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New York’s Corporate Nexus & Apportionment Rules: Overview & Update

Mark S. Klein and Daniel P. Kelly
Published Date:
Mar 1, 2018

New York’s corporate franchise tax reform, which passed in 2014 and became effective Jan. 1, 2015, was groundbreaking in numerous ways. (The Administrative Code of New York City was subsequently amended to adopt many, but not all, of the same revisions for city corporate tax purposes.)  Even though the law is nearly four years old, both tax practitioners and tax administrators continue to struggle to provide form to the framework the new law created. In this regard, the New York State Department of Taxation and Finance (the “Tax Department”) has worked hard to produce return instructions, draft regulations, and other guidance on the new laws, and practitioners have written numerous articles and commentary regarding the new laws. Still, questions abound. This article explores two of the most significant and farthest-reaching amendments in detail: New York’s new economic nexus standard for corporate taxpayers and New York’s new market-based sourcing regime for service and other select receipts.

Jan. 1, 2015: The New Regime in Effect

Over the last thirty or so years, an obvious state tax policy driver has been the desire to have out-of-state businesses and persons bear an expanding portion of total tax revenue. New York’s residency audit program is one example of this. Out-of-state businesses and individuals targeted by tax reform and the residency audit program usually do not vote or hold local office in New York; they (or their employees or agents) might not spend a meaningful amount of time or directly invest capital in New York. In short, it is easy to target out-of-staters because their ability to retaliate is limited. 

The two amendments to New York’s franchise tax that we target in this article—a new standard for economic nexus and a new apportionment regime for service businesses—caught the attention of businesses across the globe. Four years after the New York legislature passed corporate tax reform and three years after the new laws went into effect, these two amendments are proving to be a big deal.

 A. Adjustments to Nexus.  The U.S. Constitution, the U.S. Supreme Court case law interpreting the Constitution, and federal law established a standard of minimum contacts an out-of-state business must have with a state before that state can subject the out-of-state business to its tax jurisdiction. Sufficient minimum contacts between a state and out-of-state businesses is referred to as “substantial nexus.” (See, e.g., Quill Corp. v. North Dakota, 504 U.S. 298 (1992), Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977),, LLC v. New York State Dep’t of Taxation & Fin., 20 N.Y.3d 586 (2013).) In the corporate franchise tax context, these minimum contacts between the state and the out-of-state taxpayer establishing “substantial nexus” can include the out-of-state business owning or leasing property in New York, owning a limited partnership interest in a partnership doing business in New York, having strategic business relationships with affiliated companies in New York, and maintaining a satellite office in New York. You can see that, in most every case, some direct or indirect physical presence was required to establish substantial nexus.

The “substantial nexus” concept is critically linked to “apportionment” regimes. This is because without substantial nexus, an out-of-state business would not be subject to a state’s tax jurisdiction and would not be required to apportion income to that state, file returns in that state, or pay tax and minimum fees in that state. Effective Jan. 1, 2015, the New York legislature changed the playing field for “substantial nexus” purposes. Substantial nexus is still required—make no mistake about it. But now, in place of the minimum contacts established through a business’s direct or indirect physical presence in New York, the business might (arguably) meet the constitutional standard through New York’s “economic nexus” standard, set out in new New York Tax Law section 209. New York certainly wasn’t the first state to come up with an economic standard for establishing nexus—during the infancy of these new standards that blur the line of constitutional “substantial nexus,” our firm has literally been at the forefront of the fight. (See Hodgson v. Minnesota – A Window into the Future of Economic Nexus, Journal of Multistate Taxation and Incentives, Doyle, Kelkenberg & Kelly (Vol. 26, Number 4, July 2016).)

Prior to the 2015 corporate tax reform, an out-of-state business that simply sold products or services to New York customers would not have substantial nexus with New York without other qualifying presence, and it would not have been subject to New York’s tax jurisdiction.  According to the revised Tax Law Section 209, however, in addition to corporations with traditional nexus connections, corporations that derive more than $1,000,000 of New York-source receipts during the tax year are now also subject to New York’s franchise tax, even if they have no other relevant contacts with New York.  However, the protections afforded out-of-state businesses under Public Law 86-272 still apply.

