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Noonan’s Notes Blog is written by a team of Hodgson Russ tax attorneys led by the blog’s namesake, Tim Noonan. Noonan’s Notes Blog regularly provides analysis of and commentary on developments in the world of New York and multistate tax law. Noonan's Notes Blog is a winner of CreditDonkey's Best Tax Blogs Award 2017.


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A Closer Look at New York's Nonresident Allocation Guidelines: Audits of Flow-Through Entities and Their Owners

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As practitioners who deal with New York income tax audits on a day-to-day basis, we often have a front row seat to new audit techniques and new areas of focus.  And in recent years, we have noticed a lot more audit activity in the partnership or flow-through entity area.  Most of this has centered around nonresident owners of flow-through entities, and more specifically the methodology in which these entities allocate income in and out of New York. As I have outlined before in some other articles (click here and here), often we can gain insight on trends like this by studying the audit guidelines that the Tax Department issues to its auditors.  The Tax Department’s Nonresident Audit Guidelines are more widely-known, and available on the Tax Department's website., Over the years, however, the Tax Department has also issued different iterations of its Nonresident Allocation Guidelines, with the most recent version being issued in June 2013.  But after about 17 focused minutes of Google searching (which is the maximum amount of time one should spend Googling something), I have not been able to find those guidelines anywhere on the Tax Department’s website, or on the Internet generally.  That is, of course, until now.

Before this posting, the only other place you could find these Guidelines was through a FOIL request, or by ordering this completely awesome book.  See what kind of interesting nuggets you get by reading this blog?

In any event, back to the issue at hand.  One reason I think these 2013 Nonresident Allocation Guidelines are so interesting is because they include a significant discussion about the allocation of income from entities like partnerships and LLCs.  The rules themselves are not really all that interesting; we are talking about the tax law, after all.  But the fact that the Tax Department went to such trouble in these 2013 guidelines to outline the various iterations of the allocation rules for partnerships does signal a focus on issues like this.  And indeed, we have seen an uptick in these kind of audits over the past couple of years.

You can read the rules yourself, which start on page 27 of the guidelines.  But the thing that I often see many practitioners (as well as New York auditors) skip past in this area is the fact that a nonresident partner or a member of a LLC has a couple of choices to make when determining income allocation.  As the guidelines make clear, the preferred method is the so-called “books and records” method, where the partnership or LLC can do a kind of “direct accounting” allocation if their records enable them to do so.  If not, then we are stuck with the normal three factor apportionment methodology looking to property, payroll, and gross income.  Again, you can read about all of this in the now available guidelines posted herein (you’re welcome, again).  Keep in mind a couple other interesting issues as you read through these guidelines:

    • First, notice that the “gross income” factor is a little bit different than the normal “sales factor” test that applies in the corporate context.  The test in essence does not focus on where the property or services are delivered, even for entities that are selling tangible property.  Instead, the focus appears more to be on where the business is conducted.
    • Also note that although there have been lots of changes in the area of apportionment surrounding C-corporations and S-corporations (a shift to single factor apportionment; the 2015 shift to market-based sourcing for services), none of these have taken hold in the partnership or LLC context, this can create for significant mismatches for non-residents depending on the type of entity they are involved with.
    • Finally, if you are a partner in a partnership or a member of an LLC doing business in New York, don’t forget about the New York City unincorporated business tax.  And don’t forget that the allocation rules for UBT purposes are different than those outlined in these guidelines.

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