With Audits On The Rise In New York City, Contractors And Developers Need To Prepare

Audits in New York are on the rise as the state government grows more willing to go after commercial real estate businesses for taxes they may have overlooked.

Recent law changes affecting net operating losses and apportionment — as well as long-standing quirks in New York’s sales and use tax laws — have made CRE companies a favorite target of the New York State Department of Taxation and Finance. These companies should do everything they can to prepare for a possible audit as being audited is becoming more and more of a certainty for the industry.

“We’ve definitely seen a rise in sales tax and other kinds of audits,” Mazars Tax and Real Estate Partner George Moffa said. “The state is facing a serious deficit, and they’ve found success in auditing CRE companies. Contractors and developers are often not in full compliance with tax law. In the state’s eyes, that’s an opportunity.”

The notice of an audit for sales tax violations is often a company's rocky introduction to New York’s specific tax laws, Moffa said.

Unlike most states, New York and New Jersey charge sales tax not only on goods, but also labor, like building renovations. Some major construction or renovation projects are exempted from these taxes because they qualify as capital improvements, which allow contractors to draw up exemption certificates in order to avoid taxes. The rules for capital improvement status are complex, and not all projects that seem to be capital improvements qualify as such in the eyes of the state. 

“Say you’re a contractor redoing the pointing on an exposed brick wall,” Moffa said. “In your mind, this is a capital improvement, because you’re adding a permanent part of a building that extends its useful life. But the state would argue that you’re just repairing damaged bricks. That’s not exempt from sales tax.”

Many other renovation projects — including adding millwork and even replacing parts of a building’s HVAC system — can also fail to qualify for capital improvement status depending on the scope of the work. Even though there are standard precedents for what qualifies, Moffa said, many CRE professionals are still caught by surprise, as the list of qualified items is often something that only tax professionals know.

“Sales tax violations remain a perennial problem, as contractors sometimes don’t see themselves as providing a service that is taxable — everything seems like it could qualify as a capital improvement,” Moffa said. “The best thing they can do is be wary of saying that certain labor is tax-exempt, consult with tax professionals and price their services for developers with sales and use taxes in mind.”

Companies can make audits simpler, or work to avoid audits altogether, by keeping accurate records of all exemption certificates and contracts. Moffa said that understanding how the industry is exposed to tax laws will help in drafting contracts to remain in compliance with New York law.

According to Moffa, Net Operating Loss audits and inquiries related to whether an entity is subject to tax in an out-of-state jurisdiction are also becoming more common.

The tax code governing corporate NOLs shifted in 2015: The new laws limit the losses that businesses can write off and eliminate the practice of “carrying losses back.” Moffa said this year is the state’s last opportunity to audit companies that applied the new rules incorrectly in 2015.

When it comes to income tax inquiries for out-of-state jurisdictions, Moffa said companies can often get ahead of an audit and ensure they are filing everywhere they should. Companies can apportion their income in a tax-advantaged way if they take the right steps.

“A great reason to work with tax firms is to see if companies should be paying taxes in states other than New York, which can result in a lower overall tax,” Moffa said. “We can perform a 'nexus study' to analyze the jurisdictions in which companies are actually conducting business and make sure they aren’t overpaying in New York for business that’s actually done in New Jersey or Pennsylvania.”

Ultimately, Moffa pointed out, being audited is not a sign of having done something wrong — especially in CRE.

“It’s not a black mark against your company,” Moffa said. “These laws are complicated and not all that well understood. Companies should get professional tax advice and do what they can to prevent an audit, but be prepared for the possibility of it happening.”

This feature was produced in collaboration between Bisnow Branded Content and Mazars. Bisnow news staff was not involved in the production of this content.