 2021, the pass through entity did not have to make a payment, but of course, as I indicated to get the benefit in 2021, the pass through entity will have to make a payment by year end and New York shortly will be coming out with a pronouncement as to how exactly to make the payment, so I can't stress enough that it's very important to make the payment by year end.
Now, Carolyn initially talked about the federal legislation. We don't know what's going to happen, but obviously that's something to keep an eye on, past the house what's going to happen in the Senate. One thing I know in life, I'm not going to try to predict what politicians will do, because there's always last minute things that happen. So that's just something to be aware of, but the SALT Workaround is a great benefit and everyone should be taking advantage of it. And as I mentioned, I can't stress enough each state has its own rules, each state calculates the tax different, the credit is calculated different. S Corps may be treated differently than partnerships, I mentioned in New York S Corps it's on the income source to the state, whether you're a resident or non-resident. Partnerships, a resident, it's all the income, a non-residents income source to the state.
Now, one thing to be aware of is the credit for taxes paid to other states. So New York as an example, and most states have opined on this and agreed. There is a handful of states where it's questionable and some jurisdictions like PA, if it's an S Corp they give the benefit. If it's a partnership, they don't give the benefit. What am I referring to here? You get a credit as a resident individual for taxes paid to other states. So if you are a resident of New Jersey, you pay taxes to New York, you get a credit. It may not make you whole because it's on the income subject to tax times the tax rate, but you generally get a credit. The question is this pass through entity tax is technically a tax paid by the entity to another jurisdiction.
So since it's by the entity, some states, the question is, will they allow the credit to a resident individual if the resident individual pays tax at the entity level, through a SALT Workaround to another state? Most states will allow it. Remember, I will never speak exclusively and say that it refers to all states. We have four or five states that we think could be problematic, but it could be an issue to be concerned about if you are a resident of a state that could be problematic.
New York actually just issued a release frequently answered questions, where they indicated that if you pay the SALT Workaround to, they mentioned all the other states. And their position is if they have a similar workaround to New York, they'll give you a credit. So, New York's going to give you a credit for most other states. We believe Jersey, but you have to address each and every state separately to make sure that you'll get the credit.
Now, at the end of the day, the federal benefit of 37% is still likely to outweigh everything else, but it's just something to consider. Now, incidentally in New York and every state is different, what happens if you have excess payments? Because what happens is you're making payments all year estimates and incidentally in New York it doesn't apply to New York city taxes, it just applies to New York state taxes. But you're making estimates all year, and then the pass through entity to get the deduction is going to make the payment by year end.
So you could have an excess amount paid in during the year, that's refundable, that's creditable. So you're not going to lose the excess amount that you paid in for New York. I will have to say that there are a couple of states, Connecticut I know the pass through entity, the individuals get an 87.5% credit. Massachusetts, it's a 90% credit. In California, the credit's limited to the 10th of a minimum tax. I also mentioned in California, there's a carry forward of the excess.
So it's just something to be aware that each state has its own peculiar rules, and don't assume that if the law is such in one state, that the other state's going to apply the same provisions. And we're following this daily and there's more and more guidance coming out, but of course, there's still a lot of unanswered questions.
So as I mentioned before, the main benefit to making a payment for the SALT workaround by December 31st is the federal deduction. So that 37, assuming you're in the 37% bracket multiply that by the state taxes paid and you are normally limited to $10,000, which as I mentioned before, in most cases will just cover your property taxes and not even that. So there's a lot of opportunities by taking advantage of the SALT workaround.
Is there planning in it? I mean, technically there could be, because now also remember with individuals telecommuting and the way you calculate how much income is sourced to each state, you may have a different apportionment formula. Take for example, New York state. They source income to the state for partnerships. I'm talking about the state now, three factor, is payroll, property, sales. So it could be through these individuals telecommuting.
Now the sales factor is very restrictive. If you still work for the New York office, they'll say that's New York, but you could have potentially payroll or property in other jurisdictions. You could wind up less than New York, more in other states. So that's just something to be aware of.
What are the downsides of the SALT workaround? The only two that I really see is cash flow issues because in New York, as I mentioned you had to make estimates and you have to make the payment to get the federal benefit. In other states, I mentioned a couple of states where you won't get a full credit. So there's compliance involved, but also the credits. I mentioned that some states not give a resident a credit for taxes paid to other states, so that's something to look into.
