C’mon New York, Give Me Some Credit
January 27, 2020
The State of NY Tax
Last week, New York’s Governor Cuomo released his proposed budget for the State’s 2021 fiscal year. After criticizing the Federal limitation on itemized deductions for state and local taxes,[i] the Governor commented on the “out-migration” from the State of many high-earning New Yorkers, thus implying a causal connection between the two developments.[ii]
According to the Governor, “[t]hese migration patterns present a significant risk to the progressive government New Yorkers have voted for.”
Cuomo acknowledged that nearly 50-percent of the State’s personal income tax revenue comes from the top 1-percent of its individual taxpayers,[iii] and that almost 25-percent comes from the top 0.10-percent.[iv]
Interestingly, the Governor did not characterize New York’s personal income tax as a “progressive” tax.
Coincidentally, the Governor’s statements, along with the details of his budget proposal, followed the release by the IRS, a few weeks earlier, of data which indicated that New York suffered a loss of approximately $9.6 billion in adjusted gross income during the 2017-2018 period as a result of the out-migration to which the Governor referred.[v]
In response to these challenges to the State’s fiscal well-being, did the Governor announce a reduction in the State’s top personal income tax rate of 8.82-percent in order to stem the out-migration?[vi] Nope. Did he propose to cut New York’s estate tax[vii] rate of 16-percent? No, again.
How, then, will New York address this exodus of not-insignificant revenue generating New Yorkers? For the moment, it does not appear that any legislative solution is being considered. On what, then, is the State relying?
There Is No Escape[viii]
It may not be too farfetched to say that, at least in the short-term, New York will rely in part on its ability: (a) to identify those individuals who claim (i) to have “left” New York, or (ii) not to be resident in the State; (b) to examine the income tax returns filed by these individuals; and (c) to establish that these individuals (i) continue to be domiciled in New York, or (ii) are statutory residents of the State.
Either way, the individual whom the State successfully determines is a New York domiciliary or statutory resident will be subject to New York income tax on their worldwide income.
Sooner or Later
It is a given that the State will audit any high-income taxpayer who moves out of the State; in that case, the State’s goal will be to establish that the individual remains a New York domiciliary or – if they have retained some interest in New York real property – a statutory resident of the State.
It is also a given that any high-earning non-domiciliary with a New York-situs business will be audited if they also have any interest in New York real property; in that case, the State will seek to establish the individual as a statutory resident.
“A given, Lou? Really? Prone to hyperbole, are we?” No.
Consider this: the Department of Taxation and Finance[ix] has almost 300 well-trained agents assigned to residency audits; over the last few years, they have conducted approximately 3,000 residency audits every year; they have been successful in more than half their cases in defeating claims by taxpayers that they were no longer New York residents;[x] and they have collected more than $1 billion.[xi]
Looking for Signs
When an individual taxpayer who has been identifying themselves as a resident of New York on the personal income tax returns[xii] they have been filing with the State suddenly stops filing such returns, or begins filing a non-resident and part-year resident return,[xiii] the Department will be alerted to the potential for “re-claiming” the individual as a domiciliary taxpayer.
If the non-resident return filed by the taxpayer indicates that the taxpayer owns or rents real property in the State, the Department is made aware that the individual may be a statutory resident of the State.
Even in death, the estate of a deceased nonresident or former resident with assets located in New York may be exposed to resident income taxes that the Department may assert should have been paid by the decedent while they were alive.[xiv]
Prepare for Audit
In light of the many touchpoints by which the Department may become aware of an issue relating to an individual’s tax status vis-à-vis New York, it will behoove the taxpayer to assume that the State will question their residency.
Forewarned of an audit, the taxpayer should take care to familiarize themselves with the State’s residency rules. Before implementing any plans they may have formulated for leaving the State, the taxpayer and their advisers should consider each of the principal domicile factors identified by the Department,[xv] and they should honestly assess their current plan’s chances for success. If such plan needs to be modified in order to have a reasonable chance of withstanding the Department’s scrutiny, will the taxpayer be willing to live with the necessary revisions, or will these present so onerous a burden or inconvenience[xvi] that the taxpayer decides not to attempt an escape from New York?
That being said, some cases will be easier than others, and some clients will be more difficult than others.
