The recently enacted New York City (NYC) PTE tax is effective for tax years beginning on or after January 1, 2023. This is a voluntary tax applicable to partnerships, LLCs, and S corporations. Below is a numbered summary of some key points concerning this tax, but we will be happy to provide additional information as you may require.
1. The annual election into the NYC PTE tax must be made by March 15 of the relevant tax year, when the first estimated payment is due (the others are due on June 15, September 15, and December 15, regardless of the payer’s taxable year), and is irrevocable for said year unless revoked before March 15. To be eligible to make the election, a PTE must also make the annual election to be taxed under the state PTE tax.
2. A partnership with both NYC resident and nonresident partners can elect into the NYC PTE tax, but an S corporation with the same cannot. The issue of part-year resident partners remains unresolved, although state guidance currently holds that if an individual is a New York resident for more than half the year, they are treated as a full-year resident for state PTE tax purposes.
3. A federal S corporation that has not made the state S election is likely unable to elect into the NYC PTE tax, given the provisions of the germane state and city tax laws as presently written.
4. The NYC PTE return is due on March 15 following the close of the PTE’s taxable year.
5. For a partnership, taxable income for purposes of the NYC PTE tax includes all items of income, gain, loss, and deduction to the extent included in the taxable income of resident partners. Taxable income does not include any amounts attributed to nonresident partners not subject to NYC personal income taxation (e.g., corporations, nonresident individuals, etc.), a rule important when looking at tiered structures.
6. For an S corporation, taxable income for purposes of the NYC PTE tax includes all items of income, gain, loss, and deduction to the extent included in the taxable income of NYC resident shareholders.
7. The NYC PTE tax rate is 3.876%. A partner or shareholder will get a dollar-for-dollar credit for their direct share of NYC PTE taxes paid, and excess credits will be fully refundable. However, said credit must be added back to state and local taxable income on personal income tax returns.
8. The NYC general corporation tax and unincorporated business tax regimes continue to apply, with payments of the NYC PTE tax added back to the applicable tax base.
In a close 5-4 decision, the Supreme Court in the case of United States v. Bittner, with the opinion authored by Justice Gorsuch, stated that “Best read, the BSA [Bank Secrecy Act] treats the failure to file a legally compliant report as one violation carrying a maximum penalty of $10,000, not a cascade of such penalties calculated on a per-account basis.” Circuit courts had split over what constitutes a violation, as Section 5321 of title 31 of the U.S. Code (which is part of the BSA) establishes civil penalties for non-willful FBAR violations but does not define what a violation is. Additionally, subsection (a)(5)(A) of that section states that the Department of the Treasury may impose a civil penalty on a person who violates “any provision of section 5314” (which concerns FBAR requirements), while subsection (a)(5)(B)(i) of that section says the penalty shall not exceed $10,000. Justices Barrett dissented from the majority’s ruling, and her dissent was joined by Justices Thomas, Sotomayor, and Kagan.
Pursuant to a New Jersey bill recently signed by Governor Murphy, the state has decoupled from Sec. 280E of federal Internal Revenue Code of 1986, as amended, which requires affected businesses (most notably, those in the cannabis space) to calculate their taxable income based on their gross profit (revenues less cost of goods sold) and allows them no relief for amounts paid or incurred for selling, general, or administrative expenses. After this decoupling, all cannabis licensees in New Jersey that are subject to corporate income tax will reap significant savings with respect to their federally disallowed expenses.
The newly signed bill also benefits state-licensed cultivators and manufacturers, who are now eligible to take advantage of the New Jersey R&D tax credit, which is an amount equal to 10% of qualified research payments made during the privilege period. No federal R&D tax credit is available to cannabis businesses.
Please contact our office should you have any questions.
The New Jersey legislature recently enacted many significant changes to the state's CBT rules, including adoption of an economic nexus standard and changes to the unitary business rules. An excellent summary of these rules is available at the link below (please copy and paste into your browser if you are unable to directly access it):
Please contact our office to see if and how these changes might impact you.
Beginning with 2022 tax returns, a new class of S corporations is eligible for a broader PTET tax base calculation method in NYS, which may increase the amount of the associated credit available to electing taxpayers. As you may know, the original PTET rules required all electing S corporations to calculate their tax bases using only New York State (NYS) source items, regardless of the individual shareholders' residence, which typically led to a lower PTET, a lower corresponding deduction on the federal income tax return, and a smaller credit to offset the shareholders' NYS personal income tax liability.