Now, we get questions. A lot of times people think, "Well, state and local, but sometimes there are legal issues that come up, will the partnership agreement allow for special allocations?" I mentioned before, residents in New York can do it on all their income, non-residents on income sourced to the state. So in essence, you have to maybe revised the partnership agreement, and then I'm not practicing law here I'm just saying that that's something that you have to consider and speak to legal counsel in terms of how you address the situation where you're paying more on behalf of residents than non-residents.
Also, an issue that comes up, now you're calculating the tax at the entity level, so what happens with items such as sales of interests in other entities? Does that get included? I'm just utilizing that as an example or other categories of income that might not specifically be in the ordinary course of the trade or business. How do they get sourced? How are they taxed? Different states address this in different ways, but that's just something to look at. If you have an unusual situation that year with a lot of income, that's not in the ordinary course of business, how this tax paid at the entity level. And then of course the individual has to flow that through. And what happens at the individual level as a result, these are all questions that come up where we can't anticipate every single question, but we certainly address each one as it arises. And I can't stress enough, the payments have to be made by December 31st to allow for the deduction in 2021.
Now you don't have to technically make the payment for state tax purposes in New York this year, technically till March. But if you want to get the federal benefit, you got to make the payment by December 31st. And that's the whole reason and the benefit of the SALT Workaround. So be careful, don't wait till the day that the last payment is due, get it done by the 31st of December.
Lexi D’Esposito:Poll #5
Mitch Novitsky:Good, it appears that most people are on top of this. And there are situations of course, where it potentially may not be applicable, if you're in a loss as an example, if you have no income source to the state. So it's good to see that many people are aware of this and considering it for 2021. And as just to qualify, again it should be a great idea, but we are going to also follow whatever happens at the federal level very, very closely.
Another issue that comes up is residency issues. This may be potentially more on the individual side, but it does also have issues that companies need to address in terms of where individuals reside. And certainly, a lot of executives in many companies have relocated in the past year. That's probably the area that I'm spending together with the so work around changing residency is an area that we've gotten significant questions on and something that everybody should we aware of.
I'm not going to go through all the details, but there's probably individuals on this call that may have change the residency. So there's two ways to be a resident of a state for tax purposes. It's interesting. The first method is domicile. Your domicile is your permanent home. So you can have more than one residents for tax purposes. As I mentioned, you can be a resident of two states potentially, but you only have one domicile. What one's domicile, the domicile is the place that is their permanent home, where even if they leave, they intend to return to that place.
The intent must be proven by facts. I began my career with the New York finance department, having worked with many different individuals. The phrase I heard the most was the burden of proof is on the taxpayer. So the state can come in and say, you are a resident still of our state. You have to prove otherwise. And how do you prove you change your domicile? By showing that your intent was to leave a state like New York or New Jersey and never to return. You can't try this out.
I've gotten questions. You can't say, well, let me see what happens in a year or two. And then I'll come back or audit span three or so years. You got to make the intent to move permanently. And what's the intent you show that you sever as many connections as possible with the old location. If not all, but sometimes clients keep a residence or whatever, and you establish as many connections as possible with the new location.
So if you're going to say that you're moving from New York to Florida, you got to disconnect from New York and establish connections in Florida. They look at things like where your family is, where your business is, your homes, where you spend most of the time. It has to be manifested by unequivocal acts and order to is look at in order to determine how much time you're spending in each location and where you are working and spending your time and where your family is and everything. They will ask for things like cell phone records, bank statements, easy pass records, travel itinerary, airline tickets, credit card statements. Audits can be very, very intrusive. And while I'm on this note, I will say that this past year, New York state allocated an entire unit.
Sometimes they do full-scale field audit where they ask for everything, and they go back two, three years. But they're doing now is anybody that changed their residency during the past year will likely be getting a notice from New York state. And they'll say, we notice it, you change your residency. They'll ask for a few key items, show us a lease or a deed for your property. Show us your utility bills. They ask for why because this way, they see where you're spending most of your time.
They'll ask for a few different items just to see that payer actually is in the new location. Depending on the level of responses, they may send something further. So please be aware, dot your eyes, cross your Ts, make sure that you can substantiate everything because it is very important for an audit purposes to show that you change your domicile, all your business connections, your personal connections, where you worship, your doctors, the list goes on and on.
We have checklists that we go through with clients just to make sure that you've affirmatively demonstrated that you've changed your domicile to the new location. All your near and dear items should be going with you. To everyone, the near and dear items may be different. In my case, it's certainly my family, but there's art and everything else, antique cars, whatever it is, make sure that whatever is near and dear to you is moving to your new location.