Regardless of the situation, the potentially-former New Yorker has to be informed of the near certainty of being audited by the Department, of the time, effort, and not-insignificant legal and accounting costs that will be incurred in defending the taxpayer’s position, and the amount of income tax and penalties for which the taxpayer may be liable to the State.[xvii]
Similarly, the non-domiciliary who has a New York business and who either owns, rents, or otherwise maintains a residential property in New York[xviii], or who is thinking of acquiring such a property,[xix] must be informed of the risks presented, including the possibility of having the same items of income being taxed both by the taxpayer’s state of domicile[xx] and by New York.
More to the point, the New York statutory resident must recognize that, in determining their New York income tax liability, they may not be entitled to a New York personal income tax credit for taxes they have paid to the state in which they are domiciled. A recent case serves as a reminder.[xxi]
Two Tax Residences
Taxpayer worked for a New York hedge fund manager, and was domiciled in Connecticut, from 2010 through 2013 (the “Tax Years”).
Taxpayer was present in New York for more than 183 days for each of the Tax Years. Also during these years, Taxpayer owned a second home in New York[xxii] which was suitable and available for use for 12 months a year.
Taxpayer filed New York nonresident income tax returns[xxiii] for the Tax Years, and filed Connecticut resident income tax returns for the same period.
The Department audited Taxpayer’s New York returns, concluded that Taxpayer was a statutory resident for each of the Tax Years, and proposed assessments for each year. Among the items of income the Department included in Taxpayer’s gross income, for purposes of determining their New York tax liability, were capital gains from the sale of securities.
In order to minimize the accrual of interest for any potential tax liability, Taxpayer paid the tax and accrued interest that would be due if they were subject to tax as residents of New York State, but without claiming a credit for taxes paid to Connecticut. Thus, when the tax was finally assessed, Taxpayer had a balance due of zero.
Taxpayer then filed amended New York State resident income tax returns[xxiv] for the Tax Years, claiming credits for taxes paid to Connecticut for such tax years, and also claiming the resulting refunds of New York tax.
Unfortunately for Taxpayer, the Department denied the claimed resident credits, and the consequent refunds based thereon. In response, Taxpayer petitioned to the Division of Tax Appeals (the “DTA”) for relief.
Credit Against New York Tax
New York’s Tax Law defines a resident individual as one who is either domiciled in the State,[xxv] or who is not domiciled in the State but maintains a permanent place of abode in the State and who spends in the aggregate more than one hundred eighty-three days of the taxable year in the State.[xxvi]
The Department did not dispute that Taxpayer was domiciled in Connecticut, and was taxable by Connecticut as such. However, the Department also successfully established that Taxpayer was taxable as a statutory resident of New York.
The classification as a resident was significant, the DTA explained, because New York residents are, generally, subject to tax on their income from all sources.[xxvii] By contrast, nonresidents are subject to New York tax only to the extent their income is derived from or connected with New York sources.[xxviii]
According to the DTA, if an individual is subject to tax as a New York resident, there is nonetheless a credit available for income taxes paid to other states upon income derived therefrom. This resident credit[xxix] provides, in relevant part, that: “[a] resident shall be allowed a credit against the tax otherwise due under [the New York income tax law] for any income tax imposed for the taxable year by another state . . . upon income both derived therefrom and subject to tax under [the New York income tax law]”.
In other words, in order for a resident taxpayer to qualify for the New York resident credit, the tax imposed by the other state must be on income derived by the taxpayer in such state:[xxx]
“The resident credit against ordinary tax is allowable for income tax imposed by another jurisdiction upon compensation for personal services performed in the other jurisdiction, income from a business, trade or profession carried on in the other jurisdiction, and income from real or tangible personal property situated in the other jurisdiction.”
In the present case, Taxpayer sought a resident credit from New York for taxes paid to Connecticut on intangible income – specifically on gains from the sale of securities – arguing that such gains were derived from Connecticut.
