When a taxpayer moves into New York partway through the year, can she allocate her pro rata share of federal S corporation income based on the date the S corporation actually earned it, rather than prorating it day-by-day across her resident and nonresident periods?

Plain-English summary

Margaret P. Somers was a 20 percent shareholder in Geographic Marketing Group, Inc., a Pennsylvania S corporation that did business in Pennsylvania, New Jersey, and North Carolina (for New Jersey purposes it was treated as a C corporation). On June 30, 1998, the corporation sold all of its assets and stopped doing business; by August 31, 1998, it had wound up its affairs and was fully dissolved. It issued Somers a Schedule K-1 for the period January 1 through August 31, 1998, reporting her 20 percent share of the final income, gain, loss, and deduction, including the asset sale. The corporation had no income derived from or connected with New York sources.

During 1998 Somers changed residence twice: she was a New Jersey resident from January 1 to April 14, then a Pennsylvania resident from April 14 to August 11, and then became a New York resident on August 12, 1998. She asked whether her pro rata share of the S corporation's income for that year could be allocated based on the actual date the income was earned by the corporation (which wound down before her New York residency began), rather than prorated across the whole year based on how many days she lived in each state.

The Department answered no. Citing the Court of Appeals' decision in Matter of McNulty and the Tax Appeals Tribunal's decisions in Matter of Wertheimer and Matter of Greig, the opinion traced how New York invalidated two successive regulatory attempts to tie a change-of-residence partner's or S corporation shareholder's income to the entity's own tax-year-end date or accrual date. Each time, the courts held that because a distributive or pro rata share is reported without regard to actual receipt, the only valid method when residency changes mid-year is proportional allocation based on the number of days in the resident and nonresident periods - a rule later codified in TSB-M-00(1)I for tax years beginning in 1999 and after.

Applying that day-count method here, the Department concluded Somers must prorate her pro rata share of Geographic Marketing Group's income, gain, loss, and deduction between her resident and nonresident periods of 1998 based on the number of days she resided in New York. The portion allocated to her New York resident period is New York source income under Tax Law § 638(a)(1). The portion allocated to her nonresident periods is not New York source income under Tax Law §§ 632(a)(2) and 638(a)(2), because Geographic Marketing Group itself had no income derived from or connected with New York sources.

What this means for you

Shareholders in federal S corporations who change residence mid-year

If you move into or out of New York during the same year an S corporation you own stock in reports income to you on a Schedule K-1, you cannot allocate that income to whichever period it was actually earned or received. New York requires proration based on the number of days you spent as a resident versus a nonresident during the year, regardless of when the corporation itself generated the income, sold assets, or wound down.

Accountants and tax professionals

When a client changes residence during a year in which a pass-through entity reports a final K-1 (for example, following an asset sale and dissolution), remember that day-count proration under TSB-M-00(1)I applies to the shareholder's pro rata share the same way it applies to a partner's distributive share. Also check whether the entity had any New York source income of its own: if it did not, the portion of the prorated amount allocated to the nonresident period simply falls outside New York's tax base entirely, rather than being taxed on some other allocation basis.

Common questions

Q: Can a taxpayer choose to allocate S corporation income to the period in which the corporation actually earned it, instead of prorating by days?
A: No. Following Matter of McNulty, Matter of Wertheimer, and Matter of Greig, the only valid method when residency changes during the year is proportional allocation based on the number of days in the resident and nonresident periods, as set out in TSB-M-00(1)I.

Q: Why did this proration rule matter so much to Somers, given that the corporation sold its assets and dissolved before she became a New York resident?
A: Because if she could tie the income to the actual accrual or receipt date, none of it might have been attributed to her New York resident period at all. Instead, day-count proration attributes a share of the full year's K-1 income to whatever portion of the year she was a New York resident, regardless of when the underlying events at the corporation occurred.

Q: Is the portion of Somers's income allocated to her nonresident periods taxable in New York?
A: No. Geographic Marketing Group had no income derived from or connected with New York sources, so under Tax Law §§ 632(a)(2) and 638(a)(2), the pro rata share allocated to her nonresident periods is not New York source income.

Q: Does this proration rule apply only to S corporations, or also to partnerships?
A: The same day-count proration rule applies to a partner's distributive share of partnership income as well as to a shareholder's pro rata share of federal S corporation income; the opinion traces the rule through partnership cases (McNulty, Wertheimer) before applying it to Somers's S corporation shares.

Q: What happened to the earlier regulations that tried to tie this allocation to the entity's tax-year-end date?
A: They were invalidated. Former 20 NYCRR 148.6, as it existed before 1988 and again as amended in 1990, was struck down by the courts (in McNulty and again in Greig) because tying allocation to the entity's own tax-year end did not reflect the taxpayer's actual change of residence status.