 New York’s “economic nexus” statute is expected to have a vast impact on businesses that operate remotely while taking advantage of New York’s market. Take Netflix or other similar streaming service/digital products businesses as an example. Without economic nexus, a business like Netflix could avoid any material physical connections with New York while taking advantage of the state’s market and likely avoid New York’s tax jurisdiction. With New York’s new standard for deemed substantial nexus, however, Netflix’s streaming to New York’s TVs, tablets, and phones will come with extra cost—apportioning some of its worldwide income to the state (and city) and paying tax accordingly. 

We have not seen a published constitutional challenge to New York’s $1 million “economic nexus” threshold, but any statutory nexus standard that relies on less than physical presence in New York—and only on sales to New York customers—raises red flags and might be subject to constitutional assault. The New York legislature and the Tax Department certainly believe that $1 million in New York-source receipts earned in a 12-month period meet appropriate constitutional safeguards. And assuming the new economic nexus threshold sticks—and certainly until we hear otherwise—we expect this provision to subject many previously untaxed out-of-state corporate taxpayers to New York’s corporate franchise tax and apportionment regime.    

B. Sourcing Receipts for Services Business: Major Adjustment in the “Sales” Factor.  This brings us to the next major element of the 2015 corporate tax reform that has made waves both near and far for those businesses with New York tax nexus, including those recently hauled in under the “economic nexus” provision. What constitutes a “New York-source receipt” for the purposes of apportioning income?

Both before and after the 2015 corporate reform, receipts from sales of tangible property were sourced based on delivery destination; however, pre-reform receipts from sales of services were sourced based on the sometimes difficult standard of “where the service was performed,” and receipts from the residual “other business” category were sourced to New York only if the receipts were “earned” in New York.  The old “other business” category, which offers a somewhat narrow body of published advisories and litigated decisions defining its boundaries (see, e.g., Alvarez & Marsal, TSB-A-11(8)C (July 12, 2011)), amounted essentially to a location-of-the-customer-based apportionment approach. (20 NYCRR sections 4-4.3, 4-4.6.) Other targeted taxpayers—publishers and securities broker/dealers, for example—were subject to special receipts sourcing rules under the old regime.

With the 2015 corporate tax reform, New York created new receipts-sourcing silos (for example, receipts from financial transactions, receipts from digital goods) and did an about-face on service receipts, switching from place-of-performance sourcing to a market-based, customer-location sourcing methodology for “unclassified” services—in other words, services that do not fall within a specific receipts sourcing silo under Tax Law section 210-A. This adjustment essentially merged the sourcing of service and digital products receipts into the location-of-customer scheme that applied to the pre-reform “other business” receipt category.

What has New York accomplished, at least in theory, with these two major adjustments?  First, New York took normal means of establishing substantial nexus and broadened them substantially, attaching substantial nexus to out-of-state corporations that have the relatively modest amount of $1,000,000 in sales to New York customers. Next, New York shifted the tax burden away from New York-based service businesses and toward businesses based outside New York—some of which are subject to tax here for the first time under the new nexus rules! Not a bad play for a legislature concerned for its New York constituents: Haul in more out-of-state taxpayers who benefit by selling to New York customers, and lighten the tax burden on New York corporations serving non-New York clientele. 

New York Apportionment for Partnerships, LLCs Taxed as Partnerships, and Sole Proprietorships

These articles focus on the actively developing rules, regulations, and issues regarding the apportionment of receipts for New York corporate franchise tax purposes. Before we go further, we want to highlight critical differences between apportionment regimes for corporations taxable under Tax Law Article 9-A (rules that also apply to New York nonresident S corporation shareholders (but note: NYC does not recognize S corporations)), and regimes applicable to business income taxable to nonresident individuals (sole proprietors and partners) under Tax Law Article 22.

First and foremost, separate standards of “nexus” and “doing business” apply for determining whether or not an unincorporated business (or, more accurately, its owners) needs to allocate or apportion any of its income to New York. The New York Tax Law requires every partnership that (1) has a resident partner or (2) has any income derived from New York sources, regardless of the amount, file a return for the taxable year setting forth all items of income, gain, loss and deduction, etc. (Tax Law section 658(c), 20 NYCRR section 158.9(a).) Note that New York “source” is determined in accordance with the applicable rules of Tax Law section 631, as in the case of a nonresident individual.