Taxpayer admitted that the income in question resulted from the sale of intangible assets, and that such intangible assets were not employed in a business, trade, profession, or occupation carried on in Connecticut. Taxpayer maintained, however, that intangible personal property is deemed to be located at the domicile of its owner (i.e., Connecticut), so the income or gain therefrom must likewise be considered derived from or connected with Connecticut, and thus was eligible for the credit at issue.[xxxi]
The DTA rejected Taxpayer’s argument. In doing so, it relied upon an earlier case,[xxxii] involving substantially the same circumstances as Taxpayer’s, in which the State’s Court of Appeals[xxxiii] held that intangible investment income that was subjected to tax by a neighboring state, on the basis that its recipient was a domiciliary and resident of that state, and also subjected to tax by New York on the basis that its recipient was a statutory resident of New York, did not result in constitutionally impermissible double taxation. The Court explained that the income at issue in that earlier case was not “out-of-state income,” but was “intangible income,” which “has no identifiable situs,” “is not derived . . . from the taxpayer’s efforts in any jurisdiction outside of New York, and cannot be traced to any jurisdiction outside of New York,” and “is subject to taxation by New York as the State of residence.”
In Taxpayer’s case, the securities giving rise to the capital gain income in question were not employed in a business, trade, profession or occupation carried on in New York. Rather, the gain was subject to New York tax based solely upon Taxpayer’s status as a statutory resident of New York – the physical location of the intangible property was inconsequential to New York’s imposition of the tax. At the same time, New York was not able to determine that the gain from the sale of the securities was derived from or connected to any location for purposes of allowing the resident credit.
Finally, the DTA pointed to another recent New York case[xxxiv] that examined the same factual situation as was presented here. It explained that the income subject to tax in that case was intangible investment income, not business income that was traceable to an out-of-state source. According to the DTA, New York tax law does not permit double taxation of out-of-state business income – a situs-based tax – and provides a resident credit for taxes paid to another state with respect to such income. This matter, however, involved an individual who faced double taxation on intangible investment income based on their status as a domiciliary of Connecticut and statutory resident of New York, and not a situs-based tax on business income.
Thus, the Taxpayer’s petition was denied.
You Can’t Have It All[xxxv]
One would have to be delusional to believe that they can have their cake and eat it too.[xxxvi] Therefore, it must be that many taxpayers who are domiciled outside New York – like the Taxpayer, above – who have a New York business, and who maintain an apartment or other real property in the State for personal use, are delusional; either that, or they are selflessly committed to helping Governor Cuomo staunch the flow of tax dollars resulting from the out-migration of their better-advised, or more rational, business colleagues.[xxxvii]
Even those “former” New Yorkers who avoid statutory residence by keeping scrupulous records of their whereabouts will often fail to establish that they have abandoned New York as their domicile, usually because they retain ownership of their historical New York abode, or continue to manage their New York business, or spend a significant number of days in the State. Notwithstanding the presence of the foregoing factors, these individuals are usually surprised when New York succeeds in taxing them as residents for the year in which they claimed to have left New York, and perhaps for some of the subsequent years as well.
“Why, I have an apartment in Florida,[xxxviii] filed a Florida declaration of domicile, vote in Florida, use my Florida address on my tax returns, revised my will under Florida law, registered my car and boat in Florida, use a Florida doctor, joined a golf club in Florida, applied and qualified for the Florida homestead exemption, and moved my accounts to a Florida financial institution. What else am I supposed to do?”
Actually move to Florida. The foregoing “indicia of residence” – which, frankly, are easy to “establish” – will be disregarded if the taxpayer still spends close to half the year in their old New York home, especially if they are still involved in the management of their New York business.[xxxix]
These last three New York-related items – time spent, home, and active business – comprise three of the five principal factors that New York considers in determining an individual’s domicile. A taxpayer who is determined to abandon their New York domicile will quickly realize that cutting, or greatly reducing, these connections to the State will require some effort and sacrifice on their part – there is no other way, however, especially when one considers what may be described as the alacrity with which the Department pursues “out-migrants.”
[i] Added to the Code by the Tax Cuts and Jobs Act, and effective for tax years beginning after 2017. The limitation is scheduled to expire after 2025 – but who knows what 2021 will bring.
[ii] Basically, “the Feds are to blame.”
[iii] Presumably, by adjusted gross income.
At the national level, the top 1-percent pay almost 40-percent of the Federal personal income taxes collected.
[iv] Comprised of approximately 9,000 individual taxpayers. At the Federal level, the top 0.10-percent account for approximately 27-percent of the personal income taxes collected.
[v] By contrast, Florida netted $16 billion during the same period. The State has no income tax and no estate tax.
[vi] New York City residents can add another 3.876-percent, for a combined State and City rate of 12.7-percent.
