On-Demand: Changing NY Tax Guidelines
- Aug 18, 2021
This webinar addressed how changing tax guidelines can have major impacts on real estate companies and investors, and there are a number of New York developments affecting the sector.
Neil Tipograph:Broadcasting live from EisnerAmper world headquarters in New York City, we present changing New York tax guidelines and how they impact real estate companies and investors. My name is Neil Tipograph, tax partner with EisnerAmper real estate group.
I handle business and personal work for real estate families and property management companies and real estate private equity funds and their management entities and managers personal returns. With me today are two esteem tax lawyers both highly specialized in state and local issues and planning. Mitch Novitsky is a tax director at EisnerAmper and he and his team are the first line of defense against any phone call inquiry, tax notice, tax bill or questionnaire from New York State or New York City tax departments. With Mitch's experience of handling state local issues and the fact that he started his career with New York City tax department of finance, he and his group should be able to resolve or settle most matters.
If all fails at the administrative level and you need to bring in the big guns to duke it out with the state tax people in the courts, Tim Noonan is your guy. Tim is the tax residency practice leader of Hodgson Russ. Tim literally wrote the book on residency audits. He is the author of the CCH residency audit handbook and is a very popular speaker and writer on state and local topics. And today we will be discussing in the following order, Tim will discuss New York change of domiciles and residency issues. I'm going to talk about a brand new topic and if this is the first time you're hearing about this topic, you may think I went insane because the topic is insane. But it's true and I will walk you through it.
By the way, I did all of the polling questions so, one of the first polling questions is going to be during Tim's talk so here is the clue for the answer. It doesn't matter if you answered the polling questions correctly or incorrectly, it's just important that you answer it. But in my topic I'm going to be describing the New York state soul work around called the New York state pass through entity tax. The work around will allow taxpayers to claim up to 100% of the New York state and city tax liabilities as a tax deduction on their federal return. Currently all state and local taxes on personal tax returns are subject to a 5,000 or 10,000 valid limitation. Okay. And finally, Mitch is going to wrap it up and we'll be discussing New York City UBT allocation rules. And that's become a matter of importance for many of our clients who are now working outside of New York City. I now hand it over to Tim.
Tim Noonan:All right. Well, thanks Neil. Glad to participate in this great webinar. I've been doing a lot of these types of events since COVID started. Most of them here from my lovely home, actually I'm not broadcasting live from New York City. Sorry Neil. But, lovely Buffalo, New York and I've been here in my home office, always wary of a child running in but no worries. When I'm in my office, I'm wary of an associate running in so it's really the same kind of problem. But I've been doing a lot of speaking, not only on webinars like this, but more so every day, all day with clients interested in the topic that we'll be discussing for the next few minutes involving how the heck to get out of New York. Because what we've seen in the past year of course, is two things happening, tax rates going up, which is good timing on New York State's part.
Way to go New York state. To well, people are already flooding out of New York to raise tax rates, to make it even more appealing to get out of the higher tax jurisdiction but rates went up back in February effective 2021. Higher income taxpayers. They went up for folks making more than 2 million bucks a year. But the highest rate, when you look at combining it with the New York City rate as we indicate on our slide here, 14.7%. Which is close to the highest or maybe the highest in the nation. So, we're number one. Way to go New York. So, that's happening coupled with, again, COVID and with the ability to work remotely, coupled with folks whose fears about living in a compressed area. People have just been going. Right. So, a couple of quotes here that I've been gathering and on the internet and on Twitter and 900 people a day moving to Florida says the Florida CFO, Andrew Yang.
300,000 people left New York City. I mean, maybe that's right. I can tell you since March of 2020, it's almost been, for me, maybe a client today, at least calling about moving money in and oftentimes engaging our firm to help them with the move. Just unbelievable. If you call me and you get my voicemail, it says press one if you're moving to Florida, press two if you're moving to the Hamptons, press three if you're moving to Connecticut, because oftentimes the call is the same. I mean, there's people who understand the rules they want to get out. And it's interesting. The sort of demographics of our clients now have changed. It's not just the older husband and wife who are looking to get out of Florida or get out of New York before they sell their business. This is moms and dads with kids. It's 30 year old millennials who work at hedge funds. It's everyone and anyone is looking to get out of New York.
So, it's been an unusual time. I've been a popular guy over the past year or so too. It's been fun, but it's interesting to see how it's going to play out in the long-term for New York state. But of course that's not our topic today. Our topic today is, well, how are these tax audits going to play out? With all this loss and revenue and all these people leaving? And for every person that calls me or calls me or Mitch about this, or one of you guys there's five or six or 10 people who are just doing it, right. They're just not getting any advice. And New York state expect them to be aggressive. In fact, as we're going to hear, they're already aggressive on this very issue relative to the 2020 tax year. So, again, residency 101, if you're a resident of New York, you're taxed on everything, all of your income and you're only taxed on one thing, everything.
Non-residents only pay tax on sourced income in New York City residents pay tax on all of their income. It's an all or nothing thing though. If you're not a resident of the city, you don't pay any New York City tax. Again, that, and just spend a real impetus for folks to try and sort of excise the city tax from their tax bill in 2020 and in 2021. So, we'll talk about a couple of examples relative to that. Two residency tests. One's real black and white. You're here for more than 183 days and you have a place here. You're a resident of New York under the statutory test. The test that sort of there's more involvement as litigation in more confusion often is the domiciles test. That test is a more subjective test, balancing your ties to the new state versus your ties to the old state.
And you bear the burden of moving out. So if I'm moving out, burden of proof is on me to prove that I'm establishing a new home, a new domicile in Florida. And if it's a close call, I'm going to lose so, if I'm trying to argue that I'm moving and it's a 50/50 type thing, we're going to get our butts kicked in the audit. It's got to be a clear and convincing move. And when we're talking about what's clear and convincing, we're looking at factors. And we're not looking at where your driver's license is or where your voter registration is. We're not really focused on that. We got to do all that stuff and get you a checklist on that. That's easy. We're really focused on looking at how your housing ties look, where your business ties, where are you spending your time?
That ends up being a big one. How much time you're spending in Florida versus New York or the Hamptons versus New York City or whatever, where your stuff is, the near and dear factor. And then, family issues. Where will kids go to school oftentimes is a big one. So, that's kind of the basics on it. We sort of spin COVID in well, what's happening. Well, again, like I said, lots of people are moving. So, it creates just a flood of people moving out. Can New York State chase everybody? I have talked to clients about this vision in my head of just like a crowd of people walking across the border. Maybe you're in the middle of that crowd. They just can't get to you. There's so many people moving but they've taken initiatives as we're going to talk in a couple of minutes about trying to pick off people right away on this residency issue in 2020. The big issue though with COVID related moves and that again, lots and lots of conversations on this, is whether or not the move is going to be permanent.
When we think about permanence or at least indefinite moves in this context, always have to have in mind sort of what we refer to as the leave and land role. And that is that an order to change your residency, to change your domicile under that domicile test, you've got to leave New York with the intention of not coming back and you have to land in the new place with the intention of living there if not permanently, at least indefinitely. So, when we have these COVID related modes of what I think we're going to see is a lot of hindsight. If the taxpayer goes to the Hamptons and comes back, well, did they really leave and land? if they go to Florida and it just doesn't work out and they come back, did they leave and land?
