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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.  

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TiNY Report for May 28, 2020 (reporting on DTA cases issued May 21)

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Now we’re talking! There are two Tribunal decisions and four ALJ Determinations this week. Yeah, there are three timies and one other dismissal in the bunch, but one of the timies is a Tribunal reversal of an ALJ dismissal, and there are two cases that have some pretty involved substantive legal analysis. And, on balance, it was a pretty good day for taxpayers. Unfortunately, due to the complexity of the cases, our summaries are a bit more long-winded than usual.


Matter of Marrero; Division’s Rep.: Ellen Krejci; Petitioner’s Rep.: Ariele Doolittle; Article 22 (by Chris Doyle)

This case is being litigated by our firm, and the case is still in play, so I am “Joe-Fridaying” this summary.

We reported on the ALJ’s dismissal of the case (on timeliness grounds) here, and we didn’t say too darn much. So here we’ll give some additional background. The DTA issued a Notice of Intent to Dismiss. The ALJ ordered the NOITD withdrawn because one of the affidavits (i.e. the “Koslow Affidavit”) describing the mailing process used stated that the Notice was mailed on August 22, 2016, while all the other documents indicated an October 20, 2016, mailing date (oops). Undeterred, the Division made a motion to dismiss (on timeliness grounds), which the ALJ granted even though Petitioner submitted USPS tracking information that seemingly contradicted some of the mailing proof provided by the Division, and there had never been any explanation made for the inconsistent Koslow Affidavit. Petitioner took an exception to the ALJ’s determination arguing (among other points) that the contradictory information in the Koslow Affidavit and the USPS tracking information raised a question of fact, thereby making a summary dismissal of the matter inappropriate.

The Tribunal agreed with Petitioner: “Here, the Division’s employee affidavits are contradictory and the Koslow affidavit does not accurately describe the CMR. Hence, there is at least a doubt as to the material and triable issue of whether the Division’s standard mailing procedure was followed in this case . . . .”  Accordingly, the Tribunal dismissed the Division’s motion and remanded the matter back to the ALJ “for further proceedings on the issue of the timeliness of the petition, and if determined to be appropriate, a determination on the merits.”

Matter of Lewis; Division’s Rep.: Michele Milavec; Petitioner’s Rep.: Jennifer Boll; Article 22 (by Chris Doyle)

Those of you who were early adopters of TiNY know that one of my hot-button issues is retroactively-effective anti-taxpayer legislation. I just don’t see why taxpayers should be punished for the Legislature’s inability to, in the first instance, pass laws that work as intended. I suppose I am willing to make exceptions for promptly-passed technical corrections to newer enactments and revenue-raising in response to acts of terrorism, pandemics, and such. But absent those types of exigent circumstances, the normal course of events should be: 1. The Legislature enacts a tax law; 2. taxpayers (or their clever advisors) discover that the law does not always deliver the results intended by the Legislature and use the explicit language of the statute to the detriment of the State’s fisc; 3. the Tax Department discovers the unintended-consequences of the ill-framed law, and the Commissioner recommends amendments to the Governor (perhaps through his or her Budget Director) or the Chairs of the Assembly Ways and Means or Senate Finance Committees to cure the perceived infirmities of the original law; and 4. the Legislature promptly, but after due deliberation, adopts forward-looking corrective legislation. Any approach that allows ordinary-course-of-business-anti-taxpayer-retroactively-effective legislation is, in my view, both unfair and un-American. That’s right, un-American! I’m pretty sure that the Founding Fathers who thought ex post facto laws were so despicable that a prohibition against them should be included twice (!) in the Constitution (Art. 1, § 9 and Art. 1 § 10) would be mightily offended by the concept of routine retroactively-effective tax laws.

With the above rant as a back-drop, I am pleased to report the Tribunal held that, as applied to this particular Petitioner, the retroactive application of an amendment to the Tax Law permitting taxation of nonresidents selling stock of S corporations where the parties make IRC § 338(h)(10) elections was unconstitutional. Rather than recreating the wheel, I am going to cut and paste from our summary of the ALJ determination, which you can find here.

Petitioner was a nonresident of New York from 2009 through 2011. 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”), under which the ESPI shareholders, including Petitioner, sold 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 with a step up in basis of the assets in the corporation purchased. Before agreeing to the election, Petitioner consulted with his accountant regarding the tax consequences of the sale structured with an IRC § 338(h)(10) election. Petitioner’s accountant advised him that under Matter of Baum (Tax Appeals Tribunal, February 12, 2009), the transaction would be treated for New York purposes as the sale of an intangible non-business asset and, as a nonresident, he would not be subject to New York tax. As consideration for the transaction, Petitioner received both cash and an installment obligation, which qualified for treatment under IRC § 453(h)(1).