[vii] New York’s exclusion amount is $5.85 million for 2020. Although the State does not have a gift tax, it should be noted that taxable gifts made by residents before 2026, and within three years of death, are added back to the resident’s estate.
[viii] Darth Vader to Luke in The Empire Strikes Back: “There is no escape. Don’t make me destroy you.”
[ix] The “Department.”
[x] Please note that the taxpayer has the burden of proving (a)(i) that they did not have a permanent place of abode in New York or, if they did, (ii) that they did not spend more than 183 days in the State, and (b)(i) that they abandoned New York as their domicile and (ii) established a new domicile elsewhere.
Where the taxpayer has successfully carried their burden, and the State subsequently claims that the taxpayer has re-established domicile in New York, the burden is on the State to prove its claim.
[xii] Form IT-201.
[xiii] On Form IT-203. This return asks the taxpayer to identify the last day they lived in New York. The form also asks whether the taxpayer or their spouse maintained living quarters in New York during the tax year for which the return is being filed. Too many times have I seen this question go unanswered or completed “inaccurately”. No good will come of that.
[xiv] Form ET-141 “New York State Estate Tax Domicile Affidavit,” which must be completed if it is claimed that the decedent was not domiciled in New York at the time of death. The form asks if the decedent ever lived in New York and when. It also asks whether the decedent ever owned an interest in New York real property. The form must be filed with the ET-706 for the decedent’s estate. It is also filed with a petition for ancillary probate of a nonresident decedent’s estate.
[xv] Home, Time Spent, Active Business, Near and Dear Items, and Family.
[xvi] Those who can afford to maintain their New York house will usually do so. What’s more, they will refuse to lease it to others.
Then there are those who cannot step far enough away from their business.
[xvii] Not to mention the interest thereon.
[xviii] Or whose business owns or rents such a property.
[xix] Either directly or through their business.
[xx] Practically speaking, we’re talking about Connecticut, Massachusetts, New Jersey, Pennsylvania and Vermont. This is not an exhaustive list, of course – we’ve all heard stories about folks from other states who stay in New York for extended periods for business.
[xxi] In re Ressekoff et al., N.Y. Div. Tax App., No. 827740, 827741, 12/19/19.
[xxii] Shelter Island, located between the North and South Forks of eastern Long Island, and approximately 100 miles from each of Manhattan and Greenwich, CT (Taxpayer’s home).
See https://www.taxlawforchb.com/2019/09/statutory-residence-in-ny-the-permanent-place-of-abode-test-is-in-need-of-repair/ for a critique of the “permanent place of abode” test.
[xxiii] Form IT-203.
[xxiv] Form IT-201.
[xxv] NY Tax Law Sec. 605(b)(1)(A).
[xxvi] NY Tax Law Sec. 605(b)(1)(B). So-called “statutory residence.”
[xxvii] NY Tax Law Sec. 612(a).
[xxviii] NY Tax Law Sec. 631.
[xxix] NY Tax Law Sec. 620(a).
[xxx] NY Tax Law Sec. 620(a); 20 NYCRR 120.1(a)(2); 20 NYCRR 120.4(d).
[xxxi] Taxpayer premised their argument on Sec. 3, Art. 16 of the New York State Constitution, which provides as follows:
“Moneys, credits, securities and other intangible personal property within the state not employed in carrying on any business therein by the owner shall be deemed to be located at the domicile of the owner for purposes of taxation, . . .”
[xxxii] Matter of Tamagni, 91 NY2d 530 (1998); cert denied 525 U.S. 931 (1998).
[xxxiii] New York’s highest court.
[xxxv] At least not without a lot of planning, some sacrifice, and a bit of luck.
[xxxvi] I confess, someone who knows that I am idiom-challenged gave me a book of idioms in order to spare readers of this blog the effort of trying to figure out what I was trying to say.
[xxxvii] Why volunteer for statutory residence?
[xxxviii] Feel free to substitute any other lower-tax jurisdiction. Choose any climate you’d like.
[xxxix] Even management from afar presents an issue.
Then, of course, you have the situation of the tax return preparer who describes the taxpayer’s share of the losses or income from the business as “nonpassive” on Part II of Sch. E of their IRS Form 1040, and on their IRS Form 8960, Net Investment Income Tax.