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The New York City (NYC) Department of Finance (DOF) has released a list of "several notable differences" taxpayers should expect between business corporate tax (BCT) regulations currently being drafted and final corporate tax regulations adopted by the New York State (NYS) Department of Taxation and Finance in December 2023 (See Tax Alert 2024-0140).

DOF recently announced it is currently drafting BCT regulations to implement changes enacted in 2015 and that it will hold virtual public input meetings on May 14 and May 15, 2024. While NYC's new regulations "will be substantially similar to the state's," the DOF stated, it expects "several notable differences" as highlighted in a recent release.

Below is a summary of potential departures from the NYS regulations taxpayers might expect to see in the draft regulations, when released.

Allocation of partnership flow-through income .

Under NYS tax law, corporations that are partners in a partnership must compute tax using the "aggregate method" when there are sufficient contacts between the partnership and corporate partner (i.e., the corporate partner has adequate information to use the aggregate method).¹

Under the aggregate method, partnership income is treated as earned by the corporate partner, and the corporation must include its distributive share of the partnership's business receipts when computing its business apportionment factor. The corporation must then combine those receipts with its own receipts and apportion the combined amounts using the corporate apportionment rules specified in NY Tax Law Section 210-A, which generally require market-based sourcing.²

NYS allows the use of the "entity method" in rare cases when the contacts or information from the partnership is not sufficient. Under the "entity method," the partnership income is reported as business income and apportioned by the corporation's apportionment percentage derived from its other receipts.

Under NYC's Administrative Code, corporations that are partners in a partnership compute tax using any method required or permitted by regulation.³ The DOF explained that this provision "gives the commissioner … a high degree of flexibility regarding how to include a partnership's distributive share in the corporate partner's income."

Additionally, NYC partnerships are subject to the city's Unincorporated Business Tax (UBT); partners paying the BCT can claim a credit for their share of UBT. Because of these factors, the DOF said that it "intends to continue to use the UBT provisions as the primary method for the taxation and allocation of items of partnership income flowing to corporate partners."

Thus, partnership gain or income would be allocated under the UBT rules, which is generally place-of-performance sourcing for services, and the gain or income would not be included in the computation of a corporate partner's receipts factor.

Other corporate income would be allocated using the Business Allocation Percentage (BAP), which largely follows the NYS market-based sourcing provisions. A corporation's taxable income under the BCT would be the sum of the separately allocated partnership income and the business income allocated under the BAP. Corporate partners could still claim the UBT paid credit.

The language of the DOF's memo suggests that the full extent of the UBT, including its exemptions and treatment of investment income, would supersede the BCT provisions that would otherwise apply to that income.

Clear and convincing evidence

The DOF said it is considering diverging from NYS's "clear and convincing" evidentiary standards for overcoming presumptions related to certain allocation provisions and determining the existence of a unitary business. Rather, the DOF said it would not include specific standards of evidence language for overcoming these presumptions, noting that the State's "standard would be excessively burdensome for both NYC and its taxpayers."

Allocation of income from passive investment customers (PICs)

While it intends to adopt NYS's regulations on the special allocation of income from PICs, the DOF said that it may decouple from NYS's "fallback allocation approach," specifically 20 NYCRR Section 4-4.4(c), which requires taxpayers to apportion receipts from PICs to the location where the contract is managed by the PIC.

Generally, NYS's PIC sourcing rule requires a taxpayer to source fees from management, distribution and administration services provided to a PIC based on the location of the underlying investors or beneficial owners. If the taxpayer does not know the location of the underlying investor or beneficial owner, the benefit is presumed to be received where the PIC manages the contract for those services.

The DOF said it "intends to replace the second method with one that is more closely related to the primary method of investor location" and is considering an 8% flat allocation as a fallback method.

Billing address safe harbor

The DOF said that it intends to increase the number of business customers needed to meet the requirements of the billing address safe harbor from 250 to 1,000. According to the DOF, with a threshold as low as 250, the safe harbor would apply to nearly all taxpayers other than small businesses and become the default rule.

Real estate mortgage investment conduits (REMICs)

The DOF said it intends to diverge from NYS's rules excluding from entire net income (ENI) the amount of excess inclusion required to be reported under IRC Section 860E, which applies to taxpayers that hold a residual interest in REMICs.

The DOF explained that, because NYC does not include a statutory requirement to deduct the excess inclusion, it plans to "maintain conformity with federal taxable income and retain the excess inclusion when calculating ENI … "

Public comment

During the two upcoming virtual discussion sessions, the DOF is seeking public input on differences between NYC's proposed regulations and those finalized by NYS. The sessions will be held on May 14, 2024, at 10:00 a.m. and on May 15, 2024, at 2:00 p.m. Interested parties may also submit written comments regarding NYC's proposed regulations before the session.

Information on how to register for the virtual sessions and submit comments is available here.

Implications

Interested parties should review NYC's proposed deviations from the NYS regulations and consider submitting comments. Taxpayers also should monitor the DOF's proposed regulations as they make their way through the regulatory process.

Note that, among other provisions, the proposed approach to allocating partnership flow-through income, if promulgated as currently worded, might depart from existing DOF guidance, recently enacted economic nexus provisions and the stated policies behind corporate tax reform.