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State and Local Tax Blog

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Taxes in New York (TiNY) is a blog by the Hodgson Russ LLP State and Local Tax Practice Group. The weekly reports are intended to go out within 24 hours of the Division of Tax Appeals’ (DTA) publication of 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.  

TiNY Report for June 20, 2019 (reporting on DTA cases published June 13 and 20)

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This week we have a Decision and two Determinations. And yes, you read that date right, we have a same day determination – now that’s exciting stuff folks!


Matter of Zunshine; Division’s Rep.: Ellen K. Krejci; Petitioners’ Rep.: Pro Se; Article 22. 

Petitioners filed their petition to protest a Notice of Deficiency. The Division then filed a Notice of Cancellation of the deficiency and a discontinuance.  You’d think that the Petitioners would have been pleased, but they then filed a motion for sanctions,  a motion for alleged inappropriate conduct, and a motion to compel discovery for answers to a request for admissions which was relevant to the sanctions (I’m guessing that one of the Petitioners was an attorney).  By letter, the Supervising ALJ informed Petitioners that, because of the Notice of Cancellation, their requests were moot and that the DTA lacks authority to sanction an attorney. Ultimately, the ALJ issued an Order of Discontinuance.

On exception, Petitioners argued that the ALJ erred in not ruling on their motion and, by doing so, deprived them of their right to appeal. They argued that courts have an inherent power to sanction litigants.

The Tribunal agreed with Petitioners that the ALJ should not have declined to rule on the motion.  However, it determined that his opinion was clearly laid out in his letter, so it deemed his letter to be a denial of the motion included within the order. The Tribunal also confirmed that the DTA judges have not been delegated the authority to impose sanctions against the Division. So, does that mean the DTA can sanction taxpayers and their attorneys? Seems a bit one-sided to me…


Matter of Lifton; Judge: Connolly; Division’s Rep.: Michelle W. Milavec; Petitioners’ Rep.: Ellen S. Brody; Article 22. 

Petitioners were residents of Florida for all of 2011, the tax year at issue. From 2006 to 2011, one of the Petitioners owned a 50% interest, through a single member LLC, in Meadow Lane Development, LLC (“MLD”), a New York LLC, which owned real property. For the tax years 2006 through 2010, MLD reported to Petitioner his share of the interest expense. But during these years, Petitioners did not have enough net investment income to deduct the entire expense on their federal return, so they carried it forward, as permitted by IRC § 163(d).  Article 22 doesn’t have a comparable rule to IRC § 163(d), so Petitioners also did not deduct the expense on their New York returns for 2006-2011. The property owned by MLD was sold in 2011, and Petitioner’s share of the gain was $1,440,391. On their 2011 federal return, Petitioners deducted $1,458,158 of investment interest, of which $1,067,287 was carried forward. On their New York non-resident income tax return, Petitioners reported a federal AGI of $1,446,1557, itemized deductions of $2,426 (half of their charitable contribution), and a subtraction modification on line 29 of the investment interest amount reported on their federal return.

On audit, the Division accepted Petitioners federal AGI, but denied the subtraction modification for investment interest expense. The Division also determined that Petitioners were entitled to their itemized deductions, but they were subject to the cap of 50% of the charitable deduction, and issued a Notice of Deficiency.

Petitioners did not disagree with the audit adjustment. Instead, they argued that they should have been allowed an itemized deduction for the investment interest expense. Petitioners first argued that Tax Law § 615(g), which caps the itemized deductions for those with an AGI between $ 1 million and $10 million to 50% of their charitable deduction, only applies to residents, and not nonresidents like them. The Tribunal noted that Petitioners had a heavy burden with this argument and must prove that their interpretation of the statute is the only reasonable construction and that the Division’s interpretation is irrational. The Division argued that § 615(g) applies to nonresidents as §615 requires them to calculate their base tax under § 601, and § 601 requires nonresidents to calculate their tax under section (a) through (d) as if they were residents. 

Petitioners’ argument focused on the wording of the statute and noted that it does not say simply individual or nonresident individuals, but says resident individual. Petitioners also argued that to determine the itemized deductions applicable, instead of looking at § 615, § 631 should be used, which provides that the NY AGI of a nonresident is equal to the net amount of items of income, gain, loss and deduction on the federal return that is derived from NY sources. The Tribunal disagreed and noted that the deductions that go into federal AGI calculations do not include deductions for investment interest expense. Further, it noted that if § 615 did not apply to nonresidents, it was unclear how nonresidents could take NY itemized deductions.

