Tax Provisions of the 2005/2006 New York State Budget

By Mark H. Levin

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Corporation Business Franchise Tax

Single-factor sales. The four-factor formula used in computing the business allocation percentage was repealed and replaced with a single-factor sales formula that will be phased in over a three-year period, beginning with taxable years beginning on or after January 1, 2006, as follows:

Capital base maximum tax. For taxable years beginning on or after January 1, 2005, the tax-on-capital ceiling of $350,000 will be raised to $1 million for all taxpayers except manufacturers, for whom the ceiling remains at $350,000. For the purposes of the capital base tax, a manufacturer is defined as a taxpayer principally engaged in the production of goods by manufacturing, processing, assembling, refining, mining, extracting, farming, agriculture, horticulture, floriculture, viticulture, or commercial fishing.

Small-business corporate franchise tax rate. For taxable years beginning on or after January 1, 2005, the 6.85% rate will apply to business corporations with entire net income (ENI) of $290,000 or less. For business corporations with ENI between $290,000 and $390,000, the 6.85% rate is phased out as follows: The tax will be the sum of $18,850, plus 7.5% of the excess of the ENI base over $290,000, plus 7.25% of the excess of the ENI base over $300,000 but not over $390,000. Business corporations whose ENI base exceeds $390,000 will be taxed at the regular rate of 7.5%.

Bank Franchise Tax

Single sales factor. The four-factor formula used in computing the allocation percentage was repealed and replaced with a single-factor sales formula. The new single-factor formula will be phased in over a three-year period, beginning with taxable years beginning on or after January 1, 2006, as follows:

Limited liability companies (LLC) and limited liability partnerships (LLP). The temporary increase in the LLC/LLP fee to $100 per member (with a minimum of $500 and a maximum of $25,000), which had been scheduled to revert to prior levels for 2005, was extended to tax years 2005 and 2006. The single-member LLC fee remains at $100. These increased fees are scheduled to expire for taxable years beginning on or after January 1, 2007.

Credits

Special additional mortgage recording tax credit. Effective for eligible mortgages recorded on or after January 1, 2004, this credit [Tax Law section 606(f)] was extended to allow a personal income tax credit equal to the amount of the special additional mortgage recording tax paid against the personal income tax. Formerly this credit was allowed only to corporations. Individuals that are partners in a partnership may use their pro rata share of the special additional mortgage recording tax paid by the partnership against their personal income tax. This credit will not be allowed for any special additional mortgage recording tax paid with respect to a mortgage of real property principally improved by one or more structures containing in the aggregate not more than six residential dwelling units, each dwelling unit having its own separate cooking facilities, where the property is located in the Metropolitan Commuter Transportation District or in Erie County.

Low-income housing credit. The Commissioner of Housing and Community Renewal was authorized to allocate an additional $2 million of low-income housing tax credits. The additional allocation increased the total allocation to $8 million annually.

Certified Capital Company Program Five. Effective April 12, 2005, and deemed to have been in effect on and after April 1, 2005, the program that provides insurance franchise tax credits (Article 33) with respect to investments in certified capital companies (CAPCO) was expanded through the creation of Certified Capital Company Program Five. Under this new program, the aggregate amount of certified capital for which tax credits are allowed could not exceed $60 million for 2007. The certified capital could be invested in CAPCOs beginning in 2005, and credits would be allocated and vested in certified investors at the time of the investment. The credits will not be allowed for state tax purposes before tax years beginning in 2007.

Transferability of CAPCO tax credits. A taxpayer allowed a CAPCO tax credit is permitted to transfer or sell such credits, in whole or in part, to any affiliate subject to the insurance franchise tax. An affiliate is defined for these purposes in IRC section 1504, including insurance companies, but substituting a 50% voting and value test for the 80% voting and value test in IRC section 1504(a)(2).

Whenever a taxpayer transfers or sells a CAPCO tax credit, it must notify the New York State Department of Taxation and Finance and the Insurance Department of the transfer or sale within 45 days. This provision applies to all credits transferred on or after August 1, 2003.

Empire Zones. The act authorized 12 new Empire Zones, changed the benefit formulae prospectively, and extended the Empire Zone program for six years, to June 30, 2011. The act also reformed the administration of the Empire Zone program.