Citations and references

• Tax Law § 601(e) - imposes tax on a nonresident or part-year resident's New York source income, computed as if the individual were a resident and apportioned by the New York source fraction
• Tax Law § 638(a) - defines the New York source income of a part-year resident individual as the sum of New York adjusted gross income for the resident period plus New York source income for the nonresident period
• Tax Law § 632(a)(2) - governs when an S corporation shareholder's pro rata share of income is New York source income
• former 20 NYCRR 148.6 - the Personal Income Tax Regulation (both pre-1988 and as amended in 1990) invalidated by the courts for tying allocation to the entity's tax-year-end date rather than day-count proration
• Matter of McNulty v New York State Tax Commission, 70 NY2d 788 - Court of Appeals decision requiring proration of a partner's distributive share between resident and nonresident periods
• Matter of Wertheimer, TSB-D-95-(2)I - Tax Appeals Tribunal decision holding proration mandatory, not elective, for partnership losses
• Matter of Greig, TSB-D-99-(21)I - Tax Appeals Tribunal decision invalidating the 1990 version of 20 NYCRR 148.6 and extending the day-count proration rule to S corporation pro rata shares
• TSB-M-00(1)I (February 23, 2000) - Technical Services Bureau Memorandum setting out day-count proration for tax years beginning in 1999 and after

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2003.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a03_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-03(2)I
Income Tax
April 4, 2003

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I021003A

On October 3, 2002, a Petition for Advisory Opinion was received from Margaret P. Somers,
6232 S. Atlantic Avenue, New Smyrna Beach, Florida 32169.
The issue raised by Petitioner, Margaret P. Somers, is whether the amount of her pro rata
share of income from a federal S corporation for the year in which a change of residence occurred
can be allocated on a per share per day basis based upon the same date that the income is earned by
the S corporation.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner was a 20 percent shareholder in Geographic Marketing Group, Inc. (Geographic
Marketing Group), a Pennsylvania S Corporation. The corporation conducted business in
Pennsylvania, New Jersey, and North Carolina. For New Jersey tax purposes, the corporation was
a C Corporation that paid tax on its net profits apportioned to New Jersey. On June 30, 1998,
Geographic Marketing Group sold all the assets of the corporation and ceased doing business. After
June 30, 1998, its activities were limited to winding up its corporate affairs, and by August 31, 1998,
the company was completely dissolved. The corporation issued a Schedule K-1 for the period
January 1, 1998 through August 31, 1998 reporting the sale of the corporation along with the final
income, credits, and deductions attributable to Petitioner’s 20 percent interest. Geographic
Marketing Group did not have income derived from or connected with New York sources.
Petitioner was a resident of New Jersey from January 1, 1998 to April 14, 1998. On
April 14, 1998, Petitioner moved to Pennsylvania and resided there until August 11, 1998. On
August 12, 1998, Petitioner moved to New York State.
Applicable Law
Section 601(e) of the Tax Law imposes a personal income tax for a part-year resident of
New York State, and provides, in part:
Nonresidents and part-year residents. (1) General. There is hereby imposed
for each taxable year on the taxable income which is derived from sources in this
state of every nonresident and part-year resident individual . . . a tax which shall be
equal to the tax base multiplied by the New York source fraction.
(2) Tax base. The tax base is the tax computed under subsections (a) through
(d) of this section, as the case may be, reduced by the credits permitted under
subsections (b), (c), (d) and (m) of section six hundred six, as if such nonresident or

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part-year resident individual . . . were a resident subject to the provisions of part II
of this article.
(3) New York source fraction. The New York source fraction is a fraction the
numerator of which is such individual's . . . New York source income determined in
accordance with part III of this article and the denominator of which is such
individual's New York adjusted gross income determined in accordance with part II
of this article . . . .
Section 638(a) of the Tax Law describes New York source income of a part-year resident
individual, and provides:
Individuals. The New York source income of a part-year resident individual
shall be the sum of the following:
(1) New York adjusted gross income for the period of residence, determined
in accordance with part II of this article as if the taxpayer's taxable year for federal
income tax purposes were limited to the period of residence.
(2) New York source income for the period of nonresidence, determined in
accordance with section six hundred thirty-one as if the taxpayer's taxable year for
federal income tax purposes were limited to the period of nonresidence.
Opinion
For taxable years beginning prior to 1988, a nonresident individual computed his or her
New York State personal income tax based on the amount of income derived from or connected with
New York sources, and a resident individual computed his or her tax based on income from all
sources and received a credit for taxes paid to other states. When a taxpayer changed residence, he
or she computed a tax for the nonresident period based on the amount of income derived from or
connected with New York sources and computed a tax for the resident period on income from all
sources.
Under this statutory scheme, in Matter of McNulty v New York State Tax Commission,
70 NY2d 788, 522 NYS2d 103, the Court of Appeals held former section 148.6 of the Personal
Income Tax Regulations (the Regulations) invalid and required that a partner’s distributive share
of partnership income, gain, loss, and deduction for tax year 1979, the year in which the change of
residence occurred, be prorated between the resident and nonresident periods. Former section 148.6
required taxpayers who moved in or out of New York State during the tax year to treat partnership
gains or losses as having all accrued in the portion of the taxable year in which the partnership’s own
tax year ended.