The Tribunal took greatest issue with Petitioners’ attempt to look at each code section in isolation and that they ignored that § 606 states that a nonresident’s tax base must be computed under that section as if the nonresident were a resident. It found that this could only mean that because the deduction cap in Tax Law § 615 applied to resident, the cap also applied to nonresident.

The Petitioners also argued that applying the cap on itemized deductions is an equal protection violation as its application is arbitrary and capricious and amounts to discrimination. Essentially, the Petitioners argued that the denial of the deduction was unfair because they had no real economic gain, but were being forced to pay tax. But, the Tribunal stated that, “While application of the Tax Law § 615 (g) cap arguably leads to a harsh result here by treating petitioners as having income that in reality is offset by closely related expenses, unfairness does not necessarily give rise to an equal protection claim.” Petitioner failed to identify a class of similarly situated people and the Tribunal analogized this situation to a taxpayer who would be taxed on gambling winnings and denied a deduction for gambling losses.

I have to say, I found Petitioners’ statutory argument to be compelling. I agree that they didn’t sufficiently meet their burden, but if a statute uses the word resident to also mean non-resident, it should say so.

Matter of Lewis; Judge: Galliher; Division’s Rep.: Michelle W. Milavec; Petitioner’s Rep.: Jennifer M. Boll; Article 22. 

Petitioner was a nonresident of New York from 2009 through 2011. Prior to the sale, Petitioner owned 50% of the shares of Energy Service Providers, Inc. (“ESPI”), a New York S-corporation. ESPI entered into a Securities Purchase Agreement with U.S. Gas & Electric, Inc. (“USGI”), where the ESPI shareholders, including Petitioner, would sell their shares to USGI. Under the terms of the Agreement, the buyers and sellers agreed to make an IRC § 338 (h) (10) election, which provides the purchasers a step up in basis of the assets that are deemed to be purchased. Before agreeing to the election, Petitioner consulted with his accountant regarding the tax consequences of the sale. Petitioner’s accountant advised him that under Matter of Baum, the transaction would be treated for New York purposes as the sale of an intangible and, as a nonresident, he would not be subject to New York tax. (Tax Appeals Tribunal, February 12, 2009).  As consideration for the transaction, Petitioner received both cash and an installment obligation, which qualified for treatment under IRC § 453(h) (1).

ESPI filed an income tax return and franchise tax return on August 14, 2010, for the period up to the sale on June 30, 2009, where it reported a capital gain based on a 100% New York business allocation percentage (“BAP”). However, it did not indicate that it had made an IRC § 338(h) (10) election on its New York filing. Since incorporation, 100% of ESPI’s receipts had been apportioned to New York on its franchise tax filings.

Tax Law § 632(a) (2) was amended on August 11, 2010, to provide that a nonresident S corporation shareholder must treat the sale of stock under an IRC § 338(h) (10) election as the sale of assets and apportion the proceeds in accordance with its BAP to New York. The Division issued a memorandum on August 31, 2010, which provided guidance on the change and noted that it applied retroactively to January 1, 2007. Petitioner’s accountant alleged that he was unaware of both the change to the law and the guidance.

Petitioner filed his 2009 New York State nonresident return on October 14, 2010, after the change to § 632(a) (2). He reported his share of the capital gain from the sale and also a subtraction removing 100% of the gain. Petitioner did not file a return or allocate income to New York for the income that he received from the installment payment during 2010 and 2011.

The Division conducted a field audit of ESPI’s final return and income reported by its shareholders. The Division determined that it was a deemed asset sale under IRC § 338 (h) (10), and that the proceeds should be treated as New York source income to the extent of ESPI’s BAP. Thus, the Division disallowed Petitioner’s claimed subtraction modification and treated all of the gain as New York Source income based on its 100% BAP. For 2010 and 2011, the Division determined that Petitioner was also obligated to file and report the installment payments as New York source income based on its 100% BAP.

ESPI, as described by a former VP, was a “service provider that facilitated transactions between customers and public utility companies by assisting customers, most of whom were located in New York, in taking advantage of governmental incentives that had become available in connection with deregulation of the utility industry.” ESPI’s employees were located in Massachusetts, and, from a call center, they would call potential customers in hopes of signing them up as their own customers. ESPI then would sell them electricity, which it purchased from an energy pool. Its price for electricity was based on the cost to purchase the electricity from the pool, along with certain available price reduction incentives. However, the customers did not pay ESPI directly, rather, they would pay the public utility, and the utility would pay ESPI, and then ESPI would pay the energy pool. 

