The New York State Department of Taxation and Finance (Department) issued TSB-M-15(7)C, (6)I (the Memo) to explain the impact New York corporate tax reform,¹ which included changes to the income apportionment rules, will have on nonresident or a part-year resident shareholders of a New York S Corporation. The Memo discusses how the new rules apply when computing a New York S Corporation's shareholder's New York source income for tax years beginning after December 31, 2014.

A New York nonresident shareholder of a New York S Corporation is subject to New York State personal income tax under Article 22 of the Tax Law. Taxable income is based on federal adjusted gross income (FAGI) with certain modifications. A nonresident also computes New York source income. When a New York S Corporation election is made (or is mandated), the shareholder's share of New York source income from the S Corporation is determined by application of the corporate apportionment provisions (NY Tax Law Section 632(a)(2)). Income is apportioned to New York under the apportionment rules that apply to corporate taxpayers under Article 9-A of the Tax Law.

While the same concept applied for tax years beginning prior to January 1, 2015, the corporate apportionment rules were substantially different. New York source income included both items of business and investment income. Income from investment capital was allocated to New York using an investment allocation percentage (IAP) and business income was allocated to New York using a business allocation percentage (BAP). Since the IAP was generally lower than the BAP, a nonresident would pay less tax on investment income.

For tax years beginning on or after January 1, 2015, a corporation's income from investment capital is not subject to tax (certain limitations apply).² A corporate taxpayer only computes a business apportionment percentage. However, Article 22 of the Tax Law does not include a corresponding exclusion from the tax base for income from investment capital. Hence, the Memo concludes, all items of income from a New York S Corporation that enter into a nonresident shareholder's FAGI must be apportioned to New York using the New York S Corporation's business apportionment percentage.

Implications

New York S Corporations and their nonresident shareholders need to ensure that they are properly capturing and reporting New York source income in accordance with the above rules. New York S Corporations will need to provide to their nonresident and part-year resident shareholders business apportionment percentage information. The Department has not issued a specific form for this purpose; either a statement or a New York Schedule K-1 equivalent can be used. Failure to provide a shareholder with the information required to complete the shareholder's tax return may result in the Department asserting a penalty against the New York S Corporation of $50 per shareholder per month or fraction of a month, up to $250 per shareholder.

Lastly, shareholders in a New York S Corporation should consider if the above changes will impact their New York State personal income tax liability for the 2015 tax year. New York source income may be more significant than in the past given that all income will be apportioned to New York as business income. In addition, the business apportionment percentage also may change as market based sourcing principles will generally apply when computing the business apportionment percentage.

———————————————

———————————————
ENDNOTES

¹ For more information on corporate tax reform, see Tax Alert 2014-655.

² NY Tax Law Section 208.8.