In a multi-tier structure -- a nonresident individual owning an S corporation, which is a general partner in a New York partnership, which is itself the managing partner of a foreign partnership doing 35% of its business in New York -- how does New York tax flow through each layer down to the individual, and how is the New York-source share of income determined at each level?

Plain-English summary

A law firm presented the Department with a hypothetical four-layer structure to map out the New York tax consequences at each level. Mr. X, a resident of a state other than New York, is the sole shareholder of Y corporation, a foreign corporation that elected S corporation status for both federal and New York purposes and maintains an office in upstate New York (Mr. X himself works 25% of his time in New York as Y's employee). Y corporation is a general partner in Z partnership, a New York partnership. Z partnership, in turn, is the managing partner of Q partnership, a foreign partnership that conducts 35% of its business in New York and the rest in three other states. Q partnership sells all its assets, generating both capital gain and ordinary income, which flows through Q → Z → Y → Mr. X via a chain of K-1s.

The Department worked through the chain level by level. Q partnership itself pays no New York tax, but because it does business in New York and has a New York-resident partner (Z), it must file a New York partnership return; and because Z is a RESIDENT partner (not nonresident), Z's distributive share of Q's income can't be apportioned within/without New York -- Z picks up its FULL distributive share, without regard to the 35%/65% in-state/out-of-state split that would matter for a nonresident partner. Z partnership itself also pays no tax but must file its own New York partnership return, folding in its distributive share from Q. Since Z has a NONRESIDENT partner (Y corporation), Z must then determine Y's New York-source distributive share -- using Z's own books and records if they clearly show New York income, or Z's business allocation percentage if they don't. Y corporation, as an elected New York S corporation, pays no Article 9-A franchise tax (though it still owes an annual maintenance fee and a one-time license fee as a foreign corporation) and itself pays no personal income tax, but must file an S corporation informational return incorporating its New York-source share from Z. Because Mr. X is a NONRESIDENT shareholder of Y, Y must in turn determine Mr. X's pro rata share of Y's own New York-source ordinary income and capital gain -- using Article 9-A's business/investment allocation percentages if Y has activities both within and outside New York. Finally, Mr. X must file a New York nonresident individual return reporting his New York-source wages (25% of his Y-corporation salary) plus his pro rata share of Y's New York-source ordinary income and capital gain, which by that point already reflects the New York-source share that flowed up from Q through Z through Y.

What this means for you

Multi-tier partnership/S-corporation structures with nonresident owners

No entity along the chain pays New York income tax directly -- but EVERY entity with a New York nexus or a New York-resident (or otherwise relevant) partner/shareholder must file its own informational return, and each tier is responsible for determining the New York-source share of income flowing to the NEXT tier up, using its own books/records or its own allocation percentage.

Whether a resident vs. nonresident partner changes the analysis

A RESIDENT partner (like Z partnership, a resident of New York) picks up its FULL distributive share of a lower-tier partnership's income regardless of that partnership's in-state/out-of-state split -- residents aren't apportioned. Apportionment/allocation only becomes relevant once you reach a NONRESIDENT partner or shareholder in the chain (here, Y corporation as Z's partner, and Mr. X as Y's shareholder).

Tracking New York-source character through multiple flow-through layers

Each entity must separately track and characterize (ordinary income vs. capital gain) its New York-source share as it flows upward -- the character established at the lowest tier (Q partnership's asset sale) carries through unchanged to the top (Mr. X's individual return).

Common questions

Q: Does Q partnership's 35%-in-New-York activity level matter to Z partnership's own tax treatment?
A: Not directly -- because Z is a RESIDENT partner of Q, Z simply includes its full distributive share of Q's income without apportionment. The 35%/65% split matters only when a NONRESIDENT partner further up the chain (Y corporation, as Z's partner) needs its own New York-source share determined.

Q: What return does Y corporation file, given it's both an S corporation and a partner in Z?
A: Y corporation files a New York S corporation informational return, incorporating its own New York-source distributive share received from Z partnership, and separately determines Mr. X's (its nonresident shareholder's) pro rata share of that New York-source income.

