When an S corporation's shareholders are bought out and the farmers' school property taxes are paid only after the buyout by the new owners, is the resulting tax credit allocated based on who owned shares when the taxes were actually paid, or split among all shareholders on a per-share-per-day basis?

Plain-English summary

Petitioner and family members ("Petitioner's group") together owned 50% of the shares of a New York S corporation that qualified as an "eligible farmer" for the farmers' school tax credit in both 2007 and 2008. In 2008, Petitioner's group bought out the remaining shareholders, acquiring 100% of the S corporation. Only after that buyout - using funds Petitioner's group contributed after acquiring all the outstanding shares - did the corporation actually pay the 2007 and 2008 school district property taxes that generated the credit. The shareholder agreement did not require any special allocation of those taxes, and at the time of the sale the shareholders did not elect under IRC §1377(a)(2) to treat the S corporation's year as two short taxable years split at the termination date.

That set up the question: should the farmers' school tax credit go to whoever owned shares (and effectively funded the taxes) when the taxes were actually paid, or should it instead be spread among all shareholders - both the departing group and Petitioner's group - based on how many days each held shares during the year?

The Department explained that Tax Law § 210.22(b) defines an "eligible farmer" corporation by a two-thirds farming-income test, and § 210.22(a) lets an eligible farmer claim a credit against its Article 9-A tax equal to the allowable school district property taxes it paid. Under Tax Law § 606(i)(1)(A), an S corporation shareholder is treated as the taxpayer with respect to his or her pro rata share of that credit for personal income tax purposes. Because no IRC §1377(a)(2) election was made, the default rule in IRC §1377(a)(1) governs: all items of income, gain, loss, deduction, and credit are allocated among all shareholders using a per share per day method, and New York's Tax Law follows the federal allocation rules absent a contrary provision.

Since the farmers' school tax credit can only be claimed once the underlying school tax is actually paid, the Department reasoned it should be allocated the same way as the expense that produced it. So even though Petitioner's group alone funded and paid the school taxes after buying out the other shareholders, the credit is allocated to all shareholders - the departing group and Petitioner's group alike - on a per share per day basis for the year, regardless of who owned shares or contributed funds at the moment the taxes were paid.

What this means for you

S corporations with mid-year shareholder buyouts

If your S corporation claims the farmers' school tax credit and ownership changes hands during the year, don't assume the credit simply follows whoever pays the school property taxes. Unless the shareholders affirmatively elect under IRC §1377(a)(2) to close the S corporation's books at the termination date, the credit - like all other S corporation tax items - is split among every shareholder based on the number of days each held shares during the year.

Accountants and tax professionals structuring a buyout

If your client wants the credit to follow the group that actually funds and pays the school taxes after a buyout, that outcome is not automatic. The client's group would need to make (or have made) a timely IRC §1377(a)(2) election at the time of the termination; without it, the per share per day default rule applies to the credit just as it does to income, gain, loss, and other deductions.

Common questions

Q: If Petitioner's group alone paid the school property taxes after buying out the other shareholders, why didn't they get the whole credit?
A: Because no IRC §1377(a)(2) election was made to split the S corporation's year at the date of the ownership change, the default per share per day rule of IRC §1377(a)(1) applied, and the Department allocated the credit the same way it allocated the underlying tax deduction - across all shareholders based on days held, not who actually wrote the check.

Q: What would have happened if the shareholders had made the IRC §1377(a)(2) election?
A: The remaining shareholders (Petitioner's group) would have been allocated the property tax expense - and therefore the credit - based on their post-termination pro rata share, rather than splitting it with the departing shareholders on a per share per day basis.

Q: Does it matter that the school taxes were paid after the departing shareholders' interests were terminated?
A: No. The Department held that because the school tax expense itself is allocated on a per share per day basis under the IRC §1377(a)(1) default rule, the credit that depends on paying that tax is allocated the same way "regardless of when the allowable school district property taxes were in fact paid."

Q: Does New York's Tax Law have its own rule for allocating S corporation items among shareholders?
A: No separate rule applies here - unless the Tax Law specifically states otherwise, it conforms to the federal rules for allocating items of income, gain, loss, and deductions among S corporation shareholders, which is why the IRC §1377 framework controlled the outcome.

