Business Tax? But I’m Unincorporated!
By Tom Corrie, Principal, Tax & Business Services & Christian Burgos, Managing Principal, Tax & Business Services
Businesses are often surprised to learn of the New York City Unincorporated Business Tax (UBT), an entity-level tax imposed on unincorporated businesses operating within the City. Many businesses presume that as pass-through entities, such as limited liability companies, taxes are never due by the entity. Rather, the tax liabilities are passed-through and paid at the individual-partner or corporate-partner level. New York City, however, maintains a unique tax structure in which unincorporated entities, including partnerships, limited liability companies, fiduciaries, as well as sole proprietors engaged in any trade, business, profession, or occupation wholly or partly carried on within New York City are subject to tax.
New York City established the UBT in 1966 at a rate of 4%, where it has remained. Since its inception, many legislative changes have been made to the tax base, and several credits and exemptions have been added. Many of these changes, especially those adopted in more recent years, have eliminated or reduced the UBT for some unincorporated businesses.
While the UBT’s applicability is rather broad, encompassing basically any unincorporated business operating within the City, there are certain exceptions. For example, an owner, lessee, or fiduciary that holds, leases, or manages real property for the purpose of producing rental income is not subject to the UBT. Other UBT exempt activities include engaging in trading activities for an unincorporated business’ own account. The exception applies if the individual or entity is primarily engaged in trading or investing in stocks, bonds, or other securities for its own account. One is considered to be primarily engaged in exempt investment activities if at least 90% of the average monthly value of assets consists of property associated with exempt investment activities. If qualified, the income derived from such activities is not subject to the UBT.
The UBT business income computation starts with the Federal business income and is modified to reflect the differences between the City and Federal rules. For entities whose operations are conducted both inside and outside New York City, business income is allocated for purposes of the UBT. Under the UBT rules, business income is apportioned based on a three-factor business allocation percentage consisting of property, payroll and receipts. The property and payroll factors are based on property located and employees situated within the City. Sales receipts from tangible personal property are sourced to the City if the sales are made to customers located within the City, whereas receipts for service are allocated to the City if performed there. New York City is in the process of phasing out this three-factor apportionment formula in favor of a single sales factor by gradually reducing the weight of the property and payroll factors. The single sales tax factor will be fully implemented for tax years beginning on or after January 1, 2018.
Taxpayers with unincorporated business income of $95,000 or less are not required to file a UBT return. In addition, all UBT taxpayers are permitted to claim a deduction for the lesser of 20% of allocated income, or $10,000 per active partner. Furthermore, the first $5,000 of taxable income is exempt from the tax. Finally, a UBT business credit offsets any tax liability up to $3,400, but is phased down for liabilities between $3,400 and $5,400.
New York City residents, who are sole proprietors, limited liability company members, or partners in an unincorporated entity, can claim a credit against their City Personal Income Tax liability for a portion of the UBT payments. For City residents with up to $42,000 in New York taxable income, a 100% credit may be taken against their personal income tax liability for the UBT payment that flows through to them. This credit gradually phases down to 23% for taxpayers with more than $142,000 in New York taxable income. It should be noted that a corporation subject to the City’s General Corporation Tax, or a partnership subject to the UBT, is allowed a credit for a portion of the UBT payments made as a partner of an unincorporated business.
Unincorporated business taxes are rather unique in structure and application. Currently, New York City and Washington, D.C. are the only two jurisdictions to specifically impose a tax on the income of unincorporated businesses, though Philadelphia imposes a similar type of levy on unincorporated businesses known as the Net Profits Tax and Business Income and Receipts Tax.