December 21, 2020

Back in the Game: New York State Considers Pass-Through Entity Tax


New York’s neighbors, Connecticut and New Jersey, stole the march on the Empire State in enacting pass-through entity taxes, which are the most effective response to the federal limit on state and local tax deductions.  But New York State (the “State”) is now moving to catch up. On December 16, 2020, State Assembly Member Amy Paulin and State Senator James Skoufis submitted a bill to the State Legislature that would create a statewide unincorporated business tax (“UBT”) if enacted.

After the Tax Cuts and Jobs Act limited the amount of state and local tax that individuals may deduct on their federal income tax returns to $10,000, states began exploring ways to restore the deduction through alternative means, including new taxes on partnerships, limited liability companies and federal “S” corporations, which pass their income, gains, deductions and losses through to their owners instead of paying federal income tax themselves.   By taxing the companies instead of the individual owners, states believed they could substitute a business income tax for a personal income tax on the companies’ income and thereby restore at least some of the deduction that their residents and business owners lost through the new federal limitation.  The IRS recently blessed this approach in IRS Notice 2020-75.

The recent State UBT bill resuscitates a proposal that the Governor’s office and the State Department of Taxation and Finance (the “Department”) prepared in 2018, as part of the State’s initial response to the Tax Cuts and Jobs Act.  That 2018 draft did not have the benefit of the recently released IRS Notice 2020-75, which provides more flexibility around the mechanics than the original drafters might have anticipated.

The State is no stranger to a UBT. It imposed a markedly different UBT until 1981, when it formally phased the tax out. New York City, on the other hand, has continued to impose its own UBT since 1966. This model is a bit different than either of those for a number of reasons, some of which are discussed below.  Our thoughts on the current proposal are many, but here are the highlights:

  • The proposed tax would apply to all partnerships operating in New York.  It would not be an opt-in elective regime.  We encourage New York to consider the IRS’s invitation to adopt an elective approach, as electability over the tax or the base would allow residents, non-residents, and tax-exempt entities to more effectively address their differing positions with respect to flow-through income from partnerships, including investment funds;
  • The bill is described as revenue neutral and is intended as tax relief, but we should be aware that it could become a vehicle for raising revenue in a moment where the State budget is suffering from the pandemic;
  • The tax rate would be 5%, which is significantly lower than the top individual rate and could be adjusted, as New Jersey’s regime has shown;
  • The starting point for computations would be Section 702(a)(8) of the Internal Revenue Code, of 1986, as amended (“IRC”), which seems like a simple, concrete tie to federal ordinary business income. However, it is quite murky in practice and could lead to unintentional tax on hedge funds, credit funds and other investment vehicles that report ordinary income or loss;
  • The calculation of “ownership percentage,” which is necessary to calculate the amount of credit, would not be aligned with the tax base and could create disconnects between the income inclusion and credit;
  • The tax would allow for no distinction between resident and non-resident partners, which could be possible, as Wisconsin and Maryland tax regimes have shown;
  • The personal income tax credit would only apply to the State UBT, but a resident credit for similar taxes paid in other states would not cost the State and would promote comity among neighbors;
  • The bill does not include an election for tax on income from investment assets, similar to Connecticut, but that would be desirable, primarily for resident partners;
  • Non-residents would continue to have a State filing obligation, even if the partnership is their only connection to the State, but that filing could potentially be eliminated if the tax rate can be adjusted;
  • The State should consider a model that could apply to federal S corporations as well; while S corporations can elect to pay the State Franchise Tax, it has a different base and apportionment regime than the Personal Income Tax and the Personal Income Tax includes no credit for S corporation shareholders; and
  • We can expect the UBT to live or die by the State budget process, which should conclude by March 31, 2021—this provides meaningful time for the proposal to evolve.

This Legal Update summarizes the key provisions of the proposed UBT and provides our additional, general observations. Our clients, asset managers in particular, have been acting to take advantage of the pass-through entity taxes adopted by Connecticut and New Jersey on April 27, 2018,1 and January 13, 2020,2 respectively. This positioning may affect how they think about the State proposal, and careful consideration should be given to the impact of a State UBT on this positioning.

