August is Like Sunday

As far back as I can remember, the end of August has always elicited a sense of dread comparable to what many schoolchildren, and a fair number of adults, experience every Sunday afternoon.

In retrospect, I cannot say that this feeling of doom was ever fully warranted.[i] Still, its presence has been undeniable, and it is especially palpable this year, and for good reason.  

In the last few weeks, in addition to some disturbing developments in conflicts overseas, European censors threatened to arrest ordinary citizens who post “offensive” content online; Mark Zuckerberg admitted publicly that the Biden administration compelled Facebook to censor the news and other information made available to the American public;[ii] many European governments (even Switzerland) announced they are considering some serious tax hikes;[iii] the Bureau of Labor Statistics reported that the U.S. created 818,000 fewer jobs during the last 12 months than had been reported (and touted) earlier;[iv] interest paid[v] on the U.S. national debt surpassed defense spending; Bigfoot was spotted in the Adirondacks;[vi] the power brokers of the Democratic Party effectively removed the President of the United States from office[vii] and selected Kamala Harris as their candidate for the Presidential election this November;[viii] the same Ms. Harris endorsed increased income taxes on both individuals and corporations, as well as higher estate taxes.[ix]

NY Tax as a Constant

I have read that consistency provides stability and reduces uncertainty.

Assuming the truth of this statement, it is comforting to know that, in the midst of the uncertainty and anxiety created by the events enumerated above, not to mention the inordinate mistrust of the federal government felt by at least half the country, it is “comforting” to know that New York’s Department of Taxation (the “Dept.”) is steadfastly working round the clock,[x] as it has always done, to ensure that both residents and nonresidents pay their “fair share” of the State’s almost $240 billion budget.[xi]

The fruit of the Dept.’s efforts was on display in a recent decision from the Division of Tax Appeals.[xii]

Yet Another Audit

The Dept. audited Taxpayer’s returns for the taxable years 2011 through 2015. During these audits, the Dept. determined that Taxpayer had changed his domicile from New York to Connecticut during 2013.

In 2018, Taxpayer moved to Tennessee.[xiii]

In 2020, Taxpayer – who by that time was retired – was again selected for audit by the Dept., this time as a nonresident, for the years 2016 through 2018 (the “audit period”).[xiv]

The Income At Issue

During the audit period, Taxpayer was employed by Corp, and filed New York State nonresident income tax returns[xv] for each of the audited years on which he reported wage income, bonus income, dividend income, and income from the vesting of restricted stock units (“RSUs”) granted by Corp.

The following is a breakdown of Taxpayer’s W-2 income from Corp[xvi] for each of the audit years:

Taxpayer’s Allocation

On his nonresident income tax returns for the audit period, Taxpayer allocated wages to New York by comparing his number of days worked in New York to his total days worked (a workday allocation).

Taxpayer allocated his bonus income for each audit year based upon the workday allocation for the year in which the bonus was paid.

Corp granted Taxpayer a number of RSUs of its common stock, the terms of which were set forth in a Restricted Stock Unit Plan.

Vesting

According to this Plan, each RSU entitled Taxpayer to one share of Corp common stock upon vesting;[xvii] 20% of the RSUs vested on the first anniversary date of the grant, and 20% each year thereafter.[xviii]

Under the RSU Plan, Taxpayer was not entitled to dividends in respect of Corp’s common stock, or any other rights or privileges of a stockholder of Corp stock, until the RSUs were fully vested.

Furthermore, if Taxpayer was no longer employed with Corp, Taxpayer’s unvested RSUs were forfeited.

However, if Taxpayer died while employed, the unvested RSUs would automatically vest and become nonforfeitable. If Taxpayer became permanently disabled, the unvested RSUs would vest and become nonforfeitable on a pro rata basis, depending upon the number of days that had lapsed in the period.

Taxpayer sourced his income from the vesting of the RSUs, and the resulting receipt of Corp common stock, to New York based upon a workday allocation – the ratio of New York workdays to all workdays – in the year the RSUs vested.

The Dividends

After the RSUs became fully vested and no longer subject to forfeiture (as described above), Taxpayer received dividends in respect of his shares of Corp common stock.

Taxpayer did not treat any of this dividend income as New York source income subject to tax by the State.

NY Disagrees

Taxpayer provided calendars and schedules, along with other supporting documentation, detailing his total working days during each year of the audit period and his total days spent working in New York during each year.[xix]

The Dept. determined that the bonus income paid by Corp to Taxpayer during the years in question should have been sourced to New York based upon the workday allocation in the year prior to the year of receipt of the bonus. The Dept.’s auditors relied on their understanding that the bonus was paid based on the immediately preceding year’s performance and approved in March of the following year.

