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By Mark H. Levin, CPA,
H.J. Behrman & Company, LLP

As part of the 1997­98 budget, New York State has enacted the College Choice Tuition Savings Program (the Tuition Program). Beginning in tax years starting on or after January 1, 1998, both New York State resident and nonresident taxpayers may establish savings accounts to pay for qualified higher education expenses of attending recognized public or private institutions of higher education. These institutions of higher education are not limited to those located in New York State. The state comptroller is charged with implementing the program and in selecting the financial organizations to invest the funds.

Beginning in 1998, both NYS resident and nonresident taxpayers may enter into a "tuition savings agreement" (an account) and establish an account on behalf of a "designated beneficiary." Individual taxpayers may contribute up to a maximum of $5,000 per year. Taxpayers filing joint returns may each contribute up to $5,000 per year for a maximum of $10,000 for a joint return. These contributions are deductible as a subtraction adjustment on the taxpayer's New York State personal income tax return. If a taxpayer wants to contribute to several accounts, the total contributed to all of the accounts may not exceed the maximum allowable contribution as discussed above. In addition, the aggregate contributions to any account, not including any earnings thereon, may not exceed $100,000.

Any distributions from an account which are used to pay qualified higher education expenses will be exempt from taxation in computing the New York State personal income tax. This exemption covers both principal and earnings. These contributions will be deposited with the state comptroller or whomever the comptroller so designates. The comptroller, or the comptroller's designee, will have control as to how and in what manner the funds are invested. Similarly, when disbursements are required, the comptroller, or the comptroller's designee, will make payment to the requested payee. Because the tuition program is a "qualified State tuition program" for Federal income tax purposes, earnings will be tax free for Federal purposes until they are disbursed. The end result is that for Federal tax purposes the account's earnings are tax deferred and for New York State tax purposes qualified distributions of both principal and interest are tax free.

These accounts may be set up for any person the taxpayer wishes to designate, including but not limited to, children, grandchildren, other relatives, or any person for whom the taxpayer wishes to set up an account, including the taxpayer or spouse.

Qualified higher education expenses include tuition, fees, and books. Room and board costs are considered as qualified higher education expenses only if the student is carrying at least one-half of a full course load.

In order to qualify for the New York State tax-free treatment, the funds must be in the account for a minimum of three years and the disbursements must be made for qualified higher education expenses for the account's named beneficiary. Distributions that do not qualify will be taxed to the recipient as ordinary income and are subject to a five percent penalty. In the event that a named beneficiary dies, leaving a balance in the account, any amount withdrawn will be taxable, but no penalty will apply. In the event that a named beneficiary will not make use of the account for higher education, any balance in the account may be transferred to another beneficiary tax free, as long as the new beneficiary is in the same family as the beneficiary from whose account the funds are transferred. In no case may the aggregate of any contributions in the transferee's account, plus any contributions being transferred in, exceed the $100,000 limit.

If the taxpayer does not mind leaving the investment decisions up to the state comptroller or the comptroller's designee as to any amounts contributed, this seems to be a reasonable tax shelter for taxpayers with young children when viewed over the almost 20 years before it will be needed to pay for higher education costs.


By Kathleen M. Meade, CPA, Ernst & Young LLP

For tax years beginning after December 31, 1996, Federal tax law permits the creation of qualified subchapter S subsidiaries (QSSS). Following the Federal lead, the New York State Legislature amended the Tax Law to allow for QSSSs, effective for tax years beginning on or after January 1, 1997 (Tax Law section 208(1-B), added by 1997 NY Laws ch 389, pt A, section 45). On September 9, 1997, the New York State Department of Taxation and Finance released a notice detailing the changes in the state tax treatment of S corporations, including those applicable to QSSSs [TSB-M-97(6)C].

A QSSS is a domestic corporation, otherwise eligible for S corporation status, that is wholly owned by an S corporation that elects to treat it as a QSSS. A QSSS is not treated as a separate corporation. Instead, all of its assets; liabilities; and items of income, deduction, and credit are treated as assets, liabilities, and other such items of the parent S corporation. Accordingly, since the QSSS is not treated as a separate entity, it does not make its own S corporation election, does not file a separate Federal tax return, and is not required to have its own taxpayer identification number.