UBT Proposal Overview and Additional Observations

The proposed UBT would apply to all entities treated as partnerships for federal income tax purposes, including partnerships and multimember limited liability companies, but not single-member limited liability companies (which would continue to be disregarded). It does not address federal “S” corporations, possibly because they can elect to be taxable under the State Franchise Tax, as mentioned above.

Mandatory Tax

As currently drafted, the UBT would impose a 5% mandatory tax on partnerships “doing business” in the State. The 5% rate, which is less than the top rate for individual income taxpayers in the State, does not currently take into account rate differentials similar to New Jersey’s pass-through entity tax. For those taxpayers subject to higher rates, the UBT will therefore provide only a portion of the relief it is intended to provide, especially for resident partners, whose considerations also diverge from the partnership on income sourcing, as described below. 

The current mandatory nature of the tax should be one point that is certainly up for discussion following the issuance of IRS Notice 2020-75 (available here), which announced that proposed regulations would be issued to clarify that similar taxes imposed on partnerships and S corporations would be allowed as deductions, regardless of the tax’s electability or offsetting individual income tax credits. IRS Notice 2020-75 reflects an open-minded approach at the federal level that a Biden administration should be likely to continue. When the Department originally drafted its proposal in 2018, it took a conservative approach to structuring the tax because the IRS and, more generally, the US Treasury Department appeared hostile to work-arounds and the Department could not anticipate that they would accept an elective framework. That is no longer the case, and the State should take advantage of this flexibility. As discussed more fully below, electability as to the tax base is also an alternative that will make the tax more user-friendly. Because the goal of the UBT is to provide relief, and not be a revenue raiser, taxpayers should be able to opt in rather than be subject to mandatory treatment.


The term “doing business” is not defined in the proposed bill, but as currently drafted, the Personal Income Tax provisions in Article 22 would be applicable. That means a partnership would have nexus under the UBT if it has nexus under the Personal Income Tax, which is generally considered to apply the physical presence standard. Unlike for the State’s Article 9-A Franchise Tax, which adopted an economic nexus standard for tax years beginning in 2015, the State has not adopted an economic presence standard under Article 22’s Personal Income Tax. This may be good news for funds that have IRC § 475(f) elections in place, if the starting point contemplated in the current draft remains the same. Those funds might find themselves with income subject to tax, but, if they only have economic connections to the State, the UBT as proposed should not apply to them.

Starting Point

The starting point for the tax base would be federal ordinary business income with addbacks for UBT paid and guaranteed payments to partners; this amount is described as “unincorporated business net income.” To define federal ordinary business income, the bill refers to IRC § 702(a)(8).

This tie to Section 702 may not be as clear as drafters at the Department and Legislature originally intended. Section 702(a) specifies categories of income, loss, deduction and credit that must be separately stated, and the partnership reports the residual or remainder as a net figure under Section 702(a)(8). The exact types of income included under Section 702(a)(8) does not, however, come up in practice and is not well-defined. This reference therefore creates ambiguity for some types of investment income, such as income from partnerships that have a Section 475(f) election in place, that engage in lending or, potentially, in real estate investment.

Both the State Personal Income and the New York City UBT have long-standing exemptions in place for income from self-trading and real estate investment activities, and this Section 702(a)-based definition of unincorporated business net income is potentially at odds with those tax structures. If the State UBT eliminates self-trading and real estate exemptions intentionally or unintentionally, New York City would become an undesirable place to conduct business for many asset-managers. The tax would impact their performance and the returns that their largest investors—tax-exempt entities such as endowments and pension funds—receive on their investment. Their charitable goals do not include paying State tax.

These issues aside, Section 702(a)(8) would clearly pick up net income from services, such as law, medicine, accounting, asset management, engineering, architecture and advertising, and those are among the types of businesses the Department and Legislature clearly want to capture in order to restore the SALT deduction for individuals that used to benefit from it. 

The Section 702(a)(8) starting point highlights the advantage of an elective tax or base. If the tax can be elected, investment funds could elect out but allow feeders for investors or principals that want to elect in. And, if the base were to include some types of real estate income, including rents or even gains on disposition, the partnership that owns the real estate for tax purposes could elect out, but its partners could form their own partnerships to elect in. As described above, the status of income from real estate investment is ambiguous, but, under an elective system, it would be desirable to include it, as it would be included under the Personal Income Tax for residents and non-residents.  The New York City real estate market could use that flexibility at this moment. 