ESPI filed a franchise tax return on August 14, 2010, for the period up to the sale on June 30, 2009, where it reported a “deemed sale” capital gain all of which was apportioned to New York based on a 100% New York business allocation percentage (“BAP”). Since its incorporation, 100% of ESPI’s receipts had been apportioned to New York on its franchise tax filings.

Petitioner filed his 2009 New York State nonresident return on October 14, 2010. He reported his share of the capital gain from the deemed asset sale and also a subtraction removing 100% of the gain in reliance on the advice he had previously received from his accountant. Petitioner did not file a return or allocate income to New York for the income that he recognized from the installment payment during 2010 and 2011.

Unbeknownst to Petitioner, Tax Law § 632(a)(2) was amended on August 11, 2010 (i.e. more than a year after the stock sale, but before Petitioner filed his return), to provide that a nonresident S corporation shareholder must treat the sale of stock under an IRC § 338(h) (10) election as a sale of assets and source the gain to New York in accordance with the corporation’s BAP. The Division issued a memorandum on August 31, 2010, providing guidance on the change and noted that it applied retroactively to all tax years beginning on and after January 1, 2007. Petitioner’s accountant testified that he was unaware of both the change to the law and the guidance at the time Petitioner’s 2009 return was prepared.

The Division conducted a field audit of ESPI’s final return and the income reported by its shareholders. The Division determined that the IRC § 338(h)(10) election resulted in a deemed asset sale, and that the gain from the deemed asset sale 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 the corporation’s 100% BAP.

Petitioner argued that the Notice of Deficiency should be cancelled because the retroactive application of the statute violated the Due Process Clause. The ALJ found that each of three cases decided prior to Petitioner’s case: Matter of Burton, Matter of Luizza, and Caprio v. New York State Dep’t. of Taxation & Fin, found that the retroactive application of the law change did not offend constitutional due process protections. The ALJ next applied the Replan balancing test to determine whether the retroactive application violated due process. The balancing test employs three prongs: (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). The ALJ determined that each of the prongs favored a finding that the retroactive application of the amendment was permissible.

The Tribunal applied the same analysis and came to the opposite result.

Contrary to the ALJ, the Tribunal found that the forewarning/reliance factor fell in favor of Petitioner. Unlike the other cases decided against the taxpayer, Petitioner had relied specifically on the Tribunal’s decision in Baum and not simply on a legal analysis similar to that approved by Baum. This seemed to be a critical distinction for the Tribunal: “The Tribunal’s decision in Baum ‘finally and irrevocably’ decided all the issues in that case (Tax Law § 2016). Hence, the law at the time the transactions at issue were negotiated and concluded was that the deemed sale of assets pursuant to an IRC (26 USC) § 338 (h) (10) election did not change the nature of the transaction from that of a stock sale . . . (emphasis added). One senses that the Tribunal might say that it is not reasonable to rely on a legal position that is disputed by the Tax Department even if the position has been approved by your lawyer, your accountant, and an ALJ, but it is reasonable to rely on a Tribunal decision. And while that seems harsh, I get where the Tribunal is coming from . . . after all, the Tax Law explicitly states that ALJ determinations are not to be relied on. The Tribunal also found that Petitioner was not forewarned of the change in the Tax Law because, at the time Petitioner negotiated and entered into the agreement to sell his shares, there was no notice of the law change.

The Tribunal concurred with the ALJ that the length of the period of retroactivity favored a finding of constitutionality.  But, it seems like Petitioner didn’t present an argument on this point.

As for the public purpose prong, the Tribunal found it also tilted in favor of Petitioner. And I love the Tribunal’s reasoning here: “[T]he finality of Tribunal decisions as a public policy must be weighed against the Legislature’s acceptable public purpose of correcting what it considers to be a mistake of the Tribunal. Under the specific facts of this case, we find that the integrity of the finality of Tribunal decisions expressed by Tax Law § 2016 as a public policy prevails over the Legislature’s public purpose in correcting a mistake of this Tribunal.”

As the lawyer who litigated Baum I feel compelled to observe that the Tribunal did not make a mistake in that case. Further, I expect that the self-serving “Legislative Purpose” language that accompanied the retroactive law change was simply the Tax Department (or the Legislature) trying to deflect blame back to the Tribunal for the Tax Department’s always-wrong (albeit long-standing) interpretation of the original statute or the Legislature’s inability to initially draft the original statute to obtain the desired result or to correct it when it was obvious that there was a competing reasonable interpretation.

