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Taxes in New York (TiNY) is a blog by the Hodgson Russ LLP State and Local Tax Practice Group members Chris Doyle, Peter Calleri, and Zoe Peppas. The weekly reports are intended to go out every Tuesday after the New York State Division of Tax Appeals (DTA) publishes new ALJ Determinations and Tribunal Decisions. In addition to the weekly reports, TiNY may provide analysis of and commentary on other developments in the world of New York tax law.

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TiNY Report for December 26, 2019 (covering DTA cases issued December 19)

By on

The Christmas Eve Massacre of 2019

'Twas the day before Christmas, sitting in my desk chair

I booted-up my computer to see what was there.

I logged onto Explorer and the DTA site,

Did the Tribunal post something on which I might write?

I found nothing from the Tribunal to mock or to praise.

But there were early postings from four ALJs!

And the quality of the rulings was better than usual,

With issues substantive and sometimes Constitutional.

In skimming the wisdom of unbiased fact-weighers

The sentiments expressed seemed anti-taxpayer

So I dutifully read and scoured each one

And now observe with confidence: No Petitioner won . . .

And I need to pause here because writing up the cases in verse is far more time-consuming than writing in prose, and I need to focus on some client matters. Yes, I was one of the few who went to work on December 24, and when I arrived at my desk I thought I would check the DTA’s website to see if the Tribunal had surreptitiously posted a decision. There were no new Tribunal decisions, but there were four (!) new ALJ determinations posted two days early, and each of them dealt with a significant substantive tax issue (no “timies”).  


Matter of Russekoff et. ux.; Judge Galliher; Division’s Rep.: Linda Farrington; Petitioner’s Reps.: Stephen Solomon, Kenneth Moore and Roger Blane; Article 22 (by Chris Doyle). In this submitted case, Petitioner-spouses were domiciled in Connecticut. They owned a vacation home on Shelter Island, and he worked for a hedge fund manager in New York City. Petitioners filed as nonresidents, but conceded that the husband was in New York more than 183-days for 2010-2013 (the “Audit Period”), and following an audit paid tax as if they were New York residents. Subsequent to the audit Petitioners filed refund claims on the basis that they should be entitled to the resident credit in New York for the Connecticut tax paid on Connecticut-taxed income, including income from investments. The Division denied Petitioner’s credit claim and this DTA petition followed.

Judge Galliher sustained the Division’s denial of the credit. The Judge found that Petitioners were tax-residents of New York since they spent more than 183-days in New York and had a permanent place of abode in New York. The Judge then explained that the “resident credit” is available for tax paid to another state for income derived from that other state. The Judge reasoned that investment income was not—as Petitioners argued—income derived from Connecticut. Instead, the Judge found that, because the income would not have been sourced to New York if Petitioners had been domiciled in New York, the income was not derived from any state. And the Judge determined that unearned income is treated as not having a source, notwithstanding the New York Constitution’s instruction that intangible assets “shall be deemed to be located at the domicile of the owner for purposes of taxation, . . .” Key quote from Judge Galliher on this point: “the physical location of the intangible property is inconsequential to New York’s imposition (as here) of a tax based on residency alone. . ..” 

I disagree with the result since it supports the double-taxation of investment income earned by New York “statutory” residents. But until the Supreme Court rules against this travesty, we’re probably stuck with it.

Matter of LePage et. al.; Judge Behuniak; Division’s Rep.: Linda Farrington; Petitioner’s Reps.: Dennis Rimkunas, Antoinette Ellison and John Allan; Article 22 (by Chris Doyle).  Another “submitted” case, another taxpayer loss. Petitioners were nonresidents. They sold their shares in corporations that were “hybrids” (i.e. S corporations for federal income tax purposes but C corporations for New York tax purposes). In connection with the share sales, the parties made Internal Revenue Code Sec. 338 (h)(10) elections. As a result of those elections the corporations were treated as if they had sold their assets at fair market value (the deemed asset sales) and then distributed the hypothetical proceeds of the deemed sales in liquidation of the corporations (the deemed liquidations). Since the corporations were hybrids, Petitioners adjusted the deemed sale gains out of their New York adjusted gross incomes (“AGIs”). And, since they were nonresidents, the gain from the actual sale of the shares was not sourced to or taxed by New York…or so Petitioners thought.

