New York State Tax Developments

Transcription

1 New York State Executive Budget Proposal Would Make Important Changes to Tax Laws Affecting Individuals and Trusts SUMMARY On January 19, 2010, New York State Governor David A. Paterson released his executive budget proposal for New York s fiscal year (the Executive Budget Proposal ). If enacted, the Executive Budget Proposal would make a number of important changes to New York tax laws affecting individuals and trusts. Among the most important of these changes are: Making certain termination payments, non-compete payments and other compensation for past services paid to non-residents taxable in New York unless such treatment is prohibited by federal law; Requiring that gain from certain sales of S corporation stock be treated as New York source income by non-resident shareholders and therefore subject to tax in New York; Amending the definition of resident trust to eliminate the exemption for certain trusts with non-resident trustees; Expanding the base for the New York State and City mortgage recording tax by taxing the filing of a financing statement that secures a loan for the purchase of an ownership interest in a cooperative housing unit; and Preserving the $1 million exemption against the New York estate tax for decedents dying in 2010 during the temporary repeal of the federal estate tax. The draft legislation accompanying the Executive Budget Proposal would implement the NYS fiscal plan and thus it is referred to as the Executive Budget Bill. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 DISCUSSION: The Executive Budget Bill includes the following changes to current New York State tax law that would affect individuals and trusts. Certain Payments to Non-Residents for Past Services Taxable by New York The Executive Budget Bill would generally make payments made to a non-resident individual subject to tax in New York if such payments relate to a business, trade, profession or occupation previously carried on in New York, unless such treatment is prohibited by federal law. 1 These payments would include, for example, payments made pursuant to covenants not to compete and termination agreements. 2 Payments that are related to a business carried on partly within and without New York State would be allocated to New York in accordance with current New York law. 3 The Memorandum in Support of the Executive Budget Proposal states that this has been a long-standing rule in New York. 4 However, the Memorandum in Support notes that cases have held that payments made to non-residents pursuant to covenants not to compete are not taxable in New York. 5 This proposed change would apply to taxable years beginning on or after January 1, Certain Gains from the Sale of S Corporation Stock to be Treated as New York Source Income for Non-Resident Shareholders The Memorandum in Support notes that recent New York State administrative decisions have taxed sales of S corporation 7 stock as though they were sales of the stock notwithstanding special treatment under federal income tax law. Specifically, in Matter of Baum, a tax tribunal concluded that a sale of stock should not be treated as a sale of the corporation s assets for New York State tax purposes even though Executive Budget Bill, Part E, 1. Non-residents are generally only taxed to the extent they have income attributable to New York. See N.Y. TAX LAW 631(a)(1). Because New York uses federal taxable income as the starting point for taxing individuals, such income may not be subject to tax in New York if otherwise exempt from tax for federal income tax purposes. Id. All citations to N.Y. TAX LAW are to current tax law. Executive Budget Bill, Part E, 1. Id. Memorandum in Support of the Executive Budget Proposal ( Memorandum in Support ), Part E. See, for example, Matter of Penchuk, Tax Appeals Tribunal, DTA No (April 24, 1997) (concluding that payments received by a non-resident under a non-competition agreement were not New York source income). Executive Budget Bill, Part E, 2. S corporation is defined in Section 1361(a)(1) of the Internal Revenue Code of 1986, as amended (the Code ). Taxpayers are required to make a separate S corporation election for New York purposes. See N.Y. TAX LAW 606(a). -2-

3 treated as such for federal income tax purposes on account of a Section 338(h)(10) 8 election. 9 In Matter of Mintz, a New York State administrative law judge concluded that payments made with respect to an installment obligation distributed to a shareholder in liquidation of an S corporation would be treated as a payments made in respect of stock. 10 New York State had argued that the payments received by the former shareholders should be treated for New York tax purposes as payments for assets because of a special federal rule that would determine the character of such payments as if the S corporation had recognized gain or loss on the sale of the assets exchanged for the installment obligation and passed the character of such gain or loss through to the shareholders. 11 The Executive Budget Bill would treat a transaction where either a Section 338(h)(10) election is made or an installment obligation is distributed by an S corporation within the meaning of Section 453(h)(1)(A) of the Code 12 as a sale of the S corporation s assets (instead of as a stock sale) and require a dividing of the gain between New York and non-new York source income. 13 The Memorandum in Support takes the position that such treatment is required to conform with the federal income tax treatment of such transactions. 14 This proposed change would apply to taxable years for which the statute of limitations for seeking refund or assessing tax are still open. 15 In addition, the Executive Budget Bill would revise current law to provide that, where an S corporation has terminated its taxable status in New York, the income from an installment sale would retain its character See Section 338(h)(10) of the Code (permitting certain stock sales to be treated as an acquisition of the target corporation s assets followed by a liquidation of the target corporation). New York Division of Tax Appeals, Tax Appeals Tribunal, DTA Nos and (February 20, 2009). Under a stock-sale characterization, the income would generally not be sourced to New York. See N.Y. TAX LAW 631(b)(2). New York Division of Tax Appeals, Administrative Law Judge Unit, DTA Nos and (June 4, 2009). As above (see note 9), the treatment of the transaction as a stock sale would mean that the gain would generally not be sourced to New York. See N.Y. TAX LAW 631(b)(2). Specifically, Section 453B(h) of the Code requires that [u]nder regulations prescribed by the Secretary, the character of the gain or loss to the shareholder shall be determined in accordance with the principles of [S]ection 1366(b) [of the Code]. Section 1366(b) of the Code requires that the tax items of an S corporation be treated as if the tax items were realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation. These rules apply if (i) an S corporation distributes an installment obligation in a complete liquidation and (ii) the receipt of the obligation is not treated as payment for the stock by reason of Section 453(h)(1) of the Code. See Section 453B(h) of the Code. A Section 453(h)(1)(A) distribution is generally when a shareholder receives (in exchange for stock) an installment obligation as a liquidating distribution within 12 months following the adoption of a plan of liquidation if the liquidation is completed within that time period. Executive Budget Bill, Part F, 3. Memorandum in Support, Part F. Executive Budget Bill, Part F,