Now again, the law, if you intend to move to a new state and it doesn't work out and you come back, well, that's okay. You can prove a move there. We won a case a few years ago, the black case. It's also sort of infamously referred to as the "dog case" because I think we won because the guy moved his dog but he only went to Texas for like 18 months. And he came back and the tax department was like, what are you kidding me? That wasn't a leave in the land. But he went ahead and he testified. And he was able to establish that indeed he did establish a landing even though his move just didn't work out. So, that's that's leaving and landing. The other thing that we see coming up in the COVID related moves is remote work. Now this isn't necessarily a residency related issue.
Remote work type issues come up with respect to someone who indeed definitely lives in another state but is working for a New York based company and how they get taxed. So that, again, not necessarily a residency consideration but it has been really issue number two that's been major in us trying to figure out how to handle these issues on a go-forward basis for our clients. So, I found that sort of the best way to address a lot of the issues that's coming up is just sort of talking to you guys about what I've been seeing, giving you a couple of case studies or factual scenarios and it gives you a good context as to sort of how these rules are going to play out with again, these kind of COVID related moves.
So, this first one is a very typical example particularly for folks who have sort of lived and worked in New York City pre COVID. So, this taxpayer New York domicile worked in New York City lives there with wife and kids. Spouse works as well, but they place in the Hamptons. Lots of people in the city have places in the Hamptons. And in March 2022, they went there. A lot of people. And then school went remote. So the kids are zoom schooling. They continue zoom schooling into the fall. But, if you talk to them, they're coming back. Their hope is school's going to be live again. So, in next month they're going to be coming back to New York and New York City and they'll be working in New York City. But in 2020, and in 2021, their day count's going to be really good. They're only going to be in New York City about 75 days a year.
So, the issue here of course, is that leaving and landing. If they're coming back in the fall of 2021, even though they might not, ya know, forget about 75 days in New York City, maybe the 75 days they spent New York City was in the first month and a half or the first two months, sorry, the first two months and a half, and then they were gone. They didn't come back at all. And maybe they didn't step foot in New York City again until the fall of 2021. Again, the city's position is going to be absent. This taxpayer being able to prove that they did indeed intend to move to the Hamptons. And they took a lot of steps consistent with that but it just didn't work out and they came back. Absent that set of facts, which again, might be tough to prove they're going to have a very difficult time winning their residency case. And I think New York City is going to be primed to look at that and they're going to use hindsight right now.
Look, I've had a number of tax payers do it. And the factual picture number one is they probably can't come back in the fall of 2021 again, unless they can really make a case that they tried and it didn't work out. But I have particularly folks who don't have kids are doing it. They moved up to their place in the Hamptons. Maybe they got rid of their place in New York City. I think you will find and you've just from the news that it's not that super easy to get rid of a place in New York City right now. So, maybe they're going to keep their place in New York City either because they can't sell it or they do still want to have a place there. But there is a scenario where you can do it. Essentially you just have to become like the people who live in Rosalind or something who are, ya know, they live in Long Island, they work in New York City. They have a relationship in New York City with work or something but they commute.
It's hard to commute every day from the Hamptons but you have to be a Long Island person. You got to set yourself up like that. So, that means you're not in the city on weekends. You're not spending tons and tons of overnights in the city. You're really limiting your time, your work time, maybe to a couple of days or so a week. So, again, you become a commuter, you try to telecommute as much as possible. It's a factual scenario that I've had a lot of taxpayers give it a go. Query whether they'll be able to continue to do it and did 22 and 23, but they're going to have to under this leave and land role. Or at least if they want to avoid a difficult audit, sticking there for a few more years is going to be really important.
All right, here's the Florida move. So, here's an example where husband, wife, kids live in New York City. She runs a real estate management company based in the city. They had significant management fee income. COVID hits. They stay with their family in Florida for a couple of months, decide, you know what, this is okay. We can do this. We are going to put our kids in school in the fall of 2020. So, she got a rental in Florida in July. Started spending time there getting office set up, whatever, at least for her, her team was going to stay in the city and the husband and kids are joining in the fall again of 2020. They're going to get rid of the New York City apartment and they're going to get rid of their office lease for their business at some point but when things return to normal, which last I checked still aren't. So, into 2021 they still have their city place and they still have an office. The firm's still her firm still has an office.
Look, this is a real leave and land. Even though they haven't got rid of their city apartment, I find that when you have moms and dads with kids, it does become easier to sort of stick that landing. You've put the kids in school, you get a place down there, you live down there, you're there most of the time of the year. The fact that you haven't disposed of the city place isn't fatal. So, provided they stay down there and they're not coming back next month. They're going to stay in Florida. Kids are going to start the next year of school there, they got a real "leave and land". We got a good move here.
Now, when do you pick the date of the move? Well, it's probably not March of 2020 because they were just staying with family then. They hadn't really decided when they were going to plant their flag, ultimately under the law, that's when you move. You move when you decide to go and to stay there. So, if they were just kind of hiding out there in March and April and May, probably not sort of sticking the landing at that point. In July when the wife goes down there and sort of moves into their place, maybe husband and kids join in September, obviously by then we should be good. So, that is an important timing thing. The other thing to consider on a timing issue is if over the course of the entire 2020, they spent more than 183 days in New York.
Well then, even if they changed their domicile in July or September, New York is still going to say they're a resident for the entire year under the statutory test. That used to not be the rule. We actually handled the case back in 2015 or 2016 called Sobotka where the judge agreed with us that as someone moves into New York or out of New York during the year, you don't count the whole year of 183 days. But the tax department though, they lost that case. Didn't like the results. So they changed the law. So now we have to worry about that 183 day test during the year of the move. Again. For these guys, probably not an issue. But they left when COVID hit in March. So, again, they probably won't have 183 day problem but just something to flag. The last thing to flag for these guys is that for the wife's management fee income from her real estate company.
So, normally when you have someone who moves during the year, in order to determine how much New York gets paid on the management fee income, you prorate that based on her days of residency in the year. So, again, maybe you want to have an earlier change date to water down that pro-rata allocation. There are items of income that you can stick in the non-resident period totally. So, you could definitely do that. But that has to be income that is kind of crude or using a direct accounting method for a hedge fund person. For example, the portion of their carry, there's definitely an argument for hedge fund folks that if their carry is crystallized as of 1231, then we can actually book all the carry in their non-resident period. But again, in this example, we're likely going to prorate it.
And again, the portion of our management fee income still could be taxed in New York if it's sourced in New York. So, New York has sourcing rules for partnerships for S corporations. So, you'd also, for business income like that you'd have to consider sourcing. All right, a couple more. Here's folks who were in the city. Instead of the Hamptons, they got a vacation place in Connecticut. So, they're definitely not going to stay in Connecticut forever. They're totally just doing the COVID hideout thing and they definitely want to come back. But in 2020, and then again, in 2021, they had a place in Connecticut and they were more than 183 days in Connecticut. So, they're still New Yorker because they didn't "leave and land". And under Connecticut's law, shoot, they're a resident of Connecticut under the 183 day rule. So, interestingly, you know in Connecticut, it's a potential double tax issue.