Now, there will be two S corporations that can make the PTET election, an electing resident S corporation and an electing standard S corporation. Electing resident S corporations calculate their PTET bases as the sum of all items of income, gain, loss, or deduction to the extent these items would be included in the taxable income of a resident shareholder (i.e., income from all sources), which could result in a greater PTET liability and a correspondingly greater federal tax deduction and NYS PTET credit for NYS resident shareholders. Such corporations electing in to the PTET must certify at the time of the election that all their shareholders are residents of NYS. Conversely, electing standard S corporations (i.e., those with both resident and nonresident shareholders) must continue to calculate their NYS PTET bases using the sum of all items of income, gain, loss, or deduction derived from or connected with NYS sources for all their shareholders. If an S corporation electing in to the PTET does not certify that it is an electing resident S corporation, it will automatically be treated as an electing standard S corporation.
In addition to the above change, please note that the requirement for shareholders of an S corporation to add back their share of NYS and other state income taxes paid by an S corporation has been removed, with the only state income tax addback required being the NYS franchise tax imposed on federal S corporations that have not made the separate NYS S corporation election. Concomitantly, new provisions were enacted eliminating any requirement for S corporation shareholders from adding back the NYS PTET to their federal adjusted gross income (AGI) to the extent of their share of the NYS PTET credit that is added to their federal AGI, as well as any requirement for such shareholders from adding back other states' taxes substantially similar to the PTET to the extent of the other states' related tax credits allowed.
Finally, for tax years beginning on or after January 1, 2023, an elective New York City (NYC) PTET is available, which largely mirrors the NYS PTET. The associated election will be an annual, irrevocable one, due by the due date of the first estimated payment. Critically, to make the election, partnerships must have at least one owner that is an NYC resident, and S corporations must have only shareholders that are NYC residents. The NYC PTET rate is 3.876%, and this tax is in addition to all other applicable NYC taxes. The tax base of the NYC PTET is the sum of all items of income, gain, loss, or deduction attributable to a partner that is a "city taxpayer" (including disregarded entities owned by that taxpayer), or that same sum attributable to NYC resident S corporation shareholders. The tax is paid in four equal installments (notably, an owner of an electing entity entitled to an NYC PTET credit is severally liable for the tax if it is not paid by that entity), and resident owners of electing entities are entitled to a refundable credit equal to their direct share of the NYC PTET to offset their NYC personal income tax..
As you can see, these pass-through taxes are quite complex, but the benefits of electing into one can be quite meaningful, so we encourage you to reach out to us with any questions.
The Supreme Court has agreed to hear an appeal from a decision of the 9th Circuit in Moore v. U.S., 36 F. 4th 930 (2022) regarding a constitutional challenge to the mandatory transition tax, which was enacted as a part of the Trump administration's comprehensive tax reform.
The case concerns whether a couple could be taxed on earnings that were retained by an Indian company they invested in, and specifically attacks the constitutionality of the transition tax, which as you likely recall was created to target U.S. shareholders’ foreign earnings that had not been repatriated back to the U.S. While Congress is authorized to tax income under the Constitution’s Sixteenth Amendment, the plaintiffs are arguing that imposing the transition tax exceeds that authority because it targets gains that have not yet been realized by taxpayers, while the Constitution requires other direct taxes (non-income) to be apportioned among the states in proportion to each state’s population. The petitioners, who are represented by the powerhouse law firm Baker & Hostetler (and so are far from cranks making a frivolous argument), claim that their position impacts not just the transition tax, but also other potential property and wealth taxes that would also target unrealized gains (e.g., the Biden Administration’s various proposed taxes, such as the “billionaire’s tax”).
We will of course keep you informed about this very important case.
In the recent Tax Court case of Farhy v. Commissioner, 160 T.C. No. 6 (Apr. 3, 2023) (slip op.), the IRS assessed a $50,000 penalty against the petitioner (Farhy) for each tax year in controversy in connection with unfiled IRS Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The petitioner did not pay the penalties, and to collect them, the IRS issued a Notice 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing. Farhy responded by filing a Form 12153, Request for a Collection Due Process or Equivalent Hearing, and following a hearing, the IRS issued a Notice of Determination Concerning Collection Actions, sustaining the proposed collection. Farhy petitioned the Tax Court for review of the IRS’s actions, claiming that the agency lacked legal authority to assess the penalties in controversy against him.
