IMPORTANT TAX AMENDMENTS IN THE 1996 BUDGET BILL

By Jeffrey M. Cobb, and
James W. Perraglia

Tax practitioners should be alerted to several important changes to the State Tax Law and the City Administrative Code that could have a dramatic impact on the amount of tax their clients pay to New York. In July, Governor George Pataki signed the 1996 New York State Budget Bill, which includes many amendments to the Tax Law. Now that local taxpayers are beginning to digest all of the changes, they want to know what the ramifications are, particularly in the real estate area. Highlights of the amendments include a repeal of the real estate transfer gains tax, the continued phaseout of the business corporation tax surcharge, continued reduction in personal income tax rates, and the establishment of an amnesty program for delinquent taxpayers. Those changes, which principally relate to state issues, are discussed below. Changes to the New York City code are presented in a second article in this month's State and Local Taxation
column.

Repeal of Gains Tax

Perhaps the most significant item in the budget bill is the full repeal of the Real Property Transfer Gains Tax pursuant to Article 31-B of the Tax Law. Distinguished from the Real Estate Transfer Tax under Article 31, the Real Property Transfer Gains Tax (gains tax) applies to gains derived from the sale or transfer of interests in real property located in New York State where the consideration for the sale is $1 million or more. The tax is imposed at 10% of the gain, as defined by statute, and is primarily the obligation of the transferor.

The repeal is applicable to all transfers occurring on or after June 15, 1996, and if gains tax has been paid already, claims for refund may be filed. Application for refunds of any gains tax paid with respect to transfers of real property occurring on or after June 15, 1996, are to be submitted on Form TP-165.8. Until a revised tax form is issued, if real estate is transferred, the taxpayer must continue to file Form TP-584 (Combined Real Property Transfer Gains Tax), but leave blank the section related to the gains tax computation. Although the repeal applies to transfers pursuant to condominium or cooperative plans, the state is expected to issue a Technical Service Bureau Memorandum and a new form to assist taxpayers in the computation of gains tax where consideration has been previously computed through safe harbor estimates (a method of calculating anticipated consideration under a cooperative or condominium plan for unsold shares or units).

The gains tax was often an unexpected transactional cost where corporations participated in reorganizations or acquisitions. The gains tax often discouraged taxpayers with interests in real property from transferring such interests. Taxpayers who had purchased or inherited real estate and watched the appreciated value skyrocket will now be able to transfer the property without this additional cost. The repeal, however, does not impact the state and city real estate transfer taxes currently levied at the rate of $2 per $500 of consideration at the state level and at rates ranging from one percent to 2.625 percent of consideration at the city level, depending on the type of real estate and the amount of consideration involved.

Amnesty Program

Another significant item in the budget bill is an amnesty program. Under the program, any and all penalties which could be assessed on past due tax liabilities will be waived. Although interest on unpaid tax is not waived, the waiver does include the interest penalty.

The amnesty program will take place over the period from November 1, 1996, through January 31, 1997. It covers a variety of tax liabilities incurred for taxable periods ended and transactions/uses occurring on or before December 31, 1994. Amnesty will generally apply to all taxpayers, including individuals, partnerships, and corporations. However, amnesty from tax liability for certain business taxes, such as the franchise tax on business corporations, will not apply to corporations with more than 500 employees.

The taxes covered under amnesty include corporate income, personal income, sales and use, passenger car rental, motor fuel, highway use, petroleum business, utility, beverage container, and estate and gift taxes. The program also covers New York City and the City of Yonkers personal income tax provisions and the repealed New York State unincorporated business tax. The amnesty program does not apply to taxpayers who are party to any criminal or civil investigation or pending litigation where the basis for the action is the liability sought through the amnesty program. A taxpayer who is party to civil litigation, but withdraws from such proceedings may request amnesty. Furthermore, a taxpayer who has received an assessment from New York, may also be entitled to abatement of penalties through amnesty.

Amnesty programs are nothing new to New York taxpayers. In 1985, a similar amnesty program raised over $400 million for New York State. In 1994, New York established a limited amnesty program aimed at specific taxpayers during particular years. The income component of the 1994 New York Amnesty applied only to nonresident individuals and trusts or estates for tax years beginning on or after January 1, 1986, and ending before December 31, 1993. Residents of New York State were not eligible under this amnesty program. The business tax component was also limited to out-of-state businesses.

The budget bill provides that any taxpayer eligible to participate in the amnesty program who fails to request amnesty and is subsequently assessed on those liabilities, will have an additional penalty imposed which equals five percent of the existing penalty. In addition, any taxpayer who received any benefit under the state's previous amnesty programs in either 1985 or 1994 is precluded from receiving benefits under the current program with respect to the tax liability for which they received a previous benefit.