Green buildings. Period 2 of the green buildings tax credit was created, extending the original green buildings tax credit passed in the 2000/2001 Budget Act. Initial credit component certificates for period 2 may be issued in 2005 through 2009. Such certificates for period 2 may not be issued, in the aggregate, for more than $25 million worth of credit components. The total amount of the credit component allowable for the five taxable years for which the credit components are allowed, as set forth on any one initial credit component certificate, is limited to $2 million. A taxpayer that is the owner or tenant of more than one building that qualifies for the green buildings tax credit, however, may be issued initial credit component certificates with respect to each building, with the aggregate amount of credit components permitted for each such certificate being $2 million.

A taxpayer that is the owner or tenant of a building for which an initial credit component certificate was issued for period 1 will not be issued an initial credit component certificate with respect to such building for period 2.

These changes are effective for years beginning on or after January 1, 2005. Certificates for period 2 shall be limited in their applicability as follows:

Qualified emerging-technology company facilities, operations, and training credit. Effective for years beginning on or after January 1, 2005, the act creates a new refundable credit for qualified emerging-technology company facilities, operations, and training. The credit applies to certain research-and-development property, research expenses, and high-technology training expenditures. The credit is calculated for each credit component separately, and aggregated for application against the tax. Eligible taxpayers may generally claim the credit for four consecutive years. Taxpayers located in an academic incubator that relocate to a nonacademic incubator within New York State are allowed to claim the credit for one additional year.

An eligible taxpayer is defined as a taxpayer that has:

• No more than 100 employees, of which at least 75% are employed in New York State;
• A ratio of research-and-development funds to net sales that equals or exceeds 6% during the taxable year; and
• Gross revenues that, along with those of its affiliates and related members, do not exceed $20 million for the taxable year immediately preceding the taxable year in which the taxpayer claims the credit.

The rates of credit are as follows:

• Research-and-development property: 18% of research-and-development property as defined for the investment credit.
  n Qualified research expenses: 9% of qualified research expenses, which include expenses associated with in-house research and processes, and costs associated with the dissemination of the results of such products of research-and-development activities (not including advertising or promotion through the media). In addition, costs associated with the preparation of patent applications, patent research fees, patent examination fees, patent post-allowance fees, patent maintenance fees, and grant application expenses and fees are all considered eligible expenses. Eligible expenses do not include expenses involving litigation, the challenge of another entity’s intellectual property rights, or contract expenses involving outside consultants.
• Qualified high-technology training expenditures: up to $4,000 per eligible employee per taxable year for qualified high-technology training expenditures paid during the taxable year. Qualified high-technology training expenditures include a course or courses taken at an accredited, degree-granting post-secondary college or university in New York State that is related to the research-and-development activity and intended to upgrade, retain, or improve the productivity or theoretical awareness of eligible employees. Such course or courses may include, but are not limited to, instruction or research relating to techniques; macro, metatheoretical, or practical knowledge bases or frontiers; or ethical concerns related to eligible activities. Eligible coursework does not include classes in the disciplines of management, accounting, or law, or classes designed to fulfill the discipline-specific requirements of a degree at the associate, baccalaureate, graduate, or professional level of those disciplines.

The total value of these credits may not exceed $250,000 per eligible taxpayer per taxable year.

Personal Income Tax

Expiration of the temporary rate increase. The temporary rate increase enacted in 2002 will be allowed to expire as scheduled for tax years beginning on or after January 1, 2006.

Long-term care insurance (LTCI) tax credit. Effective for LTCI premiums paid on or after January 1, 2005, nonresidents and part-year residents must limit the LTCI tax credit by multiplying the full 20% credit by the same New York–source fraction used in reducing the total New York State tax, computed as if a resident, to the amount attributable to the New York–source income. Previously, both nonresidents and part-year residents were able to take the full 20% credit without limitation based on New York–source income.

Sales and Use Tax

Clothing. The budget once again postponed the reinstatement of the sales-and-use-tax exemption for clothing and footwear costing less than $110 until April 1, 2006.

Sales tax rate. The temporary 0.25% sales tax increase enacted in 2003 was allowed to expire as originally scheduled. Effective June 1, 2005, however, the Metropolitan Commuter Transportation District (MCTD) surcharge will increase by 0.125%, causing the MCTD surcharge to rise from 0.25% to 0.375%.

Separate legislation provides that, effective September 1, 2005, all clothing and footwear, and items to make or repair clothing, costing less than $110 per item, will be exempt from the 4% New York City sales and use taxes.

Cigarettes and gasoline sold by Native Americans. Effective for sales made on or after March 1, 2006, Native Americans will be required to collect sales taxes on the sale of cigarettes and gasoline to non–Native Americans, with the caveat that a tribe can reach an agreement with the state that may supercede this requirement. Such an agreement must be ratified by the legislature.

