25 N.Y.3d 734 (2015)
New York’s Constitution does not prohibit the state from taxing the New York-source income of nonresidents derived from the sale of stock in an S corporation, even if the sale is structured as a deemed asset sale for federal tax purposes.
Summary
Nonresident shareholders of an S corporation challenged a New York State tax assessment on their pro rata share of gains from a stock sale, arguing that the tax violated the New York Constitution. The shareholders elected to treat the transaction as a “deemed asset sale” for federal tax purposes. The Court of Appeals held that the tax, imposed on New York-source income, was constitutional. The court found that the constitutional provision regarding taxation of nonresidents’ intangible personal property did not apply to income taxes, and the election to treat the sale as a deemed asset sale did not shield the income from state taxation. The court emphasized that the tax was based on the income’s source within New York, not merely on the ownership of intangible property.
Facts
Nonresident former shareholders of JBS Sports, Inc., an S corporation, sold their stock to Yahoo, Inc. They elected to treat the transaction as a “deemed asset sale” under the Internal Revenue Code. As a result, JBS realized substantial gains, which were passed through to the shareholders. The shareholders reported and paid federal taxes on their share of the gains, but did not pay New York State taxes. The New York State Department of Taxation and Finance assessed state income taxes, relying on Tax Law § 632 (a) (2), which treats gains from deemed asset sales as New York source income. The shareholders challenged the assessment, arguing it violated the New York Constitution.
Procedural History
The shareholders filed a declaratory judgment action against the New York State Department of Taxation and Finance, challenging the tax assessment. The Supreme Court granted the state’s motion for summary judgment, upholding the constitutionality of the tax. The Court of Appeals retained jurisdiction over a direct appeal from the Supreme Court under CPLR 5601 (b) (2) and affirmed the lower court’s decision.
Issue(s)
1. Whether Tax Law § 632 (a) (2), which treats gains from deemed asset sales as New York source income, violates Article XVI, § 3 of the New York Constitution when applied to nonresident shareholders of an S corporation.
Holding
1. No, because the New York Constitution does not prohibit the taxation of income derived from a New York source, even if that income is realized from the sale of intangible personal property by a nonresident.
Court’s Reasoning
The court began by noting the clear language of the relevant New York tax laws, which allowed the state to tax the pass-through income of S corporation shareholders based on the income’s source. The court examined Article XVI, § 3 of the New York Constitution, which addresses the taxation of intangible personal property. The court held that the constitutional provision did not prohibit the state from taxing the income derived from the sale of the stock. The court reasoned that Article XVI, § 3 primarily addressed the location for tax purposes of nonresidents’ intangible personal property and prohibits ad valorem taxes and excise taxes based solely on ownership or possession of such property. The Court emphasized that the tax in question was not an ad valorem or excise tax. The tax was an income tax based on the income’s connection to New York, due to the corporation’s activities, and the shareholders’ election of a deemed asset sale which resulted in the recognition of gain. The court referenced the history of Article XVI, § 3, which indicated that the goal was to attract and retain nonresidents’ wealth, particularly in the form of stocks and securities, and to eliminate the ad valorem system as applied to intangible personal property.
Practical Implications
This case clarifies the scope of Article XVI, § 3 of the New York Constitution, specifically concerning income taxes on nonresidents’ intangible property. Lawyers advising clients on tax matters, particularly those involving S corporations and nonresident shareholders, must understand this ruling. It confirms that New York can tax income from intangible property (like stock) if the income is derived from New York sources. This case emphasizes the importance of understanding both federal and state tax implications of business transactions, especially those involving cross-state activities or nonresident ownership. This case affects tax planning for S corporations with nonresident shareholders, and similar cases, and highlights the need to analyze whether income is derived from New York sources.