The Tax Court first noted that Section 6201 of the Internal Revenue Code of 1986, as amended (the “IRC”) authorizes and requires the Secretary of the Treasury to make assessments of all taxes (including interest, additional amounts, additions to tax, and assessable penalties). The court also noted that liability for taxes does not depend on whether the IRS has made a valid assessment, and while the absence of an assessment prevents the IRS from administratively collecting the tax, it may still file a civil action.
The Tax Court added that the IRS may immediately assess tax determined by a taxpayer on his own return, as well as certain assessable penalties not subject to the IRC’s deficiency procedures. Critically, the court found that the term “assessable penalties” as used in IRC Sec. 6201(a) is left undefined, creating uncertainty about which penalties the IRS may assess and ultimately collect through administrative means. The court emphasized that “agencies have only those powers given to them by Congress.”
Turning to the facts before it, the court observed that IRC Sec. 6048 imposes a reporting requirement concerning interests in foreign trusts (Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts and Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner are used for this purpose). Under IRC Sec. 6677, a penalty is imposed for failing to report under IRC Sec. 6048, and IRC Sec. 6671(a) states that “the penalties and liabilities provided by this subchapter [which includes the penalty under IRC Sec. 6677] shall be paid upon notice and demand by the Secretary and shall be assessed and collected in the same manner as taxes.” Thus, the penalties for failure to report information concerning foreign trusts on Form 3520 and Form 3520-A may be assessed upon notice and demand.
The court could find no provision in the law, however, allowing the IRS to assess upon notice and demand the penalties for failure to comply with the Form 5471 reporting requirement, and it was reluctant to infer such a power in the absence of a grant by Congress. The Tax Court concluded that the IRS may not assess upon notice and demand the penalty for failure to report on Form 5471, though it may bring a civil action seeking a judgment for that penalty. To date, the IRS has taken no appeal from the court’s decision in Farhy.
Based on the foregoing reasoning, it is important to note that none of the penalty provisions in the IRC for reporting associated with Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, Form 5472, Information Return of a 25 Percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, or Form 8938, Statement of Specified Foreign Financial Assets (IRC Secs. 6038, 6038A, 6038B, and 6038D respectively) allow for penalty assessment upon notice and demand. Consequently, based on the Farhy decision, such penalties can only be imposed by judgment (i.e., following a victory by the IRS in a civil action against a taxpayer).
Thus, while it is possible for the IRS to ultimately refuse to acquiesce to the Farhy decision, and that a taxpayer assessed penalties for failure to file international information returns may be found responsible for those penalties following a successful civil action by the IRS (a costly and time-consuming process for all parties), the Farhy reasoning and decision provide a robust and important defense against any such penalties that may be assessed.
Moreover, if you have already paid a substantial non-assessable penalty (consistent with the above), you should consider filing a claim for refund of the penalty paid, which is done on Form 843, Claim for Refund and Request for Abatement.
Please contact our office should you require any assistance with the above.
The case of United States v. Collins was decided just last week by the Court of Appeals for the Third Circuit, whose opinions are controlling law in New Jersey, Pennsylvania, and Delaware. In that case, the Third Circuit affirmed a district court’s decision against the taxpayer in connection with $300,000 of foreign bank account report (FBAR) penalties assessed against him for his 2007 and 2008 tax years, finding that the taxpayer’s failures to report his foreign accounts were willful. The taxpayer insisted that his voluntary filing of amended returns and initial acceptance into the IRS’s voluntary offshore disclosure program served as evidence that his non-filing was a mistake. The taxpayer also contended that neither he, nor his accountant, nor his lawyer thought he owned any tax for the years in question, and his accountant was furthermore unaware of the FBAR requirement.
The Third Circuit, however, was unconvinced, pointing to the taxpayer’s checking “No” to Schedule B’s question of whether he had foreign accounts. The court was also skeptical of the taxpayer’s claim that he was unaware of and should not have known about the FBAR filing requirement, given that he managed hundreds of thousands of dollars in his French, Canadian, and Swiss accounts. The court additionally noted that his voluntary correction did not negate willfulness and was “tangential to the core inquiry.”