The Division audited Petitioners and found that they should not have backed out the deemed sale gain income from their New York AGIs because the S corporations should have, for the year of the sales, been “deemed” to have had New York S elections made for them under Tax Law Sec. 660(i), which requires that a New York S election be deemed to be made for any federal non-bank S corporation that has more than 50% of its federal gross income from “investment income” (the “50% test”). Investment income is defined in the statute as “the sum of an eligible S corporation’s gross income from interest, dividends, royalties, annuities, rents and gains derived from dealings in property, including the corporation’s share of such items from a partnership, estate or trust, to the extent such items would be includable in federal gross income for the taxable year.” 

And here lays the conundrum: If federal gross income were to be calculated as if the corporations were C corporations, then there would have been no deemed asset sale because a C corporation owned by individuals cannot make a 338(h)(10) election. And without the gain from the 338(h)(10) deemed asset sale, the corporations’ federal gross incomes would not be predominantly from investment income and no deemed New York S election would have been required under Sec. 660(i). On the other hand, if federal gross income were to be calculated on the basis of the corporations being S corporations, then the 338(h)(10) deemed asset sale income would have been included in federal gross income and the deemed New York S elections would have been required. 

Judge Behuniak determined that the correct approach was to calculate AGI based on the federal S corporation returns and not based on the corporations’ pro forma federal C corporation returns. As support, the Judge cited the language of the statute which referred to the corporations for which the deemed New York S election might be required as “eligible S corporations”. And the Judge cited to references in legislative history and elsewhere to the 50% test being applied to “federal S corporations”. I don’t have the benefit of the briefs submitted by the parties, but I expect that this was a close question.

The Judge also determined that investment income as used in the 50% test should include the deemed asset sale gains at issue, citing federal tax regulations that treat gains from sales of assets, including sales of goodwill, as being gains derived from dealings in property. 

Petitioners also argued that the scope of the deemed S election should, consistent with the legislative intent, be limited to those situation in which individual taxpayers minimized New York tax by contributing their investment portfolios to a hybrid corporation. The Judge found this argument wanting, citing the language of the statute. But there is a problem with the Judge’s analysis here, and that is this: if the Judge is correct, then every hybrid that predominantly sells property (as opposed to services) would be deemed to have made the New York S election. Under this reading every hybrid manufacturer, retailer and wholesaler would be deemed to have a New York S election, and that clearly was not the intention of the Legislature. I know, because I was around back when the deemed S election law was passed.

And Petitioners made constitutional arguments that Petitioners, as nonresidents, did not consent to be taxed by New York on the income from their S corporations, and that the inapplicability of the 50% test to banks violated equal protection. These arguments were likewise shot down by the Judge.

This was a 37-page long determination, so there were other arguments made and addressed, and overall it was a pretty interesting determination addressing a lot of close-call issues for which there was, until now, scant interpretive authority. 

Matter of International Business Machines; Judge Law; Division’s Rep.: Jennifer Baldwin; Petitioner’s Reps.: Scott Brandman and David Pope; Article 9-A (by Chris Doyle). The issue here was whether IBM was permitted to exclude royalties received from affiliates that were not taxable in New York. This is the same issue that Judge Law faced in Matter of Disney (May 30, 2019), and he came down the same way: There is no exclusion for royalties received from affiliates that are not subject to tax in New York. Here’s what we wrote for Disney, since it also applies here:

“At the time, N.Y. Tax Law § 208.9(o)(3) provided that: ‘[A] taxpayer shall be allowed to deduct royalty payments directly or indirectly received from a related member during the taxable year to the extent included in the taxpayer’s federal income unless such royalty payments would not be required to be added back under subparagraph two of this paragraph. . . .’

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Judge Law determined that the statute is properly read to require that the payer of the royalty be a New York taxpayer for the recipient to be able to deduct the payment. We think this is a close question, and (with respect) we would have fallen on the other side. But we admit that there is support for both interpretations. To us, the use of the phrase “would not be” instead of “are not” in former N.Y. Tax Law § 208.9(o)(3) indicates that the Legislature contemplated that non-taxpayer royalty payers would not preclude a royalty recipient from claiming the special exclusion. We agree with the Judge that the royalty payment add-back and exclusion was intended to combat the use of intercompany royalties to shift earnings out of high-tax states and into low or no-tax jurisdictions.  But fairness dictates symmetry in tax provisions like this. So for every deduction denial, there ought to be a corresponding exclusion. Certainly the Division would not have permitted a New York royalty payer to avoid the deduction add-back requirement if the royalty recipient were not a New York taxpayer since this is exactly the situation the law was intended to address. But there is no symmetry unless the law is properly construed to permit an exclusion for a New York royalty recipient when the payer is a non-taxpayer. Otherwise, New York has a “heads I win, tails you lose” situation.”