Citations and references

• Tax Law § 210.22(a) - farmers' school tax credit equal to allowable school district property taxes paid by an eligible farmer corporation, credited against Article 9-A tax
• Tax Law § 210.22(b) - two-thirds farming-income test for "eligible farmer" status
• Tax Law § 606(i)(1)(A) - S corporation shareholder treated as the taxpayer for his or her pro rata share of the corporation's tax credit for personal income tax purposes
• IRC § 1377(a)(1) - default rule allocating all S corporation income, gain, loss, deduction, and credit items on a per share per day basis
• IRC § 1377(a)(2) - election allowing shareholders to treat the S corporation's year as two short taxable years split at a shareholder's termination date

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2009.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a09_15i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-09(15)I
Income Tax
November 4, 2009

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I090803A

The petition asks whether the farmers’ school tax credit of Petitioner, name redacted, an S
corporation, is to be allocated to the shareholders of the S corporation based on their ownership interest at
the time the property taxes were paid or whether the credit should be allocated to all shareholders during
the S corporation’s tax year using a per share per day basis method.
We conclude that, while the qualified school district property taxes were paid after the
shareholders’ termination, the farmers’ school tax credit must be allocated on a per share per day basis
when the shareholders did not make an election under Internal Revenue Code §1377(a)(2).
Facts
Petitioner and family members (“Petitioner’s group”) collectively owned 50% of the shares of a
New York S corporation that qualified for the farmer’s school tax credit in both 2007 and 2008. In 2008,
Petitioner’s group bought out the other shareholders of the S corporation. After Petitioner’s group had
acquired a 100% interest in the S corporation, the group paid both the 2007 and the 2008 school taxes.
The school taxes were paid with funds that were contributed by Petitioner’s group after they had acquired
all the S corporation’s outstanding shares. Also, the shareholder agreement did not require that the school
taxes be specially allocated in a manner that differed from the shareholders’ ownership interest in the S
corporation. Further, at the time of the sale, the shareholders did not elect to terminate the S corporation
year as permitted under IRC §1377(a)(2).
Analysis
Under Tax Law § 210.22(b), a corporation is an eligible farmer if, during the taxable year, its
Federal adjusted gross income from farming is two-thirds of its excess Federal gross income. A
corporation that satisfies the eligible farmer test can claim a credit, under Tax Law §210.22 (a), equal to
the allowable school district property taxes it paid, against its Article 9-A tax.
Tax Law §606(i)(1)(A) permits a New York S corporation shareholder to be regarded as the
taxpayer with regard to his or her pro rata share of the S corporation’s tax credit. Therefore, an S
corporation shareholder can apply his or her pro rata share of the Article 9-A farmers’ school tax credit in
determining his or her New York State personal income tax liability under Article 22.
An issue arises as to how to allocate the farmers’ school tax credit among S corporation
shareholders, if a shareholder’s interest is terminated before the end of the S corporation’s tax year and
before the allowable school district property tax is paid, and the shareholders did not make an election
under IRC §1377(a)(2). In a year in which a shareholder termination occurs, IRC §1377(a)(2) allows the
S corporation shareholders to elect to treat the S corporation as if it had two short taxable years, the first
of which ends on the date of the shareholder’s termination, and the second of which starts the day after
the shareholder termination and continues until the date the S corporation normally ends its tax year.
Therefore, if the shareholders make an election under IRC §1377(a)(2), all shareholders prior to the

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TSB-A-09(15)I
Income Tax
November 4, 2009

termination will receive their pro rata share of all income, gain, loss, deduction and credits realized prior
to the termination. Any income, gain, loss, deduction or credits realized after the termination are
allocated to the remaining shareholders, in accordance with their after-termination pro rata share.
At the time when Petitioner’s group bought out the remaining shareholders, the IRC §1377(a)(2)
election was not made. Thus, the default rule under IRC §1377(a)(1) applies in determining a
shareholder’s pro rata share. IRC §1377(a)(1) requires that all income, gain, loss, deduction, and credits
of the S corporation be allocated to all shareholders using a per share per day basis method. Had the
shareholders made the election under IRC §1377(a)(2), and Petitioner and its group paid the allowable
school property taxes after the other group of shareholders’ interests were terminated, the remaining
shareholders would be allocated the property tax expense/deduction based on their new pro rata share
after the termination. Unless specifically stated otherwise, when allocating items of income, gain, loss,
and deductions, the Tax Law conforms to the Federal rules for allocating these items. Therefore, even
though Petitioner’s group contributed the money to pay the school property taxes after the other group of
shareholders’ interests were terminated, all shareholders both pre- and post-termination will be allocated
the school property tax expense based on a per share per day basis.
Because the farmers’ school tax credit can be claimed only if the school tax is paid, it is
reasonable to allocate the credit among the S corporation shareholders in the same manner as the
expense/deduction that gave rise to it. Therefore, when there is a S corporation shareholder termination
and the shareholders do not elect to treat the S corporation as if it had two short tax years, as provided for
under IRC §1377(a)(2), the farmers’ school tax credit will be allocated on a per share per day basis
regardless of when the allowable school district property taxes were in fact paid.

DATED: November 4, 2009

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to
the facts set forth therein and is binding on the Department only with respect to
the person or entity to whom it is issued and only if the person or entity fully and
accurately describes all relevant facts. An Advisory Opinion is based on the law,
regulations, and Department policies in effect as of the date the Opinion is issued
or for the specific time period at issue in the Opinion.