As specified in the notice, New York State's QSSS rules are intended to conform to Federal law, largely ignoring the separate existence of the QSSS for purposes of the Article 9-A franchise tax (i.e., assets, liabilities, income, and deductions of the QSSS are reported on the parent's franchise tax return). However, with regard to other New York State taxes, such as sales and excise taxes, a QSSS will be recognized as a separate taxable entity. Further, QSSS treatment is not permitted under Article 9-A unless both parent and subsidiary are general business corporations that would each separately qualify for taxation under Article 9-A. Specifically, QSSSs will be treated as follows for New York State franchise tax purposes:

Where the parent is a New York S corporation. New York will follow the Federal QSSS treatment. Accordingly, the parent and subsidiary will be taxed as a single New York S corporation under Article 9-A whether or not the subsidiary, viewed on a stand-alone basis, is a New York taxpayer.

Where the parent is a New York C corporation. New York will follow the Federal QSSS treatment if either 1) the subsidiary is a New York taxpayer, or 2) the subsidiary is not a New York taxpayer, but the parent makes a "QSSS inclusion election." In both instances, the parent and subsidiary will be taxed as a single New York C corporation. If the parent does not elect QSSS inclusion, the parent will file as a New York C corporation on a stand-alone basis.

If the parent is a nontaxpayer. New York will follow the Federal QSSS treatment where the subsidiary is a New York taxpayer but the parent is not, if the parent so elects. The parent and subsidiary will be taxed as a single New York S corporation. If the parent does not elect, the subsidiary will file as a New York C corporation on a stand-alone basis.

In all instances where Federal QSSS treatment is followed, the subsidiary is exempt not only from the income-based franchise taxes, but also from the fixed dollar minimum tax, the capital tax, and the alternative tax based upon assets.


By Rose Litvack, CPA, Kingsborough Community College

The question of whether a nonresident taxpayer of New York is entitled to take a deduction for alimony paid to their former spouse to reduce their New York income tax liability has been a recent issue before the New York Tax Appeals Bureau and in the New York Courts.

In a recent decision, In the Matter of the Petition of Harvey J. Coopersmith (DTA No. 813823, September 25, 1997), the New York Tax Tribunal (tribunal) reversed the Administrative Law Judge (ALJ) determination and disallowed the alimony deduction to a nonresident taxpayer. The tribunal based its decision on a New York Court of Appeals decision in a similar case, In the matter of Christopher H. Lunding et al. v. Tax Appeals Tribunal of the State of New York, et al. (No. 260, December 18, 1996), which had reversed the New York Supreme Court, Appellate Division's decision.

The ALJ determination in Coopersmith was based on the Appellate Division's decision in Lunding, which allowed a nonresident taxpayer to deduct the alimony paid to his former wife from his New York source income. But in the intervening time between the ALJ determination and the tribunal decision, the New York Court of Appeals had reversed the Lunding decision. In Lunding, New York's highest court ruled that the statute that prevents nonresidents from reducing their New York taxable income by claiming a deduction for alimony did not violate their rights under the Privileges and Immunities, Equal Protection, or Commerce Clauses of the U.S. Constitution. Even though New York residents are allowed to claim the deduction, the New York Court of Appeals reasoned that the disparate treatment was justified since nonresidents are taxed only on their income earned in New York, while residents are taxed on all income earned from whatever sources.

It should be noted that the United States Supreme Court has decided to review the Lunding decision (U.S. Supreme Court, Dkt. 96-1462, petition for certiorari granted May 19, 1997).

On January 21, 1998, the Supreme Court ruled that New York was unconstitutionally discriminating against nonresidents by denying them the deduction for alimony payments from New York taxable income. In commenting on the decision, Justice Sandra Day O'Connor said the state had not provided any "reasonable explanation or substantial justification for the discriminator provision."

State and Local Editor:
Marshall L. Fineman, CPA
David Berdon & Co. LLP

Interstate Editor:
Alan J. Preis, CPA
Own Account

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

John J. Fielding, CPA
Price Waterhouse LLP

Warren Weinstock, CPA
Paneth Haber & Zimmerman LLP

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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