The Dept. also made adjustments to the sourcing of Taxpayer’s income from Corp’s RSUs that vested in 2016, 2017 and 2018, using a date-of-grant to date-of-vesting allocation methodology.[xx]

Finally, the Dept. also asserted tax on dividend income reported on Taxpayer’s W-2[xxi] on the basis that this was part of Taxpayer’s compensation package and should be properly allocated to New York and subject to tax based upon the workday allocation in the year of receipt.

In 2021, the Dept. issued a notice of deficiency reflecting these adjustments for each of the audit years and asserting additional tax and interest against Taxpayer.

Taxpayer filed a petition for the redetermination of these alleged deficiencies with the Division of Tax Appeals.

The ALJ Hearing

At the subsequent hearing before an Administrative Law Judge (“ALJ”), Taxpayer explained that he was retired from Corp, but during the audit period he was the CEO of one of Corp’s divisions. Taxpayer indicated that he did not have an employment contract with Corp and that the bonus payments received from Corp were 100% discretionary and not guaranteed.

Taxpayer also explained that, pursuant to the terms of the RSU Plan, a grantee of Corp RSUs could elect to defer receipt of their RSUs, which would then be administered by the Plan. Taxpayer testified that the dividends, as reported on his forms W-2 during the years in issue, were paid out of this plan and the RSUs from which the dividends had emanated were vested. It was Taxpayer’s position that this dividend income was not attributable to a business, trade or profession carried on in New York because the Corp common stock on which the dividends were paid had long since vested.

In support of his testimony, Taxpayer submitted a letter from Corp’s then General Counsel[xxii] stating that the bonus income paid to Taxpayer by Corp was purely discretionary on the part of Corp, and that Taxpayer did not have a contractually guaranteed bonus. Taxpayer also presented the testimony of Corp’s current General Counsel who corroborated that the dividend income at issue stemmed from RSUs that had vested.

ALJ’s Determination

The issues before the ALJ were as follows:  

“I. Whether Taxpayer’s income from the vesting of the RSUs should have been sourced to New York using the grant-to-vesting allocation methodology employed by the Dept.; and  

II. Whether dividend income earned by a nonresident New York taxpayer from a deferred compensation plan (like the RSU Plan) and reported on federal form W-2, wage and tax statement, was subject to taxation by the State.[xxiii]

The ALJ explained that New York generally imposes income tax upon the taxable income of a nonresident individual[xxiv] to the extent such income is derived from or connected to New York sources.[xxv] The amount of tax imposed upon such a nonresident is equal to their “tax base” – i.e., the tax computed if the nonresident were a resident, reduced by certain credits – multiplied by the “New York source fraction.”[xxvi] The New York source fraction is a fraction the numerator of which is the nonresident’s New York source income, and the denominator of which is the individual’s New York adjusted gross income.[xxvii] 

The taxpayer’s total income is derived from “New York adjusted gross income.”[xxviii] The New York source fraction, in turn, is equal to the individual’s “New York source income” divided by the individual’s New York adjusted gross income from all sources for the entire year.[xxix]

A nonresident individual’s New York source income is defined as “the net amount of items of income, gain, loss, and deduction entering into his federal adjusted gross income, . . . derived from or connected with New York sources,”[xxx] which is determined by reference to the taxpayer’s “federal adjusted gross income.”[xxxi]

After the Dept. conceded that the total amount of income designated as bonus income was properly allocated to New York by Taxpayer using his workday allocation in the year of receipt, the ALJ turned to the only income amounts that remained in dispute; specifically, the income from the vesting of the RSUs and the dividend payments for the audit years.

The RSUs

With respect to restricted stock units granted to nonresidents, the ALJ stated that, according to the Tax Law, “A nonresident taxpayer who has been granted statutory stock options, restricted stock, nonstatutory stock options or stock appreciation rights and who, during such grant period, performs services within New York for, or is employed within New York by, the corporation granting such option, stock or right, shall compute his or her New York source income as determined under rules and regulations prescribed by the commissioner.”[xxxii]

The Dept.’s regulations provide that a “nonresident individual has New York source income from compensation received from stock options, stock appreciation rights or restricted stock if at any time during the allocation period the nonresident individual performed services in New York State for the corporation granting such options.”[xxxiii]

The ALJ explained that “allocation period” means: “in the case of restricted stock . . . , the period of time from the date that the stock was received to the earliest of the date that the stock is substantially vested (transferable or not subject to substantial risk of forfeiture), the date that the individual’s services terminate, or the date that the stock is sold, except that, with respect to the portion of the compensation related to the stock that is attributable to dividends paid on the stock, the same period of time that applies to regular, non-stock-based remuneration from the grantor during the taxable year that such dividends were received.”[xxxiv] Such stock option compensation is reportable to New York in the tax year that the income is included in federal adjusted gross income.[xxxv]

The ALJ then observed that restricted stock units, like those at issue in Taxpayer’s case, are not specifically mentioned in the Tax Law or the regulations promulgated thereunder. Still, the ALJ continued, Taxpayer’s RSUs fell within the ambit of the regulations. “Like stock options, stock appreciation rights and restricted stock, restricted stock units are a form of equity-based compensation,” the ALJ stated, and “[t]here is no clear distinction that justifies sourcing income from the vesting of restricted stock units differently than income from the vesting of restricted stock.”