And Connecticut likely will tax well as a resident, definitely will tax all of the taxpayer's income. They'll give credit for the sourced income, but investment income and such gets double taxed. Now, I think there's a good possibility that Connecticut was going to be gentle on this issue at least in 2020 based on some conversations I've had with Connecticut tax people. In 2021, I don't expect it because I think that the rationale is 2020 was a wacky year. People are trying to figure things out. But by the time we get to 2021 people should know. So, that's how that could play out.
Lexi D'Esposito:Poll #1
Neil Tipograph:There were some questions in the chat box, Tim. I don't know if you can take a look.
Tim Noonan:Yeah, I mean, I just saw one. One of the questions from Jamie was what are the requirements of someone who leaves New York? So they definitely moved, but they kept a place in New York. Well, look that taxpayer likely still has to file as a non-resident taxpayer on a going forward basis provided they have some sourced income. So, if there's no source of income and the fact that you maintain a place in New York, does it give you a filing requirement. But if there is sourced income, the issue there is, well, there's a box on the tax return that says, do you maintain living quarters in New York? Well, you've got to check that box, yes. I often think that question also could be read as, would you like to be audited by New York? Yes or no, you check it yes, that could raise an issue. So, that's the.. If you keep a place in New York, again, it doesn't mean you can't prove a move, but it's definitely a flag for an audit.
Again, it doesn't mean you can't prove a move, but it's definitely a flag for an audit.
Neil Tipograph:Yeah. There's one other question. Karen asks, what is EisnerAmper going to do for remote people? So I can't speak for the company, but I can speak what I'm doing with my clients. I do have a client that allows employees to work anywhere in the country and we do file in any state that there is an employee working whether it's in an office or out of their home. We do file entity level tax returns and of course, payroll withholdings and the unemployment and the workers' comp are all paid to that particular state where the employees are located.
Mitchell Novitsky:If I'm going to say—
Neil Tipograph:Yeah. Yeah, Mitch?
Mitchell Novitsky:Yeah. I'm going to get to that in my presentation with remote employees. There have been a lot of exceptions during COVID with regard to Nexis so we'll cover that a little bit more. Yeah.
Tim Noonan:All right. Great. Well, I don't know who the joker is who answered cats and dogs, but we'll go for it. All right. So, a couple more and then I want to get to sort of I think our star of the show on the past, Serenity Tax, because that's, I know there's a lot of questions there, a couple more things.
Here's a situation where someone doesn't really want to move. They want to come back to the city so they're not going to change their domicile, but they have a big income of incoming, right? So, it kind of be nice not to pay New York tax on said income event. But also, COVID's happening so they can be wherever the heck they want for the next 18 months or so. So they implement the 548-day tests which is a special safe harbor in New York that applies to domiciliary. It's people who aren't moving, but who were in a 548-day frame which is 18 months, spend basically 15 months, 450 days in a foreign country, and less than 90 days in New York.
They can be a non-resident for that 18-month period even if they're coming back, even if they're not leaving and landing. So, we've had a number of clients more. No, probably more clients do 548 in the past two years or as many clients that I've had in '20 because the ability of people to move around. So, the 548-day thing has been a cool little safe harbor. Again, complicated a little by COVID-related sort of travel restrictions and such, but definitely still doable. This goes to the remote work question that just came up.
Here's a taxpayer, really legit, is moving to Florida. She gets rid of her place it in New York, gets a place in Florida, moving there for good, all good. But she's telecommuting to New York. So, there's issues for our employer about Nexis and such like that. But for her personal taxes, she clearly moved. She's clearly a non-resident, but she's working for a New York company and she's working remotely. We're under New York's convenience rule. New York says that we still get to tax that because you're working in Florida for your own convenience.
And guys, even if her employer closed the office in 2020 and 2021, New York's position still has been too bad, so sad. You're still working for your own convenience remotely in Florida or for wherever you work. So, New York's going to try to grab that. That's going to be a big issue in these audits. There are ways around it. You could open up a new office for her. You could set up employer office in her home which is under a special set of New York rules, that works. Or, if you've never, ever stepped foot in New York again, then you could get around that convenience roll that.
All right. Lastly, as I said, enforcement's going to be a big deal here. New York is excellent in maybe a bad way on enforcement. They do 3,000 of these audits per year. They have 300 auditors. Tons and tons of revenue, right? So, and they're focusing on whether someone moves, income allocation, and that kind of thing. But, I think this is really going to get stepped up. It's going to have to get stepped up given all the people that have moved. And in fact and there's just been some news on this in the past couple of weeks, what they're now sending out these desk audit letters. See on this next slide here, this is what it kind of looks like.
So many people who filed in May, and I'm sure a lot of you folks have seen this, have received a letter like this from the desk audit unit like, Hey, we're just checking. One of the articles I read, I think it actually was an article I was quoted in, but it also had said that the state, I don't know where they got this number, but the state sent out 149,000 of these just for May filers. So they're all getting these desk audit letters, fill out this residency questionnaire, fill out this income allocation questionnaire. And, we're already starting to see responses and it's not good, right? I mean, the people, the computers or whoever are looking at these responses, don't know residency, don't understand the rules.
We're getting kind of ridiculous answers. We're getting refunds held up. I don't know what we're going to do with November. I've definitely not taken a vacation in November because when all you guys filed tax returns for your client in October, just expect these things to come out. It used to be raining cats and dogs with these notices so I don't think these are real audits, but they're really annoying and it's going to be, it's sort of I think a triage maybe for the tax department.
We had one, big one, that went to this desk audit and it's already been referred to a real field auditor. So maybe, that'll happen. That's fine. But we've seen a lot of them especially at smaller dollar amounts which are tough to sort of deal with economically as an accounting firm or a law firm where they're just denying the refunds, not making any sense. So that's no fun.
So, that's sort of my spiel on residency. Again, if there are questions popping up, I'll even answer some of the questions as we go. I'm sort of typing them in, but want to turn it over to Neil for our past Serenity discussion.
Mitchell Novitsky:If I can just interject for one second. Great job, Tim. It's a privilege to be on a panel with you. Having begun my career with New York City, the burden of proof is on the taxpayer. So just following up on Tim's last point, they're sending all these notices. These notices may have no basis. They may not understand they're computer-generated, but you have to prove your case so please, save documentation. I'm going to get to that a little bit more in my presentation, but it's all about documentation being able to prove your case.
Neil Tipograph:Okay. Thank you, Tim. Thank you, Mitch. So, we're exactly on time. It's 11:30. I'm going to do my best to finish at 12:00. I may finish at 12:10, see how it goes. So I'm about to describe a brand new tax system of New York state. It's called the New York State Pass-Through Entity Tax. It's going to probably be about four or five points that I'm going to keep repeating because I want to hammer it home. If I say it enough times, it'll start making sense to you.