Income from New York sources includes, among other items, income attributable to a business, trade, profession, or occupation carried on in New York State. (Tax Law section 631, Instructions to 2016 Form IT-204.) Instructions to New York’s current partnership tax return note that “A partnership carries on a business, trade, profession, or occupation within New York State if (1) it maintains or operates an office, shop, store, warehouse, factory, agency, or other place in New York State where its affairs are systematically and regularly carried on, or (2) it performs a series of acts or transactions in New York State with regularity and continuity for livelihood or profit, as distinguished from isolated or incidental transactions (emphasis added).”  So there might be situations where an out-of-state business has infrequent or inconsequential contacts with New York and no New York office or base of operations, and it does not actually need to apportion income to New York.

If, however, an unincorporated business or sole proprietor had a New York filing obligation, it would apportion income using a substantially different method than corporations subject to tax under New York Tax Law Article 9-A. First, if the entity’s books and records allow, the entity should use direct allocation of income to one place or another. Assuming the books and records do not allow direct allocation, these entities would use an apportionment formula that equally weights gross income, property, and payroll factors. An exception is for income from real or tangible personal property, which is always directly allocated to the location of the property.  (Tax Law section 631(b)(1)(A).) Unlike corporations under the post-reform rules, these entities continue to use place-of-performance for purposes of sourcing service sales receipts. Going a step further, place-of-performance is deemed to be the primary office out of which the provider renders the service. (See Instructions to 2016 Form IT-204 pp. 8-9, and Instructions to New York Form IT-203-A (Business Allocation Schedule), Suffice it to say that, at this point, out-of-state partnerships and sole proprietorships can rest easier than their corporate brethren in terms of New York tax obligations and nexus, while partners, members, and sole proprietors with a significant New York presence are still carrying a heavy New York tax burden.

Practice Pointer – Selecting an Entity: Choice of entity considerations cover many goals, and sometimes state and local taxes (rightfully) take a back seat. There are shareholder concerns, liability-limiting provisions, tax opportunities, and drives for simplicity. The choice of entity decision tree grew a bunch of new branches as the result of the recent federal tax reform and rate overhaul. The ramifications of the Tax Cut and Jobs Act is beyond the scope of this article. 

Let’s ignore the federal tax consequences of choice of entity and focus on the New York consequences. Take two identical businesses. One is an LLC taxed as a partnership, and the other is an S corporation. Both have a single office in New York, they each have 25 employees who all work from the New York office, and they provide professional consulting services to businesses across the country. In each case, the New York customers generate only 10% of sales revenue. The S corporation’s nonresident shareholders pay New York tax —at the personal income tax rates—on just 10% of their share of the company’s income (assuming the corporation is taxed on its business income base) because only 10% of the receipts are New York source, and single-factor receipts-only apportionment is used.  The LLC’s nonresident members, by contrast, pay New York personal income tax on their share of 100% of the entity’s income because nonresident partners use three-factor apportionment, the receipts factor sources all receipts to the location of the partnership’s sole office in New York, and the property and payroll factors are also both 100% New York. All other choice of entity considerations being equal, as the tax landscape in New York currently stands, you can see how entity selection can be crucial for nonresident shareholders.

 New York’s Market Based Sourcing for Services: Questions and Complexities

The next installment of this article picks up here next month. There will be more written about the 2015 New York tax reform as time goes on, the draft regulations are finalized, and case law fills in the gaps.  In the meantime, accountants, taxpayers, and others are left with several good questions—and have little in the way of bright lines to follow.

Mark S. Klein is a partner and chairman in the firm of Hodgson Russ LLP. He concentrates in New York state and New York City tax matters. He has over 35 years of experience with federal, multistate, state and local taxation and speaks frequently on tax topics. He can be reached at 716-848-1411 or


Daniel P. Kelly is a senior associate in Hodgson Russ's tax practice area.  Daniel counsels corporations and individuals on a wide range of tax matters, with a focus on New York state, New York City, Florida, and multistate tax planning and controversy.  Daniel is licensed in New York and Florida.

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