Practice and Procedure

Mandatory electronic filing. Tax-return preparers that prepared more than 200 original personal income tax returns during 2005 must, if they are preparing one or more original returns using tax software for the 2005 tax year, file all authorized returns electronically for the 2006 tax year and thereafter. The 200-return threshold will be lowered to 100 original returns for calendar years beginning after 2005. The number of returns is calculated at the entity level. Thus, if an entity has multiple employees working on returns at several locations, the total number of returns prepared by all employees at all locations determines whether the entity is required to file electronically. Preparers that do not use tax software to prepare any New York State personal income tax returns are not required to file electronically.

An original return is defined as any personal income tax return that is filed, without regard to extensions, during the calendar year for which that return is required to be filed. An authorized return is defined as any personal income tax return that the Commissioner of the Department of Taxation and Finance has authorized to be filed electronically.

As of this writing, Department of Taxation and Finance spokespersons have indicated that the mandatory electronic filing requirement will apply to all personal income tax returns, both resident income tax returns (Form IT-201) and nonresident/part-year income tax returns (Form IT-203). In addition, as a transitional rule for tax year 2005 only, any personal income tax return filed by mail that contains the 2D-bar code cover sheet will be considered electronically filed.

Because an electronically filed return cannot contain a manual signature, the Department of Taxation and Finance is developing an authorization form that the taxpayer must sign before the electronic return may be transmitted. This authorization form will constitute a digital signature and is to be retained by the preparer. Taxpayers will have the option of electing not to have their return filed electronically. A new opt-out form is being developed that must be signed by the taxpayer and retained by the preparer as proof of the opt-out election.

While the Department of Taxation and Finance is currently requiring the electronic filing of only resident and nonresident/part-year income tax returns, the Budget Act authorizes it to ultimately require the filing of all returns required under Tax Law Article 22. This would also include returns for partnerships (Form IT-204) and for trusts and estates (Form IT-205).

Preparers required to file electronically that use tax software packages that will not support electronic filing must switch to a software package that supports electronic filing.

Tax-shelter disclosure. The budget now requires tax preparers of returns under Articles 9, 9-A, 22, 320, and 33 to report to the New York State Department of Taxation and Finance any reportable transactions that are required to be reported to the IRS. A copy of the federal Form 8886 must be sent to the New York State Department of Taxation and Finance for each taxpayer involved in any federal reportable transaction during the year. The six categories of federal reportable transactions are:

• Listed transactions;
• Confidential transactions;
• Transactions with contractual protection;
• Loss transactions;
• Transactions with a significant book-tax difference; and
• Transactions involving a brief asset-holding period.

The act also permits the Commissioner of the Department of Taxation and Finance to prescribe by regulation New York reportable transactions. New York reportable transactions are to be reported on a form to be provided by the Department of Taxation and Finance. It imposes the same tax-shelter recordkeeping requirements on material advisors and tax-shelter promoters as required by the IRS for both federal and New York State reportable transactions.

The act also provides penalties for noncompliance for both preparers and taxpayers for reportable transaction understatements and nondisclosure. The commissioner has the power to rescind all or any portion of any penalty for reportable transaction or recordkeeping requirements if the violation is for a reportable transaction other than a listed transaction, and if rescinding the penalty would promote compliance with the tax-shelter reporting and recordkeeping requirements.

In addition, the act provides for an extended statute of limitations for assessments related to tax-avoidance transactions.

The Department of Taxation and Finance will prepare a written report showing the effect of the tax-shelter provisions, to be delivered to both the President of the New York State Senate and the Speaker of the Assembly no later than April 1, 2007.

The tax-shelter disclosure provisions are effective April 13, 2005, for listed transactions that a taxpayer participated in at any time that were required to be reported to the IRS. However, the act applies only to those reportable transactions other than listed transactions in which a taxpayer participated during any taxable year for which the statute of limitations for assessment has not expired as of April 13, 2005. It is effective for all other items on June 12, 2005.

The above tax-shelter reporting provisions will be deemed repealed on July 1, 2007.

Other Provisions

Effective April 12, 2005, the Commissioner of the Department of Taxation and Finance is authorized to enter into reciprocal tax offset agreements with the City of New York and with other states.

The act makes permanent the reporting requirements of Manhattan parking vendors. These requirements expired on November 30, 2004.
The act extends the authorization of the Division of the Lottery to operate Quick Draw for one year, until May 31, 2006. It also alters the distribution of revenues from video lottery terminals.