Although Taxpayer advocated for use of the workday allocation in the year of receipt as a more equitable allocation method, the ALJ found that the justification for this position was lacking, other than it would result in less tax due in Taxpayer’s specific case. Accordingly, the ALJ rejected Taxpayer’s argument.  

The Dividends

With respect to the dividend income, the ALJ noted that both Taxpayer and Corp’s general counsel provided credible and uncontroverted testimony that the stock that generated such dividends had vested at the time the dividends were issued.

The ALJ, however, found that the Dept. failed to provide any witness testimony or citations to the hearing record to support its conclusion that the dividend income was earned as a result of a business, trade or profession carried on in New York.

That being the case, the ALJ determined that the dividend income was not taxable to a nonresident, such as Taxpayer.

Remember

In general, a New York resident taxpayer is responsible for reporting and paying New York personal income tax on income from all sources regardless of the nature of the income or where it was generated.

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

Thus, significant benefits may be derived from establishing one’s nonresident status as to New York.

However, because a nonresident taxpayer’s New York source income will remain subject to New York’s tax jurisdiction, it behooves the nonresident taxpayer to become familiar with the State’s sourcing rules and, to the extent possible, to plan accordingly. For example, a nonresident may want to use a like kind exchange[xxxvi] to remove real property from New York to another jurisdiction. They may also want to structure their New York investment so it generates interest or dividends, or gains from the sale of intangible personal property. In the case of compensation for services performed in New York, the nonresident employee may consider planning in advance with their employer to minimize the days worked in the State, to the extent feasible.

Depending on the circumstances, some of New York’s source rules may be more easily applied than others. In cases where facts may be disputed, the taxpayer can almost always rely upon the State to discern and assert the requisite nexus. The nonresident taxpayer should prepare on a contemporaneous basis – i.e., before filing their income tax return – the record on which they will rely to support their reporting position and refute any challenge by the Dept.

The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] For which I am thankful.

[ii][ii] Twitter’s collusion was uncovered last year.

[iii] The U.K.’s recently installed Labour Party is considering tax increases for capital gains, profits interests, and inheritances, among other items.

[iv] A mere “revision”? At some point, fiction becomes a lie (it’s a matter of intent), and if the intended effect of the lie is sufficiently widespread it becomes a crime.

[v] Approximately $787 billion.

[vi] Just checking that you’re awake. However, there have been several reported sightings of “something” in the area of Whitehall, NY.

[vii] I’ve never respected the man. He is one of the most selfish, dishonest and deceitful individuals to be elected to public office, and that’s saying a lot.

The Constitution, on the other hand, is sacred and any efforts to circumvent it represent a challenge to the principles and theory of government it embodies and should not be taken lightly. Just focus on the Preamble, which established the framework for the entire document:

“We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.”

For an interesting, and colorful, take on the Preamble and its meaning, I recommend Kid Rock’s We the People. 

[viii] Someone please tell me who the Commander in Chief is.

Article Two of the Constitution provides “The President shall be Commander in Chief of the Army and Navy of the United States, and of the Militia of the several States, when called into the actual Service of the United States.”

[ix] Among other measures, Harris mentioned the taxation of unrealized gain in certain cases, though the NYT reported that her donors were urging her to drop the latter. https://www.nytimes.com/2024/08/29/us/politics/donors-harris-tax-ultrawealthy.html .

[x] Desperate times . . .

[xi]  So much of which is wasted on unnecessary projects, including the $4.3 billion to be spent for illegal aliens through the State Fiscal Year 2025-2026. https://www.osc.ny.gov/reports/asylum-seeker-spending-report#:~:text=The%202024%2D25%20Enacted%20Budget,billion%20through%20July%2031%2C%202024.

[xii] In the Matter of the Petition of Dale A. Adams: Determination DTA NO. 850026 (August 8, 2024).

[xiii] Tennessee became a true “no individual income tax” state in 2021.

[xiv] Think about it. 2011 through 2018. Eight consecutive years, during most of which Taxpayer was a nonresident. “Poor” bastard. Obviously, New York decided the potential return was worth the investment.

