More businesses are investigating what the New York State Employer Compensation Expense Program (“ECEP”) is and how it can help their employees mitigate the tax effect of the federal $10,000 state and local tax itemized deduction limitation. The ECEP is one of many concepts New York State (NYS) is developing in an attempt to re-characterize personal state and local income tax liabilities as something else in an effort to circumvent the state and local tax (“SALT”) federal $10,000 limitation. After all, it’s estimated that the SALT limitation will cost New Yorkers an additional $14 billion per year, (i.e., New Yorkers will no longer have $14 billion of their state and local income taxes subsidized by the federal government in the form of reduced federal taxes.)
What are the benefits of the ECEP?
The ECEP established a new optional Employer Compensation Expense Tax (“ECET”) that employers can elect to pay if they have employees that earn over $40,000 annually in wages and compensation in NYS. The benefit to the employer is the ability to take a deduction for payroll taxes paid on their federal tax return. The primary benefit to the employee includes a NYS credit in proportion to the NYS taxes paid by the employer, eliminating or reducing the limitation related to the individual federal income state and local tax limitation of $10,000.
The ECET is being phased in over three years:
| For quarters in tax year: | The rate of tax is: |
|---|---|
| 2019 | 1.5% |
| 2020* | 3% |
| 2021 and after | 5% |
*Enrollment for 2020 will begin on October 1, 2019.
If an employer elects to join the program, they will pay the ECET on the payroll expense incurred by the employer for NY wages and compensation that exceeds $40,000 for the calendar year paid to each employee who is employed in NY for whom the employer is required to withhold NYS tax. If the election is made, the ECET must be paid for all NY employees with compensation exceeding $40,000. There is not an option for the selection of employees.
Whether or not the ECET will generate a significant economic benefit for the employer and employee largely depends on how the U.S. Treasury plans to treat the employer’s payment of the tax when it has a beneficial effect on the employees’ state income tax, albeit indirectly. While NYS’s ECEP approach relies on the premise that it would not be considered compensation for federal income tax purposes (similar to START-UP NY employee credits), the Old Colony Trust Company vs. Commissioner Case could present an opposing position. The 1929 Supreme Court Case directly questioned whether the direct payment by the employer to federal and state tax authorities of income taxes directly assessable against the employee constituted additional taxable income to the employee. The Court ruled that the direct discharge by a third person of such an obligation is equivalent to compensation.
How does it work?
So, for example: 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 purposes of the first quarter ECET filings but is at the second quarter (when their total wages to date exceed $40,000).
The employer would pay $2,400 in ECET for tax year 2020 as shown below:
| 2nd Quarter | $20,000 x 3% | $600 |
| 3rd Quarter | $30,000 x 3% | $900 |
| 4th Quarter | $30,000 x 3% | $900 |
| TOTAL: | $2,400 |
The credit the employee would be able to take in NYS related to the ECET tax paid is $2,262, calculated based on the formula below.
Employee’s wages in excess of $40,000 × ECET tax rate × [1 − (Employee’s NYS Personal Income Tax, Before Credits ÷ Employee’s Taxable Income)]
$80,000 x 3% x [1-5,825 ÷ 101,950(*)] = $2,262
*Taxable Income 120,000 – 16,050 standard deduction – 2,000 personal exemptions
Based on the ECET program, the employer would pay $2,400 ECET with respect to an employee’s NYS income tax liability and the employee would receive a credit of $2,262 on his or her NYS tax return. The NYS program would shift the deduction of the ECET to the employer’s federal business tax return—where there is no $10,000 SALT limit— from the employee’s individual federal income tax return where little to no benefit would be received.
Viability of the program
The benefit received by the employer and employee are quite different, depending on whether the $2,400 of NYS income tax would be treated as compensation paid by the employer to the employee at the federal level.
Employer Benefits (C Corporation):
| Assumes ECEP not treated as federal compensation | Assumes ECEP is treated as federal compensation | |
|---|---|---|
| ECET Payment | $2,400 | $2,400 |
| Payroll Tax Savings | $184 (7.65% x 2,400) | $0 |
| Federal Tax Increase | ($39) ($184 x 21%) – decreased deduction related to payroll tax | $0 |
| State Tax Increase | ($13) ($184 x 7.1%) | $0 |
| Total Cash Savings | $132 (184-39-13) | $0 |
Employee Benefits:
| Assumes ECEP not treated as federal compensation | Assumes ECEP is treated as federal compensation | |
|---|---|---|
| Wages | $117,600 ($120,000-2,400)* | $120,000 |
| State Income Tax | $3,410 (5,672-2,262 credit) | $3,410 (5,672-2,262 credit) |
| Payroll Tax Savings | $184 (7.65% x 2,400) | $0 |
| Federal Tax Savings | $576 (24% x 2,400) | $0 |
| State Tax Savings** | $160 (6.65% x 2,400) | $160 (6.65% x 2,400) |
| Total Cash Savings | $782 (160+576+184-2400+2262) | $22 (-2400+2262+160) |
*Assuming the additional $2,400 of NYS income tax paid by the employer is adjusted through the employee’s base salary or bonus, the benefits would be as follows to the employer/employee. Assume the employee outside the ECEP program earned $120,000, but was adjusted to $117,600 ($120,000-$2,400) to compensate for ECET payments made by the employer. The adjusted wages could negatively affect future pay increases, profit sharing plan, etc.
**Assumes NYS would make an adjustment to exclude any ECET paid by employers through the ECEP from compensation, regardless of federal tax treatment.
Points to consider
The federal government recently released final regulations that torpedoed NYS’s concept to circumvent the state and local tax limitation by providing a NYS income tax credit for certain charitable contributions. Based on current authoritative guidance, the intended ECEP benefits could perhaps be similarly negated. We caution businesses that may be considering entering the ECEP that the benefits of the program could be significantly altered depending on how the federal government treats the employer’s payment. It should also be noted that if an employer’s participation in the ECEP results in the failure to report and pay the proper amount of W-2 income and related withholding taxes and FICA liabilities (employer trust taxes), adverse consequences could extend to “responsible persons” of the employer (e.g., officers, executives, owners, directors, etc.) Therefore, analysis of the risks and benefits should take place before participating in the program.
For more information, contact Lynn Mucenski Keck, Principal, at lmucenski-keck@bonadio.com.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