Sales Tax

One of the more interesting aspects of the budget bill is a one-week pilot program, from January 18, 1997, through January 24, 1997, during which clothing and footwear items sold for less than $500 will be exempt from sales tax. Local governments, however, retain the option not to participate in the program. After the pilot program is completed, the Commissioner of Taxation and Finance will submit to the Governor, on or before November 1, 1997, a written report evaluating the impact of this exemption. The pilot program demonstrates the concerns of numerous New York vendors who are in competition with out-of-state vendors and mail-order companies for clothing and footwear sales. A practical concern to many retail businesses will be the technical difficulty associated with the implementation of a changing system which reflects this exemption on qualifying sales made during this limited period.

Other sales tax provisions include an exemption, effective December 1, 1996, for parking facilities owned and operated by municipalities. Also exempt from sales tax, effective December 1, 1996, are promotional items and related services. The exemption for promotional items and related services is geared toward New York's printing and publishing industry with the intent to make New York more competitive, thereby creating more jobs and stimulating the economy.

Phaseout of Surcharge and
Tax Rate Reductions

A very important part of the budget bill is the continuation of existing tax cuts previously introduced by the Pataki administration. Although there is no discussion of such tax cuts in the budget bill, its silence preserves the tax reductions which began in 1995.

These reductions were reflected in the highest rates of the personal income tax. The highest New York personal income tax rates will be reduced to 7.125% for 1996 and 6.85% for taxable years beginning after 1996. In addition, the tax brackets have been expanded in both 1996 and 1997 thereby decreasing the number of people paying tax at these rates. For example, a taxpayer filing on a joint return basis in 1996 will pay 7.125% of New York taxable income for income over $26,000. For tax years beginning after 1996, that taxpayer will pay the reduced rate of 6.85% of New York taxable income for income over $40,000. After 1996, therefore, less taxpayers will pay the highest rate on their New York taxable income.

Another tax item left undisturbed by the budget bill is the phaseout of the business tax surcharge for tax years ending after July 1, 1997. The surcharge was originally imposed at 15% in 1990 and scheduled to sunset in 1993.

Article 9 Taxpayers

Trucking and railroad companies currently filing under Article 9 of the New York State Tax Law and paying a tax on gross receipts will be granted an election, beginning in 1998, to remain under Article 9. Unless a one-time election is made to remain under Article 9, the trucking or railroad company will be subject to Article 9-A and pay a corporate franchise tax. This election to remain under Article 9 is valid until revoked. If the trucking or railroad company chooses not to make the election to remain taxable under Article 9, that decision is permanent. Further, the tax on gross earnings from sources within New York that is currently imposed on trucking and railroad companies under Article 9 will be reduced, effective January 1, 1997, from 0.75% to 0.60%.

The budget bill also includes provisions for taxpayers that do not make the election to remain taxable under Article 9. In order to compute the New York State apportionment factor and the Metropolitan Commuter Transportation District apportionment factor, a single-factor apportionment percentage, based on mileage, has been established. Trucking and railroad companies under Article 9-A that apportion under the single factor apportionment percentage, however, will be prohibited from filing on a combined basis with other Article 9-A companies that do not use a single factor apportionment formula.

Miscellaneous Highlights.

* Petroleum Business Taxes. Beginning January 1, 1997, the railroad diesel fuel tax will be reduced to $.042 per gallon and reduced by $.013 each year thereafter until it is phased out. In addition, beginning on January 1, 1997, the railroad diesel fuel is exempt from the supplemental tax. Effective March 1, 1997, commercial gallonage is also exempt from the supplemental tax instead of the current credit the taxpayer can take against the supplemental tax. As defined in the budget bill, commercial gallonage is defined as gallonage that is either nonautomotive-type diesel motor fuel or a residual petroleum product that does not qualify for the utility credit as manufacturing gallonage. Beginning on January 1, 1998, the supplemental tax is further reduced by $.0075 per gallon and an additional $.01 per gallon beginning on April 1, 1999. The exemption for distillate fuels and residual fuel oils are extended to all petroleum business taxes effective January 1, 1998, and the utility tax credit has been increased by $.005 per gallon effective April 1, 1999.

* Credits for Household and Dependent Care Services. Existing state tax credits for household and dependent care services will increase from the current amount of 20% of the Federal credit to 30% of the Federal credit for 1996 and 60% of the Federal credit thereafter for families earning up to $10,000. For families earning between $10,000 and $14,000, the credit will regress back to 20% of the Federal credit, remaining at 20% for earnings over $14,000, but it will be made refundable to all taxpayers qualified to receive it.