And, here are the points. So, this is what we call SALT workarounds. SALT stands for, by the way, state and local tax. And as we know on a personal income tax return, the state local tax deduction is limited to the $5,000 to $10,000. So, the states have come up with very creative ways to get around this limitation. You would think the IRS would close this down and as you will see, the IRS did something quite opposite.
So, the points are as follows. What I'm describing the pass-through entity tax, it's a New York state business tax on eligible partnerships and S corporations which is deductible on a federal tax return and not subject to the SALT limitation cap. This program will create a New York state refundable tax credit to be used by individual's trust and state partners and shareholders on their personal tax returns. And again, you're going to see this all through the slides. I'm just going to keep repeating these points over and over again so that you get it. Partnerships and S corporations need to make an election into the system by October 15, 2021. If they want to come under this regime for the 2021 year, one minor problem. There are no rules on how to make the selection so we don't even know how it's done. We got two months to go. So, this is going to get interesting.
The 2021 tax forms addressing the SALT workaround, New York state SALT workaround, have not been published yet. So whatever I say today and I'm going to give an example, we need to check it against the tax forms when they come out and make sure because they're going to be more informative than what I'm about to say. But, I think we have a good handle on what's supposed to happen so this should be informative and helpful what I'm about to say. Okay. The New York state Pass-Through Entity Tax is easy. I believe, personal opinion, it's easy to administer for simple, small partnerships. And as for corporations and the type of partnerships you would, in S corporations you would see in a family business or a two-partner partnership, this should be easy to administer. Alternatively, in the fund context especially complex funds, this is going to be very difficult to administer.
Okay, here we go. So again, what is this New York state PTE tax? It's a business tax that, in my view in reality, is a state withholding tax, but it's disguised as a business tax expense. As a business tax expense, it lowers the federal taxable income of the business which flows onto the individual return and it's going to apply and is going to provide the individual with a federal tax benefit. That benefit is going to be 37% of the tax expense for real estate professionals and 40.8% for other real estate investors. So we're talking a really, really big benefit here that someone pays each year a hundred thousand of New York state and city taxes and you can move that tax liability onto a business entity return, you're going to be saving about $40,000 of cash in your pocket. If we have taxpayers that pay a million dollars of New York state and city tax each year, they're going to be saving up the $400,000 a year of cash in their pocket. So, I think this is critical to understand and implement for certainly, the high-taxpayer taxpayers that can come under this.
The applicable partners and shareholders will receive a business deduction in lieu of a distribution. That sort of sounds bad, plus the distribution is actually better than a business deduction, but I should add they're getting a tax credit equal to the business deduction. So, it ends up being a super, super big win for the individual partners and shareholders.
The deduction is taken only on federal partnership and S corporation returns. It is not deducted on any other type of federal income tax return. So, you're not going to see this on a 1040 return or 1041 or an 1120 tax return. You're only going to see it on a partnership or S Corp. return. Who's eligible for this? Any partnership that's required to file a New York state partnership return is eligible for this program. Only New York state S corporations with valid New York S corporation elections are eligible for this program. The deduction. This is the critical words here that the tax people on the program will understand, the partnership tax people. This is treated. This is again for the IRS as you will see. This is going to be treated as a non-separately stated deduction on Lines 1 or 2 of Schedule K. What that means is it's treated as a business deduction.
The deduction is a trade or business deduction and should be associated with trade or business income. However, the IRS guidance which we will get to, appears to improve the situation. The IRS guidance appears to indicate that the New York state PTE tax paid on investment income should also be deductible on Line 1 of Schedule K and not treated as non-deductible portfolio expense, Line 13 W, as anticipated by tax professionals. So, this is right now an area of controversy until we see more guidance from the IRS. We're not certain what I'm saying is correct. However, I'm somewhat certain what I'm saying is correct. And for the old tax people out there, I direct you to section, code section 67, B2. Code section 67, B2. 2% for a miscellaneous itemized deductions. These types of deductions which include the portfolio type productions that everyone's talking about, do not include the deduction under Section 164 related to taxes. So this is the internal revenue code is saying that taxes can never be a 2% itemized deduction.
Even better. Passive activity. The passive activities under the PAL rules do not include investment or portfolio activity. So I believe my reading, again, controversial. I believe this deduction which is going to show up on Line 1 or Line 2 of Schedule K for purposes of an investment partnership, partnership that just has investment assets, is not going to be treated as passive. Again, this is all too good to be true. A lot of people using the smell test saying, This can't be so. But in my personal view, it is true.
The deduction can be substantial and may be a cash drag on the business entities. So, we have a lot of partnerships that have phantom income and partnerships with phantom income may require capital calls to fund the tax payments. As a new expense, so you're now going to produce, for the accountants out there, you have a general letter, a general ledger, a trial balance, you're going to have a new item on it that's called the New York state pass-through entity tax. This is for the statements you produce for your partnerships and your S corporations.
There's going to be a new expense line. It could be up to 10% of your bottom line. It's quite substantial. So when you look at this new expense, you're going to have to address non-tax ramifications, loan convenance, real estate tax appeal filings, escalation billings, and there's probably other things that I can't think of right now that may be effected by this. So just, if you do implement this new tax system on your partnership and S Corp. returns, envision what happens to your financial statements when you have this new deduction and see if there are any non-tax-ramifications associated with it.
Okay. Controversial issue. What to do? How to allocate the expense? Again, this is my view. It's the only way to make this whole scheme makes sense. Partnerships should specially allocate the expense to each partner depending on their share of the entity's PTE taxable income and tax. Partnership agreements and LLC operating agreements do not likely address these special allocations and may need to be revised. My advice to my clients is partnership should wait, should may wish to wait for further guidance from the IRS prior to amending agreements. It is possible when the IRS ultimately comes out with regulations, that they may provide certain safe harbors related to special allocations. And if that's the case, maybe the partnership agreements that would need to be amended in the interim for those who are concerned about making furniture allocations not in accordance with the partnership agreements, they may want to provide a Form 8275 disclosure to the tax returns saying that they are doing such elevations.
Partnership should adjust partner distributions for the disproportionate allocation of the PTE tax. So I said in the beginning, this tax is in many ways like a withholding tax and we know from withholding taxes that when a partner receives, when a partnership makes a payment on behalf of a partner, it's for withholding tax purposes. It's treated as a distribution. And, what it does is it lowers the cash distribution that's ultimately paid to that partner. The same thing happens here when there is the special allocation of the current year pass-through entity tax expense, once that is known, the distributions that would go to that partner should be lowered because again, that's the only fair way of handling this.
The issue here is that that information is not known until the following year so there's going to have to be coordination between the CPA and the client side, the client personnel responsible for distributions. And, I do recommend that if you are making distributions in the current year and you know that some of your partners are going to come under this regime, you're going to potentially do some hold backs for next year. Again, these are some of the added complications.
The PTE tax is elective for tax years beginning on and after January 1st, 2021, The 2021 election must be made by March 15th of 2021.
Tim Noonan:October 15th, I think. Inadvertently, you said March.
