New York Law Review

Tag: Source Income

  • Michaelsen v. New York State Tax Commission, 67 N.Y.2d 579 (1986): Taxation of Nonresident Stock Option Gains

    Michaelsen v. New York State Tax Commission, 67 N.Y.2d 579 (1986)

    When a nonresident exercises stock options granted by a New York employer, the taxable gain in New York is the difference between the option price and the stock’s fair market value on the exercise date; subsequent stock sale gains are not taxable in New York.

    Summary

    James Michaelsen, a Connecticut resident, challenged a New York State income tax assessment on gains from exercising stock options granted by his New York employer, Avon. The Tax Commission argued both the gain from exercising the option and the later stock sale were taxable in New York. The Court of Appeals held that only the gain realized at the time of exercising the options (difference between option price and fair market value at exercise) was taxable in New York. The gain from the later sale of the stock was not taxable because it was considered investment income and not derived from New York sources.

    Facts

    James Michaelsen, a senior executive at Avon in New York City, received stock options in 1968. In 1972 and 1973, he exercised these options while working in New York, purchasing 6,000 shares of Avon stock. In 1973, while a resident of Connecticut, Michaelsen sold all the shares, realizing a gain of $179,761. He did not report this gain on his New York State nonresident income tax return.

    Procedural History

    The New York Tax Commission assessed additional income tax liability of $19,017.12. Michaelsen challenged this in an Article 78 proceeding. Special Term dismissed the petition. The Appellate Division remitted the case to the Tax Commission to recompute the tax based on the difference between the stock’s fair market value when the options became exercisable and the option price. The Tax Commission appealed to the Court of Appeals.

    Issue(s)

    Whether gains derived from the exercise of stock options granted to a nonresident by a New York employer, and the subsequent sale of stock acquired through those options, constitute income derived from or connected with New York sources for income tax purposes under Tax Law § 632.

    Holding

    Yes, in part, because the gain derived from the exercise of the option is taxable in New York, calculated as the difference between the option price and the fair market value of the stock on the date the option is exercised. No, in part, because the gain from the subsequent sale of the stock is not considered income derived from New York sources and is therefore not taxable in New York.

    Court’s Reasoning

    The Court considered Tax Law § 632 (a)(1) and (b)(1)(B), noting that New York’s income tax law conforms to federal authority where possible. Referencing Commissioner v. LoBue, 351 U.S. 243 (1956), the Court acknowledged that federal tax law taxes the compensation an employee receives by purchasing stock at below market value via options. However, the court distinguished between the *realization* and *recognition* of income. The gain is *realized* when the option is exercised but *recognized* when the stock is disposed of. Citing Treasury Regulations, the court emphasized that the value of an option includes not only the difference between the exercise price and the stock’s value at exercise but also the opportunity to benefit from future appreciation. The Court rejected the Appellate Division’s formula, stating it undervalued the options and conflicted with federal law. The proper method is to subtract the option price from the fair market value of the stock when the option is exercised. The court stated, “Plainly the option on the date it becomes exercisable is worth more than merely the difference between the fair market value of the stock at that time and the option price.” The court found that taxing the gain from the stock’s increased value after purchase improperly taxed intangible personal property not derived from a New York source, stating, “Any gain petitioner realized from an increase in the market value of Avon stock between the time the option was exercised and the time the stock was sold is clearly investment income rather than compensation and, as a nonresident, petitioner cannot be taxed on this amount.” The case was remitted for tax assessment based on the stock value at the time of option exercise.

  • 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.