* Qualified Rehabilitation Expenses for Historic Barns. Effective January 1, 1997, taxpayers are allowed a credit equal to 25% of the qualified rehabilitation expenses incurred to restore any agricultural barns built before 1936. Qualified rehabilitation expenses are defined in the Budget Bill as any expenditure that qualifies for the rehabilitation credit under IRC section 47(c)(2). Any increase in value of such structures as a result of the rehabilitation will be exempt from property taxes for the first year, but this exemption will be phased out in equal amounts over the following nine years. Taxpayers who meet the definition of an "eligible farmer," whose Federal gross income from farming for the taxable year is at least two-thirds of their total Federal gross income, will be granted a refundable tax credit equal to the amount of school property taxes paid on qualified farmland. *

Jeffrey M. Cobb, JD, and James W. Perraglia, JD, LLM, are managers in the multistate tax consulting practice of Price Waterhouse LLP. Jeff and Jim acknowledge the assistance given by David Prebit in the preparation of the article

1996-1997 NEW YORK CITY TAX LEGISLATION

By Paul R. Comeau, Mark S. Klein, and Robert D. Plattner

The New York State legislature ended its 1996 regular session on July 13 with a flurry of activity that included significant tax legislation affecting both state and city taxes. Despite budgetary concerns, including the threat of reduced Federal dollars, this year's legislation continued the tax reduction efforts of recent years designed to bring New York's tax burden in line with other states and to serve as an engine for job creation. The New York aspects of the act are discussed in an accompanying article. Presented below are the major changes in New York City taxes.

General Corporation Tax (S.7635-B)

Allocation. Major changes to the allocation procedures are as follows:

* A corporation is no longer required to maintain a regular place of business outside the city in order to be allowed to allocate its income (effective for tax years beginning on or after July 1, 1996).

* A manufacturing corporation may elect to double-weight the receipts factor of its business allocation formula.

* For purposes of calculating the property percentage of the business allocation formula, the value of rented property will be equal to eight times the annual gross rent.

LLCs. Associations classified as corporations for Federal tax purposes, including LLCs so classified, will be subject to the GCT rather than the UBT (effective for tax years beginning on or after January 1, 1996).

Income Plus Compensation Base. The income plus compensation base is modified as follows: For tax years beginning on or after July 1, 1996, but before July 1, 1998, 75% rather than the total amount of the salaries and other compensation paid to officers will be added back in figuring the tax; for tax years beginning on or after July 1, 1998, but before July 1, 1999, 50% of such payments will be added back; and for tax years beginning on or after July 1, 1999, no addback will be required for payments to officers. A full addback will continue to be required for salary and other compensation payments to greater-than-five-percent shareholders. Further, the exemption allowed in calculating the base is increased to $30,000 for tax years beginning on or after July 1, 1997, but before July 1, 1998, and to $40,000 for tax years beginning on or after July 1, 1998.

Unincorporated Business Tax
(Chapter 128)

The city unincorporated business tax changes includes provisions that--

* allow businesses to allocate income outside the city whether or not they maintain an office outside the city (S.7635-B).

* allocate receipts from sales of tangible personal property based upon the destination of the property.

* provide a full credit if the tax is $1,000 or less (effective for tax years after 1996).

* raise the income threshold for requiring a declaration of estimated tax from $15,000 to $20,000.

* expand the self-trading exemption.

* exempt income from the self-trading activities of entities primarily engaged in trading for their own account. ("Primarily engaged" means at least 90% of the entity's assets qualify for the self-trading exemption. This reform responds to the problem of the "tainting" of investment income by income subject to the UBT.)

Sales Tax (Chapter 366)

Manufacturer's Exemption. Expands the current manufacturer's exemption to include parts with a useful life of one year or less, tools and supplies, and services performed on production machinery, equipment, parts, tools and supplies, in conformance with the state exemption. With this change in the law, the city's manufacturer's exemption is now broader than that offered by other localities statewide, which do not exempt services performed on production machinery, equipment, parts, tools, and supplies. *

Paul R. Comeau and Mark S. Klein are members of the New York and Florida Bars and are resident partners in the Buffalo Office of the law firm of Hodgson, Russ, Andrews, Woods & Goodyear, LLP. Robert D. Plattner is a partner and resident of the firm's Albany Office. All are members of the firm's New York State Tax Practice Group.

State and Local Editor:
Marshall L. Fineman, CPA
David Berdon & Co. LLP

Interstate Editor:
Stuart A. Rosenblatt, CPA
Wiss & Company LLP

Contributing Editors:
Henry Goldwasser, CPA
M. R. Weiser & Co LLP

Leonard DiMeglio, CPA
Coopers & Lybrand L.L.P.

Steven M. Kaplan, CPA
Konigsberg Wolf & Co., PC

John J. Fielding, CPA
Price Waterhouse LLP

Warren Weinstock, CPA
Paneth Haber & Zimmerman LLP