New York Establishes Employer Compensation Expense Program

John Calogero, Principal (Aug, 2018)

This past April New York established the Employer Compensation Expense Program (ECEP) as a component of the 2018-2019 New York Budget (S7509-C/A9509-C) which will begin in 2019.  The new optional payroll tax referred to as the Employer Compensation Expense Tax (ECET) is a workaround to reduce the effects of the Tax Cuts and Jobs Act (TJCA) that limits itemized deductions for state and local income taxes (SALT) for individuals to $10,000 per year.  The TJCA limits the deductibility of state income taxes paid by individuals, however, there is no cap for ordinary and necessary business expenses paid or incurred by employers in carrying on a trade or business.

The SALT deduction limit will have a significant impact on states where there is a high tax rate such as New York, New Jersey and Connecticut.  New York State is the first state to enact legislation specifically designed as a workaround to the new $10,000 limitation on state and local taxes SALT enacted as part of federal tax reform.

This workaround was part of a series of responses by New York specifically aimed at protecting New Yorkers from the impact of the SALT cap. New York has also enacted a charitable contribution workaround, decoupled from certain changes to the federal itemized deductions.  However, the IRS and Treasury released proposed regulations on August 23, 2018 that would essentially block states’ programs to bypass the SALT cap via charitable contributions in exchange for state or local tax credits. 

Although the new guidance from Treasury and the IRS is a proposal at this point, it has an effective date of August 27th and is intended to apply to transactions made after then.  In particular, the proposed regulation says that if a taxpayer receives a benefit — for instance, as a state or local tax credit — for making a charitable contribution, then that taxpayer must reduce the amount claimed as a charitable deduction on his or her federal return.  If the tax credit received is less than 15 percent, then the taxpayer would get the full charitable deduction.

The intention of each of these programs is to shift the state tax burden from the individual (which would be subject to the cap) to either a charitable deduction or to a business entity.  In addition to the actions referenced above, New York has also joined New Jersey, Connecticut and Maryland in filing a lawsuit against the Internal Revenue Service regarding the SAL cap. 

New York recently issued guidance regarding the ECET, (see below ECEP, TSB-M-18(1) ECEP, July 3, 2018).

How the ECET Works

The NYS ECEP established a new optional ECET that employers can elect to pay if they have employees that earn over $40,000 annually in wages and compensation in New York State.  The ECET is being phased in over three years beginning on January 1, 2019 according to the following schedule:

Requirements

An employer that elects will pay the ECET on the payroll expense incurred by the employer for New York wages and compensation that exceeds $40,000 for the calendar year paid to each employee who is employed in New York for whom the employer is required to withhold New York State tax. If at least one of the tests for determining whether an employee is employed in New York is met, then an employee is deemed to be employed in New York.

Employee Wages Covered by the ECET

If you elect into the ECEP for the year, you will pay the ECET on the New York payroll expense that exceeds $40,000 for the calendar year paid to each employee employed in New York State.

The ECET is being phased in over three years as follows:

Tax Rates

For quarters in tax year:                              The rate of tax is:

2019                                                                  1.5%

2020                                                                  3.0%

2021 and after                                                 5.0%

The Election

  • An employer will make an annual affirmative election to participate in the ECEP no later than December 1st to pay the optional tax in the following calendar year.
  • The initial election must be made no later than December 1, 2018.
  • The Department will be providing a web-based registration system to accommodate the employer election into the ECEP.

If you elect, you should communicate to your employees:

  • That you made the election for the year,
  • that covered employees making over $40,000 may be eligible for a tax credit when filing their income tax return and should review their IT-2104, Employee’s Withholding Allowance Certificate to adjust their withholding, and
  • the amount of wages subject to ECET for the year (the Department’s website will provide a sample template that can be used to communicate this amount to covered employees).

When to File and Pay

The ECET will be paid on the same dates that your withholding tax payments are required to be made.

The quarterly returns are due on the same dates that your withholding tax returns are due:

Quarters and Due Dates

Quarter                                                           Due Date*

January 1 - March 31                                     April 30

April 1 - June 30                                              July 31

July 1 - September 30                                   October 31

October 1 - December 31                            January 31

* When the due date falls on a Saturday, Sunday, or legal holiday, you may report and pay on the next business day.

