New York Tax Reforms Include Significant Changes for Nexus, Calculation of NOLs

By Mitchell M. Novitsky, J.D., New York City

Editor: Howard Wagner, CPA

State & Local Taxes

On March 31, 2014, New York Gov. Andrew Cuomo signed legislation that makes significant changes to the tax law, particularly to the corporate franchise and bank taxes imposed under articles 9A and 32 (N.Y. Laws 2014, S. 6359, c. 59). The changes affect almost every aspect of these taxes, including activities that create nexus, items included and excluded from taxable income, the rules for combined reporting, how receipts are apportioned, the calculation of net operating losses (NOLs), the various tax bases and rates, and the available credits. In some situations, taxpayers may make elections that could significantly reduce their tax liability. The new law also provides special provisions for manufacturers. A summary of the legislation follows. Unless otherwise indicated, all changes are effective for tax years beginning on or after Jan. 1, 2015.

Expansion of Current Nexus Provisions

New York dramatically increased the number of corporations that are subject to its corporate tax by adopting an economic nexus standard. In addition to the physical presence nexus provisions currently contained in New York tax law, a corporation now will be subject to tax in New York if it is "deriving receipts from an activity in [New York]" (N.Y. Tax Law §209.1(a), added by S. 6359, Part A, §5). A corporation is deemed to derive receipts from an activity in New York if it has $1 million or more in New York receipts (N.Y. Tax Law §209.1(b), added by S. 6359, Part A, §5). For purposes of this provision, New York receipts are defined as the receipts included in the numerator of the corporation's apportionment factor (id.). Members of combined groups will have nexus with New York if any one member has New York receipts of $1 million or if the total receipts from each member with at least $10,000 of New York receipts exceed $1 million in the aggregate (N.Y. Tax Law §209.1(d)(i), added by S. 6359, Part A, §5).

The nexus provisions also have been modified to provide that a taxpayer that has an interest in a partnership doing business in New York will be considered to be doing business in New York (N.Y. Tax Law §209.1(f), added by S. 6359, Part A, §5). Unlike under the previous law, no exceptions apply.

In addition to the new economic nexus standard, the budget bill expanded on the nexus provisions applicable to credit card lenders. Under the new law, if credit cards are issued to 1,000 or more New York customers, or if the credit card lenders have 1,000 or more locations in New York covered by merchant contracts to which they remit payments, or they have any combination of customers and merchants totaling 1,000 or more, the issuer is deemed to have New York nexus (N.Y. Tax Law §209.1(c), added by S. 6359, Part A, §5). If the taxpayer is part of a combined group, the group is deemed to have nexus. The combined group also is deemed to have nexus with New York if the total customers and/or merchant locations for all members with more than 10 credit card customers and/or merchant locations exceed 1,000 (id.).

Combined Reports

Under current law, affiliated corporations are required to file a combined report if they meet an 80% ownership test and engage in "substantial intercorporate transactions" with other members of a unitary affiliated group (N.Y. Tax Law §211.4(a)). The new law overhauls this framework by eliminating the substantial-intercorporate-transactions standard and adopting a 50% common-ownership test requiring a taxpayer to file a combined report if (1) it owns or controls either directly or indirectly more than 50% of the voting power of the capital stock of one or more other corporations; (2) more than 50% of the voting power of the capital stock of the taxpayer is owned or controlled, either directly or indirectly, by one or more other corporations; or (3) more than 50% of the voting power of the taxpayer's capital stock and the capital stock of one or more other corporations is owned or controlled, directly or indirectly, by the same interests, and the taxpayer is engaged in a unitary business with those corporations (N.Y. Tax Law §210-C.2(a), added by S. 6359, Part A, §18).However, the new law does not define a unitary business relationship. Under prior law, alien (foreign or non-U.S.) corporations were excluded from a combined return with their U.S. domestic affiliates. Under the new law, foreign corporations with effectively connected U.S. income now must be included in the combined report (N.Y. Tax Law §210-C.2(c), added by S. 6359, Part A, §18).

One aspect of the new law that significantly departs from the combination framework of the current law is the ability of an affiliated group to elect to file on a water's-edge combined basis and include nonunitary members. If the taxpayer does not satisfy the unitary-business test, it may still elect to file a combined report, provided all members in the combined group satisfy the more-than-50% common-ownership test. The election must be made on an originally filed return and is binding for seven years (N.Y. Tax Law §210-C.3(c), added by S. 6359, Part A, §18).

Repeal of Tax on Subsidiary Capital

The separate tax on subsidiary capital has been repealed. All income from subsidiary capital is now characterized as either investment income, or other exempt income, or business income.

