City Journal

Daniel Seligman
The UBT’s Last Gasp?
New York’s hated unincorporated business tax is going, going . . . but not quite gone.
Autumn 1997

Can it be that New York City's infamous unincorporated business tax is actually going bye-bye? That the Giuliani administration is really making good on that 1993 campaign pledge to phase out the hated levy? Will chronically enraged UBT taxpayers like me no longer have to do business with the city's gastritis-inducing Department of Finance?

Could there be a catch in here somewhere?

Well, only a small-to-medium catch. New York being New York, it is reducing, not eliminating, the tax—so any time the city's huge revenue windfalls from Wall Street cease, a reasonable person might fear a UBT comeback. Furthermore, the new tax deal is monstrously complicated, in classic Gothamite tradition, so widespread bafflement about how the law works could give prospective tax-raisers lots of wiggle room.

Still, something amazing really is happening: New York is becoming significantly more attractive to the self-employed small-business and professional people who are not incorporated and therefore get hit with the tax. The legislation Albany has just passed after a huge Giuliani administration lobbying effort will completely liberate 10,600 self-employed taxpayers from the UBT—those who live in one of the five boroughs and have business income of $55,000 or less. Equally important, the new legislation will provide varying amounts of tax relief for UBT victims earning more than $55,000.

What's more, until now, the state Legislature and the governor had to approve any changes in the UBT. But in the new deal, the state washes its hands of the tax and will allow the mayor and the City Council to make future changes by themselves. For its part, the Giuliani administration seems to be saying that this year's cut is the beginning of the end for the tax. "This legislation doesn't go all the way toward eliminating the UBT," states Adam Barsky, acting commissioner of finance, "but it's a first step."

By some measures, the UBT is peanuts. Only around 31,000 taxpayers have filed UBT returns in recent years, and the tax adds only about $550 million (about 1.5 percent) to city revenues. But the tax has been keeping thousands of talented people out of the city. A New York-area writer or accountant—or anyone with an unincorporated business that could be done outside the city limits—couldn't but look at the UBT as an invincible argument for Great Neck or Hoboken. The most visible defector has been Andrew Tobias, a well-known New York-born writer who became a proprietor of the TaxCut computer program. After a lengthy row with the city's Department of Finance, Tobias paid $44,496.29 in back taxes, penalties, and interest—and moved to Florida. He graphically expatiated on the injustice of it all in a 1987 New York Times Magazine article.

Everybody knows that New York City taxes are a horror story, but many folks are incredulous when first hearing about the UBT. I have been glumly paying it for ten years—ever since I ceased to be an employee of a large media conglomerate and became instead a "contract writer"—and I have often found myself grousing about it to other self-employed friends. I kept making the embarrassing discovery that many of them had never heard of the tax and were amazed—and not entirely grateful—to learn that they were breaking city law by not paying it. Their incredulity about the tax is easy enough to understand. It naturally seems counterintuitive that, after paying the city's personal income tax, which nowadays ranges up to 4.46 percent, folks were expected to turn around, reinvent themselves as an unincorporated business, and pay the same jurisdiction another tax—a flat 4 percent—on the exact same income. No other American city has anything like this.

Double taxation is an old and unoriginal theme among people who complain about paying taxes, but most of the deals they groan about involve a certain amount of indirection by the taxing authority. It takes a modicum of fiscal sophistication to appreciate, for instance, that taxes on both dividends and corporate income amount to double taxation. But to see the UBT as double taxation requires no heavy thinking at all, and anyway, the Department of Finance cheerfully admits it. I had a conversation recently with Deputy Mayor Randy Mastro, who led the Giuliani administration lobbying effort in Albany to cut back the UBT, and he allowed at one point that the tax "could be viewed as double taxation." Since he was otherwise being extremely helpful, I declined to scream at the "could be viewed."

Many who complain about double taxation seem to be under the impression that it is illegal or unconstitutional. Alas, not so. A number of cases New Yorkers have brought have argued that imposing double taxation on any particular class of taxpayers violates the federal Constitution's due-process clause. The New York courts have endlessly rebuffed that argument, often citing Justice Oliver Wendell Holmes's dictum that, barring confiscation, "the Fourteenth Amendment no more forbids double taxation than it does doubling the amount of a tax." In fact, until a years-long lawsuit put an end to it, the partners in some law and investment banking firms who were themselves incorporated as individuals were being triply taxed—paying, on the same income, the unincorporated business tax, the general corporation tax, and the personal income tax.

Until 1966 the city had neither a personal income tax nor an unincorporated business tax. When John V. Lindsay ran for mayor in 1965, his platform featured a "no new taxes" pledge. But early in 1966, to almost no one's surprise, he sought Rockefeller administration approval for a new personal income tax and for increased business taxes. When Rockefeller resisted, Lindsay threatened vaguely to "take to the streets" to remind voters that Albany was responsible for the disasters that would occur were his fiscal package not enacted. Asked about his "no new taxes" pledge, he answered that he viewed the taxes as a last resort—and "the last resort is here." He defended the tax hike with what a New York Times reporter called an "apt quotation" from Troilus and Cressida: "He that will have a cake out of the wheat must needs tarry the grinding." But for that quotation to make any sense at all, you need to share the mayor's assumption that taxpaying New Yorkers were demanding more "cake," or social services, from the system. Quite the reverse: taxpayers viewed the huge enlargement of the city's Great Society programs with dismay.

