New York Issues Guidance on Payroll Expense Tax “Workaround” for State and Local Tax Deduction Cap– September 19, 2018 by Cynthia Pedersen

In response to the Tax Cuts and Jobs Act’s (TCJA’s) $10,000 cap on state and local tax deductions, the state of New York became the first to pass legislation intended to provide relief for their residents. As part of the relief package included in the state’s 2019 budget, New York implemented a new elective Employer Compensation Expense Tax (ECET). On July 3, 2018, the New York State Department of Taxation and Finance issued guidance on the ECET in the form of the Employer Compensation Expense Program as outlined in TSB-M-18(1)ECEP. 

What is the Employer Compensation Expense Program (ECEP)?

The ECEP is an optional payroll withholding tax. Beginning on or after January 1, 2019, employers with eligible employees receiving more than $40,000 in New York-source wages, may make an annual affirmative election to participate in the ECEP. The annual election to opt-in for the following tax year is required to be made no later than December 1 each year on a web-based registration system, which will be created by the Department of Taxation and Finance.
 
If an employer elects to pay this tax, a credit will be available for the employees, thereby reducing their New York personal income taxes and alleviating the effect of the TCJA’s state and local tax deduction limitation. If an employer makes this election, the payroll withholding applies to all “eligible employees.” The person authorized to make this election depends on the entity classification.

If the employer is: The election is made by:
A corporation (for profit or not-for-profit) An authorized officer or manager
A pass-through entity Any member, owner, or other individual with authority to bind the entity or sign income tax returns
A trust The unanimous consent of all trustees
 

Who is Eligible for the ECEP?

Only employers with “eligible employees” may make the annual election. An eligible employee is any individual considered to be “employed in New York” and earns more than $40,000 per year in “New York wages.”
 
Employed in New York
The test for determining if an employee is “employed in New York” is the same test to determine if an employee is employed in the Metropolitan Commuter Transportation District (MCTD), substituting the geographic area as New York state rather than the MCTD. Meaning, an employee must meet at least one of the following MCTD tests to be considered “employed in New York.” 

  • Localization Test: The employee must perform services either entirely within New York state or both in and out of New York, but the services performed outside of New York are only incidental compared to the services provided in New York state. For example, the services provided outside of New York are temporary or consist of isolated transactions.
  • Base of Operations: The employee’s base of operations must be in New York state. An employee’s “base of operations” means the place where the employee is continuously located or where he customarily starts out to perform services. A base of operations is where the employee returns to receive instructions from his employer, receive communications from other persons, or perform any other function necessary in the exercise of his trade or profession.
  • Place of Direction and Control: New York state is the place from which the employer directs and controls the activities of the employee, and the employee also performs some services within New York. This does not necessarily mean the employer’s principal office; however, it must be the place where job assignments are made and/or instructions are issued to employees. 

New York Wages
Generally, ECET withholding only applies to New York-source payroll expense in excess of $40,000 per year, per eligible employee. New York-source payroll expense includes any wages subject to income tax withholding in New York. Therefore, apportioning the wages of an otherwise eligible employee may be required if the employee provides services both within and outside of New York state.
 
For example, Samantha, an employee of a multinational firm that elects to pay the ECET, receives an annual salary of $250,000. Samantha works from the Vermont office from January 1 until August 31. On September 1, Samantha begins working from the New York state office. She receives $150,000 in wages while employed in Vermont and $100,000 in wages while employed in New York. The electing employer is required to pay ECET on Samantha’s payroll expense — above the $40,000 — that occurred while she was employed in New York. So in this case, the employer would be paying ECET on $60,000. 

How Do You Calculate the ECET Tax?

The ECET tax rate is being phased in over a three year period at 1.5% in 2019, 3% in 2020, and 5% in 2021 and thereafter. The ECET requires quarterly payments and information returns to be filed online pursuant to the following schedule:
 

Quarter Due Date
January 1 - March 31 April 30
April 1 - June 30 July 31
July 1 - September 30 October 31
October 1 - December 31 January 31
   

An employer that overpays the ECET may apply for a refund. However, the department will apply all or part of an overpayment to any past-due legally enforceable debt the employer may owe. 

Will the IRS Allow This Workaround?

On August 23, 2018, the Treasury issued proposed regulations disallowing a federal deduction for the state charitable fund work arounds issued by states including New York. It is unclear if the IRS intends to also limit the use of other workarounds, including this payroll expense. We recommend discussing the benefits and potential risks involved in electing into the payroll expense with your tax advisor before moving forward.
 
Read our blogs on other state workarounds:
Connecticut Passes State and Local Tax Deduction “Workaround”
IRS Puts a Stop to Charitable Deduction State and Local Tax “Workarounds”
  
Please contact a member of your service team, or contact Cynthia Pedersen at cynthia.pedersen@cohencpa.com for further discussion. 
 

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.