4 as New York source income for non-resident shareholders. 16 The Memorandum in Support indicates that, under current law, if an S corporation terminates its taxable status, the non-resident shareholders may be able to avoid New York tax. 17 This proposed change would apply to taxable years beginning on or after January 1, Amend the Definition of Resident Trust Under current New York State tax law, a resident trust is exempt from tax if: (1) all of its trustees are domiciled outside New York; (2) the entire corpus of the trust, including real and tangible property, is located outside New York; and (3) all income of the trust is sourced outside New York. 19 A resident trust is any testamentary trust created under the will of a decedent who was domiciled in New York and any irrevocable lifetime trust created by a New York domiciliary. Thus, a resident trust with no property located in New York and no New York-source income can avoid New York taxation by having out-of-state trustees. 20 The Executive Budget Bill would repeal this exemption. 21 The Executive Budget Bill would add a rule that a resident non-testamentary trust with no New York source income would be taxed based on the ratio of ascertainable New York resident individual beneficiaries to the total number of ascertainable individual beneficiaries. 22 The Memorandum in Support notes that the three-part test for exemption set out above was enacted to codify a rule set forth in New York case law. The Memorandum in Support explains that recent state and federal court decisions have upheld the constitutionality of taxing a percentage of a trust s income where the grantor is a state resident and the tax is based on the percentage of beneficiaries that are state residents as well as the permissibility of taxing all of a trust s income where the decedent was domiciled in the state. 23 This proposed change would apply to taxable years beginning on or after January 1, Executive Budget Bill, Part F, 3. Memorandum in Support, Part F. Executive Budget Bill, Part F, 4. See N.Y. TAX LAW 605(b)(3)(D)(i)(I)-(III). Memorandum in Support, Part G. Executive Budget Bill, Part G, 1. Executive Budget Bill, Part G, 2. Memorandum in Support, Part G. Executive Budget Bill, Part G,

5 Expand the Mortgage Recording Tax Base Under current New York State and New York City tax law, recording of a mortgage on real property is subject to the mortgage recording tax. 25 However, filing of a financing statement to perfect a lender s security interest in the shares in a cooperative housing corporation (and the related unit lease) is not subject to the recording tax. The Memorandum in Support takes the position that the filing of a financing statement for a lender s security interest in a cooperative housing unit is analogous to the recording of a mortgage on real property. 26 If enacted, the proposed change would expand the tax base of the mortgage recording tax to include the principal amount of any loan secured by the filing of a financing statement where the loan is used to finance the purchase of an ownership interest in a cooperative housing unit in New York State. 27 The proposed change would also permit New York City to impose a recording tax under the same circumstances. 28 The Memorandum in Support notes that payment of the tax would be required for any remedies for the enforcement of the lender s rights relating to its security interest. 29 The proposed change would take effect on the first day of the third month after the proposed change becomes law and would apply to financing statements filed on or after this effective date. 30 Preserve the $1 Million Exemption Against New York Estate Tax for Decedents Dying in 2010 During the Temporary Repeal of the Federal Estate Tax New York law provides for an exemption against New York estate tax equal to the federal estate tax exemption amount (subject to a maximum of $1 million), effectively exempting the first $1 million in value of New York taxable estates from New York estate tax. Because of the current temporary repeal of the federal estate tax, there is no federal exemption amount for decedents dying in As a result, taxable estates of decedents dying in 2010 subject to the New York State estate tax would be taxed on the full value of the estate without the benefit of any estate tax exemption See N.Y. TAX LAW 253, 253-a; N.Y.C. ADMIN. CODE Memorandum in Support, Part P. Executive Budget Bill, Part P, 1. Executive Budget Bill, Part P, 2. Memorandum in Support, Part P. See also Executive Budget Bill, Part P, 4. Memorandum in Support, Part P. See also Executive Budget Bill, Part P, 5. Memorandum in Support, Part BB. In 2009, the federal exemption amount was $3.5 million. See Section 2010(c) of the Code. -5-

6 The Executive Budget Bill would remedy this unintended result by preserving the New York estate tax exemption at $1 million for New York purposes irrespective of changes to federal law. 32 This proposed change would take effect immediately upon enactment and would apply to estates of decedents dying on or after January 1, * * * Memorandum in Support, Part BB. See also Executive Budget Bill, Part BB, 1. See Executive Budget Bill, Part BB, 2. Copyright Sullivan & Cromwell LLP

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