New York Optional Employer Tax

As part of its most recent budget, New York State created an optional employer compensation expense tax.  The aim of the new optional tax is to work around the new federal limitations on the deduction for state and local income taxes that were enacted as part of the December 22, 2018 federal tax law.  However, its usefulness is very questionable.

Under the optional system, an employer can pay a tax of 1.5% of the wages paid to employees, for any employee that makes more than $40,000 per year.  (The percentage is scheduled to increase in future tax years).

Employers who wish to elect to be part of this optional new tax system for the 2019 tax year must make an election on or before December 1, 2018, according to TSB-M-18(1)ECEP, which was issued by the New York Department of Taxation and Finance on July 3, 2018.

Since the new federal tax law caps the deduction for individuals for state and local income taxes (along with real estate taxes) at $10,000, the premise of the new optional tax is to create a tax that remains fully deductible and can be a substitute for the state personal income tax.

The new optional tax would be fully deductible for the employers that pay it, and employees would receive a credit on their own personal New York income tax returns for the amount of tax that was paid by the employer.  As a result, such employees would have a lower New York State income tax and would, therefore, need to have less New York State income tax withheld from salaries.

However, since the employer would not be permitted to withhold the new optional tax from the compensation of the employee, the employer would incur an additional expense by paying this new tax.  Therefore, this new system transfers a portion of the state income tax burden from the employee to the employer.  Unless all or most of the employees are also owners of the company, it is unlikely that an employer would be motivated to pay this new optional tax.

There is one further consideration: Even if employers wish to join this optional new tax system, there is no guarantee that the IRS will condone the new system.

The IRS recently confirmed that businesses remain able to deduct business-related payments to charities or government entities for which they receive state or local tax credits; however, such payments must be for ordinary and necessary business expenses, according to IR-2018-178, which was issued on September 5, 2018.

It is presently unknown whether the IRS will challenge the new optional system created by New York, especially since the system provides credits for employees (not the employers who pay the tax), and the system was created to circumvent the new cap on the federal deduction for taxes on Schedule A.