Posted by Michael Jacobs, April 23, 2009

When New York State enacted a three-year increase on the personal income tax (PIT) for high-income taxpayers last month, few noticed an accompanying change in an arcane provision in the state’s tax laws. Because of the so-called “recapture” provision, many high-income taxpayers were already paying a single, flat rate on all of their income rather than getting the benefit of the state’s progressive tax rates. The new law not only adds brackets and rates but also expands the recapture provision. IBO estimates that New York City taxpayers will pony up about $2 billion more in taxes under the PIT increase—about $400 million of it due to the recapture rules.

So how exactly does this work? The state PIT increase expands the number of tax brackets from five to seven, with two new brackets carved out of the previous top bracket. The fifth bracket begins at $40,000 of taxable income for a married couple filing jointly and now ends at $300,000, with a marginal tax rate of 6.85 percent. The new sixth bracket ends at $500,000 and has a marginal tax rate of 7.85 percent—a 14.6 percent increase in the tax rate. The marginal rate for incomes above $500,000 (where the seventh bracket begins) is 8.97 percent, or 30.9 percent higher than the old rate.

Many of those falling in the new brackets will now see their tax bill increase by the full change in the marginal rates. Most joint filers falling into the new sixth bracket will have all of their taxable income taxed at the 7.85 percent rate, thus recapturing the benefits of the lower rates in the tax tables. If their adjusted gross income—taxable income before deductions and exemptions—is between $300,000 and $350,000, there’s a phase-in of the recapture rules.

Likewise, for most of those whose incomes fall in the top bracket the full recapture is in effect with all of their taxable income subject to the highest tax rate. For those with adjusted gross incomes between $500,000 and $550,000, the recapture again phases in.

IBO estimates that 89,000 out of the city’s nearly 2.3 million resident taxpayers will be paying a total of $2 billion more in state taxes in 2009 as a result of the PIT increase; the expanded recapture provisions account for about $400 million of that additional tax liability.

For filers with income near the thresholds for full recapture these provisions can account for most of their PIT increase. For example, a joint filer with $550,000 in adjusted gross income and $520,000 in taxable income will pay $12,318 more in state tax, over two-thirds of which results from the recapture. Because the recapture amounts do not increase as incomes rise above the $550,000 threshold, recapture accounts for a declining share of the total tax increase as incomes rise. Slightly less than 40 percent of the tax increase that a joint filer with $1 million in taxable income will pay results from the recapture rules.

The recapture provisions also mean the average tax rate and marginal rate for many taxpayers are one and the same, giving New York State’s highest-income residents a “flat” income tax. Of course, that doesn’t mean flat tax proponents are cheering the changes. Most proponents of a flat tax envision a single rate that is considerably lower than pre-existing top rates and one that applies to all taxpayers.