Neil Tipograph:Oh. Very sorry. I meant to say October 15th, 2021. Future years, I believe it's made on March 15th so starting in 2022, it's March 15. But for this year, it's October 15th, 2021. From what I read, it appears that the election is going to be made online. The election is annual so you can make it in 2021, but you don't have to make it in 2022, not making in 2021 that side to make it in 2022. But once you make the election, it's irrevocable for that particular year. We believe there's going to be a new set of tax returns. Sorry. But tax return is due on March 15th of the following of the close of the year. It can be extended.
There will be estimated tax payments due paid during the normal quarterly estimated tax payment periods. For 2021, there are no estimated tax payments required. Instead, the 2021 New York state PTE tax will be doing payable March 15th, 2022. We are hoping that New York state will allow the eligible partnerships and S corporations electing in 2021 to be able to make a payment by December 31, 2021. And that's going to be desirable for cash basis partnerships and S corporations that will be needed to provide those corporations and partnerships with a 2021 tax deduction for departments and shareholders. Give me one second. I'm just going to drink something here or I'm going to choke.
Tim Noonan:And, Neil. Yeah, I'll just say briefly. I've been calling slash harassing people in New York state just like, What's going on here, guys? Is there going to be guidance? October 15th is just around the corner and the response I'm getting is we're working on it. So, that question, the tax returns, all these are really important questions where we need guidance on. It's kind of crazy that it's August 18th and we don't have it, but I suspect it's going to be in the next couple of weeks, but no one has a firm date yet.
Neil Tipograph:Yeah. I was, I thought, given my luck and it was going to be issued at 10:30 today. And so, it would have been a mad dash between 10:30 and 11:00 reading all the new rules fortunately that. Okay. Getting back on course here. So the tax, as I said, it's only calculated for individual trust and estate partners and S Corp. shareholders, and we call those Article 22 taxpayers. And then to make it even further more complicated but when it comes to partnerships, electing partnerships, there's two rules on how you do the calculation. One rule for New York state resident partner. One rule for New York state non-resident partner. New York state resident partner, the PTE tax is imposed on all items of income, gain-loss, deduction included in taxable income. So, that all means and includes the investment income that's allocated to other partners. For the New York state non-resident partners, PTE tax is imposed only on New York-sourced taxable income so that would exclude most investment income.
Mitchell Novitsky:Just real quick. For a New York city resident, it doesn't apply to New York city taxes, just New York state. So, you'll always have to make those New York city estimates.
Neil Tipograph:Yeah, I'm not. We'll see what happens on the tax forms, Mitch.
Neil Tipograph:Because when you get to the New York state form, you're going to get a refundable credit. And, I believe that refundable credit possibly can absorb the New York city tax. We'll see that, again, once we see the forms. So, that's one of those unknowns. For electing S Corps, it's only on New York-sourced taxable income. And so, what happens is for either the partnership or the S corporation, you sum up these various income allocation buckets of income and it's called the pass-through entity taxable income. So in your partnership, you're finding all of your individual trust and estate partners. You're adding up the New York state income or all of their income depending on if they're a resident or non-resident, and you're getting the entity level pass-through entity taxable income.
Lexi D'Esposito:Poll #2
Mitchell Novitsky:Hey, Neil, one question came in and you may have sort of addressed it, but investment partnerships.
Mitchell Novitsky:I put my investments into a partnership.
Mitchell Novitsky:How does that work?
Neil Tipograph:So again, that's the controversial area. Everyone was saying, oh, it's probably not going to work for investment partnerships because the tax very likely is going to be a 2% itemized deduction. And then as I looked at the code, as I read the IRS notice, that's going to address this, we're going to get to that, I've come to a different conclusion. My conclusion is even though the tax is based on investment income, the tax itself is called a business deduction. And for the code section that says just before 67 B2, taxes can never be included as a 2% portfolio expense. So I believe the IRS guidance is telling us to treat this as a line one business expense and I believe it works. I know everyone says it can't be true, but this is what the code says. So I'm just following the code.
Neil Tipograph:Not what our common sense is telling us.
Neil Tipograph:Very good. Oh, very bad. Let's see. Very good. The election is made annually and it's only irrevocable only for that year. Well done everyone. We are getting lots of questions. They're somewhat technical in nature. I don't know that we're going to get through them, but I do believe we get everyone's questions and their email address so you won't get an answer from us. If not now you will get an answer through email from us.
Mitchell Novitsky:And Neil, I'm giving it a go on some of these. So I'll answer them incorrectly and you can fix it later.
Neil Tipograph:Awesome. Awesome. All right. So we've gotten to the point where we figured out how to calculate pass through entity taxable income, and then we now multiply and by these rates, you see the rates go from 6.85% all the way to 10.9%.
It is based on me, entities total pass through entity taxable income. It is not based on any partners individual tax rates. So it's possible you have a partner who is only in a 6.8% tax bracket who gets all of their income from a very large profitable partnership that's made the selection. So the profitable partnership is going to take 10.9%. It's going to calculate a 10.9% pass through entity tax, which as we know, creates a credit for the individual taxpayer.
Guess what, if that person is a New York City resident in my view, and again, we don't know until we see the tax forms, this excess credit that they're getting, the fact that it's 10.9% withholding and they're only at a 6.85% tax rate for New York state. I believe that access is going to be absorbed by the New York City tax.
So in my view, this is going to pay in benefit the New York city residents. Again, you need to see the forms to be sure of this. Bad news, partners shareholders must continue filing their individual tax returns. This new regime doesn't affect our personal filing requirements. As I've stated, I'll keep on stating this, New York state pass through entity tax is claimed as a credit, and it's a refundable credit on the partners and shareholders New York personal income tax return. If the credit exceeds the tax due for the tax year, the excess is treated as over payment to be credited to the following year or refunded to the individual fiduciary filer.
For 2021 only, this is bad news, partners shareholders must continue to make their New York personal income tax estimates without regard to their expected PTE tax credit. Otherwise, estimated tax penalties may apply. Starting in 2022 partners shareholders may lower their estimated tax payments by their expected PTE tax credits.
Just checking the time. Seemed to be all right. This gets a little more complicated. So there's a concept in New York and most all states have this concept. When you work in one state and you reside in another state, your resident state typically gives you a credit for taxes paid to other states. Well, New York is doing the same thing related to another state's SALT workaround. So New York says I'll let you claim credit for another state SALT workaround on your New York state tax return.
However, the following must be true. The other state's tax needs to be similar to New York. The New York state resident partner shareholder is a member of an entity that is also subject to the New York state PTE tax. So what that is saying to me and saying to other people is, the partner must already be included on some other New York State pass through entity tax return. And then for S corporations they seem to have a rather restrictive rule, which seems to be unfair.
Lexi D'Esposito:Poll #3
Mitchell Novitsky:While we're answering that question, I just want to make a note while we're answering that question.
Mitchell Novitsky:That New York will provide a credit. One of the unanswered questions, because a lot of the other states that have SALT workarounds, and there's more than about 15 or so states at this point, we're not sure 100% whether those states will provide their residents a credit for New York taxes paid because the credit is technically on taxes paid by the individual. Will they allow it since it's technically paid by the entity on behalf of the individual? That's an open question. We believe most states will, but we're not 100% sure that every state will, especially since many have not addressed the issue at all.
