“Leaving” the Business
There is a common theme that runs through the history of most closely held businesses. It begins with a motivated, diligent, and independent individual who is not afraid to take charge and to make things happen. Add a bit of luck to the mix, plus the support and guidance of family, friends and mentors, and the business may grow and thrive. The years pass and, at some point, the owner may decide that they are ready to begin the next stage of their life.
In many cases, that next stage is retirement – the owner sells their business and rides off into the sunset.
For some owners, however, the next stage looks more like a form of quasi-retirement, where they step back from the day-to-day management and operation of their business – turning this function over to a family member or a trusted employee – and become a passive investor. This “conversion” may be accompanied by a transfer of some equity in the business to the owner’s anointed successor.
Alternatively, it may mean selling all or part of the business and starting another. The new business may be a variant on the old one, though on a smaller scale; it may be something entirely new; or it may be one that does not require as much hands-on involvement.
For many business owners who reside in New York, this quasi-retirement is often coupled with a change in residence, usually to a warmer, less expensive, and less taxing environment, like Florida.
A quasi-retired business owner who decides to make such a move has to recognize that, at some point, they may be required to convince the New York State Department of Taxation and Finance that they have established Florida as their new domicile.
Under New York’s Tax Law, an individual’s “domicile” is defined as the place the individual intends to be their permanent home. It is a subjective inquiry because it goes to one’s state of mind.
Once an individual’s New York domicile has been established, it continues until they abandon it and move to a new location with the bona fide intention of making their permanent home there.
Whether or not an individual’s domicile has been replaced by another depends on an evaluation of their circumstances. According to the State, certain “primary” factors must be considered in determining the individual’s intent as to domicile – these factors are viewed as objective manifestations of such intent.
Each primary factor must be analyzed to determine if it points toward proving a New York or other domicile. In conducting this analysis, an individual’s New York ties must be explored in relationship to the individual’s connection to the new domicile claimed. Each factor is weighed separately, and then collectively.
The primary factors are as follows: (i) the individual’s use and maintenance of a New York residence, (ii) their active business involvement, (iii) where they spend time during the year, (iv) the location of items which they hold near and dear, and (v) the location of family connections.
The evidence required to support a change of domicile must be “clear and convincing.” Thus, a taxpayer who has been historically domiciled in New York, and who is claiming to have changed their domicile, must be able to support their intention with unequivocal acts.
This is where the nature of the business owner’s continuing connection to their New York business – when weighed against their connection to any business activity in which they are already engaged in Florida, or which they decide to undertake after moving to Florida – may put them at a disadvantage in proving the abandonment of their New York home, as was demonstrated in the decision described below.
Audit of Nonresident Return
Like many others, Taxpayer immigrated to New York and established a successful business. Taxpayer started his business with a single retail location in New York. He later opened additional locations, both in New York and in Florida. Building upon the success of, and parallel to, his retail business, Taxpayer also developed extensive real estate holdings by investing in New York and Florida rental real estate.
Taxpayer and his spouse jointly filed New York State and City resident income tax returns up until the tax years under audit (the “Audit Years”). For both those years, Taxpayer filed a New York nonresident income tax return, claiming the filing status of married but filing separately, and identifying his Florida address as his home.
The Department of Taxation and Finance examined Taxpayer’s nonresident income tax returns for the Audit Years – which included a large gain from the sale of real property in Florida – and concluded that he had failed to present clear and convincing evidence that he had abandoned his New York domicile and acquired a new Florida domicile.
The Department issued a notice of deficiency assessing additional personal income taxes, as well as penalties, against Taxpayer, which he challenged. However, an Administrative Law Judge (“ALJ”) sustained the deficiency. Taxpayer appealed the ALJ’s decision to the Tax Appeals Tribunal, which affirmed the ALJ’s determination. Following this setback, Taxpayer filed a so-called “article 78 proceeding” to appeal the Tribunal’s decision.
Taxpayer’s Business Connections
The Appellate Division, Third Department (to which Tax Appeals Tribunal decisions are appealed), began by stating that, for income tax purposes, an individual is a resident of New York when that individual is domiciled in this State. A person’s domicile, the Court continued, “is the place which an individual intends to be such individual’s permanent home.” Once a domicile is established, it “continues until the individual in question moves to a new location with the bona fide intention of making such individual’s fixed and permanent home there.”
As the individual seeking to establish a change in domicile, it was Taxpayer’s burden, the Court noted, to prove his change of domicile by clear and convincing evidence.
The Court observed that Taxpayer did not contend that his domicile changed from New York to Florida as of a date certain. Rather, Taxpayer maintained that his contacts in Florida dated back over 25 years, to when he opened his first retail location in the State and purchased a condominium there. Taxpayer contended that, slowly over the course of time, his business interests grew and he began spending an increasingly significant amount of time at his Florida residence such that, by the Audit Years, he had effectively abandoned his New York domicile and established a new domicile in Florida.
