NEW YORK STATE NONRESIDENT ISSUE: TERMINATION AND BUYOUT PAYMENTS

By Raymond Haller CPA, Grant Thornton LLP

Many entrepreneurs who have worked long hours to build a successful business in New York State eventually decide that there is more to life than just work. Thoughts of retirement, playing a daily 18 holes of golf, or sailing in the Gulf now dance in their heads.

After relocating to their chosen retirement state, he or she may now want to transfer the ownership of the business or terminate employment, while still maintaining a steady income stream for a few years. There are several options available which include the following:

1) Payment for past services

2) Payment for future services

3) Payment for relinquishing right to future employment

4) Payment for a covenant not to compete

The taxability in New York State will vary for each of these income streams. New York State has a reputation for challenging the source of income of nonresident filers. For example, the State Tax Appeals Tribunal in Laurino (DTA No. 807912), stated, "In determining whether termination pay is derived from or connected with New York sources, it is necessary to identify the activity upon which the income was secured or earned."

It is important to determine exactly what services the nonresident is providing in exchange for consideration received in order to determine if the income should be properly sourced as New York. In determining if income is derived or connected with New York sources, the New York Tax Law sections 631(b)(1)(B) and 631(b)(2) state, "Items are either (a) attributable to a business, trade, profession, or occupation carried on in New York or (b) income from intangible personal property to the extent it is property employed in a business, trade, profession, or occupation carried on in New York." Essentially, the origin of the consideration received must be examined to determine its connection, if any, to the business in New York.

A payment for past services will be considered New York source income to the extent that the past services were rendered within New York. Usually this type of payment is given to an employee as an incentive to stay and complete a job. The knowledge and experience of the employee will make for a smooth transition or winding down of operations.

If the payment is for future services rendered, the income should be reported according to where the future services are to be performed. The problem that arises here occurs when a lump sum payment is made for services to be performed over a period greater than 12 months. Since the income cannot be matched with the services performed, an allocation must be made. There is also a possibility of misstating New York income upon receipt of a lump sum if services are rendered in different states in different years.

When a payment is received for relinquishing the right to future employment, the payment must be classified as an absolute contractual right to future employment. The State Tax Appeals Tribunal has taken the position that where the nonresident has an absolute contractual right to future employment, the connection of this right to New York is merely speculative and any payment for the relinquishment of that right is not considered New York source income.

Payments under a covenant not to compete are payments for a former employee's promise not to compete with the employer. For New York State purposes, a covenant is reviewed in two parts: income attributable to a business carried on in New York and income attributable to tangible property employed in a business in New York. When a former employee surrenders his right to compete anywhere in the country, the New York State Appeals Tribunal states that this income cannot be allocated directly to New York. If the covenant is determined to be intangible property used in a business that was not the taxpayer's business, income from the covenant would not be subject to New York tax if the employer was not a resident of New York.

Based on the above views of the New York State Appeals Tribunal, it is safe to assume that unless termination payments are for past services rendered, when a New York nonresident business owner or employee stops working in the State of New York, their nexus with New York is severed. *

This article first appeared in the newsletter of the Nassau Chapter of the
NYSSCPA, April 1998.

State and Local Editor:
Barry H. Horowitz, CPA
Eisner & Lubin LLP

Interstate Editor:
Nicholas Nessi, CPA
Ernst & Young LLP

Contributing Editors:
Henry Goldwasser, CPA
M.R. Weiser & Co LLP

Leonard DiMeglio, CPA
Coopers & Lybrand L.L.P.

Steven M. Kaplan, CPA
Kahn, Hoffman, Nonenmacher & Hochman LLP

John J. Fielding, CPA
Price Waterhouse LLP