New York Personal Income Tax for Part-Year Resident Partners

By Brian J. Rebhun and Khondkar E. Karim

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Background

A 1999 New York Tax Appeals Tribunal decision, In the Matter of Greig (DTA No. 815529), changed the manner in which a partner or a shareholder of a New York S corporation reports his share of the income, gain, loss, or deduction of the partnership or New York S corporation when he changes resident status during the year. The taxpayer in Greig was a partner in a New York law firm who had moved into New York during the tax year at issue. Prior to Greig, New York State Department of Taxation and Finance (DTF) regulations provided that the part-year resident tax treatment of the distributive or pro rata share of income, gain, loss, or deduction from a partnership or New York S corporation depended upon the individual’s resident status when the partnership’s or New York S corporation’s tax year ended. The Tax Appeals Tribunal (TAT) decision in Greig, however, held the DTF’s regulation to be invalid, and provided that the amount of partnership or New York S corporation income, gain, loss, or deduction for the year in which the change of residence occurs must be prorated between the resident and nonresident periods.

In response to the decision in Greig, the DTF issued a Technical Service Bureau Memorandum (TSBM) that stated a policy by which it can require taxpayers to prorate income, gains, losses, and deductions from partnerships or New York S corporations between resident and nonresident periods. However, the TSBM did not address the situation presented in In the Matter of Falberg (DTA No. 818960), where the items of income had an actual date of receipt. In this case, Gregg and Stephanie Falberg moved to Florida in 1997, and as of July 21, 1997, they were no longer residents of New York. During that year, Greig Falberg owned 59% of the shares of a New York subchapter S corporation. Less than two weeks after their move, the New York subchapter S corporation sold all of its assets. The capital gain from the transaction passed through to Falberg, proportionate to his stock holdings. On his 1997 New York partial-year resident return, Falberg treated the capital gain as if it had been received during his nonresident period and did not allocate the earnings between his resident and nonresident periods. In Grieg, the TAT provided two alternatives for allocating items of income and expenditure earned by a partner or shareholder of a New York S corporation who changes residence during the year at issue: either the actual date of receipt, or a proration between the periods of residence and nonresidence.

It is interesting to note that the DTF, in allocating the interest income between the resident and nonresident periods in Falberg, used the actual date that the interest income was earned in determining which period to include such income, yet denied the actual date of receipt methodology for the capital gain. The administrative law judge (ALJ) stated that this action by the DTF was inconsistent with the policy established in the Greig TSBM. Furthermore, the ALJ indicated that allocating based on a pro rata determination is not the only acceptable method of reporting partnership and New York S corporation income and expenditures, as the DTF argued in Falberg. The TAT stated that requiring the petitioner to allocate the capital gain on a pro rata basis was not only inconsistent with the statutes, case law, and regulations, but was inconsistent with the direct accounting method employed by the DTF on audit in allocating the interest income.

Recent Legislation

In response to the decision in Falberg, the New York State Legislature recently enacted Senate Bill S7561, which amended the rules under section 639 of the Tax Law to address the situation when a partner or S corporation shareholder changes domicile or residency during the tax year. If a partner or S corporation shareholder changes domicile or residency status, the portion of the individual’s share of partnership or S corporation income is allocated to the resident and nonresident periods on a proportionate basis throughout the tax year of the partnership or S corporation.

In calculating the proration amount, the portion of the share allocated to the period of domicile or residency is determined based on the number of days of residency within the reporting period of the partnership or S corporation over the total number of days in the reporting period of the partnership or S corporation. However, the revised law also states that DTF may require, or an individual may elect, to determine the portion of the share allocated to the period of residency, or nonresidency, in a manner that reflects the actual date of accrual of income by the partnership or S corporation (i.e., the actual date of sale). The legislature also provided comparable provisions for the New York City personal income tax for individuals who change their domicile or residency to or from New York City.

Under the new rules, taxpayers should recognized that, absent a direct accounting for each item of partnership or S corporation income and expenditure, the proration of items earned and incurred by the partnership or S corporation is required and most accurately reflects when the items were earned or incurred.