Neil Tipograph:Okay. So Craig asks a very good question. There is movement in Congress to eliminate the SALT cap. Does this go away if that happens? So my answer is I hope not. And the reason is that, as you know, your normal personal income tax deduction is a below the line deduction and as you will learn very shortly, because I'm going to talk about it, this new pass through entity tax deduction is an above the line deduction. It's much better. So I'm hoping that they'll keep this thing around if in fact they do get rid of the SALT `cap limitation. What it does is it allows us to get full benefit of state local income tax deductions, where previously under the AMT we did not. So this is, as you will see, this is what I call the gift that keeps on giving.
Mitch said to me, my questions are a little tricky. So maybe this is a tricky one, but the answer is no, it's not always available. There has to be at least some hurdles to overcome in New York in order to take the credit. But I have a feeling the hurdles for partnerships are rather simple. Okay. Okie doke. All right. So why do we have this insane system that I just described to you? Why would New York go through the trouble and why do you have 17 or 18 other states? And it all started in 2018 with the TCJA limiting state and local tax deductions to 10,000 for married 5,000 for a single parent. You call that the SALT cap limitation.
By the way, it will expire after 2025, like many of the laws in the TCJA. And as we know, the SALT limitation negatively impacts individuals, bank tax, and high tax states, such as California, New Jersey, New York. And we know that even prior to the TCJA individuals residing in high tax states had difficulty deducting state taxes due to the AMT.
As we know a provision for the state tax payments made in connection to trader business income is not subject to SALT cap limitations whose provision, this is in section 164 of the internal revenue code, this provision relates to state tax payments made by trader business partnerships and S corporations. And also in that little SALT cap limitations, they also mentioned that entities with investment activities also are not subject to SALT cap limitations. As a result, states introduce a SALT cap work around.
Connecticut introduced this in 2018. And when I first read what Connecticut did, I said, oh, the IRS is going to close this down in a split second. I said, oh, this is going to be funny when we hear from the IRS about this. Okay. And I think that was the reaction to many tax professionals. Okay. Now we come to some point in time in 2020, and the IRS has given taxpayers the gift that keeps on giving. It is true. It is too good to be true. It fails the smell test. I don't know what else I can say, but this is almost crazy. But I believe in the end, the IRS is following the internal revenue code.
Notice 2020-75 provides guidance regarding SALT cap work arounds and the intent to issue regulations about the deductibility, the PTE tax payments. Keep in mind the notice is only about five pages. I imagine the regulations could be many, many, many more pages. We shall see, but so far, the notice is extremely generous. The notice states that the proposed regulations will clarify that state and local income taxes imposed on and paid by PTE pass through entities are allowed as a deduction in computing the PTEs non separately stated taxable income for the tax year. That's a very, very important phrase. The applicable tax is reported as a deduction on schedule K lines 1 and 2.
So for rental properties, it goes on line 2, for management companies it goes on line 1. Thank you Lexi. Just got the warning. So wrap it up. Per the notice that PTE state local tax deduction is without regard to whether the SALT workaround is elective or mandatory. In New York State it is elective each year. Whether the partner shareholder receives partial full deduction, exclusion credit, or tax benefit based on their share of the entities, state, and local tax deduction.
New York gives 100% benefit of the credit. Connecticut, by the way, it doesn't give 100%. I think it gives 80, maybe 85%, something like that. But New York has been very generous with their law. The notice provides that the PTE income taxes are not included in the SALT limitation for partners and shareholders who itemize. The effective date is 2020 but actually it's effective for tax years after 2017. Currently business taxes are above the line deductions. Not added back to the AMT. I believe they will reduce the SE taxes. I believe they will reduce the Obamacare taxes and it should provide, since your AGI, by bringing the deduction above the line, your lower AGI should provide lower limitations based on just gross income.
This is all great stuff. Again, we'll know more when we see the tax forms. But currently in-state and out-of-state business taxes are added back on state individual tax returns only when specified under state law. Okay, so the guidance has this very important term, specified income tax payment. And I think I take this verbatim from the IRS items. Means any amounts paid by a partnership or S-corporation. Any amount. The word any should be emphasized. Okay.
Currently this definition appears to include taxes paid on investment income. Currently this definition does not appear to include a trader business requirement. So you can contrast this to section 212 portfolio. Expenses, which are not deductible through 2025. Generally speaking, state income tax payments are not the type of expenses that are considered portfolio expenses. And again, once again, I wrote this before realizing that the code actually addresses this. In fact code section 67 B2 specifically says that state income tax payments are not the type of expenses that would be considered portfolio expenses.
Here are all the states that are providing the workaround. This is useful information when you get into this credit, when you look at the New York State credit for other pass through entity tax payments. Let's make the use to you. Quick example. And I think I'll make it to 12:10. She'll be very happy. Mitch you'll have 20 minutes to wrap it up. Here's a nice example of how I believe this whole thing should work. Again, once we get tax forms and more guidance from the IRS, we'll be more certain about this. So we have a somewhat simple partnership. We have two equity partners. These are all individuals, two equity partners. They're 50 50. One person is from New Jersey. One person resides in New York. This is a New York State business, by the way. And a third partner, we call them a service partner. They have no equity, but they do get a $250,000 payment.
Okay. So the profits of the business are 2 million after the guaranteed payment. Prior to the guaranteed payment, the profits of the business for 2 million, 250,000. And we'll just use a 10% PTE tax rate just to make the math simple. All right. Here's how I think it works. Partner A who's the New Jersey partner, again, after this $2 million of profits after the guaranteed payment, he gets 50%. That's a million. The New York State business apportionment factor, which was stated in the facts. I may not have stated this. It's a 10% apportionment factor and a 10% tax rate. His tax or per tax is only going to be $10,000.
The resident partner is going to be paying $100,000, or the entity is going to be paying $100,000 for the New York resident partner. Again, $2 million, 50% ownership. And when you're a New York resident partner, it's all of your partnership income, not just your New York source income. Times 10% tax rate gets you to 100,000.
What gets interesting is the third partner who's getting the guaranteed payment. Again, we're not clear on this until we see the tax forms, but I think this is how it's going to work. You're going to take the guaranteed payment times 10%, and I think partner C is also a New York resident partner, the entity is going to pay 25,000 of tax on behalf of the service partner. The entities total expense is the sum of these three numbers. 135,000. Each partner is going to get a credit equal to these three numbers. The question is, how do you allocate the expense? There can only be one logical answer here to make this work. The expense has to be allocated to each partner equal to their credit that they are getting.
Now let's talk about, so observations. Partner B, so A and B are both equity partners. Partner B is receiving a 90,000 more of a tax payment, and is getting a tax credit 90,000 more than the partner A. Partner A's distribution should be 90,000 higher than these distributions. How should ABC allocate the 135,000? I've answered that. Should C get any of the deduction? I think absolutely yes. And here's another interesting point with guaranteed payments. Should partner C 25,000 New York state PTE tax payment and corresponding credit be deducted from his or her guaranteed payment. I believe the answer is yes.
So there's a lot going on here that's not in the partnership agreement. So for me, I'm going to just disclose this. First I'm going to make sure that the clients approve of what I suggest. They are the general partners. They get to dictate a lot that goes on in the partnership. I will first get their approval. I will second disclose this on the tax return. And hopefully at some point in time, we'll either get IRS guidance saying this is okay to do, or the partnership agreements may need to be relaxed.