The Court acknowledged that Taxpayer had submitted evidence demonstrating his significant business ties to Florida, including his ownership and operation of four retail locations and nine rental properties, and the fact that he helped manage another business located in one of his Florida buildings. Taxpayer had also submitted evidence that he had moved many personal items to his Florida residence, and that he had spent the majority of the Audit Years in Florida.
The Court pointed out, however, that there was similarly no dispute that Taxpayer also continued to maintain substantial and significant business and personal contacts in New York.
Significantly, Taxpayer continued to maintain his New York business and, in fact, was working on expanding it. He also maintained a warehouse affiliated with his New York business and another that he rented to third parties.
In addition, Taxpayer acknowledged that the administration and bookkeeping functions for all of his New York and Florida businesses were centralized and maintained in New York. All tax filings for the Florida businesses listed Taxpayer’s New York City office address, and his New York City bookkeeper processed all receipts from the Florida businesses and rental properties.
The Court observed that, over the years, Taxpayer had established a regular pattern of travel, generally consisting of his spending long weekends in Florida, during which he visited his Florida business and investment locations, while spending the rest of the week working in New York.
Moreover, Taxpayer managed and controlled all administrative, operational, and financial aspects of his New York and Florida business and real estate investment interests from his New York City office, and he continued to be the sole owner of the entities that held these interests.
The Audit Years were no exception: all administrative and financial functions for all of Taxpayer’s businesses and real estate investments continued to be handled in New York, Taxpayer spent almost half the year in New York, he derived significant income from his New York businesses and investments, and he continued to be actively engaged in the management and control thereof.
Such active business ties to New York, the Court maintained, typically indicate a failure to abandon a New York domicile.
On the record before it, including Taxpayer’s New York business and real estate investment interests, the presence of his spouse in New York, and his continued ownership and use of his long-time New York City condominium, the Court sustained the Tax Appeal Tribunal’s determination that, as of the Audit Years, Taxpayer had not shown a change in his lifestyle that would support his claimed change of domicile to Florida and the abandonment of New York as his domicile.[I]
Is It All or Nothing?
A business owner’s continued employment or active participation in their New York business, or their substantial investment and management of their New York business, after they have acquired a new residence elsewhere, will be a primary factor in determining their domicile.
If the owner continues to be actively involved in their New York business by managing or actively participating in such business without establishing comparable or greater business connections to the location they claim to be their new home, then their New York business activity will support their continued status as a New York domiciliary.
Does this mean that a business owner who has moved out-of-state cannot remain connected to their New York business if they hope to abandon New York as their domicile?
Not necessarily. It depends upon the extent and nature of the owner’s control and supervision over the New York business.
On the one hand, an owner’s active participation in the day-to-day operation or management of a New York business points to continued New York domicile, even if the business is being run from an out-of-state location.
On the other hand, an owner’s conversion of his interest in a New York business from an active to a passive investment is not supportive of continued domicile; for example, where the owner has resigned his position as an officer and employee of the business, has reduced his compensation accordingly, and has actually – not simply formalistically – turned management over to others.
The conversion of the owner’s interest to that of a “mere” investment does not require that the owner disregard the business entirely. In fact, it is reasonable to expect that the owner would take some interest in the business they have built and which now supplies a stream of income to them in retirement. This continuing interest does not compel a conclusion that the owner remains actively involved in the business.
Thus, the owner’s occasional office visit or phone call to the business should not constitute evidence of active involvement where they are limited in amount of duration.
If the owner has also undertaken other activities in their new home on which to focus their attention and efforts, the change of their relationship to the New York business is consistent with the so-called “change in lifestyle” that supports a conclusion that one domicile has been replaced with another.
Of course, it may be difficult for some owners to step away from their business and to pass control to someone else – did I mention something about an owner’s independence and determination? It’s the same issue they confront when considering gift and estate planning strategies, or in approaching succession planning. Interestingly, the proper planning for any one of these purposes will necessarily assist the owner in successfully removing themselves from New York.
[i] It should be noted that on both of Taxpayer’s nonresident income tax returns, the “No” box was checked in response to the question, “Did you or your spouse maintain living quarters in NYS [for that given year],” despite the fact that Taxpayer continued to own and maintain the condominium in New York City in which his spouse resided, and in which he stayed when he was in New York. The Court sustained the assessment of a negligence penalty against Taxpayer based on this “misrepresentation.” Despite the fact that Taxpayer claimed these misrepresentations were the product of a mistake by his accountant, the Court found no error in the Tribunal’s reliance upon these misrepresentations in upholding the negligence penalty.
I encounter the “‘No’ box” situation with too much frequency. First and foremost, a tax return must be accurate and truthful. The taxpayer is charged with reviewing the return to confirm the information contained therein – whether one owns or rents an apartment in the City is an easy one. Why give the auditor a lay-up, not to mention a bad impression?