New York State and New York City Business Allocation: What Has Changed, and What Has Not
This article originally appeared in the November 2015 TaxStringer and is reprinted with permission from the New York State Society of Certified Public Accountants.
By Brian Gordon
In the past few years, there have been vast changes to the landscape of corporate allocation in the world of state and local taxes. For example, we have seen New York follow some other states into the realm of economic nexus, where nexus (i.e. filing responsibilities) could be based solely on sales in a particular state rather than on the old test of physical presence. This is effective for tax years beginning on or after January 1, 2015.
Market based sourcing is also a new trend in state allocation methodology. Under this method, service income will also create nexus as long as the customer benefits from the service in New York State, even if the service is not performed there. It seems like every few months another state is beginning to utilize these methodologies. You must keep up to date with this changing environment; otherwise, you risk incurring a tax liability or a penalty for failing to file from a state in which, under the new rules, you are now conducting business.
Just to help you through the maze a little...
For New York State, the business allocation percentage is based only on your apportionment of receipts. For New York City, a three-factor formula of property, payroll and receipts is still being used, although property and payroll are in the process of being phased out. There will be an option for most companies to extend the inclusion of a small amount of property and payroll. Please remember that for corporations in both New York State and New York City, it is not required to have a place of business in another state in order to allocate income on your New York returns.
A very significant change involves economic nexus and sourcing of income. Under the new market based sourcing rules, you can have nexus with New York State even if you have no physical presence. This is referred to as economic nexus. For example, if you are a service company such as an architectural firm physically located 100% in New Jersey and you perform all of your services in New Jersey, you will have nexus in New York if the architectural services were performed for a building located in New York and the income from these services exceed $1 million. Under the old sourcing rules (cost of performance method), the income would be sourced to the location that the service was performed, which was New Jersey in this case. Although this could hurt a New Jersey corporation, these rules would benefit a New York corporation as they will now allocate this type of service income outside of New York to the location that benefits from the service. In addition to income from services, you can also create nexus in New York State from sales of intangibles and sales of digital files to customers in New York State of over $1 million.
Sales of tangible personal property with no physical presence does not result in tax to New York because of the protection provided by Public Law 86-272. This law protects against tax on the net income from the sale of tangible personal property when there is no physical presence in a state.
According to the New York State’s Department of Taxation and Finance representatives, a foreign corporation with no physical presence should file a return if sales of tangible property is over $1 million, however an exemption from tax can be claimed for sales of tangible property. For comparison, consider California: under this same scenario, California requires you to file a return and pay a minimum tax.
New York City recently followed New York State with most of its changes for 2015, including the adoption of market based sourcing; however, it did not adopt economic nexus. Therefore, you still need physical presence in New York City to be required to file.
Partnerships and Sole Proprietorships
After talking about the new world and changing landscapes, we must step back into the Jurassic Period in order to talk about partnership and sole proprietor allocation for New York State. The rules discussed above do not appear here. Economic nexus does not apply; physical presence is still required. In addition, if your business is located in New York State, you can only allocate if you also have business locations in other states.
The primary method for allocation for partnerships and sole proprietors is what is sometimes referred to as “the books and records” method, or direct reporting. The books of the business will determine how much income is derived from or connected with New York sources. Each business location determines its own profit or loss from the business books. If that is not possible due to the type of business, then a three-factor formula using property, payroll, and receipts is the backup method. When using that method, however, the allocation of receipts is not based on the location of the customer, as is the case with corporations, but rather on the location of the home office of the employee responsible for the sale, or the location with which the service provider is associated.
In a recent ALJ hearing, In the Matter of the Petition of Patrick J. Carr, the state took the position that a lawyer's license in New York alone determined the location of the business. Mr. Carr was primarily retired. While he maintained his New York law license, he no longer had an office in New York or any business in the state. He also had a law license in New Jersey, but had no business there either. His only income was from Florida, where he had an office and was admitted to practice pro hac vice, meaning that he was approved only to practice on one particular Florida case. New York defended its position by citing a case where the attorney's only "office" was in New York: because the only office was in New York, there was no allocation allowed. That, however, was not the situation in Carr. Mr. Carr’s New York license was not "a business" located in New York, and Mr. Carr won his case. Inexplicably, New York didn’t consider the New Jersey license. Although New York’s position was quite a stretch in this case, a summary of this case is included to emphasize the difference in partnership allocation rules.
To complicate things further, New York City partnership and sole proprietor Unincorporated Business Tax returns do not require or allow direct reporting, and they allow allocation without a place of business outside New York City. Unincorporated business tax requires a three-factor formula that is moving towards a single receipts factor. Sales of tangible property are allocated by ship-to destination. Income from services are allocated to the location the service was performed.
If you have any questions on these issues, or about state audits, please contact the author.
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