Okay. I got two minutes left. I'm just going to skip this. This is for the accountants that will appreciate all this. How to book the expense. How to treat the payments. Distributions. Care should be taken when making current year distributions for partners subject to the tax. A reasonable holdback should be made. Okay.
Lexi D'Esposito:Poll #4
Neil Tipograph:So, I see Adam has asked a very good question. Adam, you're correct. In the example the tax rate should be 6.85%. But for illustration purposes, we use 10% just to make the math simple. Mitch or Tim, do you see any other real good, easy questions that we can answer?
Tim Noonan:No, I kind of ripped through them too. So I think we answered a bunch of them.
Neil Tipograph:Oh okay, good. Good. All right.
Neil Tipograph:Okay. So answer D, all of the above is the best answer possible. Finally, I'm just going to run through this. This is probably the most important thing. And then I'm going to hand over to Mitch. Management companies and real estate equity funds with income source to New York State. I'll say with only resident partners, in my view, should be making the PTE election in most cases. Management company, real estate equity funds with partners who reside in states not crediting payments made on the entity level on partner level. It's a very confusing point. I'm talking about situations where other states may not allow the New York pass through entity tax as a credit on their state returns. There's going to be a double state tax. So be aware. So I say these entities may wish to forego the election. Of course, the federal benefit may exceed the situation of double tax payments, but so on.
Sophisticated fund structures may now include what I'll call pass through entity tax eligible in non-eligible feeder. So our very complex funds have all these feeders that deal with the UBIT and deal with tax exempt taxpayers and deal with foreign taxpayers. And they create structures to accommodate these special taxpayers. What I'm saying is, if this sticks, this type of tax regime, and it's not just New York state, many other states have the same thing, our funds may introduce new feeder funds that can accommodate those investors. Real estate debt funds need additional guidance from the IRS confirming whether the PTE tax paid by the entity will qualify as the deductible, non-separately stated line one business expense. So that was here. Again, in my view, I've come to the conclusion that it is in fact, a line one deduction. There may need to be form 8275 Disclosures, maybe required for what a whole investor funds, taking the New York state PTE taxes as a business expense, and partnerships making special allocations to partners, not in accordance with the partnership agreements.
And finally, the significant planning opportunities for the owners of management companies and property entities. Strategies will customize the PTE tax to approximate the owner's annual New York State, New York City tax obligation. So I could see a strategy of first starting with the owners, say, what is their annual tax? Then looking at their business entities, and structuring things so that one or more of the business entities provides the owner with the tax credit that will approximate the owner's tax obligations. There's many, many ways to do it. One of the ways here is Schedule C and Schedule E activities, sitting in single member LLCs, or otherwise directly owned by individual taxpayers may be converted into some multi-member LLCs. All right, I'm going to wrap it up. I hope you enjoyed it. Mitch, I apologize, but I did my very best to be fast.
Mitchell Novitsky:No problem. Thank you, Tim, Neil, and Lexi, and thank you to all of you that are participating in this presentation. And I've been doing SALT a lot of years. I will tell you I had hair on my head when I first started doing SALT, but I lost my hair at a very young age. But I'm doing this a lot of years, and I can tell you that I've never seen more issues than in the last couple of years with regard to state and local tax. First of all, anytime there's a federal issue, that's the starting point for state. There's a lot of state issues that come about, putting the whole PTE tax that came about as a result of a federal issue, and there's a million other separate state issues. Tim's whole presentation on residency, non-residency, and there are so many other issues that come up in state local.
I'm just going to try to cover the overviews of two other issues in terms of opportunities, as well as potential exposure areas. So, we have to be aware of all the things that we need to address. One of the key issues that has come up in the last year is the New York City Unincorporated Business Tax, and I'm going to give you a very general overview, just so we understand the issue here, and then feel free to follow up, give us a call, speak to your tax practitioner in terms of what opportunities may present themselves. But New York City is one of the places that imposes an Unincorporated Business Tax on businesses doing business in the city. The tax rate is 4%. They phased in. Now that you have a one factor receipts factor, so how were your revenues sourced?
You look at your receipts in the city versus your receipts everywhere. Unlike New York State, New York State for partnership purposes uses three factors. For corporate, they use one factor. But New York City has a bit different rule than New York State. New York State looks at the office that an individual is connected to in terms of sourcing receipts from services. New York City looks at where the services are performed. And that whole concept that Tim mentioned about convenience of the employer rule, which applies for New York State with regard to employees and withholding, doesn't apply to New York City Unincorporated Business Tax. So in short you look at where the services are performed, and that's where you determine what amount of revenue should be sourced to the city. So what has happened as a result of COVID is that many people may work for a New York City firm, but they live in New Jersey, they live in Long Island, they live in Connecticut, and they're performing services on behalf of their entity from those respective locations.
At one time in New York city, when I mentioned I began my career there, there used to be a regular place of business requirement elsewhere. They don't have that. So to the extent that individuals have been performing services outside of the city due the COVID, there's an opportunity for many companies that normally would have been sourcing most of their revenues to New York City, because most of the individuals would have been working in the city, to now source a significant percentage of their revenues outside the city, particularly if on an ongoing basis, individuals will be working more outside of the city. Now I wanted to document, I'm going to get to in a second.
You have to look also at the potential issues in the location where those individuals are working, because that could potentially create a filing obligation there, particularly after COVID. But this is the opportunity. This slide just goes through general provisions of the Unincorporated Business Tax. I know this is a real estate presentation. There are certain exemptions holding, leasing, managing real property. That's a topic for another discussion, trading for your own account. There is a UBT credit to individuals, if they're New York City residents for taxes paid by the entity Unincorporated Business Tax. But in short, if the unincorporated business carries on a business within and out of New York City, you can allocate for purposes of UBT. Where do you source receipts from services? Where the services are performed. So they're performed outside New York City? You should be able to source those receipts outside New York City. And get a reduction in your New York City Unincorporated Business Tax.
I do want to stress that you're technically supposed to look at the revenue-generating individuals. So to the extent that someone may be in an admin, an HR function, an IT function, they may not be included in the calculation, but those individuals that generate revenues, you do an allocation of the revenues in New York City versus the whole. So we have seen companies significantly reduce their potential Unincorporated Business Tax liability for the year. We were wondering was New York City going to issue any guidance on this because they're potentially losing a lot of revenues? They haven't issued any guidance, and I believe the reason is because they know the law is against them. I mean, having come from the city, maybe they're going to do the same thing as states do with these residency audits, you just throw out a bunch of letters, and see where they can go with taxpayers. But at the end of the day, there's a solid position, to the extent that services were performed out of the city, to source the income from those services out of New York City.
But as I stress, and I was on the other side, the burden of proof is on the taxpayer. When I was with the city, I worked with guys, there was a guy in the office next to me. He worked for the district attorney before he joined the finance department. And he took the approach everyone was guilty until proven innocent, and he just said, "Prove it." That's the way some of the auditors will take the position. You have to document, document, document. Most important thing to get out of this presentation, if you have issues like these, document. How do you document time outside of the city? Time sheets, IT reports, there could be building records, when you swiped. I mean, there was a period when nobody was allowed in the office, and some people are allowed in some companies. Everyone has their own different policy.
