New York may be starting a trend, becoming the first state to decouple from a provision in the federal virus response package that temporarily relaxes limits on business interest payment deductions.
The state Legislature, in an item buried in an omnibus budget bill (A.9508B/S.7508B), amended the New York tax law and administrative code to require taxpayers to continue to limit their deduction for business interest expenses to 30% of the adjusted taxable income on their state and New York City returns. That’s the case even if taxpayers elect to use the more generous 50% limit allowed for federal income taxes for 2019 and 2020 tax years.
The federal stimulus law enacted March 27 (Public Law 116-136), known as the CARES Act, temporarily relaxed the business interest expense deduction limit under tax code Section 163(j) of the 2017 tax law, to offer relief from economic impacts of the pandemic.
New York wasted no time in decoupling from the federal changes, since lawmakers were already meeting urgently to pass a budget by an April 1 statutory deadline. But with so many legislative proceedings suspended during the pandemic, other states looking to recoup revenue that way may have to wait until special sessions are called.
New York’s budget action, taken last week during a session disrupted by the coronavirus response, leaves the state’s and city’s conformity to federal rules on personal income tax for individuals, estates, and trusts where it was on March 1, for tax years prior to 2022.
The state faces “a gaping and growing budget gap” from the crisis, said Joshua Gewolb, a tax partner at Harter Secrest & Emery LLP in Rochester, N.Y. “New York simply cannot afford an expanded interest deduction,” he said.
Adopting the federal stimulus law changes, “most notably a significant expansion of allowable loss deductions for noncorporate taxpayers, would have resulted in sizable revenue losses for both the State and New York City, which would have further exacerbated the $10 billion to $15 billion in revenue the State already expects to lose as a result of the COVID-19 driven economic downturn,” Freeman Klopott, a spokesman for the state Budget Division, said Wednesday in an email to Bloomberg Tax.
“Unlike the federal government, New York State must balance its budget, and we continue to call on the Federal government for support to offset these revenue losses,” Klopott said.
“We had to decouple to avoid losing more revenue,” New York City Finance Department spokeswoman Marcy Miranda told Bloomberg Tax Wednesday.
New York’s budget measure also means the state and city tax systems have decoupled from the stimulus law’s taxpayer-favorable provisions involving net operating losses in personal income tax, Jack Trachtenberg, a principal with Deloitte Tax LLP in New York, said.
The decoupler on the business interest expense deduction, however, doesn’t extend to the related tax code Section 163(j)(10)(B)(i), Trachtenberg said. It would thus appear that New York business taxpayers “would be permitted to elect to use their 2019 adjusted taxable income as their adjusted taxable income in 2020,” he said.
Decoupling from the federal amendments to Section 163(j) might mean that New York state and city tax agencies will have to amend their 2019 guidance on allocating interest expenses between business and investment income, said Elizabeth Pascal, a partner with Hodgson Russ LLP in Buffalo, N.Y. That guidance is tied to the state’s and city’s overall conformity with the tax section.
The revenue disruption from the pandemic in New York “will reveal the true cost” of state and city business tax cuts enacted in 2014 and 2015, “and the state may regret phasing out its tax on capital,” said Zal Kumar, a partner in Mayer Brown LLP in New York.
“It’s not clear how those earlier policy choices will affect decisions this year, but it would be safe to assume that revenue will be a predominant consideration when the legislature reconvenes,” Kumar said.
The Covid-19 emergency has disrupted the work of state legislatures, but once they “are back in session, their responses to the CARES Act will be among the issues that taxpayers will need to monitor,” said Scott Smith, national technical practice leader with BDO USA LLP in Nashville, Tenn.