Q: Can another similarly structured group rely on this specific ruling?
A: No. It's a hypothetical fact pattern submitted for advisory purposes; the opinion binds the Department only as to the facts presented and can't be relied upon by an actual taxpayer with different facts.

Citations and references

Statutes and regulations:

• Tax Law § 601(b); § 658(c)(1)-(2) (partnership/S corporation filing requirements)
• Tax Law § 660(a) (New York S election); § 612, § 617(a)-(b), § 632 (resident computations); § 637(a)(2), (c), (e)(1)-(2) (nonresident allocation)
• Tax Law § 181.1, § 181.2 (foreign S corporation fees)
• Income Tax Regulations § 119.1; § 131.15 (nonresident partner allocation methods)
• IRC § 1366(f)(2)-(3)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1987.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/multitax/a87_10c_3i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-87 (10) C
Corporation Tax
TSB-A-87 (3) I
Income Tax
May 14, 1987

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. Z861008A

On October 8, 1986, a Petition for Advisory Opinion was received from
Herbert Paul, P.C., 805 Third Avenue, New York, New York 10022.
Petitioner has presented the following hypothetical set of facts and
requests an advisory opinion as to the New York corporate and income tax
consequences.
Facts

1. Mr. X is a resident of State A (not New York).
2. Mr. X is the sole shareholder of a foreign corporation (Y corporation), an S
   corporation for federal income tax purposes. Y corporation is also an S
   corporation for New York purposes. Y corporation maintains an office in upstate
   New York. Mr. X is also an employee of Y corporation and performs 25% of his work
   in New York. Y corporation provides consulting services.
3. Y corporation is a general partner in a New York partnership (Z partnership).
4. Z partnership is the managing partner of a foreign partnership (Q partner­
   ship). Q partnership conducts 35% of its business within New York and the balance
   in States A, B & C.
5. Q partnership sells all its assets and generates capital gain and ordinary
   income. A portion of these items flow through to Z partnership and then to Y
   corporation by way of a schedule K-1. The results then pass to Mr. X also by a
   schedule K-1.
6. As a result of conducting business in States A,B, & C the following tax
   results will occur:
   States A & B- No tax consequences to either Z or Q partnerships or to Y
   corporation since they are pass-thru entities. Mr. X is required to file
   a nonresident individual income tax return in each state for the portion
   of flow through income (including capital gain) attributable to the
   particular state (So stated in Petition).
   State C- Q partnership is required to file a return and pay business
   taxes. Z partnership and Y corporation are not required to file returns.
   Mr. X is required to file a nonresident individual income tax return for
   the portion of flow through income which is attributable to State C.
   TP-8 (3/83)

-2­

TSB-A-87 (10) C
Corporation Tax
TSB-A-87 (3) I
Income Tax
May 14, 1987

Issues
(a)

How are any of the above entities and Mr. X taxed in New York. Does every­
thing flow through to Mr. X.

(b)

What portion of the income is taxable to Mr. X.

(c)

Will he apportion the income based on the three factor formula. If so, will
this be determined at the partnership or corporate level. How is it
calculated. If at the partnership level, is it at partnership Z or Q's
level.

(d)

To what extent is Mr. X required to report capital gain to New York which
he receives from corporation Y.

Law
Section 601(b) of the Tax Law and section 119.1 of the New York State
Personal Income Tax under Article 22 of the Tax Law regulations (hereinafter
Income Tax regulations) provide that a partnership itself does not pay a New York
State personal income tax, but the individual partners are taxed on their
respective distributive shares of the partnership income, whether or not such
shares are actually distributed to them.
Section 658(c)(1) of the Tax Law provides that every partnership having a
resident partner or having any income derived from New York sources shall make
a return for the taxable year setting forth all items of income, gain, loss and
deduction and such other pertinent information as the State Tax Commission may
prescribe.
Under section 660(a) of the Tax Law, shareholders of a federal S
corporation are permitted to make an election to treat the corporation as a New
York S corporation whereby the corporation would be exempt from the corporation
franchise tax and the shareholders would be taxed under the Personal Income Tax
Law on their pro rata share of the S corporation's items of income, loss,
deduction and reduction for taxes described in section 1366(f)(2) and (3) of the
Internal Revenue Code which are taken into account for federal income tax
purposes.
Section 658(c)(2) of the Tax Law provides that every S corporation for
which the election provided for in section 660(a) is in effect shall make a
return for the taxable year setting forth all items of income, loss and deduction
and such other pertinent information as the State Tax Commission may prescribe.
The New York taxable income of a resident or nonresident individual is
computed by subtracting from its New York adjusted gross income, the individual's
New York deduction and New York personal exemptions.