You'll have to keep records. Even in a worst case scenario, emails. Get the information from the employees that aren't the revenue-generating individuals, get it now at an employees, as well as the partners, because basically the city will allow you, and that's my next slide, to use a reasonable method. If you have, on a contract by contract basis information, and then you know where those services were performance, that's better. You can also use potentially time. I'm not going to get into details as to how to do the allocation, speak to your tax practitioner. We worked with many clients, and we make sure that our clients document how they're coming up with their percentages, so that should an audit occur, they have sufficient documentation to prove the case. Also, you got to be reasonable to take that same approach next year. You can't use one approach this year and another approach next year, while you're still on the same audit period.
But make sure that you document everything, and the location where partners and employees are performing services is controlling. I mentioned before, only revenue-generating individuals are considered. This is a New York City rule: "taxpayer may request to have the amount attributable to services performed within the City determined on the basis of relative values of, or amounts of time spent in performance of such services within and without the city of, or by some other reasonable method." I've been on audits. I've argued different positions. And in short, that should be something that should be discussed with your tax professional as to how you arrive at the percentage that should be attributable to amounts both within the city and without the city, and document.
So that's the first issue and that's more of a planning opportunity, but of course, with COVID and everything, came planning opportunities, as well as potential exposure items. What's the major exposure items? As I mentioned before, you have a lot of individuals that are telecommuting, so they could work for an office in New York City, but now they're working in New Jersey, and some of the companies now are going into permanent telecommuted situations. Some are going to formal arrangements, some are going to informal arrangements. What happens if you have an employee working remotely in another state? Does that create filing obligations in that state? Well, there's many issues you have to consider. There's an entity level tax, it could be a corporate tax, could be a partner level tax, and then there are issues in terms of potentially sales tax. If you're dealing with an item that has sales tax ramifications, and the individuals are now located in another particular state, and there otherwise wouldn't have been nexus of those sales tax, economic nexuses, it's very easy to generally have sales tax nexus these days, if your sales are over a certain threshold. But also payroll taxes, and most states forgave potential payroll taxes.
So, if you had an individual that is spending time with their family in North Carolina, they normally work in New York, a lot of states had exemptions for those types of situations, but those were generally during COVID-19, and COVID-19 most states provided, if it's due to the emergency situation due to COVID-19. A lot of states that granted those exemptions, are now pulling back when those exemptions, and New Jersey being one of them, because technically the state of emergency is being lifted. And I know we can go on forever. I mean, I had a client yesterday that was saying they thought when they stopped working in March, working from their home, two weeks later they'd be back in the office. I mean, here we are. Who knows where this is going? But states are now saying that that gift that we gave you of not being subject to tax and not having nexus, that is coming to an end. The state of emergency is coming to an end.
So, it is very, very important to look on a state-by-state basis. And one thing I can tell you that every state pulls in their own direction. Some go one way, some go the other way. Some may go for this tax one way. Some may have different thresholds. So you have to look at situations where if you have individuals telecommuting, where they are, and whether you have an obligation for entity level taxes, potentially for sales taxes, payroll taxes, and I can tell you another thing having worked for the government. Payroll taxes and sales taxes, those are trust fund taxes. So you do it really as an agent on behalf of the government, but if you don't do it, you're stuck with the liability, and I saw many situations where employees were stuck with the liability. So from an employer perspective, if you have a payroll tax withholding obligation, and you don't withhold, they could come after you for that liability, and you can try to do whatever you want with that individual. They may not work there anymore, but the liability sticks on the employer. So be very, very careful.
And every company now should be addressing where they have telecommuting employees and they have an agreement on a going forward basis, where people will either formally or informally be working here or there, this and that, what issues need to be addressed? Are there filing obligations in other states? That's the general gist of it. And I'm just going to go through the slides very quickly, but that's the point that I wanted to hit across. We're not going to solve and answer all the questions. We just want you to spot the issues. The important thing is to spot the issues and go from spotting the issues to ask the questions and see if there's a potential issue in your situation of significance that needs to be addressed.
So, as I said, most states took action during COVID-19. Some gave formal relief, some didn't. Now we have a chart here, which states this and that. Please don't rely on this as the Bible, because it changes every day. So as Tim said, or as Neil said, he was afraid New York would come out with guidelines. I don't know, a state might've come out with some guidelines this morning. So note there what I put in capital letters: "This list is constantly changing. These are general rules. Each taxpayer must analyze its own specific situation to determine if the rules apply to their situation." Very, very important. And following up more what Tim raised this morning, convenience of the employer role, that is the craziest role that New York has, some other states have. It potentially went to the Supreme court, but then the Supreme Court declined to take it. There was a case in Massachusetts v. New Hampshire.
I know there's a law professor, Zalinski. He lost the case years ago. He's now raising the case again. So in situations, I guess, even where you have individuals working remotely, you have to address, is there nexus in the other situation? But you can still have the employee. The employer has to withhold on behalf of that employee. So I know a lot of you were working in New Jersey this past year. Your employer is still withholding New York taxes. You're saying, "Why is my employer withholding New York taxes?" Well, your employer is technically doing the right thing, unless you're never going to walk into New York again. Technically if you come in sometimes or this or that, it's convenient to the employer. We have to continue withholding New York tax. And as Tim says, even during COVID, there was no exception. So they required entities to continue to withhold New York taxes. Oh, PTE, a polling question.
Lexi D'Esposito:Poll #5
Neil Tipograph:Yes, it's Neil. All of the above is correct.
Lexi D'Esposito:Poll #6
Neil Tipograph:So, I just want to thank everyone for all of the questions. We have over 30 questions, and hopefully, Tim, you provided sufficient answers. And if not, we will get back to you afterwards.
Tim Noonan:I provided sufficient answers. Hopefully the right answers, but sufficient will do for now.
Neil Tipograph:And yes, all of the above is correct. Mitch, hopefully you have a few closing words.
Mitchell Novitsky:I can tell that Neil's not a professor. I teach at Rutgers because whenever there's an all of the above, that seems to be the answer, so the students would catch on after a while, but they're excellent questions. And you got to really read the specifics of each one. Just closing, just remember to spot the issues with regard to telecommuters. At all, what was the case previously, is not the case, so if you have individuals that are going to be working now and New Jersey, I just want to close the presentation with New Jersey. As of October 1st, before that, they granted exceptions, said, "Keep everything going. We're not going to assert nexus." Now that changes. Look for that in a lot of other states. Be aware of telecommuters, and on the Unincorporated Business Tax issues, just be aware of opportunities if you have individuals continuing to work outside the city. Thank you everybody for attending, and it was great to be part of this panel.
Neil Tipograph:Yes. Thank you, Tim, Mitch. It was a lot of material. We got through it all. Important stuff, and we're here for anyone in the audience needs help with these matters. Thank you.
Tim Noonan:Thanks everybody.
Transcribed by Rev.com
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