Albany ultimately gave Lindsay permission to impose a personal income tax, at rates ranging from 0.4 percent to 2 percent (less than half of what they are now). His request for new business taxes ultimately led, via serpentine political meanderings, to the unincorporated business tax—a tax modeled on the state's own UBT. The state phased out its UBT in the late seventies, even as the city tax began to look permanent.

In its original 1966 version, the city UBT exempted most self-employed professionals on the ground that their income was in effect personal compensation like that earned by salaried professionals. The statute specifically excluded "the practice of law, medicine, dentistry or architecture and the practice of any other profession in which capital is not a material income producing factor and in which more than eighty percentum of the unincorporated gross income . . . is derived from personal services actually rendered by individuals or members of the partnership or other entity."

So whom was the 1966 UBT supposed to cover? Mainly small, mom-and-pop stores, plus the occasional larger enterprise willing to forgo the advantages of limited liability in an effort to duck corporation taxes. But I could not help noticing that self-employed writers ultimately got collared by the 1966 law. In the long-drawn-out case of a writer on foreign affairs named William R. Frye, the New York State Court of Appeals ultimately decided that writers and journalists aren't true professionals like doctors and lawyers: they lack licensing, advanced degrees, or any special course of study. How true. But what about that 80 percent rule? It didn't help Frye, who lost his claim for exemption and got clobbered for back taxes.

In December 1966, with his new income tax and UBT in place, Lindsay told the New York Times that the city was approaching the outer limits of its ability to raise taxes. He echoed the same theme endlessly during his 1969 run for reelection. In 1971, again to no one's surprise, he began a successful push to enlarge the ambit of the UBT—specifically, to get doctors, lawyers, accountants, Wall Street firms, and other professionals covered by the tax. Hilariously or otherwise, self-employed writers and journalists now counted as professionals. The 1971 act, which hugely beefed up the UBT's revenue-raising potential, in essence created the law that has endured until now.

Lindsay's reason for going after professionals was obvious: the city, collapsing under the weight of its social programs, thirsted for any new tax revenues it could seize. But along the way, an elaborate rationale for the tax has grown up. The argument is that New York is different from most large cities. In most places, "big business" means a bank, an airline, a utility, or a manufacturing company—all of which will surely be incorporated. But in the Big Apple, big business more often means brokers or accountants or law firms—many of which are partnerships. These days the biggest partnership of all is Goldman, Sachs, which hopes and believes it will earn around $3 billion in 1997 (and which is almost certainly the single largest payer of the UBT). So if you want to tax organizations like Goldman, you need something like the unincorporated business tax.

In this vein, Professor Dick Netzer of NYU's Graduate School of Public Service, citing the "unusual structure of the New York City economy," contended in a recent paper that he found the tax quite plausible. The paper took a long look backward at the origins of the tax and argued that the state and city could not have limited their business taxes to corporations. Netzer's bottom line: "In New York . . . to tax only the income of corporations was to ignore the income of some of the most important and profitable sectors of the economy."

That sounds reasonable enough at first blush. And yet there is a certain tension between this section of Netzer's paper and another of its major themes, the broadly depressing effect of taxes on economic activity in states and metropolitan areas. The UBT has of course never been a tax that could be viewed in isolation. Instead, to employers who had any options at all about where to locate, it came across as just another horrifying feature of the basic high-tax proposition that left the city and state looking so ugly. In another section of his paper, Netzer serves up some fascinating data quantifying this effect. "Taxes matter a lot," he writes. "If state and local taxes in a state amount to 12 percent of gross state product (GSP), close to the New York level, . . . a $1 billion reduction in the overall level of taxes in that state should increase GSP over time by $3.3 billion." The UBT has been part of the package that depressed GSP.

Even if you accept Netzer's highly debatable case for a UBT targeted at big business, New York-style, it doesn't explain why the city should have been taxing non-big business: the self-employed professionals, mom-and-pop stores, struggling entrepreneurs, and thousands of other small operators who are the source of much of the vigorous job growth in the rest of the nation and who would not be doubly taxed by their cities anyplace else in America. And the ultimate folly of taxing guys like me, to get personal again, is that we don't generate much revenue. UBT revenues come overwhelmingly—72 percent in a 1993 study—from a relatively small number of large partnerships, mostly in finance and law.

The Giuliani administration's UBT tax cut has taken advantage of this arithmetic and adds up to great politics as well as great economics. As noted above, the administration has totally liberated 10,600 filers—those under the $55,000 line. It has also given varying amounts of relief to another 18,000 filers. Even the remaining UBT payers get a break, in the form of lower personal income taxes. (See the box below for further details.) Of the 31,000 UBT returns filed each year, 34 percent will now be free of the tax, and another 58 percent will get some real relief from it. And this has been accomplished by giving up only $75 million of city tax revenues—an amount equivalent to 14 percent of the $550 million generated by the UBT. Great numbers for a guy running for reelection.

