New York Law Review

Tag: Nonresident Taxation

  • Burton v. New York State Dept. of Taxation & Finance, 25 N.Y.3d 734 (2015): Nonresident Tax on S Corporation Income Derived from Deemed Asset Sale Not Unconstitutional

    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.

  • Matter of Speno v. Gallman, 35 N.Y.2d 256 (1974): Clarifying the ‘Convenience of the Employer’ Test for Nonresident Income Tax

    Matter of Speno v. Gallman, 35 N.Y.2d 256 (1974)

    The “convenience of the employer” test determines whether a nonresident is liable for New York State income tax on income earned outside the state; if the work is performed out-of-state out of necessity for the employer, it is not taxable in New York, but if done for the employee’s convenience, it is taxable.

    Summary

    Frank Speno, Jr., a New Jersey resident and president of a New York-based company, sought to allocate his income to avoid New York State income tax, claiming many workdays were spent at his New Jersey home. The New York State Tax Commission recomputed his taxes, deeming those days as taxable because they were performed for his convenience, not out of necessity for his employer. The Court of Appeals upheld the commission’s determination, reaffirming the validity and application of the “convenience of the employer” test. The court emphasized that since Speno performed services in New York, the test appropriately determined whether his out-of-state work was a necessity or a convenience.

    Facts

    Frank Speno, Jr., a New Jersey resident, was president of Frank Speno Railroad Ballast Cleaning Co., Inc., based in Ithaca, New York. His duties involved public relations and attending railroad meetings. He spent significant time traveling, including working from his New Jersey home. While traveling involved meetings and promotion, work at home primarily consisted of phone calls. No business calls were received on his unlisted New Jersey number, and he entertained no business contacts there.

    Procedural History

    Speno and his wife filed joint New York State nonresident income tax returns for 1960 and 1961, allocating income based on days worked outside New York. The Department of Taxation and Finance rejected this allocation. The State Tax Commission, after a hearing, reassessed Speno’s tax liability, including the days worked in New Jersey. The Appellate Division confirmed this determination, prompting an appeal to the Court of Appeals.

    Issue(s)

    Whether the “convenience of the employer” test is a valid method for determining the tax liability of nonresidents who perform services both within and outside New York State.

    Holding

    Yes, because the “convenience of the employer” test is a valid refinement of the place of performance doctrine and is appropriately applied to nonresidents who perform services both within and outside New York State, determining whether out-of-state work is a necessity or a convenience.

    Court’s Reasoning

    The court addressed the validity and application of the “convenience of the employer” test. The court explained that New York tax law taxes nonresidents on income from “sources within the state.” The “convenience of the employer” test refines the place of performance doctrine, which initially stated that work performed outside New York was not taxable. The test dictates that if a nonresident performs services in New York or has an office there, they can only avoid New York tax liability for out-of-state work if it’s a necessity for the employer. If the out-of-state work is for the employee’s convenience, it generates New York tax liability.

    The court cited prior cases like Matter of Burke v. Bragalini, Matter of Morehouse v. Murphy, and Matter of Churchill v. Gallman, which consistently applied the test. It also noted that the test is incorporated in New York Income Tax Regulations (20 NYCRR 131.16). The court reasoned, “since a New York State resident would not be entitled to special tax benefits for work done at home, neither should a nonresident who performs services or maintains an office in New York State.”

    The court distinguished the present case from Matter of Oxnard v. Murphy and Matter of Linsley v. Gallman, where the test was not applicable because the individuals did not perform services in New York. In Speno’s case, he performed services in New York, making the “convenience” test applicable. The court emphasized that Speno allocated a significant number of days to working in New York. Because Speno performed services both within and without the state, the “convenience” test was correctly applied.

    Notably, Speno himself admitted he “could live in Hong Kong and do what I am doing,” indicating the New Jersey work location was for his convenience, not the employer’s necessity.