Now I said before, even if you domiciled, you change your domicile. New York, Jersey and Connecticut also have a statutory residency rule. So what's a statutory residency rule? That if you maintain a place of a boat, if you maintain a place in the old jurisdictions and spend more than 183 days, you could still be considered a statutory resident.
You could be a resident for tax purposes. And that doesn't mean, some people say, well, what about if I transfer title to the property to someone else? No. It's if you have access to the place, so it can be your you're a spouse, your employer, your girlfriend, whatever the scenario is that is deemed to be a place that's on your behalf. And then if you spend more than 183 days, and any part of a day is a day.
If you spend every time you spend overnight, that's two days, that's the day before or the next day, you will be a resident. And those audits can be very intrusive too. They'll ask for easy pass records, cell phone records. They can tell from the cell phone tower where you are at any point in time. The burden of proof is on you.
So if you are changing your residency, make sure you changed your domicile. If you still maintain a place in where you were, that you don't spend 183 days and don't even be close. I can tell you that. As I said before, that everyone that's changed their residency in the past year will likely be getting a notice from New York.
They're also sending to those people. I'm going to go to the convenience of the employer real soon that have allocated a lot of wages out of New York but still work for a New York employer. Because New York has this rule. That if you work for a New York employer, even if you are elsewhere, you still have to pay New York taxes.
Lexi D’Esposito:Poll #6
Mitch Novitsky:20% is still a decent amount. You see that people are moving at and I think you're going to see more and more. As many companies are adopting telecommuting policies, you'll see more and more people moving to different locations and sometimes the location, and in many cases could be a location with a lower tax rate.
The next topic, as I mentioned before, this may not be potentially planning, but if you don't follow the rules, you could get stuck with potential liabilities down the road. So, as a result of telecommuting, we've gotten a lot of questions from clients. I got somebody that's working now in North Carolina, someone in Georgia. Do I have to file a return in that jurisdiction?
So, in short, during the COVID pandemic, a lot of states provided exceptions because they said, it's due to COVID, it's national emergency this and that. We won't make you file returns. And when I say file returns, it could be corporate income, it could be withholding taxes. Because you've got individuals now residing in a jurisdiction. And as a result, they're performing services in that jurisdiction, which in essence requires you to withhold on their behalf in that jurisdiction.
So states during COVID, a lot of them bent the rules, but once COVID ended, a lot of states are saying, now that all bets are off, do you have a filing obligation in those jurisdictions. Why do I stress this? Because every employer that has employees working in states where they didn't otherwise file needs to address whether or not there's a filing obligation in that particular state as a result of the presence of the employee performing services on your behalf. And as I mentioned, it covers all potential taxes.
I worked, as I mentioned, for the New York finance department. We had situations where an employer was to withhold, didn't withhold. And guess what? The employer got stuck with the obligation because withholding is a trust fund tax, same thing with sales tax. You don't do what normally is, just collecting money from someone else. You are stuck with the liability, be aware of withholding obligations, especially now employers are registering for legal purposes. As in other jurisdictions, you got to be aware of filing obligations as a result.
Now there's other issues that come along. This is a topic for another discussion, but there was a Wayfair case at the state level where economic presence that used to be, you needed physical presence now if you just have sales into many states. You have to file. That law has been interpreted very aggressively, and that's been applied.
So you need to really look, everybody needs to look, and you need to look not just at one tax at all, taxes, income sales withholding. You need to look, is there an obligation because of my telecommuting employees, because of economic nexus or whatever, to file an additional jurisdictions.
I do a lot of due diligence, and the one issue that I come across over and over and over again when companies is, we see that our client is looking at a company and that company filed in five states. It should have filed in 25. So that's something that I always bring to our attention because you can get stuck with liabilities. If you don't file, be aware now with telecommuting, with employees in new locations, you could have additional filing obligations in those locations.
Now, these are some miscellaneous issues. As a result of telecommuting, some things have changed some state source based on a payroll factor. So, where is your payroll now? It used to be your payroll might have only been in New York. Now your payroll may be in other jurisdictions. And where do you determine where the payroll is? Where you pay unemployment taxes on behalf of that individual.
So not only is registration obligations, have they changed where you may need to file in a bunch of different jurisdictions, but the amount of income you source to each jurisdiction could potentially have changed. And you need to address all the rules associated with telecommuting. A filing obligations and B how you source income.
