September 2000


By Ernest G. Foundas

A recent court decision has once again called attention to New York’s aggressive “work-at-home” and sourcing rules regarding nonresidents, rules which determine income derived from or connected with New York sources [Phillips v. New York State Dept. of Taxation and Finance, 267 A.D.2d 927, 700 N.Y.S.2d 566 (N.Y.A.D. 3 Dept., Dec. 30, 1999); leave to appeal denied by Phillips v. New York State Dept. of Taxation and Finance, 94 N.Y.2d 763, ___ N.E.2d ___, ___ N.Y.S.2d ___ (N.Y., Apr. 6, 2000)].

New York State’s aggressive approach to sourcing nonresident income may pose significant audit and assessment risk for nonresident corporate board members (directors) that often receive significant income for attending board meetings, providing consulting services, and associated preparation work.

According to New York personal income tax law section 631(a), all items of income, gain, loss, and deduction entering into federal adjusted gross income that are derived from or connected with New York sources will be taxable by the state, raising the question of how far the inclusion of income “derived from or connected with New York sources” should extend. The regulations lend additional insight into these definitions and seem to push the bounds of inclusion.

Earnings of Nonresident Employees and Officers

Nonresident employees and officers that provide services within and without New York State must apportion their income based on the number of working days they spend in and out of the state [NYS Personal Income Tax Regulations section 132.18(a)]. Of particular concern here is the necessity-convenience analysis, otherwise known as the “work-at-home rule,” employed by the Department of Taxation and Finance. According to this rule, the only days that may be claimed outside of New York must be based upon the “performance of services which of necessity, as distinguished from convenience, obligate the employee to perform the duties out of the state.”

New York courts have consistently applied this rule in the context of employees working at home [See Speno v. Gallman, 35 N.Y.2d 256, 259, 319 N.E.2d 180 (N.Y., Oct. 8, 1974) and cases cited therein.] In Phillips, the Appellate Division concluded that Phillips, a specialized bond trader in New Hope, Pa., was working at home “for his convenience.” The trading firm that Phillips worked for provided computers, information systems, fax machines, and 25 phone lines for his in-home office located two hours from the firm’s Manhattan location. Phillips testified that he monitored world markets and had to be available 24 hours a day to make trades within minutes of a client’s request. The court concluded that because the firm could have made accommodations at its New York office, Phillips’ home-office work was not due to employer necessity.

The rules set forth in Phillips and Regulations section 132.18 may be applied to directors that wear multiple hats. In addition to attending board meetings, directors often function as officers or consultants to a company. The issue is whether the director will be viewed as an employee or officer and thus fall under the rules of Regulations section 132.18(a); the analysis will likely turn on whether the director can produce evidence as to the source and segregation of compensation derived from these various functions. If the company issues a W-2 for all services provided with no written contract, the state may treat all of the income as employee income, in which case the work-at-home rule may apply and any preparation time or consulting work conducted outside of New York will be disallowed.

The company could reduce exposure for this kind of assessment by issuing separate W-2s or 1099s for the various services provided and drafting written contracts explaining the nature of the services provided. If the chain of evidence is sound, a director may argue that the compensation is not employee or officer compensation, thus placing it outside of the scope of Regulations section 132.18(a) and the Phillips work-at-home rule.

Business Carried on Both Inside and Outside of New York

Income received by a director that is not employee or officer compensation will likely be treated as business income under Regulations section 132.15, which applies to nonresidents that carry on a business, trade, profession, or occupation both within and without New York State. Under this regulation, income received by a nonresident may be allocated according to the books and records of the business if they provide a sufficient basis upon which the allocation can be made. If the books and records do not provide an adequate basis for apportionment, a factor analysis may be employed (property, payroll, and gross income factors).

The primary benefit of treatment under Regulations section 132.15 is that the aggressive work-at-home rule will not apply. In other words, a director who attends six board meetings in New York and six in New Jersey and spends two days preparing at home for each meeting (24 total at-home days) can argue that the only New York days were the six days spent at board meetings in New York (out of a total of 36 days). For such an argument to prevail, the director would need to produce evidence regarding the location of all board meetings and records of all time spent working outside of New York. This approach would require meticulous record-keeping and might be challenged by the state.

In this example, the state might seek a 50% allocation based on applying preparation days to the location of the meeting. In other words, the 12 preparation days associated with the six New York meetings would be New York days as well (totaling 18 New York days, not the six shown above). However, the taxpayer could argue that if the books and records are not sufficient, Regulations section 132.15 factor apportionment must be applied and, depending on the facts, the apportionment could accurately reflect the nature of the services provided and produce a favorable result for the director.

Keeping Detailed Records

The most important factor in determining the proper allocation of nonresident director compensation is accurate books and records, especially for directors who also function as officers or consultants. A conservative and simple approach is to source the compensation to the location of the meetings only, without regard to consulting or preparation work. Such an allocation may be easy to defend from an evidentiary standpoint, although it might not accurately reflect the true nature of the services. Representatives dealing with this issue should bear in mind that New York’s aggressive approach to capturing nonresident income makes this front-end planning extremely important in order to ensure that various sources of income can be segregated according to their true nature.

Ernest G. Foundas, JD, LLM, is an associate in PricewaterhouseCoopers LLP’s state tax consulting practice and dispute resolution group, based in New York City. Prior to joining PricewaterhouseCoopers, he was an assistant city solicitor with the law department of the City of Philadelphia, where he was the lead trial attorney for major tax collection cases and represented the revenue department in audit defense matters.

The author would like to acknowledge James W. Perraglia, a senior manager at PricewaterhouseCoopers LLP, for his assistance and contribution to this article.

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

Interstate Editor:
Nicholas Nesi, CPA
BDO Seidman LLP

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

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

John J. Fielding, CPA
PricewaterhouseCoopers LLP

Warren Weinstock, CPA
Marks Paneth Shron LLP

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