One Day . . .
It is the dream of so many New York business owners: build a successful business, get your kids involved in the business, transition the operation, management and – eventually – the ownership of the business to the kids, move to Florida (or another warm, tax-friendly venue), successfully fend off New York’s inevitable challenge to your claimed change of domicile, stay involved in the business, pay no New York income tax on any income derived from the business, and pass away – yes, that is a morbid thing to say, but “death and taxes” – happy in the knowledge that your estate will not be subject to New York’s estate tax. Not much to ask for, right?

Earlier posts have described the factors that New York considers in determining an individual’s domicile or residence. See, e.g., “New York Business, the Federal Tax Return, and New York Domicile.”

Escape from NY . . .
The resolution of a taxpayer’s resident status vis-à-vis New York is of paramount importance to the taxpayer.

A New York State resident taxpayer is responsible for reporting and paying New York State personal income tax on income from all sources regardless of where the income is generated, or the nature of the income.

A nonresident taxpayer, however, is given the opportunity to allocate income, reporting to New York State only that income actually generated in New York. In addition, the nonresident need only report to New York income from intangibles which are attributable to a business, trade or profession carried on in the State.

Thus, significant benefits may be derived from filing as a nonresident.

. . . Not Entirely
Because a taxpayer’s New York source income will remain subject to New York’s tax jurisdiction even where the taxpayer has successfully established his or her status as a non-resident, it behooves the taxpayer to become familiar with New York’s sourcing rules. A nonresident taxpayer’s New York income will include the taxpayer’s income from:
• real or tangible personal property located in New York State, (including certain gains from the sale or exchange of an interest in an entity that owns real property in New York;
• services performed in New York;
• a business, trade, profession, or occupation carried on in New York;
• his or her distributive share of New York partnership income or gain;
• his or her share of New York estate or trust income or gain;
• any income he or she received related to a business, trade, profession, or occupation previously carried on in New York State, including but not limited to covenants not to compete and termination agreements; and
• a New York S corporation in which he or she is a shareholder.
Some of these source rules are more easily applied than others. In those cases where the facts are disputed, the taxpayer can count on New York to assert the requisite nexus.

In a recent decision, an Administrative Law Judge (“ALJ”) rejected New York’s somewhat creative attempt to tax a Florida resident’s consulting fees. [Carmelo and Marianna Giuffre, DTA NO. 826168)

Unfortunately, the ruling is light on facts and, so, leaves several questions unanswered.

Father Knows Best?
The Taxpayer resided and was domiciled in Florida during the year at issue. He was employed by Consulting LLC (Consulting). Consulting was a Florida limited liability company with its principal place of business located in Florida. Taxpayer was its sole member.

Prior to his employment by Consulting, Taxpayer was the president Family Corp., located in New York City. Family Corp. was a family-owned company that operated Business in New York and New Jersey. During the year at issue, Taxpayer’s sons and nephew owned and operated Business.

Consulting provided “management consulting” services for Business. Taxpayer rendered these services as an employee of Consulting, from its offices in Florida.

By agreement between Consulting and Family Corp., Consulting agreed to perform consulting work for Family Corp. The agreement explicitly provided that the consulting services “shall be provided via telephone or electronically” and that it is not anticipated that the consulting services would require any Consulting employee to travel to New York City or any of Business’s other locations.

Under the agreement, Consulting acted in an advisory role, and neither it nor Taxpayer was involved in the day-to-day management or decision-making process of Family Corp. The consulting services were performed, and the business of Consulting was conducted, from its Florida office. Taxpayer was paid an annual salary for his services by Consulting.

Taxpayer visited New York during the year at issue. The primary purpose of his visits were personal in nature. He visited family members who resided in the New York metropolitan area. Although he also visited the Business locations owned by Family Corp., these visits also were personal in nature. Taxpayer did not maintain a desk or office in any of the locations. He was not involved in any daily operations of Business during the year at issue.

New York’s Unsuccessful Play
New York asserted that Taxpayer had New York source income for the year at issue, based upon an allocation formula that used the number of Business locations in New York, divided by the total number of Business locations, to arrive at an allocation of 10/17, or approximately 59%. The State then multiplied that percentage by the amount of Taxpayer’s salary from Consulting for that year to arrive at a net allocation of almost $800,000 as New York income.

The only issue before the ALJ was whether Taxpayer had income that was derived from, or connected to, New York sources; in other words, whether Taxpayer had rendered consulting services in New York during the year at issue. According to the ALJ, he did not.

