Negative Modifications for Professional Service Corporation Shareholders

By LaPaglia, James A. | The CPA Journal, March 1994 | Go to article overview

Negative Modifications for Professional Service Corporation Shareholders


LaPaglia, James A., The CPA Journal


Under New York State Tax Law Sec. 612(b)(7), taxpayers who were shareholders of a professional service corporation were required to add to their Federal adjusted gross income the retirement plan contributions made by the corporation on their behalf to the extent these contributions exceeded the lesser of 1) $15,000 or 2) 15% of the shareholder's earned income derived from the corporation for that year. This additional modification, which was effective for tax years beginning before 1988, was repealed as part of New York State's Tax Reform and Reduction Act of 1987.

As a result of this positive modification and the inclusion of these retirement plan contributions in the taxpayer's New York income, New York State provides for a negative modification in the years in which the retirement benefits are received. The amount of the negative or subtraction modification in any year is dependent upon the amount distributed to the recipient and the method by which the benefits are paid. Since neither the tax law nor regulations provides guidance on the subtraction amount when benefits are received, some rely upon the New York State Department of Taxation and Finance's position which adopts the Federal annuity investment recovery rules (IRC Sec. 72) in effect in 1982.

Thus, the Department's position provides taxpayers with two alternatives in computing the subtraction modification. Under the first alternative, if the sum of all prior years' addition modifications with respect to these retirement plan contributions can be recovered over a three-year period, the total amount of benefits received may be subtracted in arriving at New York adjusted gross income, up to the aggregate amount of the prior years addition modifications.

Example: Dr. Smith is a retired shareholder of a professional corporation. In 1993 he began receiving annual retirement benefits of $75,000 from the corporation's retirement plan. Assuming that the sum of his addition modifications under IRC Sec. 612(b)(7) totaled $200,000, Dr. Smith will be able to subtract the following amounts on his New York State income tax returns:

(Amounts omitted)

If, however, a taxpayer cannot recover within three years, the sum of his or her prior years addition modifications related to these retirement plan contributions, then the following formula should be used in determining the applicable subtraction modification:

Aggregate add-backs in prior years/Expected return X Amount of benefit received

The expected return represents the total amount of benefits to be paid under the retirement plan to the retiree and is determined when the benefit payments begin. …

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