-3­

TSB-A-87 (10) C
Corporation Tax
TSB-A-87 (3) I
Income Tax
May 14, 1987

The New York adjusted gross income of a resident individual is the individ­
ual's federal adjusted gross income with the modifications required by section
612 of the Tax Law. Section 632 of the Tax Law sets forth the computation of a
nonresident individual's New York adjusted gross income. An individual's federal
adjusted gross income includes a partner's distributive share of the
partnership's income, gain, loss and deduction and also includes a shareholder's
pro rata share of a S corporation's income, loss, deduction and reduction for
taxes, described in section 1366(f)(2) and (3) of the Internal Revenue Code.
Section 617(a) of the Tax Law provides that when computing New York adjust­
ed gross income and New York taxable income of a resident partner or a resident
shareholder of an S corporation not subject to tax under Article 9-A, any
modification described in section 612(b), (c) or (d) or section 615(c) or (d) (2)
or (3) which relates to an item of partnership or S corporation income, gain,
loss or deduction shall be made in accordance with the partner's distributive
share or the shareholder's pro rata share, for federal income tax purposes, of
the item to which the modification relates. Section 617(b) of the Tax Law
provides that each item of partnership and S corporation income, gain, loss or
deduction shall have the same character for a resident partner or shareholder
under Article 22 as for federal income tax purposes.
Section 637(c) of the Tax Law provides that when computing New York
adjusted gross income of a nonresident partner or S corporation shareholder, any
modification described in section 612(b) or (c) which relates to an item of
partnership or S corporation income, gain, loss or deduction shall be made in
accordance with the partner's distributive share or the shareholder's pro rata
share for federal income tax purposes of the item to which the modification
relates, but limited to the portion of such item derived from or connected with
New York sources. Section 637(e)(1) provides that the provisions of section
617(a) apply when determining a nonresident partner's distributive share or
shareholder's pro rata share of income, gain, loss or deduction. Section
637(e)(2) provides that section 617 (b) applies when determining the character
of partnership or S corporation items for nonresident partners or shareholders.
Section 131.15 of the Income Tax regulations provides that where a partner­
ship carries on a business, trade, profession or occupation both within and
without New York State and maintains books and records from which the New York
income of the business can be determined, a nonresident partner's distributive
share of partnership items derived from New York sources will be determined from
the books of account. Where the partnership does not maintain books and records
from which New York income can be determined, it will use the business allocation
percentage or an authorized alternative method to determine a nonresident
partner's distributive share of partnership items derived from New York sources.
The business allocation percentage consists of three percentages: property,
payroll and gross income. The percentages are described in subdivisions (d), (e)
and (f) of section 131.15 of the Income Tax regulations.

