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Tax The Rich

Last Thursday, New York State Senator Gustavo Rivera, who represents the 33rd District (basically, the northwestern quadrant of The Bronx), proposed legislation that seeks to collect more taxes from the State’s high-income and high net worth residents.

Specifically, the stated purpose of the legislation is “amend the New York tax law to introduce an additional tax on investment income (capital gain), for the purposes of correcting the unfair federal tax benefit for income earned from investing rather than working.”

In support of this purpose, the Sponsor Memo explains that New York is “the most unequal state in the nation,” a status that it attributes to the failure of the tax system to keep “pace with changes in the economy, leaving many high-earning individuals and wealthy families in this state undertaxed.”

The Sponsor Memo then shifts its attention to the federal Code, which “for many decades,” the Memo states, “has imposed a much lower tax rate on capital gains than on wage income.” This rate difference, it asserts, “is one of the starkest examples of how federal tax policy openly favors the rich.”

By imposing the proposed additional tax on capital gains, the Memo concludes, “New York can take action to respond to regressive federal tax policy,” while generating $7 billion of annual revenue for the State.

Nowhere to Hide

The introduction of Senator Rivera’s bill, on January 19, was coordinated with the introduction of “tax-the-rich” legislative proposals in seven other states in which the executive and legislative branches are controlled by the Democratic Party – specifically, California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, and Washington.

Together, these few states are home to approximately 50% of the country’s billionaires.

Referring to the individuals at whom these proposals are targeted – “the rich” for short – a sponsoring lawmaker in one of these states said, “Let’s make sure if they move, they have nowhere else to go because we’re all taxing them together.”

I guess her knowledge of geography does not extend to states like Florida, Texas, and Nevada.

Already Happened

Ironically, Senator Rivera’s proposal (Bill S. 2162), which was co-sponsored by 19 other Democratic Senators, comes only nine days after New York’s Governor Hochul announced in her State of the State speech that she will not seek to raise income taxes this year.

Indeed, significant tax increases were enacted fairly recently under the Governor’s predecessor. These increases, which became effective in 2021 and are scheduled to expire after 2027 (which is doubtful), apply as follows to married couples filing jointly:

  • 6.85% for taxable income in excess of $215,400
  • 9.65% of the amount over $1,077,550
  • 10.3% of the amount over $5,000,000
  • 10.9% of the amount over 25,000,000

The top rate in the City for married residents filing jointly is 3.876% for New York City taxable income over $90,000.

It’s Never Enough

Of course, the Governor’s Democratic colleagues in the State Assembly and Senate may have other plans.

They also have a veto-proof majority in each Chamber that may advance a tax increase over the Governor’s objection.

Low Tax Investment Income

Under the above-referenced bill, which would add a new Section 601-b to the Tax Law, New York would impose an additional tax on “New York residents” with respect to each of the following items of income (“low tax investment income”):

  • long-term capital gain and qualified dividend income, which are taxed at 20% under the federal Code
  • unrecaptured Section 1250 gain (basically, the straight-line cost-recovery claimed with respect to depreciable real property), which is taxed at 25% under the Code
  • gain from the sale of collectibles (such as art), which the Code taxes at the rate of 28%.

The new tax would apply to individuals who are domiciled in New York. However, it would also apply to individuals who are domiciled elsewhere but who are treated as statutory residents of the state; for example, a domiciliary of New Jersey who works in Manhattan and maintains a permanent place of abode in the Hamptons.

Because New York may not treat the income or gain in question as having been derived in the statutory resident’s domicile (for example, gain from the sale of stock), New York may not allow a statutory resident a credit for the tax paid by the individual in their state of domicile.

Individuals

The bill proposes an additional 7.5% tax on the long-term capital gain and qualified dividend income (“low tax investment income”) of resident married couples filing jointly with New York taxable income in excess of $500,000; the tax would be phased in proportionally over the first $50,000 of New York taxable income in excess of $500,000 dollars.

The rate would increase to 15% of such investment income in the case of couples filing jointly with New York taxable income in excess of $1 million and would be phased in proportionally, beginning with a phase-in fraction of 50%, over the first $100,000 of New York taxable income in excess of $1 million dollars.