Given the court’s stark position in this case regarding what constitutes a willful failure to file an FBAR, it is critical to disclose the existence of foreign bank accounts and to take care when answering questions concerning those accounts on tax returns and on the FBARs themselves.
Another important FBAR case (following on the heels of Collins, which we provided an update about last month ) was just decided by the Court of Appeals for the Third Circuit, a court whose decisions are controlling in New Jersey, Pennsylvania, and Delaware. The case is United States v. Bedrosian, and there, the appellant failed to disclose one foreign account (allegedly not knowing he had another; he did disclose one small account), with the key issue before the courts being whether his omission was willful.
The district court (the trial-level court) initially found in 2017 that Bedrosian’s actions “were at most negligent, which does not satisfy the willfulness standard.” The Third Circuit remanded, prescribing a broader concept of willfulness than it said the district court may have employed. The civil standard for willfulness “includes both knowing and reckless conduct,” according to the Third Circuit. Further, an individual can commit a reckless FBAR violation if their actions violate an objective standard, the Court said.
On remand, the district court shifted its focus from Bedrosian’s subjective intent to an objective evaluation of the record and determined that Bedrosian had acted with reckless disregard sufficient to satisfy the willfulness standard. The government urged the district court to uphold the maximum penalty, and in a January 2021 order, the court obliged, finding no abuse of discretion by the IRS in its penalty calculation. Yesterday, the Third Circuit affirmed the district court’s judgment.
Critically, the Third Circuit stated that Bedrosian acted recklessly (and therefore, willfully, according to the Court), because he knew or should have known that the FBAR which he signed was inaccurate. Specifically, he checked a box on the FBAR reflecting there was less than $1 million his account, but at trial he stated his “main” account had more than that amount in it. This, coupled with other evidence about Bedrosian’s correspondence with his foreign bank, led the Court to conclude that even if he did not know he had two accounts, he should have investigated further, and that he ought to have “looked at the forms he signed.”
Given the Third Circuit’s broad understanding of willfulness in this context of FBAR filings, one that it has emphasized in two cases just this summer, the significance of accurate and complete FBARs is particularly heightened.
The IRS recently finalized its instructions for filing Schedules K-2 and K-3, including updates to the new filing exception for domestic partnerships.
To qualify for this exception, the partnership must: (1) have no or limited foreign activity; (2) have only U.S. persons as direct partners; (3) provide a notification to its partners (by the date that the partnership furnishes Schedules K-1 to its partners, at latest; the notification can be attached thereto) that the partners will not receive Schedule K-3 unless they request it; and (4) not receive a request from any partner for Schedule K-3 on or before one month prior to the date that the partnership files Form 1065 (for 2022 calendar year partnerships, this date is August 15, 2023 at latest, if the partnership files an extension).
Please note that if a partnership receives a request from a partner for Schedule K-3 information after the above-mentioned date and has not received a request from any other partner for such information on or before that date, the filing exception is met and the partnership does not have to file 2022 Schedules K-2 and K-3 with the IRS or provide Schedules K-3 to the non-requesting partners, but it must furnish Schedule K-3 to the requesting partner by the later of the Form 1065 filing date or one month from the request date. The partnership must also complete and file tax year 2023 Schedules K-2 and K-3 with respect to the requesting partner by the 2023 filing deadline for Form 1065.
Please note also that if a partnership satisfies criteria 1 through 3, above, but not criterion 4, the partnership is required to file Schedules K-2 and K-3 with the IRS and furnish Schedule K-3 to the requesting partner. The schedules are required to be completed only with respect to the parts and sections relevant to the requesting partner. For example, if a partner requests the information reported on Part III, Section 2 (Interest Expense Apportionment Factors), the partnership is required to complete and file that same part of Schedule K-2 with respect to the partnership’s total assets and that part of Schedule K-3 with respect to the requesting partner’s distributive share of the assets. On the date that the partnership files the schedules with the IRS, it must provide a copy of the filed Schedule K-3 to the requesting partner. The partnership does not need to complete, attach, file, or furnish any other parts or sections of the Schedules K-2 and K-3 to the IRS, the requesting partner, or any other partner.
If you would like more information as to what constitutes “foreign activity,” which partners qualify as U.S. persons, or if you have any other questions regarding the foregoing, please contact our office.