A number of states have recently proposed or passed new laws related to state-level taxation, some of which are taxpayer-friendly and some of which are expected to impose additional tax burdens on taxpayers. They vary in subject from efforts by states to mitigate the new federal limitation on the deductibility of state and local taxes to proposed changes to state income taxation of “carried interest.” This update reflects some of those recent proposals and laws.
Mitigation of Federal Limitation on Deductibility of State and Local Taxes
Recently, some states have reacted to the 2017 Tax Cuts and Jobs Act’s (TCJAs) limitation on the deduction of state and local tax (SALT) for US federal income tax purposes. Some of the proposed legislation, and new laws passed in Connecticut and New York, may benefit taxpayers by helping to mitigate the impact of $10,000 limit placed on the federal deductibility of SALT.
In response to some of these proposals, the federal government has already announced, via Notice 2018-54, that it intends to propose regulations to disallow the use of such state-level workarounds for the SALT deduction limitation. The Notice specifically addresses proposals that allow taxpayers to receive SALT credits for certain transfers to funds controlled by state or local governments; however, it is likely that, with time, the federal government will work to disallow additional workarounds for the SALT deduction limitation.
On May 31, 2018 Connecticut Governor Dannel Malloy signed into law Connecticut Public Act No. 18-49 which imposes an income tax on pass-through entities (PTEs) effective retroactively as of January 1, 2018. The tax is imposed at a rate of 6.99% on the PTEs taxable income but is able to be offset by a personal income tax credit of 93.01% on the pro rata share of taxes paid by PTEs shareholders, partners, or members. Entity level taxes imposed on PTEs are generally not subject to the new SALT deductibility rules such that the PTE tax provides a PTE’s owners with an effective deduction against federal income tax without resulting in additional state level income taxes. The law applies to S corporations, partnerships, and limited liability companies (LLCs) treated as partnerships for federal income tax purposes. Furthermore, the law permits Connecticut municipalities to provide property tax credits to residents for amounts contributed to “community supporting organizations.”
New York recently enacted an optional employer level payroll tax. If employers elect into this new payroll tax, based on wages in excess of $40,000 paid to employees, then employees can take a credit for such payroll tax against their New York personal income tax liability. The election applies annually on a calendar basis and is limited solely to “employees” (rather than independent contractors, consultants, etc.). However, the administrative costs to implement the new tax, concerns regarding possible adjustments to employee compensation, and complex issues with non-resident employees might negatively impact how many employers actually make this election. If elected the payroll tax has a three-year phase-in starting in 2019 with the following rate structure:
California has proposed three bills in order to help relieve state tax burdens of taxpayers:
Treatment of Carried Interest
Under current federal law, a portion of income earned by investment managers called carried interest receives favorable tax treatment by being taxed at capital gains rates as opposed to the higher rates imposed on ordinary income. Certain states have enacted or proposed legislation to close this perceived loophole.
The substantial assistance of summer law clerks Denise Ghartey (2L at Harvard Law School), Kaitlyn Flynn-Rozanski (2L at Boston University School of Law), and Kathryn Potter (3L at Suffolk Law School) is gratefully acknowledged by the authors.