On December 26, 2019, in Matter of Mackenzie Hughes LLP v. New York State Tax Appeals Tribunal, the New York Supreme Court, Appellate Division, held that New York’s retroactive decertification of Qualified Empire Zone Enterprise (QEZE) tax credits violated the taxpayers’ due process rights.1


For taxable years beginning on or after January 1, 2001, New York State has provided tax credits against corporate and personal income taxes for QEZEs, including to the members of QEZE partnerships.2 To obtain the credits, the entity must conduct operations on owned or leased real property located in an Empire Zone.3  

In April 2009, Governor David Paterson signed legislation that amended the criteria for a business to remain certified as a QEZE. In part, the legislation: (1) added a cost-benefit analysis test, which focuses on the business enterprise’s projected job creation and investment in the Empire Zone versus the total amount of QEZE tax credits the business enterprise could utilize;4 and (2) forbade the practice of “shirt-changing.” Shirt-changing is “a process whereby existing businesses reincorporate or transfer existing employees or assets among related entities so as to appear to have created new jobs or made new investments in order to qualify for, or maximize, empire zones program benefits.”5 Despite the April 2009 legislation date, if a previously QEZE-certified business entity did not meet the new criteria, the business entity would be decertified retroactively to January 1, 2008.6

Matter of Mackenzie Hughes LLP v. New York State Tax Appeals Tribunal

Mackenzie Hughes LLP is a law firm operating as a limited liability partnership. In 2001, its predecessor firm executed a long-term lease for office space in an Empire Zone in downtown Syracuse. Because of the office’s location, the law firm qualified for and later became certified as a QEZE. In June 2009, the Department of Economic Development notified the law firm that it was revoking the law firm’s QEZE certification, effective January 1, 2008, concluding that the law firm had previously engaged in the disallowed practice of shirt-changing to obtain the tax credits. Regardless, the partners and their spouses (the taxpayers) claimed QEZE tax credits on their 2009 original or amended income tax returns.7

The Department of Taxation and Finance (Department) denied the credits. On appeal, both the Division of Tax Appeals and the Tax Appeals Tribunal upheld the Department’s decision, ultimately concluding that the QEZE decertification should be deemed effective as of January 1, 2009. The Tribunal concluded that while the 2009 amendments were applied retroactively, that retroactive application did not violate the taxpayers’ due process rights.

The New York Supreme Court, Appellate Division, however, reversed the Tribunal and determined that the retroactive application of the 2009 amendments to the taxpayers’ 2009 tax year infringed upon their due process rights. In reaching its conclusion, the Appellate Division applied a three-factor test that New York courts have used to determine whether a retroactive law is constitutional:

  1. The public purpose of the retroactive application;
  2. The length of the retroactive period; and
  3. A taxpayer’s forewarning of the change in law and the reasonableness of his or her reliance on the old law.8

The Appellate Division determined that the public purpose factor favored the taxpayers because the New York Court of Appeals had previously examined the 2009 amendments at issue in a previous case and determined that they did not serve a public purpose.9 For example, the retroactive legislation was neither an attempt to correct an error in the tax code nor an attempt to spur investment or create jobs (which was the purpose of the QEZE tax credit).

Regarding the second factor, the taxpayers conceded at oral argument that the relatively short 97-day period of retroactivity favored the State.

On the application of the third factor, the Appellate Division explained that it focuses on “whether the [taxpayers] had adequate forewarning of a change in the law and an opportunity to change their behavior.” The Court rejected the State’s argument that the taxpayers were on notice as of the date of the 2009 amendments’ introduction in the legislative session. Merely introducing legislation does not guarantee that “such legislation would ultimately be passed by the Legislature or signed by the Governor. In other words, the introduction of proposed legislation only gave the [taxpayers] notice that, at most, a new law was being contemplated. It did not give them any warning of a change in the law.” 

EVERSHEDS SUTHERLAND OBSERVATION: While it should be obvious, a bill’s introduction is not notice of a statutory amendment. A taxpayer cannot be expected to change its behavior in reaction to introduced bills that may never take effect. As such, a governor’s signature—and not a moment earlier—should serve as notice of a law change.

The Appellate Division explained that, “although the Tribunal found that there appeared to be nothing that the [taxpayers] could have done to alter the result of being decertified, this factor does not focus on what actions they could have taken.” Instead, “consideration is given to whether the [taxpayers] had adequate forewarning of a change in the law and an opportunity to change their behavior.” More importantly, the Court continued, consideration must be given to whether the taxpayers’ “reliance has been justified under all the circumstances of the case” and whether their “expectations as to taxation have been unreasonably disappointed.” 

The taxpayers’ law firm had considered various places to relocate before signing its long-term lease to remain in downtown Syracuse, and the firm had invested approximately $800,000 in equipment and furnishings. Testimony showed that the law firm’s expenditures and investments were “made in reliance on receiving QEZE credits,” and the law firm continued to operate its business with the QEZE certification until it was decertified in 2009. Thus, the Court concluded that the taxpayers’ reliance on the old law was reasonable.

EVERSHEDS SUTHERLAND OBSERVATION: The Tax Appeals Tribunal previously determined that the taxpayers failed the third factor. It interpreted the factor to “protect[ ] a taxpayer who reasonably relied on the law in effect at the time an action was taken, but is not afforded the opportunity, due to lack of notice of the possible change in the law, to take any action to avoid the repercussions of the new law.”10 Because the law firm allegedly used so-called shirt-changing in 2001 and 2002 to obtain the credits, no matter the amount of notice, it would not have been able to avoid decertification. 

In another case issued shortly before the Appellate Division released its opinion in Mackenzie Hughes LLP, the Tax Appeals Tribunal held, in Matter of NRG Energy, Inc., that the retroactive application of the new cost-benefit analysis test enacted as part of the 2009 legislation was impermissible.11 The difference between the two cases is that the taxpayer in NRG asserted that, had it known of the cost-benefit analysis test in December 2008, it could have avoided decertification by making budgetary changes. The Appellate Division’s decision in Mackenzie Hughes is broader; taxpayers are not required to show that they would have been able to make changes to retain certification. Rather, the law change must have denied taxpayers the opportunity to do so.

If a legislature has second thoughts on a tax credit offering intended to bolster investment in their state, taxpayers should be mindful of Mackenzie Hughes and its due process holding.12