Investment Income

Investment income is defined as income from investment capital less certain expenses attributable to investment capital (N.Y. Tax Law §208.6(a), added by S. 6359, Part A, §4). Under the new law, investment income is excluded from tax, unlike previously, when it was taxed based on its investment allocation percentage (N.Y. Tax Law §208). The new law substantially narrows the definition of investment capital. Only stocks held by a taxpayer for more than six consecutive months that are not held for sale to customers in the regular course of business are included in investment capital (N.Y. Tax Law §208.5(a), added by S. 6359, Part A, §4). Since investment income is excluded from tax, expenses attributable to investment income must be subtracted from total investment income.

Taxpayers are required to subtract from investment income only interest deductions allowable in computing entire net income that are directly or indirectly attributable to investment capital and investment income. In lieu of subtracting the interest deductions, however, a taxpayer may elect annually to reduce its total investment income by 40% (N.Y. Tax Law §208.6(b), added by S. 6359, Part A, §4). A taxpayer making this election also will be required to make the 40% election for exempt controlled foreign corporation (CFC) income and exempt unitary corporation dividends.

Other Exempt Income

Other exempt income, which consists of exempt CFC (subpart F) income and dividends from unitary subsidiaries not included in the taxpayer's combined report, is excluded from tax (N.Y. Tax Law §208.8, as amended by S. 6359, Part A, §4). This exempt income also must be reduced by expenses attributable to it.

Net Operating Losses

The deduction allowed for NOLs currently is applied on a preapportionment basis (N.Y. Tax Law §208). In other words, NOLs are deducted from a taxpayer's taxable income before the income is apportioned to New York. The budget bill radically changes the application of the NOL deduction by requiring a taxpayer to deduct its NOLs on a post-apportionment basis—i.e., after its taxable income has been apportioned to New York state (N.Y. Tax Law §210.1(a)(ix), added by S. 6359, Part A, §4). As outlined below, special transition rules apply for the use of any NOLs incurred prior to the enactment of the new law. Computing the new NOL deduction also has changed and is now computed without reference to the federal deduction (N.Y. Tax Law §208.9(f), repealed by S. 6359, Part A, §4). Twenty-year carryforwards and three-year carrybacks are allowed for all NOLs generated under the new law; however, no carryback is permitted to any year starting before Jan. 1, 2015 (N.Y. Tax Law §210.1(a)(ix)(4), added by S. 6359, Part A, §12).

The new law provides a special transition rule for using any unabsorbed NOLs that were incurred prior to the enactment of the new law. This transition rule, the prior NOL conversion subtraction, is intended to preserve the value of all NOLs accumulated and not used before the budget bill's effective date. In effect, it converts preapportioned NOLs incurred in years before 2015 that are calculated with a 7.1% rate to post-apportioned NOLs that are calculated at a 6.5% rate (N.Y. Tax Law §210.1(a)(vi), as amended by S. 6359, Part A, §12). A taxpayer's NOL conversion subtraction is calculated as follows:

  1. The taxpayer determines its unabsorbed NOL. A taxpayer's unabsorbed NOL is the amount of NOL carryforward it would have had at the end of its base year (Dec. 31, 2014, for calendar-year taxpayers, or the last day of a taxpayer's fiscal year before it is subject to the new law).
  2. The taxpayer is required to multiply its unabsorbed NOL by its base year business allocation percentage, and then multiply that product by the tax rate in effect and applicable to the taxpayer during the base year.
  3. The amount from step 2 is divided by 6.5%, or 5.7% for qualified New York manufacturers (the definition of which is discussed later), and the result is the taxpayer's prior NOL conversion subtraction pool.

As a general rule, the law provides that the amount of a taxpayer's prior NOL conversion subtraction for a given year equals 10% of its prior NOL conversion subtraction pool, plus, for subsequent years, any amount of unused prior NOL conversion subtractions from previous tax years. Any unused conversion subtraction may be carried forward through the 2035 tax year (N.Y. Tax Law §210.1(a)(viii)(B)(4), added by S. 6359, Part A, §12). Alternatively, the law permits taxpayers to make a one-time election on a timely filed return, to deduct 50% of the conversion subtraction pool over a two-year period. (If this election is made, any unused amounts are lost after the two-year period (N.Y. Tax Law §210.1(a)(viii)(B)(2)(IV), added by S. 6359, Part A, §12).) The NOL conversion subtraction amount must be used first, before any NOLs generated under the new law are used.

Sourcing of Receipts for Apportionment Purposes

New sourcing rules apply to receipts from various transactions, including the sale of digital products, numerous financial transactions, and advertising. Receipts from services no longer are sourced based on the cost-of-performance method. Under the new law, receipts from services are sourced to the location of the customer based on the following hierarchy:

  • Where the benefit is received.
  • The delivery destination (N.Y. Tax Law §210-A.10(b), added by S. 6359, Part A, §16).

If the delivery destination or where the benefit is received cannot be determined, the taxpayer must look to the apportionment fraction for that type of service receipt for the preceding tax year or the apportionment fraction in the current tax year for the taxpayer's other service receipts where the receipt of the benefit or delivery destination can be determined.