The ALJ explained that New York imposes personal income tax on the income of nonresident individuals to the extent that their income is derived from or connected to New York sources (Tax Law Sec. 601[e][1] http://codes.findlaw.com/ny/tax-law/tax-sect-601.html ). A nonresident individual’s New York source income includes the net amount of items of income, gain, loss and deduction entering into the individual’s federal adjusted gross income derived from or connected with New York sources, including income attributable to a business, trade, profession or occupation carried on in New York (Tax Law Sec. 631[a][1]; [b][1][B]).

The ALJ also observed that, under New York’s tax regulations, a business, trade, profession or occupation is carried on in New York by a nonresident when:
“such nonresident occupies, has, maintains or operates desk space, an office, a shop, a store, a warehouse, a factory, an agency or other place where such nonresident’s affairs are systematically and regularly carried on, notwithstanding the occasional consummation of isolated transactions without New York. (This definition is not exclusive.) Business is carried on within New York if activities within New York in connection with the business are conducted in New York with a fair measure of permanency and continuity” (20 NYCRR 132.4[a][2]).

The ALJ found that Taxpayer was employed by Consulting, the offices of which were located in Florida. There was no evidence that Taxpayer or Consulting maintained any office or place of business within New York.

In fact, as noted above, the consulting agreement specifically stated that the services provided by Taxpayer would be rendered via telephone or electronically. The agreement did not mention any work space located in New York nor did it contemplate Taxpayer providing any services within New York.

The State relied on case law that involved nonresident individuals who were employed by a New York employer, yet for convenience worked both within and without the State. According to this precedent, a nonresident who performs services in New York, or has an office in New York, is allowed to avoid New York tax liability for services performed outside the State only if they are performed of necessity in the service of the employer. Where the out-of-State services are performed for the employee’s convenience, they generate New York tax liability.

The ALJ rejected the State’s reasoning, finding this case law distinguishable from the Taxpayer’s situation. Taxpayer was a nonresident who worked for a Florida company, not a New York employer. Moreover, Taxpayer did not render services in New York and he did not have an office in New York. As such, the “convenience of the employer” analogy was inapplicable to the Taxpayer.

Any Takeaways?
Although the ALJ’s opinion does not state that Taxpayer was previously a New York resident, it is safe to assume that he was domiciled in New York before moving to Florida.

However, query over what period of time, and how (gifts, sales, GRATs, etc.), Taxpayer transitioned the management of Business, and transferred the ownership of Family Corp., to his sons? This would have been an important consideration in establishing that Taxpayer was no longer domiciled in New York.

According to the opinion, Taxpayer was not involved in the day-to-day management or decision-making process of Family Corp., and his “management consulting” services were to be rendered “via telephone or electronically.” The ALJ based its opinion on these “facts.”

That being said, Family Corp. nevertheless must have determined that Taxpayer’s ongoing services were important to its continued well-being. After all, New York sought to tax $800,000 (or 59%) of Taxpayer’s salary from Consulting for just one tax year. What, then, was the nature of the advice given? (I should tell you, Business operated car dealerships.)

Query also why the ALJ does not seem to have asked whether the fee payable to Consulting (and thereby to Taxpayer) represented reasonable compensation for the services rendered? What if the fee was excessive? To what would the excess amount be attributed? A form of continuing equity participation in Business? Additional, deferred, purchase price for Taxpayer’s equity in Family Corp.? Payment for Taxpayer’s promise not to compete against Family Corp.? Deferred compensation for services rendered by Taxpayer to Family Corp. when he was still a New York resident?

I don’t believe that I would be going out on a limb to suggest that at least one of these elements was at play. In any case, each of these re-characterizations would have generated New York income.

Or was the Family Corp.’s payment made simply to accede to Taxpayer’s demand for some cash flow from “his” business (not an uncommon occurrence) and to thereby remain in Taxpayer’s good graces? After all, a “last” will and testament (or revocable trust) may be changed at any time before the testator’s (or grantor’s) death. (Back to death again.)

As always, it is best for related parties to treat with one another on an arm’s-length basis. Taxpayer undoubtedly gave up ownership and control of Family Corp. and Business in order to support his claim that he had abandoned his New York domicile, and to achieve certain income and estate tax savings.

Yet Taxpayer appears to have required significant cash flow from Business – he could not afford to part with all the economic benefits associated with Family Corp. Granted, that reality is difficult to reconcile with the ends desired (e.g., no New York tax), but “you can’t always get what you want,” but with a little planning, . . . (you know how it goes).