The State’s UBT proposal stands in contrast to the new regimes in Connecticut and New Jersey particularly in the lack of flexibility it would provide. Connecticut allows an alternative base for unsourced income that can give partners the option to elect into state tax on investment income by creating resident-only partnerships. New Jersey resident-only partnerships can create the same impact and allow for tax to apply without regard to New Jersey’s non-resident sourcing rules.


It is important to note that the UBT would be based on apportioned income (i.e., State source income). As currently drafted, the UBT provides for an equally weighted three-factor apportionment formula, comprised of property, payroll and gross income percentages. The three-factor formula copies the formula applicable to the personal income tax under Article 22.

The three-factor formula is a throwback in this age of single-factor formulas, often market-based in whole or in part, but it likely benefits resident partners by increasing the share of income subject to tax. Because wages and rents tend to be higher in the State relative to the rest of the country, the 3 factor formula therefore has the capacity to skew income toward the State. In this regard, however, it creates a disconnect for corporate partners in their calculation of income subject to Franchise Tax and amount of credit available; this could be to their advantage. A corporate partner’s incremental tax liability from the partnership’s income will probably be less than credit due to the single-factor market-based sourcing that applies to corporations, and that means the corporation may get to use the credit against other income.

For resident partners, while the three-factor formula may be beneficial, imposing tax on apportioned income still means that there is a difference in the tax bases under the UBT and Personal Income Tax because they must include their entire, not just apportioned, distributive shares on their Personal Income Tax returns.  This means the UBT proposal may only address a fraction of the SALT deduction they seek to reclaim, at least for those partners that own a stake in multi-state or multinational firms.  Those partners would need to reorganize their firms to isolate their State income or accept that the tax will apply to less than the amount they include into income for State Personal Income Tax purposes.

States such as Wisconsin and Maryland have structured their pass-through entity taxes to allow the tax base to more closely align with resident income inclusions, but special allocations of the pass-through tax deduction are necessary to give those partners the benefit. As mentioned above, New Jersey’s approach would also potentially address resident partner concerns but, in that case, by allowing resident-only partnerships that would include the full amount of income subject to tax, thereby bypassing the allocation and apportionment rules for non-resident partners. These resident partnerships could serve as feeders into larger partnerships and increase the amount of pass-through entity tax based on residence.


The UBT proposal includes separate credits for partnership partners, corporate partners and individual partners.

Partnerships would compute their tax on an entity-level basis and add the already apportioned income of lower-tier partnerships to their own already apportioned income. Under this structure, they would receive credits for UBT paid by lower-tier entities, and those credits would equal the larger of the lower tier’s (a) UBT or (b) UBT credits from other partnerships. Upper-tier partnerships would not be able to carryforward their credits, but their individual partners and corporate partners would be able to do so.

For corporate and individual partners in an overall loss position, the credit is not refundable, but it could be carried forward indefinitely. Both individual and corporate taxpayers would calculate the credit at 93% of their respective shares of the UBT, based on their ownership percentage, which is calculated as their distributive share percentage of overall partnership items for the year, as opposed to Section 702(a)(8) income. It is possible that this ownership percentage would differ from each partner’s share of Section 702(a)(8) income, and the disconnect should be addressed.

Unlike with the Connecticut and New Jersey neighbors, the credit may not be claimed for pass-through entity taxes paid to other states. Since a credit for tax paid to other states would not be a cost from a budgetary perspective, this is a step the State should consider. For partnerships whose partners are not State taxpayers (e.g., in the unlikely scenario where a partnership is doing business in the State, but its corporate or individual partners are not themselves State taxpayers), the credit is of little to no value, but there remains a filing obligation.


The proposed bill includes estimated tax and administrative provisions that we have not covered above.  In large measure, they adopt the mechanics of Article 22.  This would presumably include the requirement to report federal changes to income, but it is not clear.  A flow-through of changes would potentially be helpful to allow an offsetting deduction for the inevitable State Personal Income Tax on the changes. 


Overall, it is encouraging that the State is reviving its push for the UBT, and the proposal can benefit State taxpayers.  There are, however, key elements that need further consideration and revision, and we look forward to working together with our clients and partners in government to continue refining the product.

1 CT S.B. 11 (Public Act 18-2) (Apr. 27, 2018).

2 NJ SB346 (Jan. 13, 2020).

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