THE ALIMONY DEDUCTION AND NONRESIDENTS

By Mark H. Levin, CPA, H.J. BEHRMAN & COMPANY, LLP

New York State has lost another round in their never-ending attempt to deny nonresidents of New York State the deduction allowed for alimony paid, in the Matter of the Petition of Christopher H. Lunding et al. v. Tax Appeals Tribunal of the State of New York et al., New York Supreme Court, Appellate Division, Third Department, No.74021, March 14, 1996.

Before discussing Lunding, a brief history of New York's tax treatment of alimony paid is appropriate.

Since 1976, when the Federal treatment of alimony was changed from an itemized deduction to an adjustment toward Adjusted Gross Income, New York had taken the position that the adjustment for alimony was governed by Tax Law Sec. 632(a)(1) (old law prior to 1988), which limited adjustments to income to those amounts derived from or connected with New York sources. Based on Sec. 632(a)(1), the Department of Taxation and Finance administratively took the position that alimony was not connected with, or derived from, New York source income.

In 1985, the Department of Taxation and Finance issued Technical Services Bureau Memorandum TSB-M-85(7)-I (the TSB-M) in response to the NYS Court of Appeals decision in the Matter of Lance J. Friedsam v. State Tax Commission, 192 N.Y.L.J. No. 122, p.19 (December 27, 1984).

In Friedsam, the New York State Court of Appeals held on statutory, not constitutional, grounds that New York must allow an alimony deduction as an "adjustment to income" in the same manner that it was previously allowed as an itemized deduction. In response to this decision, the Department of Taxation and Finance issued Technical Services Bureau memorandum, TSB-M-85-(7)-I, which spells out how to compute the alimony paid adjustment for nonresidents. The TSB-M defined how a nonresident should compute the amount of the Federal alimony paid adjustment that may be deducted against New York source income.

The computation as defined in the TSB-M is shown in the Figure.

The TSB-M remained in effect until 1987, when the Tax Law was amended and Sec. 631(b)(6) was added.

Effective for years beginning after 1987, alimony was disallowed, by statute, as a deduction for nonresidents under Tax Law Sec. 631(b)(6), which states, "The deduction allowed by section two hundred fifteen of the internal revenue code relating to alimony, shall not constitute a deduction derived from New York Sources." Since the enactment of Sec.631(b)(6), New York has disallowed any alimony deduction taken against New York income

As mentioned previously, in March 1996 the Appellate Division, once again, handed down a decision that overturns New York's position with respect to the allowance of an alimony paid adjustment against New York source income. In Lunding, the taxpayer, on his 1990 personal income tax return, calculated that 48.0868% of a Federal adjustment for alimony paid of $108,000, or $51,934, represented the amount of business income derived from or connected with New York and included it as a Federal adjustment in arriving at the amount of Federal AGI derived from New York sources. New York disallowed the adjustment for alimony paid as an adjustment against income from New York sources based on Tax Law Sec. 631(b)(6). The Tax Appeals Tribunal upheld the decision of the Department of Taxation and Finance [Matter of the Petition of Christopher H. Lunding et al. v. Tax Appeals Tribunal of the State of New York et al., Tax Appeals Tribunal (DTA) No. 810921, February 23, 1995]. The Appellate Division reversed the decision of the Tax Appeals Tribunal and stated "...it is declared that Tax Law Sec. 631(b)(6) is unconstitutional." Based on this decision, the Federal adjustment for alimony paid is allowed against income from New York Sources, to the extent that it represents amounts derived from, or connected with, income from New York sources. It would appear that the rules as stated in the TSB-M might, once again, be the method for calculating the amount of the Federal alimony paid adjustment that would be allowed to a nonresident.

While the denial of the alimony adjustment to nonresidents has been declared--at least for the time being--unconstitutional, this does not mean that New York will favorably act on nonresident returns claiming the adjustment for alimony paid. In conversations with representatives of the Department of Taxation and Finance, the author was advised that New York is appealing the decision. In the meantime, they have stated they will accept, but not take action on, any nonresident returns with an adjustment for alimony paid taken against New York income.

It may be prudent to make protective claims for all open years for any nonresident taxpayer for which an alimony paid adjustment was not taken against New York income. It may also be prudent to make protective claims, for all open years, for any nonresident taxpayer who has been examined and assessed additional tax based on disallowed alimony. *

STATE TAXES IN CYBERSPACE ARE UP IN THE AIR

By Wayne Berkowitz, JD, CPA, David Berdon & Co. LLP

State taxing authorities may be preparing for battle with Internet merchants. Although it certainly doesn't seem that anyone, including the tax man, can interfere with the sheer force behind Internet growth, electronic commerce is destroying the states' conventional basis for imposing tax.

Nexus: The Portal to Taxation

In order for a state to levy either an income tax liability or a sales tax collection obligation, sufficient contact with the state, i.e., nexus has to be satisfied. Traditionally, the concept of nexus was based on physical presence. Now, with the advent of computer-provided goods and services the prevailing notion of physical presence is quickly eroding.

The commercial use of the Internet typically involves a provider or seller of goods physically located in one or several states, but serving as many as all 50 states. The actual merchant or information provider depends on contracting with a service provider to furnish a gateway to and throughout the Internet. These service providers are likely to have physical presence in multiple states. To complicate the issue further, some providers, called beam and bill providers, do not retain a third party and directly beam information to and bill customers in all 50 states. The states are therefore faced with the extraordinary task of redefining nexus or risk of losing further revenue.

Pressure on Physical Presence: States Look to Gravity and other Supernatural Forces

Under the current state of the law, electronic vendors seem to be winning the early battles. However, cyberspace merchants should be forewarned that states can and will pursue alternate arguments to overcome the limits imposed by the physical presence standard. The states' attacks will most likely arise from a detailed review of all the components of, and parties involved in, an electronic transaction.

Looking to third parties may provide states with one line of attack. The states are likely to assert that service providers are agents of the merchant. Furthermore, they may argue that physical presence exists when a third party maintains tangible property located within their borders. Accordingly, the states may claim an income tax liability and sales tax collection obligations.

Another avenue states may pursue to augment the tax base is to establish physical presence through the use of software supplied by information service providers to access the service.

Although the Supreme Court has previously stated that having several floppy disks in a state is not enough to create substantial nexus, the implication of having thousands or millions of copies of software within the state has not yet been addressed.

Completely departing from the physical presence standard, states may attempt to establish nexus by contending that they provide a market for the seller or service provider. This market maintenance theory especially pertains to beam and bill providers who have no direct or indirect physical presence in the state. Although this theory is the least compelling, it is likely to gain more attention as technology enhancements require decreasing physical presence.

Coming Back Down to Earth

The threatened loss of substantial revenue to the states almost promises that the nexus concept will be redefined or addressed though Federal legislation. Therefore, it is essential that those participating in electronic commerce closely follow this ever-evolving body of law. *

State and Local Editor:

Marshall L. Fineman, CPA

David Berdon & Company LLP

Interstate Editor:

Stuart A Rosenblatt, CPA

Wiss & Company LLP

Contributing Editors:

Henry Goldwasser, CPA

M. R. Weiser & Co LLP

Leonard DiMeglio, CPA

Coopers & Lybrand L.L.P.

Steven M. Kaplan, CPA

Konigsberg Wolf & Co., PC

AUGUST 1996 / THE CPA JOURNAL