First, Petitioner argued that the Notice of Deficiency should be cancelled because the retroactive application of the statute violated the Due Process Clause. Petitioner alleged that he reasonably relied on Baum that the transaction would not result in New York source income.  The ALJ then performed a review of the relevant cases involving a nonresident’s treatment of gain from the sale of stock in a New York S-corporation where there was a IRC § 338(h)(10) election, including Baum, Matter of Mintz, Matter of Luizza, and Caprio v. New York State Dep’t. of Taxation & Fin. The ALJ made certain factual analogies and distinctions.

However, he noted, it was in response to Baum and Mintz, that Tax Law § 632(a) (2) was amended, as it did not specifically explain how a New York nonresident’s gain from the sale of stock in an S corporation would be treated when it was a deemed sale of assets under IRC § 338(h) (10). In both Caprio and Luizza, the Petitioners took issue with the retroactive application, but both opinions upheld the retroactive application.

The ALJ next applied a balancing test to determine whether the retroactive application as applied here violated due process. The balancing test employed three factors: (1) “the taxpayer’s forewarning of a change in the legislation and the reasonableness of [the taxpayer’s] reliance on the old law;” (2) “the length of the retroactive period;” and (3) “the public purpose for the retroactive application.” (Matter of Replan Dev., 70 NY2d at 456).

Ultimately, the ALJ determined that the Petitioner had been forewarned of a change and that Petitioner’s reliance on Baum was not reasonable. The ALJ noted that in light of the decisions in Caprio, Burton, and Luizza, it is settled law that the amended law can be applied retroactively without finding a due process violation. As such, Petitioner’s 2009 tax return was not properly filed. However, Petitioner acknowledged this and argued that there was still a violation as applied to him, and that unlike those cases, the transaction took place after Baum, and that this tipped the scale. The ALJ stated that this argument ignores the Caprio court’s recognition and acceptance that the amended law served to confirm and clarify the Department’s longstanding interpretation and application of the law. The ALJ also noted that the facts here are almost identical to that of Luizza, except for the addition of Baum.

The Petitioner argued that the only relevant date was the date of the sale, but the ALJ noted that the date of his 2009, 2010 and 2011 filings are also relevant. As such, as of the date of the filings, his position was inconsistent with the amended law that was passed before the filing dates.

The ALJ then goes on to say that, “By making the 2010 Amendments retroactive, the Legislature evinced both its clarifying and corrective aims. In doing so, it drew no distinction between transactions that predated the Tribunal’s decision in Baum, such as was the case in Luizza, or postdated such decision, notwithstanding that some taxpayers could claim, as is the case in this matter, to have relied on Baum. The Legislature did not limit the retroactive reach of the 2010 Amendments by any reference to the Baum decision, but rather extended retroactivity to all open years upon the foregoing clarifying and correcting justification bases. Thus, the Legislature’s intended sweep of retroactivity included those who could have, and as is made evident by this case, in fact did rely on Baum.” This is where I disagree. If the Legislature wanted to overrule Baum, it should have just said so. The ALJ is using the lack of reference as a point for the Division, but I see it the other way. If a decision is clearly not the intent of the legislature, it, or at least the Division, should clearly say so in order to avoid confusing both taxpayers and accountants.

With regard to the other two factors, the ALJ also found that Petitioner had not met either the “length of retroactive period” or “the public purpose for the retroactive application” requirements. Relying on Caprio and Luizza, the ALJ found that there was a legitimate public interest in curing the consequences of Baum, including avoiding unintended refunds, confusion in filing, and protracted litigation (yeah, that clearly happened). Nor did the ALJ find there to be any issue with the length of the retroactive period as the amendments were consistent with “the Division’s longstanding view and interpretation of the relevant statute.”

Second, Petitioner argued that ESPI’s BAP should be zero and that its receipts should be “receipts from services” as it only facilitates transactions, and does not provide “tangible personal property or electricity” to its customers.  However, the ALJ found that this argument was defeated by the energy purchase contacts between ESPI and the energy pool, the testimony at the hearing, and the fact that ESPI always self-apportioned 100% of its receipts to New York and nowhere else. As such, the ALJ found that ESPI was an energy supplier, and not merely a facilitator, notwithstanding the way that ESPI’s customers were actually billed. Even if the receipts were “other business receipts” as the Petitioner argued, they would be sourced to where they were earned, which would be on the sale of electricity to ESPI’s customers in New York, where it self-apportioned 100% of its receipts.

Finally, the Petitioner also requested a penalty abatement for 2010 and 2011. The ALJ denied this as well because the accounting firm that Petitioner utilized, which filed all of his relevant returns, also filed ESPI’s final return and failed to respond “yes” to the IRC § 338(h)(10) election question. The ALJ found that this raised questions of full disclosure and the credibility of the Petitioner’s and his tax advisor’s reliance on Baum.

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