IRS Rules Septic Grant Recipients Should Receive 1099s And Pay Taxes On Funds

The Internal Revenue Service has stated that Suffolk County residents who have received grants for septic upgrades should pay tax on the funds. PRESS FILE

The Internal Revenue Service has issued a ruling that deals a blow to Suffolk County’s septic replacement grant program — and means there will be a tax liability for grant recipients after all.

The IRS determined that recipients of grants to replace cesspools and aging septic systems with innovative and alternative nitrogen-reducing systems should pay federal income taxes on the grant proceeds.

County Comptroller John Kennedy had requested an IRS ruling last spring after he was blasted for issuing 1099 tax forms to both the grant recipients and the installers who put in the septic systems. The grant program was initiated to reduce nitrogen loading in Suffolk County bays and ponds and, as a result, improve the water quality.

Critics accused Mr. Kennedy, a Republican, of making politically motivated decisions to undermine the septic improvement program, a hallmark initiative of County Executive Steve Bellone, a Democrat. Mr. Kennedy — who was the Suffolk County Legislature minority leader before being elected comptroller in 2015 — unsuccessfully challenged Mr. Bellone for county executive in 2019 as they also butted head over the 1099s.

Mr. Kennedy last year said it was his understanding that both the grant recipient and the company being paid to conduct the work should be issued a federal tax form, and that he was doing what was necessary so that the county would not be fined by the federal government.

“The decision by County Comptroller John M. Kennedy to issue 1099 tax forms to Suffolk homeowners have cost them thousands of dollars that they otherwise would not have to pay for installing new advanced septic systems to reduce nitrogen pollution and improve our water quality,” Mr. Bellone said in a statement Wednesday morning. “But then Comptroller Kennedy went even further — he chose to seek an IRS opinion, against the advice of the county’s tax counsel, as part of his scheme, and the IRS has now decided to go along with this costly plan.”

In the IRS ruling dated January 15, Branch Chief Angella L. Warren wrote that, whether paid directly to homeowners or to third-party contractors on their behalf, the grants are included in the homeowners’ gross income, and Suffolk County is required to report it to the IRS.

U.S. Senator Charles Schumer of New York, who last spring called upon the IRS not to tax the homeowners, criticized the decision in a statement Tuesday.

“The IRS got this flat wrong, because the local program is a win-win for Suffolk homeowners and the environment, which is overrun with nitrogen pollution in our waterways,” Mr. Schumer said. “Homeowners and Suffolk County are already taxed by nitrogen and shouldn’t also get a bill from the IRS for trying to reduce it. Uncle Sam isn’t losing out on a dime when a Suffolk homeowner participates in this grant program, because the local contractors are already paying the tax — it’s just that simple.”

Deputy County Executive Peter Scully, who serves as Mr. Bellone’s water czar, said in a phone call on Tuesday that the program had previously been retooled so that grant checks went only to the installers — not the homeowners — with the goal being that the grant recipients would not be subject to taxes.

He said one person involved in discussions about what to do next observed: “We shouldn’t really be surprised. The IRS is in the business of collecting revenue, and asking them whether they think we should tax this revenue stream is like asking a dog if it wants a piece of steak — they’re unlikely to say anything other than ‘yes.’”

The average cost of a nitrogen-reducing septic system is $21,900, according to Suffolk County, and grants can be as much as $30,000 per income-qualified household. The towns of East Hampton and Southampton offer grants of up to $20,000, using Community Preservation Fund money, which, combined with the county grants can reduce the cost to the homeowner to $0.

But the IRS ruling could make those amounts received by the homeowner taxable income.
“It’s unfortunate that the comptroller made a decision to seek this private letter ruling and fund the request with taxpayer dollars, to add insult to injury,” Mr. Scully said. “And the outcome, while unexpected, is unfortunate.”

He noted that similar programs administrated by the Catskill Watershed Corporation and the Maryland Department of the Environment do not issue 1099 forms to homeowners — a fact that Suffolk County officials confirmed with administrators of those programs back in 2017. Rather, the vendors receive the tax forms and are responsible for the taxes.

He added, “This issue is too important, and we need to find a way to tweak the program so homeowners are protected.”

Mr. Scully said that even though applications had been modified last year to make homeowners aware that they could be subject to income tax if they receive a grant, completed applications are pouring in at record numbers. In January, 111 applications from county residents were received, compared to just 40 in January last year.

He said it is obvious that some people have decided not to move forward, but there are still so many applications that it is hard to keep up with the pace — and many applications are coming from the South Fork.

“Let’s be clear — the comptroller’s actions have been contrary to the intent of the Suffolk County Drinking Water Protection Program, the legal opinion by the county’s tax counsel, and longstanding practices used by similar programs in Maryland and other municipal jurisdictions,” Mr. Bellone said in his statement. “He chose to politicize water quality and decimate a program that has been praised by environmental, labor and business leaders alike.”

Mr. Kennedy did not respond to requests made to his office Tuesday for comment, and county offices were closed Wednesday for President Abraham Lincoln’s Birthday.

Mr. Scully said that Mr. Bellone intends to work with other elected officials to find a solution that protects homeowners, which could include changes to the grant program or a legislative fix. Discussions have begun with Mr. Schumer U.S. Representative Tom Suozzi, whose district includes parts of Suffolk and Nassau counties, as well as Queens.

Mr. Suozzi sent a letter opposing the ruling to IRS Commissioner Charles Rettig on Tuesday.

“I strongly oppose this decision, as it undermines the program’s mission, and similarly constructed programs such as the State of Maryland’s Bay Restoration Fund did not require 1099 forms to be issued to homeowners,” the letter reads.

Mr. Suozzi cited the contributions that cesspools and septic systems have made to declining water quality in touting the septic replacement program.

“I am eager to discuss potential solutions to help protect our environment and groundwater without putting additional onus on Suffolk County homeowners who are already struggling with the recent cap on their state and local tax deductions,” the letter concludes.