-4­

TSB-A-87 (10) C
Corporation Tax
TSB-A-87 (3) I
Income Tax
May 14, 1987

Pursuant to section 637(a)(2) of the Tax Law, an S corporation that has
nonresident shareholders and business activities outside New York State deter­
mines a nonresident shareholder's pro rata share of items of the S corporation's
income, loss and deduction entering into the shareholder's adjusted gross income,
increased by reduction for taxes described in section 1366(f)(2) and (3) of the
Internal Revenue Code derived from or connected with New York sources by using
the business allocation and investment allocation percentages used under Article
9-A of the Tax Law. Such business allocation percentage consists of four factors:
a real and tangible personal property factor, a business receipts factor, a
payroll factor, and an additional factor equal to the business receipts factor.
The business allocation percentage is described in Subparts 4-2, 4-3, 4-4, 4-5,
and 4-6 of the Business Corporation Franchise Tax regulations. The investment
allocation percentage is described in Subpart 4-7 of the Business Corporation
Franchise Tax regulations.
Section 181.1 of the Tax Law provides that a foreign New York S corporation
must pay a license fee for the privilege of exercising its corporate franchise
or carrying on its business in New York State. This fee is payable only once
unless the capital share structure changes or the amount of capital stock
employed in New York State has increased since the last license fee report was
filed.
Section 181.2 of the Tax Law requires that a foreign New York S
corporation, that is authorized to do business in New York State pursuant to
Article 13 or Article 15-a of the Business Corporation Law, shall pay annually
a maintenance fee of $200.
Discussion
For New York income tax purposes, Q partnership, itself, is not subject to
tax. However, Q partnership carries on business within and without New York and
has a resident partner, Z partnership. Therefore, Q partnership must file a New
York partnership return pursuant to section 658(c)(1) of the Tax Law. Even though
Q partnership carries on business both within and without New York, Z
partnership's distributive share of Q's ordinary income and capital gain cannot
be allocated within and without New York because Z partnership is a resident
partner.
For New York income tax purposes, Z partnership, itself, is not subject to
tax. However, Z partnership is a New York partnership and as such must file a New
York partnership return pursuant to section 658(c)(1) of the Tax Law. Z
partnership must include in its computation of income, its distributive share of
ordinary income from Q partnership.
Z partnership's distributive share of
capital gain from Q partnership is included in Z partnership's computation of
capital gains and losses.
Z partnership has a nonresident partner, Y
corporation. Therefore, Z partnership will determine Y corporation's distributive
share of Z's ordinary income and capital gain derived from New York sources.
If Z partnership is not carrying on business outside New York, all income
and capital gain is from New York sources. If Z partnership is carrying on
business both within and without New York and Z partnership's New York income

-5­

TSB-A-87 (10) C
Corporation Tax
TSB-A-87 (3) I
Income Tax
May 14, 1987

can be accurately determined from Z's books and records, as described in section
131.15(b) of the Income Tax regulations, that is the allocation method to be
used. If the books and records are not maintained so that New York income can be
determined, Z partnership will use the business allocation percentage described
in section 131.15(c) of the Income tax regulations or some other authorized
alternative method.
For New York corporation franchise tax purposes, Y corporation is exempt
from Article 9-A, pursuant to sections 209.8 and 660(a) of the Tax Law. However,
Y corporation must pay annually a maintenance fee, pursuant to section 181.2 of
the Tax Law. In addition, Y corporation must pay a license fee and file a license
fee report as required by section 181.1 of the Tax Law.
For New York personal income tax purposes, Y corporation, itself, is not
subject to tax, but pursuant to section 658(c)(2) of the Tax Law, Y corporation,
must file a S corporation return. Y corporation must include in its computation
of income, its distributive share of Z partnership's ordinary income from New
York sources. Y corporation's distributive share of Z partnership's capital gain
from New York sources is included in Y corporation's computation of capital gains
and losses. Since Mr. X, the shareholder of Y Corporation, is a nonresident, Y
corporation must determine Mr. X's pro rata share of Y corporation's ordinary
income and capital gain from New York sources. If Y corporation does not have
business activities outside New York, all income and capital gain is from New
York sources. If Y corporation has business activities both within and without
New York, Y corporation allocates its ordinary income and capital gain by the
business allocation and investment allocation percentages used pursuant to
Article 9-A of the Tax Law described in Subparts 4-2, 4-3, 4-4, 4-5, 4-6 and 4-7
of the Business Corporation Franchise Tax regulations.
For New York personal income tax purposes, Mr. X must file a New York
nonresident return and include in his New York adjusted gross income his wages
derived from New York sources as well as his pro rata share of Y corporation's
ordinary income and capital gain from New York sources.

DATED: May 14, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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