Suffolk County Seeks New Look At Septic Grant Program By IRS To Save Participants Tax Bills

Suffolk County officials are making a new pitch to the Internal Revenue Service to reverse its position on the taxable status of one of the East End’s most touted environmental initiatives, saying that the county comptroller’s office failed to present the federal agency with crucial details about the program that they say should make it tax-free for property owners who participate.

According to Suffolk County Executive Steve Bellone’s office, attorneys are already in talks with the IRS about submitting more information about the septic system replacement grants, which they hope will convince the feds to change the assessment of the program they issued last month, which said that any grants received must be counted as taxable income by a homeowner.

Deputy County Executive Peter Scully said on Monday that the information about the program that Mr. Kennedy presented to the IRS last spring contained a number of factual errors and missing details that his office is now laboring to explain more clearly, in hopes of saving county residents hundreds of thousands of dollars in taxes per year.

“The county executive made clear from the day we announced the program that the whole thrust was to make it easy and affordable for homeowners to participate,” said Mr. Scully, a former regional director of the State Department of Environmental Conservation who has spearheaded the county’s water quality improvement initiatives, of which the septic replacement program has been a marquee component. “What the comptroller has done is exactly the opposite. In one fell swoop, he’s made it both more difficult and more expensive for homeowners who care about water quality to do the right thing. One way or another, the effects of this ruling must be reversed.”

The county and Southampton and East Hampton towns each have their own grant programs through which homeowners can now apply for upward of $30,000 in funding support to pay for the cost of putting in a nitrogen-reducing septic system.

The systems typically cost more than $20,000 to design and install, with some costing substantially more.

The towns and county have labored to streamline the application and design process and cover almost any costs, to convince more homeowners to replace aging or obsolete waste systems like cesspools that marine biologists have said are the root cause of destructive algae blooms that have plagued local bays and ponds in recent decades.

The programs were originally cast as rebates, but the county and Southampton Town retooled them in 2018 into a grant program that lifted the burden on the homeowner of paying for the projects upfront. East Hampton followed suit late last year.

All three programs now pay the grant money directly to the contractors who design, sell and install the new systems. Because the homeowner never receives any money, the county and Southampton Town had maintained that they should not be taxed on it. The county attorney’s office solicited an opinion from an independent law firm supporting the position.

But last spring, Mr. Kennedy said he doubted that position would pass muster with the IRS and began sending 1099 forms to any homeowner who received grant funding.

The county executive’s office cried foul, accusing Mr. Kennedy — who was, at the time, mounting an ultimately unsuccessful campaign for the county executive’s office — of trying to hobble the program for political reasons, at the expense of county homeowners.

Mr. Kennedy submitted a request to the IRS for a “private letter” assessment of the program, which led to last month’s response. He has treated the response from the IRS as vindication.

“This is an issue we went to them with in April 2018, and they simply said they had this other opinion and that’s how they were going to treat it,” Mr. Kennedy said this week. “They were relying on cases that were tangential and didn’t accurately represent the concept or the way the enhanced septic system was being operated.”

He added, “This notion that I have to collaborate with [Mr. Bellone] to satisfy a tax-exempt issuance — that is not upholding my fiduciary duty and puts the county at risk for the unpaid raw tax, interest and penalty.”

Mr. Bellone’s office has said that other municipalities have long operated similar environmental improvement grant programs without issuing 1099s to residents, and that Mr. Kennedy could have simply not issued 1099s for the grant funding, and the resultant tax implications would never have been foisted upon homeowners or the county by the IRS.

Instead, some homeowners have found themselves with expensive tax bills they hadn’t counted on when they agreed to install the new septics.

Hampton Bays resident Jean Raymond, for example, a part-time proofreader for the Express News Group, received some $25,000 in grants from the county and Southampton Town in 2018 and filed her 2018 taxes in late January of last year — before Mr. Kennedy’s office had begun mailing out the 1099s. When her 1099 did come, she didn’t realize that it meant she would need to file an amended return.

Last week, she received a notice from the IRS: She owed approximately $7,300 in taxes, plus nearly $2,000 in penalties and interest for not having paid the tax last year.

Environmental advocates have said that sort of burden could kill a program that they see as crucial to reversing decades of harmful inputs to the bays.

“Just as the program is really taking on steam, they go and deflate the tires,” said East Hampton Town Supervisor Peter Van Scoyoc. “The politics aside, it’s remarkable to me that the federal government and our representatives in Washington have done nothing to gain an exemption for something that provides community benefit and, basically, no personal benefit. It’s not like this is in your living room — it’s underground, and there’s nothing new about it in terms of what you had before. You push a lever, and your toilet flushes.”

U.S. Senator Charles Schumer said that he thinks the IRS’s position on the program last month was the wrong one and called the program a “win-win” for Suffolk County residents and the environment.

U.S. Representative Lee Zeldin said this week that his office has looked at the local program, the IRS opinion and other similar programs that have remained tax-free, and concluded that Suffolk County and the local towns need to consider changes to the program guidelines that could win it tax-free status.

“I would recommend Suffolk County work with the IRS to tailor this program so it falls under the general welfare exclusion or another exclusion and is not considered taxable income on the part of the homeowner,” Mr. Zeldin said in an email, referring to one of the potential grounds for exclusion that the IRS referenced in its letter to the county.

Mr. Scully said that if the executive office’s appeal to the IRS doesn’t change its assessment of the program, the county will undertake changes to the requirements of the program to make it tax-free moving forward.

The letter from the IRS nods to the fact that the grant program still leaves homeowners with most of the control over whether to install one of the new systems, which system is installed, which contractor is used, and how the payment of grant money is disbursed.

Southampton Town Comptroller Leonard Marchese said that Southampton Town is still of the opinion that when grant money is paid directly to the contractors, the value of the work that contractor did should not be taxable on the homeowner. But, he added, the IRS opinion may leave open some avenues to restructure the process slightly in ways that may nudge it into nontaxable status.

Meanwhile, despite the disputed tax implications and the stories of unexpected bills in the headlines over the last year, the septic replacement program has still seen a steadily growing interest.

In East Hampton Town alone, the number of new systems installed through the grant program grew from 18 in 2018 to 51 in 2019. The town has approved 249 grant eligibility requests and has received 71 applications for new grants since October — 25 last month alone.

“The bottom line is that, under the current code, if you need to replace your system, it has to be upgraded — so doing it voluntarily through the incentive program is going to save you a lot of money, even with the taxes,” Mr. Van Scoyoc noted. “And if you were going to replace it with a conventional system under the old code, it’s pretty much comparable in cost to what the taxes are anyway, so there shouldn’t really be that much of a disincentive.

“There still should be a general exemption on this kind of thing,” he added. “If you are trying to protect the environment and the quality of life of everyone in a community, why are you getting taxed for that?”