The New York Court of Appeals, the highest court in New York, recently upheld the imposition of New York state income tax on a nonresident shareholder who sold stock in an S corporation and elected under Section 338(h)(10) of the Internal Revenue Code to treat the sale of stock as a sale of assets for federal income tax purposes. In the case of a New York S corporation, New York follows the federal income tax treatment and imposes a New York state income tax on the portion of the gain allocable to New York.
In Burton v. NYS Department of Taxation & Finance, the taxpayer argued that despite the express provision of the statute, taxation was prohibited by Article 16, §3 of the New York Constitution. That provision fixes the domicile of a nonresident’s intangible personal property not employed in business in New York as the domicile of the owner, and prohibits ad valorem and excise taxes based solely on the ownership or possession of intangible personal property. Burton asserted that, despite the IRC Section 338(h)(10) election, the transaction is a sale by a nonresident of stock – intangible property that is not used in a trade or business in New York – and therefore cannot be taxed.
The Court of Appeals unanimously rejected the taxpayer’s argument and affirmed the summary judgment the trial court granted to New York. Nothing in the language of the state constitution insulates a nonresident from an income tax. In fact, the legislative history makes it clear that the income from intangible personal property may be taxed. Moreover, the taxpayer voluntarily filed an IRC Section 338(h)(10) election and presumptively was aware of its effect. The deemed asset sale was not merely a fiction of federal law. Rather, the election allowed the parties to change the means by which the gain was realized, as well as the person who realized the gain.