NYC’s Vision for Taxing Corporate Partners Is Gathering Backlash

New York City has yet to formally propose rules implementing an overhaul of its corporate tax system, but practitioners already are hitting back against one measure said to be under consideration.

Public comments from city tax officials about how they plan to tax corporate partners has some tax professionals arguing the city’s current thinking represents a significant departure from the nearly decade-old state law that prompted the rulemaking process now underway.

The debate over how the city should draft its corporate tax regulations has begun now that changes have been made at the state level. New York State last December formally adopted regulations detailing how to calculate corporate taxes under a 2014 tax reform law, including the adoption of market-based sourcing—which taxes receipts based on where a customer receives a product or benefits from a service.

The move to market-based sourcing broadened the number of companies that fall under the state’s corporate tax structure, as businesses no longer must have a physical presence in New York to be subject to tax. The state applies this approach to corporations with partnership interests, using market-sourcing rules to source the receipts of the partnership in determining the corporation’s tax.

Now it’s the city’s turn to issue its own rules to reflect the changes that were made on the state level, or otherwise detail how the city’s position will differ. (The state enacted a law in 2015 reforming the city’s corporate tax structure to reflect changes made at the state level a year prior.)

Feedback on Proposals

But the city has said it may take a different approach when it comes to computing a corporate partner’s tax on partnership income, instead using rules under its Unincorporated Business Tax to source receipts based on where the service is performed. The move could increase the tax burden on any partnership with an office in the city and a national customer base, such as investment managers or consulting services.

“The city is saying, ‘No, if you receive something from a partnership, you should isolate that income from the partnership and use the partnership rules—place of performance—to source that income,’” Aaron Shafer, state and local tax principal at KPMG LLP, said in an interview.

Shafer added the city’s approach is “antithetical” to the state’s changes made under the 2014 tax reform law, and that he sees “the potential for litigation” and the possibility it “would incentivize businesses to move their operations out of the city.”

Kate Trachtenberg, deputy director of the city Finance Department’s tax advocacy and resolution unit, said in a February that the city will mostly align with the state’s adopted rules, but plans to diverge in a few areas—including the allocation of income that will be rolling to a corporate partner. The draft regulations aren’t expected to be released until the end of the year, with the goal of implementation in early 2025.

“We look forward to holding productive discussions with the tax practitioner community in the coming months to ensure the new rules are developed with ample opportunity for input from affected businesses so that the final rules serve to make compliance with the City’s tax laws clear, fair, and as straightforward as possible,” Finance Department spokesperson Ryan Lavis said in a statement.

‘Intended to Avoid’

Debate over the taxation of corporate partners is expected to intensify in the months ahead.

Katie Quinn, a partner at Jones Walker LLP in New York, said in an interview the city’s approach to taxing corporate partners would “increase the New York City tax burden on corporate partners that have partnerships with physical employees in the city.” The issue has already come up in audits, she said.

“This is exactly what market-sourcing was intended to avoid,” she said.

The city is also considering diverging from the state’s corporate tax rules in other areas, though tax attorneys don’t expect them to be as hotly contested as its current position on taxing corporate partners.

Trachtenberg said in February the city is weighing whether to “flip the script on the state” on its treatment of income from extraordinary events, such as the sale of a capital asset. The state’s final regulations called on taxpayers to include those receipts in the apportionment formula, unless they can prove it creates “distortion"—or unfairly represents the taxpayer’s activity in the state. The city is considering the opposite approach, leaving those receipts out as the default.

Other areas on which the city may not conform with the state include its billing address presumption for the sourcing of digital goods and services and sourcing rules for passive investment customers, Trachtenberg said.