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In McNulty, recognizing that the taxpayer’s distributive share of partnership income did not
indicate actual receipt of the income, the Court of Appeals found harm in requiring taxpayers who
move into or out of New York State during the tax year to treat partnership gains and losses as
having all accrued in the taxable period in which the partnership’s own tax year ends, regardless of
when the income was actually received. The court concluded that this was inconsistent with the
change of residence status rules which required an allocation that reflects either actual date of receipt
and expenditure or encompasses an annual amount distributed on a proportionate basis.
In Matter of Wertheimer, Dec St Tax Trib, January 12, 1995, TSB-D-95-(2)I, the issue
addressed was whether the petitioners were required to prorate their partnership losses between their
nonresident period and resident period for the 1986 tax year. In that case, the petitioners maintained
they could properly report all partnership losses in the resident period of their part-year income tax
return rather than prorating the losses between their resident and nonresident periods based on the
number of months that they resided in New York State, as held in the McNulty decision. The
petitioners asserted that the McNulty decision did not mandate proration, but permitted it. As such,
the petitioners maintained that they had a choice of prorating their distributive share of partnership
losses between their resident and nonresident periods, or allocating all of their share of partnership
losses to either the resident or nonresident period depending upon when the loss was deemed to have
accrued. The Tribunal disagreed with the petitioners’ position. The Tribunal noted that the basic
principles of taxation of income earned by a partnership under section 706(a) of the Internal
Revenue Code requires that each partner’s distributive share of the income, gain, loss, and deduction
be included in that partner’s taxable income for the taxable year of the partnership ending within or
with the partner’s tax year. A partner is required to report and pay tax on his distributive share of
the net income of the partnership in this manner without regard to whether this amount was actually
distributed or distributable to him in that year. In the Tribunal’s view, the holding of McNulty,
supra, is that where a partner’s distributive share of income is reported without regard to actual
receipt, the only possible method of allocation when there is a change of residency is on a
proportionate basis throughout the year. In McNulty, the accrual date method of allocating the
distributive share of partnership income was rejected because this method did not reflect the actual
date of receipt of the income.
The New York Tax Reform Act of 1987, Chapter 28 of the Laws of 1987, changed the
manner in which nonresidents and part-year residents compute their tax for a taxable year beginning
on or after January 1, 1988. Now, under section 601(e) of the Tax Law, the tax imposed on a
nonresident or part-year resident individual’s taxable income derived from sources in New York
State is computed as if the individual were a resident, reduced by certain credits, and apportioned
to New York by the New York source fraction, the numerator of which is the individual’s New York
source income and the denominator of which is the individual’s New York adjusted gross income.
As a result, when a resident individual changes residence during the taxable year, the New York
source income is the sum of (1) the individual’s New York adjusted gross income from all sources
for the period of residence, determined as if the individual’s taxable year for federal income tax
purposes were limited to the resident period, plus (2) the individual’s New York adjusted gross
income derived from New York sources for the nonresident period, determined as if the individual’s

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tax year for federal income tax purposes were limited to the period of nonresidence. The
denominator of the New York source fraction used to compute the tax is the individual’s New York
adjusted gross income from all sources for the entire year.
In 1990, section 148.6 of the Regulations was amended to reflect the Department’s view of
how the McNulty, supra, and Werthheimer, supra, cases apply under the current law. These
regulations provided that where there is a change of residence, the taxpayer’s distributive share of
partnership income, gain, loss and deduction to be included in the numerator of the New York
source fraction should be determined according to the status of the taxpayer as a resident or
nonresident at the time the taxable year of the partnership ends.
The Tax Appeals Tribunal found this regulation invalid in Matter of Greig, Dec St Tax Trib,
September 16, 1999, TSB-D-99-(21)I. The Tribunal relying on the Court of Appeals decision in
McNulty, supra, stated that the taxpayer’s distributive share of partnership income, gain, loss and
deduction or pro rata share of New York S corporation income, gain, loss and deduction for the year
in which the change of residence occurs must be prorated between the resident and nonresident
periods. The decision is reflected in Technical Services Bureau Memorandum entitled New York
Tax Treatment of Partnership and New York S Corporation Income of Part-Year Residents,
February 23, 2000, TSB-M-00(1)I, which states that, for tax years beginning in 1999 and thereafter,
the rules for prorating between resident and nonresident periods are based on the number of days
in each period.
Accordingly, following McNulty, supra, Wertheimer, supra, and Grieg, supra, in this case,
Petitioner must prorate the amount of her pro rata share of income, gain, loss, and deduction reported
on Schedule K-1 from Geographic Marketing Group between Petitioner’s resident and nonresident
periods of the year. Pursuant to TSB-M-00(1)I, supra, the amounts prorated are based on the
number of days resided in New York State. The pro rata share of Geographic Marketing Group’s
income, gain, loss, and deduction allocated to the resident period of the year is New York source
income pursuant to section 638(a)(1) of the Tax Law. The pro rata share of Geographic Marketing
Group’s income, gain, loss, and deduction allocated to the nonresident period of the year is not
New York source income pursuant to sections 632(a)(2) and 638(a)(2) of the Tax Law since
Geographic Marketing Group did not have income derived from or connected with New York
sources.

DATED: April 4, 2003

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.