How to File and Pay

Although the ECET return and payments are due at the same time as your withholding tax, you must file and pay the taxes separately. You must file all quarterly ECET returns and make all payments online.

Here are 3 examples provided by New York State:

Example 1:  An electing employer has three employees. Two of the employees earn less than $40,000 annually.  The third employee earns $120,000 annually ($30,000 each quarter).  The third employee is not a covered employee for the purpose of the first quarter ECET filings, but at the time in the second quarter when the employee’s total wages to date exceed $40,000, the employee is deemed a covered employee and the employer is subject to the ECET.  Therefore, the employer must pay $1,200 in ECET for tax year 2019, as shown below:

  • 2nd quarter $20,000 × 1½% = $300
  • 3rd quarter $30,000 × 1½% = $450
  • 4th quarter $30,000 × 1½% = $450

Example 2:  Employee X receives an annual salary of $300,000 from an electing employer. Employee X is employed by an electing employer in California from January 1 until November 30. On December 1, Employee X is transferred to New York State and is then employed by the electing employer in New York.  Employee X received $275,000 in wages while employed in California and $25,000 in wages while employed in New York.  The electing employer is not required to pay ECET on the payroll expense paid to Employee X because Employee X’s wages in New York did not exceed $40,000.

Example 3:  Employee Y receives an annual salary of $250,000 from an electing employer.  Employee Y is employed by an electing employer in Georgia from January 1 until August 31.  On September 1, Employee Y is transferred from Georgia to New York State and is then employed by the electing employer in New York.  Employee Y received $150,000 in wages while employed in Georgia and $100,000 in wages while employed in New York.  The electing employer is required to pay ECET on the payroll expense paid to Employee Y while employed in New York that exceeds $40,000.  The electing employer will be required to pay ECET on $60,000 of wages paid to Employee Y while employed in New York because Employee Y’s New York wages exceeded $40,000.

Benefits

  • This new legislation would allow employers that have no cap on their business SALT deduction to absorb their employee’s state tax liability.
  • Any lost Federal SALT deduction is shifted from the employee to the employer, who can still take the deduction for business tax purposes.
  • If the employer is a part of this program, employees would have a lower state tax liability because any ECET paid by an employer would result in a corresponding NYS income tax credit to the employee.  This will result in employers assuming the cost of the employee's state income taxes.
  • In order to reduce the cost to the employer many have discussed offering employees the ECEP tax credit in exchange for a decrease in employee salary. The new tax credit that corresponds in value to the ECEP will decrease the personal income tax on wages for those employees who would be subject to ECEP, resulting in economic benefits to the employees.
  • This credit can also be available to nonresidents of New York State paying taxes based upon New York source wages, provided the New York employment tests are met.

Effect on New York State

According to the state budget office, this new program is expected to be revenue neutral. The decrease in personal income tax receipts will be mitigated by the substantial increase in ECEP revenue assuming large volume of elections into the program.  The revenue from this program can only be determined by the number of elections made. The state has not given any revenue projections at this point.

Considerations and Potential Issues

It remains to be seen whether employers will opt into the ECET program.  While New York employees will benefit from the program by bypassing the $10,000 SALT cap, the employer will bear the additional costs associated with the ECET – and the law expressly does not allow such amounts to be deducted from the employee’s wages.  The additional costs will also include additional quarterly filings, with the potential for the imposition of penalties. 

It also remains to be seen whether the ECET would be an effective workaround for federal income tax purposes and whether or not the IRS will accept the structure.  The IRS has issued a notice indicating its intention to question state workaround programs, specifically mentioning the charitable contribution programs (see IRS Notice 2018-54) and, as mentioned above, the IRS and Treasury proposed regulations released on August 23, 2018 that will essentially block these charitable contribution programs that generate state or local tax credits. 

An additional consideration is whether residents of states other than New York will actually be hurt by this program as the resident state may not treat the ECET as a creditable income tax. Please contact your Dermody, Burke & Brown advisor if you have any questions related to the Employer Compensation Expense Program or Tax.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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