Favorable Provisions for Qualified N.Y. Manufacturers

Now is an excellent time to be a manufacturer in New York. The new law provides tax savings for many manufacturers. In particular, the bill imposes a zero percent rate on the net business income base of qualified New York manufacturers (as well as favorable capital and minimum tax rates) (N.Y. Tax Law §210.1(a)(vi), as amended by S. 6359, Part A, §5). To qualify for the tax rate benefit, two requirements must be satisfied. First, the taxpayer must be principally engaged in manufacturing, meaning more than 50% of the gross receipts of the taxpayer or its combined group, respectively, must be derived from receipts from the sale of goods produced by manufacturing activities. For purposes of the 50% test, the manufacturing activities do not have to occur in or be connected with New York state. Second, the taxpayer must be a manufacturer with either all of its real and personal property located in New York or, alternatively, a manufacturer that owns in New York depreciable property used in the manufacturing process that has an adjusted basis of $1 million or more (id.).

A taxpayer or combined group that does not satisfy the principally engaged requirement can still be a qualified New York manufacturer if it employs at least 2,500 employees during the tax year in manufacturing in New York and has property in New York that is used in manufacturing with an adjusted basis of $100 million or more (id.).

In addition to the favorable zero percent rate on its net business income, qualified New York manufacturers can take advantage of a real property tax credit equal to 20% of the real property taxes that they pay during the tax year on real property principally used for manufacturing in New York (N.Y. Tax Law §210-B.43, added by S. 6359, Part A, §17). The credit can reduce the tax on the capital base or the fixed-dollar minimum. For qualified New York manufacturers subject to tax under article 22 (personal income tax), the credit is fully refundable (N.Y. Tax Law §606(xx), added by S. 6359, Part R, §4).

The zero percent rate and real property tax credit for qualified New York manufacturers are effective for tax years beginning on or after Jan. 1, 2014.

Tax Rate Changes
  • The corporate income tax rate is reduced from 7.1% to 6.5% for tax years beginning on or after Jan. 1, 2016 (N.Y. Tax Law §210.1(a), as amended by S. 6359, Part A, §12).The tax rate on income for qualified New York manufacturers is reduced from 5.9% to zero for years beginning on or after Jan. 1, 2014 (N.Y. Tax Law §210.1(a)(vi), as amended by S. 6359, Part A, §12).
  • The current capital base tax rate of 0.15% is retained, with a phasedown to zero percent for tax years beginning on or after Jan. 1, 2021 (N.Y. Tax Law §210.1(b)(1), as amended by S. 6359, Part A, §12). The tax on investment capital and the alternative minimum tax are repealed. The maximum tax on capital increases from $1 million to $5 million (N.Y. Tax Law §210.1(b), as amended by S. 6359, Part A, §12).
  • The fixed-dollar minimum tax has additional brackets, and taxpayers with New York receipts of more than $1 billion will pay a $200,000 tax (N.Y. Tax Law §210.1(d)(4), as amended by S. 6359, Part A, §12).
  • For qualified New York manufacturers, the fixed-dollar minimum tax is reduced.
  • The Metropolitan Transportation Authority (MTA) surcharge increases from 17% of the New York franchise tax to 25.6% for tax years beginning on or after Jan. 1, 2015, and will be redetermined for tax years beginning on or after Jan. 1, 2016 (N.Y. Tax Law §209-B.1(a), added by S. 6359, Part A, §7).
Financial Institutions

Banks now will be subject to the same provisions as general corporate taxpayers. Before the changes, banks were subject to a separate tax regime under article 32 (repealed by S. 6359, Part A, §1).

For tax years beginning on or after Jan. 1, 2015, the following deductions will be available to certain thrifts and small banks (generally institutions with average assets of the combined reporting group that do not exceed $8 billion):

  • Subtraction modification for qualified residential loan portfolios.
  • Subtraction modification for community banks and small thrifts (N.Y. Tax Law §208.9(s), added by S. 6359, Part A, §4).

The new law permits a qualified institution to take one of the two aforementioned deductions. In addition, a small thrift institution or a qualified community bank that owns real estate investment trusts (REITs) that were active on April 1, 2014, can continue to take the REIT deduction, but these institutions or banks are not eligible to take either of the subtraction modifications mentioned above (N.Y. Tax Law §208.9(t), added by S. 6359, Part A, §4).

Certain exclusions and deductions currently available to banks are being eliminated, and the apportionment provisions have changed significantly. For income apportionment purposes, banks will be subject to a single-factor market-based receipts formula rather than the three-factor formula that currently applies.

As of the date of publication, New York City has not adopted the New York state changes, though it is anticipated that it will adopt most of the changes at a future date.

EditorNotes

Howard Wagner is a director with Crowe Horwath LLP in Louisville, Ky.

For additional information about these items, contact Mr. Wagner at 502-420-4567 or howard.wagner@crowehorwath.com.

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

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