In New York state, gain realized by an out-of-state S-corporation on the sale of certain leasehold interests in Massachusetts was properly apportionable to New York.
The taxpayer, a New Jersey S-corporation, operated laundry machines at over 4,000 locations in a number of different states. Taxpayer would enter into lease agreements with property owners to occupy a certain defined space within a given property. In 2004, owners of four properties planned to sell to buyers that did not wish to assume the laundry facility agreements between the original owners and taxpayer. After negotiations, the taxpayer agreed to sell the four leases to the buyers for $500,000. This was taxpayer’s first time selling a leasehold interest.
New York state imposes an annual franchise tax on all corporations for the privilege of doing business in the state. The tax is usually based on a taxpayer’s “entire net income”(ENI), which is generally the same as the corporation’s federal taxable income. Once ENI is determined, it is separated into two components, “investment income” and “business income.” Business income is then apportioned according to the taxpayer’s in-state sales, property, and payroll.
An audit by the state concluded that taxpayer did not properly report the gain from the leasehold interests as business income. The taxpayer argued that the gain in question resulted from an “unrelated business activity that constitutes a discrete business enterprise” and should not be considered business income. The Administrative Law Judge (ALJ) in the matter decided that it was clear that taxpayer was a unitary business enterprise and that the leasehold interests sold are an ongoing integral part of taxpayer’s ordinary and necessary course of conducting its business. Further, the sale of such a business asset, though uncommon and unusual, does not rise to the level of a discrete and unrelated business activity. The ALJ believed the taxpayer presumably received value for the leases it sold commensurate to the income that would have been realized from the continued operation of its laundry facilities. The ALJ concluded that the gain on the sale of the leasehold interests was clearly tied to taxpayer’s overall business operations.
All taxpayers must be careful when differentiating between business and non-business income. States take different approaches in making this distinction. Careful planning can avoid state adjustments and penalties and can lead to tax savings.
The views expressed in this article are those of the author and do not necessarily reflect the position or policy of Berkeley Research Group, LLC.
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