In adding up the benefits of the tax cut, don't forget to count another big one: the reduced exposure New Yorkers will have to the user-hostile agency that administers the UBT, the Department of Finance. DOF, which also collects the city's general corporation tax, its property taxes, and its parking tickets, has been a vexatious minor theme in my life for the past ten years. Typical encounter: it is a day last October, and I am under heavy deadline pressure. Alas, the morning mail brings a notice stating that DOF is auditing my 1995 return and demanding certain documents. "To complete our desk audit, the following information is required: Copy of federal Schedule C, form 1040, all schedules. Breakdown of taxes deducted on your federal Schedule C, form 1040, listing each tax separately."

The notice is bewildering on two counts. First, DOF already has my Schedule C—I attached it to my UBT return, as required. Second, I have never deducted any taxes on Schedule C. I anxiously call the auditor who signed the letter. When I reach her extension, there is no answer, so I start to leave a message. But in the middle of this process, she suddenly comes on the line. It turns out that what really concerns her is whether my listed business expenses include any payments for "taxes and licenses." I say no, of course not, and point out that I have left blank the line where one would list such expenses. She says fine, but then requests that I fax her a copy of the letter she sent me, also a copy of my federal Schedule C. I hasten to comply and am too polite—too intimidated, really—to point out that she already has copies of both documents. A few days later I get a call from the auditor, who says she is returning a phone message. It is instantly clear that she has no recollection of our previous conversation and has not looked at the stuff she told me to fax in. Par for the course.

Even the most routine communications from DOF can leave you scratching your head. For example, the agency has endless trouble with its quarterly estimated-tax deadlines. Unlike most tax jurisdictions, which give you all four forms for quarterly payments at the beginning of the year and ask you to mail them in on the required dates, DOF mails out the UBT forms each quarter—but often either sends them after the date on which payment is due or sends them in time but misstates the due date. Last year it sent out a notice promising to correct the system error responsible—then made the same mistake this year.

And if you want a real headache, try initiating a communication with the department yourself. A recent Newsday survey of "wait time" for citizens trying to reach city agencies by telephone showed DOF worst of all, with an average wait of 27 minutes. My own recent experiments show that any effort to reach a live representative invariably ends with a recorded announcement stating that you can anticipate a 40-minute wait—a figure that doesn't appear to change at any point during the day.

Arguably more vexatious is the agency's strong-arm approach to collecting taxes from suspected delinquents. DOF typically identifies suspects by extensive computer cross-matching with state and federal tax authorities. But—a chronic problem over the years—it mails many of its bills to out-of-date addresses, and when the intended recipients do not respond, it hits them with late-payment charges. Worst of all, DOF sometimes bills taxpayers for amounts that are largely guesswork, based on what businesses of the same size have paid. When a 1995 case triggered challenges to this practice, a DOF spokesman responded: "In the collection business, we want people to pay, so whatever we think is likely to get the taxpayer to respond is something we're going to make use of."

But DOF's aggressiveness has given way to a curious passivity about notifying taxpayers of the recent tax cut. The reduction was a done deal in the first week of August, and Governor Pataki signed it into law on August 26. But as of October 1, DOF had still not broken the good news of their diminished liability to its constituents (most of whom meanwhile had made September 15 estimated-tax payments). Nor had the press mentioned the new tax rules.

One final problem bedevils unincorporated businesses that do part, but not all, of their business in the city. In principle, each business may differentiate between income earned in the city (and subject to the UBT) and income earned elsewhere (which is exempt). Newsday publicized the exemplary case of an optometrist named Edward Rubin, who had offices in both Brooklyn and Long Island. DOF insisted on taxing his entire income, even though more than one-third of it was attributable to Long Island business. Though Rubin ultimately won his case in court, victory came only after many months, during which DOF computers kept billing him and ignoring his responses, and the city attached his bank account. Rubin ended up closing his Brooklyn office.

The incumbent DOF boss is Fred Cerullo, who at this writing is on leave to work in the Giuliani reelection campaign. Cerullo is a Republican with close links to Staten Island's Molinari family and a prior record of acting appearances in ABC-TV soap operas. He has also been a member of the City Council (from Staten Island) and has served briefly but memorably as head of the city's Consumer Affairs Department. There he made news in a crusade against salad bars that counted the weight of the salad containers, and not just of the salad itself, in calculating final prices to salad eaters.

Giuliani named Cerullo commissioner of finance two years ago and charged him with the mission of making the department more "user friendly" (a term that recurred in the news stories about his appointment). Had he been willing to talk to me—he canceled our one appointment and declined to return any of my three telephone requests for a rain check—I would surely have mentioned that I personally discerned no signs of augmented amity for users. I might also have asked whether his All My Children role as an orderly at an insane asylum was in any sense helpful in preparing him for his present position.

But I probably would have lost my nerve.

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