Finding that two-out-of-three equities balanced against retroactive application of the law change to Petitioner, the Tribunal ruled that retroactive application violated due process.


Matter of Carlson; Judge: Law; Division’s Rep: Stephanie Scalzo; Taxpayer’s Rep: Gary Kanaley; Articles 28 and 29 (by Joseph Endres)

This is a follow-up to a pretty convoluted sales tax case that we previously analyzed here. In a previous order, the ALJ ruled on competing motions for summary determination. The ALJ granted the Division’s motion on two issues (whether the Division properly furnished Petitioner with the applicable Notices of Determination by electronic means, and whether Petitioner could be held personally liable for sales tax liabilities that had been assumed by the purchasing entity in an asset sale), but determined that there were triable issues of fact on the remaining issues: whether any consideration changed hands during the asset sales and the proper valuation of the assets transferred. This determination addresses these final issues.

A bulk sale purchaser’s liability is limited to the greater of the purchase price or the fair market value of the business assets sold or transferred. Petitioner asserted both that no consideration changed hands during the asset sales (the selling entities were owned by Petitioner’s father), and that the fair market value of the assets was zero. The ALJ rejected these arguments primarily due to a lack of evidence. The ALJ noted that Petitioner neither testified at the hearing, nor submitted any contracts to detail the asset sales. According to the ALJ, there was nothing in the record that established how the business assets were transferred. Thus, Petitioner failed to prove that there was no consideration. And, in fact, there was contradictory evidence in the record in the form of Petitioner’s claimed deductions for amortized goodwill.

Petitioner also argued that the fair market value of the assets transferred was zero because the assets were encumbered by federal tax liens. As a general matter, the optics of using other tax deficiencies to avoid the tax liabilities under review isn’t a great look. But even if the ALJ accepted that the federal liens effectively encumbered the property, Petitioner failed to establish the fair market value of the property at the time of transfer. The final nail in the coffin was the conflicting evidence contained in the late-filed bulk sales notifications wherein Petitioner assigned these assets significant value.

Given the facts found, this could be charitably described as an “uphill battle” for Petitioner. Ultimately the Division went three-for-three on the issues decided by the ALJ. Take note that asset purchases have to be handled very carefully in most states or the purchaser can be saddled with a significant latent sales tax liability. This is true even when the transaction is between family members.

Matter of Figliolia; Judge: Gardiner; Division’s Rep: Elizabeth Lyons; Taxpayer’s Rep: Michael Gasi; Articles 28 and 29 (by Chris Doyle)

Judge Gardiner found that the Division proved both its standard mailing practices and that they were followed when it mailed the notice at issue to Petitioner’s last known address on July 6, 2017. Petitioner’s petition filed on July 20, 2019, was therefore pretty late.  Accordingly, the Judge granted the Division’s motion to dismiss the petition.

Matter of Garcia; Judge: Gardiner; Division’s Rep: Elizabeth Lyons; Taxpayer’s Rep: Michael Gasi; Articles 28 and 29 (by Chris Doyle)

Judge Gardiner found that the Division proved both its standard mailing practices and that they were followed when it mailed the notice at issue to Petitioner’s last known address on July 6, 2017. Petitioner’s petition filed on July 20, 2019, was therefore pretty late.  Accordingly, the Judge granted the Division’s motion to dismiss the petition.

Matter of Rhodes; Judge: Galliher; Division’s Rep: Michael Trajbar; Taxpayer’s Rep: pro se; Article 22 (by Chris Doyle)

Following notification by the IRS to the Division that Petitioner’s 2015 federal AGI was being increased, the Division issued to Petitioner a Notice of Additional Tax Due (NoATD) of $7,206. Petitioner filed a petition challenging the conclusions reflected in the NoATD. The Division filed a motion to dismiss, which the Judge granted. Tax Law § 173-a specifically states that a taxpayer shall not be entitled to a hearing before the Division of Tax Appeals to challenge, among other documents, an NoATD.

While I totally agree with the Judge’s conclusion in this matter, I worry that a strict adherence to Tax Law § 173-a would prohibit a challenge to an NoATD issued in error. We have, for instance, represented clients that received NoATDs claiming that they should have filed as residents and not as non-residents. An NoATD is not supposed to be issued with respect to that type of determination.

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