The income counted for purposes of applying these thresholds would not be limited to the investment income in question; for example, it would also include the taxpayer’s compensation, business income, and other investment income (such as interest on bonds).

In other words, the compensation paid to a valued and hard-working employee may result in the imposition of the increased rate on the employee’s dividend income and long-term capital gain.

Estates and Trusts

The increased rates would also apply to resident estates and trusts – i.e., those created by resident decedents and resident grantors, respectively.

The low tax investment income of a New York estate or trust with New York taxable income in excess of $400,000 would be taxed at 7.5%, phased in proportionally over the $50,000 of New York taxable income in excess of $400,000.

The rate would increase to 15% if the New York taxable income of the estate or trust in question is over $800,000, beginning with a phase-in fraction of 50%, over the first $100,000 of New York taxable income in excess of $800,000.

Long-Term Capital Gain

As indicated above, the “low tax investment income” on which the new tax would be imposed includes the gain recognized on the sale of investment assets that the taxpayer has held for more than one year, including, for example, securities and real property held for investment.

It would also cover gain from the sale of depreciable assets used in a trade or business, as well as gain from the sale of real property used in such a trade or business (other than real property held for sale in the ordinary course).

The new tax would also be imposed on the income from transactions that are treated as sales of property; for example, the income recognized by a partner who receives a distribution of cash from a partnership – including “relief” from indebtedness and, sometimes, marketable securities –in an amount greater than the partner’s adjusted basis for their partnership interest.

Finally, the tax would cover the individual resident’s share of such income that is derived from an S corporation or partnership of which the individual is an owner.

If It Passes – Some Examples

The bill has been referred to the Senate Budget and Revenue Committee. If enacted, the new tax would become effective immediately.

The Working Couple

In that case, any “low tax investment income” recognized during a taxable year by a working married couple resident in New York would be subject to the proposed 7.5% tax if their New York taxable income for such year is more than $500,000 but not more than $1 million. More likely than not, the largest portion of the couple’s income consists of wages, which would not be an atypical situation for a couple of professionals who work very long hours, and often on weekends.

When the new tax on the couple’s dividend and capital gain income – income that is attributable to the investment of the after-tax savings from their wages – is added to the 6.85% state income tax already imposed on such income, the aggregate state tax rate on such investment income becomes 14.35%.

If the couple happens to live in New York City, their investment income would be taxed at an additional rate of 3.876%, or a combined state and city rate of 18.226%.

Of course, one cannot forget the federal income tax of 20% that is imposed on long-term capital gain and qualified dividends, plus the 3.8% surtax on such net investment income – an additional 23.8%.

Assuming state and local taxes remain nondeductible for purposes of determining an individual taxpayer’s federal income tax liability, the low tax investment income of the New York couple described above would be subject to a combined tax rate of approximately 42%.

Sale of a Business

What about a couple that sells the business they founded and have operated for many years? Assume they recognize $12 million of gain from the sale, almost all of which is treated as long-term capital gain.

Their top state rate on the gain from the sale would include the current 10.3% for taxable income in excess of $5 million, plus the proposed 15% tax for long-term capital gain in excess of $1 million. If applicable, add New York City’s rate of 3.876%.

Finally, consider the federal rate of 20%, and perhaps the 3.8% federal surtax on net investment income.

At that point, the couple may be looking at the imposition of a combined marginal tax rate of approximately 50% (perhaps more) on their long-term capital gain.

Can this be the intended result in the case of what, for most, would be a once-in-a-lifetime transaction?

Who Cares?

Proponents of tax hikes like the one described above have argued that such increases would not cause the “rich” to leave New York – the rich would never walk away from all the benefits that New York has to offer, or so the argument goes.

Although that may be true of most of the billionaires who reside in the state – notwithstanding that some of their peers have already left – what about the broad spectrum of New York’s more than 465,000 “millionaire households,” many of whom are professionals or the owners of closely held businesses?

I would not take their continued presence in the state for granted.