So the payroll factor could, if now you're paying unemployment taxes and employing people in other jurisdictions, sourcing of revenue could change because some states, you look at where the services are performed, and this applies corporate entities potentially partnership. Another thing with sourcing revenues and apportionment each state has its own rules. So when I speak, I don't speak for one jurisdiction. I just caution you that don't assume that the law in jurisdiction A is the same as a law and jurisdiction B, but sourcing a revenue could change if a state looks at where the services are performed. Well, now the services are no longer performed in one jurisdiction. They're performed in another jurisdiction.
If a state looks at where the customer is, well, your customer may have telecommuting employees. And that may create a different sourcing to the jurisdictions now where your customer is, because that may have as a result of telecommuting.
Telecommuting has changed a lot of things. Where is a company's commercial domicile for certain items like non-business income? And don't worry if this goes over your head if some of you aren't familiar with this. I'm just trying to say the general principles you look at where the company's commercial domicile is, where the decision making is and everything else. That may have changed because a lot of companies now, everybody telecommutes. So where, where is the company headquartered? So be aware of all the issues that we face as a result of telecommuting.
I mentioned before the convenience of the employer rule in New York state. New York state has this rule. A bunch of other states do Massachusetts has of the rule. New Hampshire sued them. I thought the Supreme court would address it, but they did not. So what's the convenience of the employee rule. And that's also generating a lot of notices.
If you work for a New York employer, but you live, let's say in New Jersey, your employer has to withhold New York taxes unless they required you to work in New Jersey to perform services on their behalf. Are you doing it for your own convenience, working in Jersey? Or are you working in Jersey at your employer's request? If it's at your employer's request, you could source those income to Jersey those wages. But if it's for your own benefit, you have to source it still to New York.
The crazy thing is that even during COVID, I thought New York may grant an exception, but they did not. They said, even if people are telecommuting due to COVID, even though they weren't allowed to go into the office most for a period of time, even though their employers weren't available and open for them to go in, does it matter? And that's the second area where I'm seeing a lot of notices from New York. So if you're an employer, you rightfully should make sure to apply that convenience of the employer rule. If the employee is telecommute for their own benefit, you still have to withhold New York tax.
Now there is a policy bulletin. How do you change that? It there's a lot of stringent requirements. You'd have to have an office on behalf of the employer and the other jurisdiction. You have to meet clients. There there's lot of very stringent requirements. You can't just say to the employee, okay, you're working from home. That becomes an office. Therefore we don't have to withhold New York tax. Don't forget also that creates potentially a filing obligation in New Jersey.
So there's a lot of ramifications to our actions today as a result of tele commuters, and we need to address all those ramifications. Convenience to the employer will be aware, cover yourself if you're an employer. Don't let, if the employee pushes back, say to the employee. You know what? Speak to your accountant, that's your decision. But we have to withhold tax. If you don't, you could get stuck with the bill. As the employer, I saw it. I dealt with it.
Some states, just another note, have suspended their statute limitations due to COVID. So you may think, oh, the statute's up. Nope, because of COVID, they extended the statute. Just be aware of that. There's not many, but there are some New Jersey being one of them.
Finally, the New York city have unincorporated business act. This was a planning opportunity. I hope many companies took advantage of it. And you certainly should take advantage of it. New York City for unincorporated businesses looks at where the services are performed. Generally, you look at the revenue generators, where they perform the services?
If you are normally in New York city and a hundred percent of your services were in New York city, a hundred percent of your income was taxed to New York for unincorporated business tax. The rate being 4%. Now, if 70% of your individuals live outside of the city, remember this is Long Island. This is New Jersey. This is Connecticut anywhere else. And you look at technically it's the revenue rate generated, so you include like the IT people.
But then, if you have a large percentage that are outside of the city, those revenues should be sourced outside the city. So many of our clients we've seen their apportionment percentages, drop significantly because they look at where their services are performed. And since most individuals do not live in the city and perform the services out of the city, they were able to reduce their apportionment or amount of income instead of being a hundred percent to a much lower percentage of tax to New York City.
But once again, I want to stress. The burden of proof is on a taxpayer. Make sure you keep records, make sure whether it be timesheets, whatever situation you have. IT reports to establish the amount of time that the individuals outside of the city, should you be ordered at a later date? And that's it for my presentation. Feel free to follow up with any of us with any questions. And I'm going to turn it over, I guess, to Carolyn or Lexi.
Carolyn DolciWe did answer a couple of questions during this time, and we only have two minutes left. We're going to let you all go and enjoy your rest of your afternoon and wish you all a very happy and safe Thanksgiving holiday. Thank you.
Transcribed by Rev.com
Explore More Insights
Receive the latest business insights, analysis, and perspectives from EisnerAmper professionals.