Petitioner also made a constitutional argument, which the Judge found to be a facial challenge he didn’t have the jurisdiction to consider. Petitioner argued that the statute violated the non-discrimination prong of Complete Auto Transport. As I noodle on the case and reflect back on what I wrote for Disney, I think there is an as-applied constitutional argument to be made here, and that is that the Division’s interpretation of the statute violates the fair apportionment prong of Complete Auto Transit, and in particular that the interpretation creates a violation of the internal consistency test: If every taxing jurisdiction had the same law and interpreted it as the Division and the Judge interpret it, New York would require inclusion of the royalty income by Petitioner and the royalty payer’s jurisdiction would deny the payer a deduction for the royalty payment.  This results in double taxation of the royalty income. Given that foreign commerce is implicated (thus triggering even stricter Commerce Clause scrutiny than normal per Kraft), I think a constitutional argument like this might receive a favorable reception at the Tribunal.

Matter of GRJH, Inc.; Judge Russo; Division’s Rep.: Brian Evans; Petitioner’s Reps.: Ariele Doolittle and Chris Doyle; Articles 28 and 29 (by Chris Doyle).  We are involved in this case so I am going to “Joe Friday” this summary.

Petitioner operated gas stations in New York, some of which participated in a fuel rewards program. Under the program, participating customers who shopped at Price Chopper were entitled to price reductions for fuel purchased at Petitioner’s Sunoco stations. The more groceries a customer purchased at Price Chopper, the more points the customer earned. Customers were given a card or fob that they could present at the gas pumps of Petitioner’s participating Sunoco stations, and the pump would (through communication with Price Chopper computers) adjust the price of the gas commensurate with the points previously earned by the customer. Price Chopper paid Sunoco an amount equal to the discount less some offsets. Sunoco then credited Petitioner an amount equal to the discount less the Price Chopper offsets and some additional Sunoco offsets. From the determination: “The reimbursements by Sunoco are made one to two days later, and are reflected as a credit against petitioner’s purchase cost of gasoline from Sunoco”; “[t]he credits petitioner received from Sunoco were only redeemable against petitioner’s future purchases of fuel from Sunoco”; and “[t]he credits petitioner received from Sunoco could not be redeemed for cash nor could petitioner request that the credits be paid in cash.” 

For the audit period the Division concluded that Petitioner collected sales tax on the price paid by the rewards customers instead of the undiscounted price of the gas. Since the Division viewed participation in the program as the equivalent of the use of a manufacturers coupon, it decided that tax was due on the undiscounted price of the fuel sold. The Division found Petitioner’s records lacked the necessary detail to determine the amount of the untaxed discount. So the Division devised a method for computing the additional tax based on OPIS figures and Petitioner’s daily fuel sales information. OPIS provides fuel pricing information for fuel stations like those operated by Petitioner. Based on its estimates, the Division issued Notices of Determination asserting additional tax due, and this hearing ensued. In a subsequent audit involving the same issue, the Division used different information (the Sunoco Report) to estimate the additional tax liability.

Petitioner argued that it was improper for the Division to resort to an estimate since Petitioner had adequate records. The Judge disagreed that Petitioner had adequate records.

Petitioner argued that the Division should have used a methodology for the audit period that was similar to the more accurate method used in the subsequent audit. The Judge disagreed, finding that when a taxpayers records are not adequate the Division has latitude in choosing the tax-estimation method; the method need not be correct, it just needs to be reasonable.

Petitioner argued that it should only owe tax on the discounted price paid by the customer. The Judge disagreed, finding that the gross credit granted to Petitioner by Sunoco was an additional receipt for the fuel. The Judge found that the Division correctly analogized the fuel advantage program sales to sales involving manufacturer’s coupons.

Petitioner argued that penalties should be abated due, in part, to its pursuit of clarity on the issue through a prior ALJ hearing. The Judge disagreed.

And once I had summarized the four determinations

I powered down my computer for a day-long vacation.

And I thought about my role as TiNY reporter,

Although sometimes I’m critical, I’m a DTA supporter.

To Department auditors and lawyers we sparred with this year,

To Judges and Commissioners before whom we appeared,

And to the twelve (or so) readers for whom weekly we write

Happy Christmas to all, and to all a good night.

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