[xv] Form IT-203.

[xvi] We’re not feeling sorry for Taxpayer, but the fact remains that he changed his domicile from NY to CT (a top rate of almost 7%) and, five years later, to TN. Adapting some of the lyrics from Johhny Cash’s “God’s Gonna Cut You Down”: you can run on for a long time, sooner or later NY will cut you down.

[xvii] Property is substantially nonvested when it is subject to a substantial risk of forfeiture, and is nontransferable. Property is substantially vested for such purposes when it is either transferable or not subject to a substantial risk of forfeiture. A substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, upon the future performance of substantial services by any person, or upon the occurrence of a condition related to a purpose of the transfer if the possibility of forfeiture is substantial. Treas. Reg. Sec. 1.83-3(b), (c).

[xviii] In general, property that is transferred to an employe in connection with their performance of services is not taxable (under IRC Sec. 83(a)) until it has been transferred to the employee and become substantially vested in such employee. In that case, the excess of the fair market value of such property at the time that the property becomes substantially vested, over the amount (if any) paid for such property shall be included as compensation in the gross income of such employee for the taxable year in which the property becomes substantially vested. Until such property becomes substantially vested, the employer shall be regarded as the owner of such property, and any income from such property received by the employee (such as a dividend paid on stock) constitutes additional compensation and shall be included in the gross income of such employee for the taxable year in which such income is received. Treas. Reg. Sec. 1.83-1.

[xix] The parties agreed that Taxpayer’s New York wage allocation was 38.70%, 34.53% and 18.14%, during 2016, 2017 and 2018, respectively.

It should be noted that New York’s “convenience of the employer” rule was not implicated in this case. Although Taxpayer performed services for Corp both within and without New York, Taxpayer’s “assigned or primary office” was not in New York. https://www.taxslaw.com/2023/02/new-yorks-convenience-of-the-employer-rule-new-jersey-and-connecticut-respond/

[xx] As set forth in the Dept.’s regulations at 20 NYCRR 132.24.

[xxi] Query why these dividends were reported on a W-2 when the shares of stock on which they were paid had already vested in the hands of the Taxpayer.

[xxii] During the audit years.

[xxiii] The federal “Pension Source Law” (4 USC Sec. 114) was not implicated in this case. It provides that no state may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such state. For purposes of the Pension Source Law, the term “retirement income” means any income from qualified plans. However, it also includes income from any nonqualified plan if such income (i) is part of a series of substantially equal periodic payments, not less frequently than annually, made for the life or life expectancy of the recipient, or the joint lives or joint life expectancies of the recipient and the designated beneficiary of the recipient, or a period of not less than 10 years, or (ii) is a payment received after termination of employment and under a plan, program, or arrangement (to which such employment relates) maintained solely for the purpose of providing retirement benefits for employees in excess of the limitations on contributions or benefits imposed by the Code with respect to qualified plans. The term “nonqualified deferred compensation plan” means any plan or other arrangement for deferral of compensation other than a qualified plan. IRC Sec. 3121(v)(2)(C). Neither the bonuses nor the RSUs were covered by this federal law.

[xxiv] NY Tax Law Sec. 605(b)(2).

[xxv] NY Tax Law Sec. 601(e)(1).

[xxvi] NY Tax Law Sec. 601(e)(2), (3).

[xxvii] NY Tax Law Sec. 601(e)(3).

The tax is determined by applying the appropriate graduated rate to the taxpayer’s total income from all sources less any statutory deductions, exemptions or credits. 606; 611(a).

[xxviii] NY Tax Law Sec. 611.

[xxix] NY Tax Law Sec. 601(e)(3).

[xxx] NY Tax Law Sec. 631(a)(1) and (2).

For example, a nonresident’s New York income will include the taxpayer’s income from:

• real or tangible personal property located in New York, 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;
• their distributive share of New York partnership income or gain;
• their share of New York estate or trust income or gain;
• income they receive related to a business, trade, profession, or occupation previously carried on in New York, including but not limited to covenants not to compete and termination agreements; and
• their pro rata share of New York S corporation income.

[xxxi] NY Tax Law Sec. 612.

[xxxii] NY Tax Law Sec. 631(g).

[xxxiii] 20 NYCRR 132.24(a).

[xxxiv] 20 NYCRR 132.24(c)(3)(iii). The allocation period may span multiple years.

[xxxv] 20 NYCRR 132.24(a).

[xxxvi] IRC Sec. 1031. I’m assuming the like kind exchange will not be removed from the Code. Mr. Biden sought to limit its application to the point it became meaningless. There is no reason to believe a Harris administration would not pick up where its predecessor left off.