New York Advisory Opinion TSB-A-87 (1)I: Must a private banking partnership add back, under section 612(b)(4) of the Tax Law, interest deducted on indebtedness incurred in the ordinary course of its banking business, where the partnership also holds tax-exempt U.S. Treasury securities?

Plain-English summary

Brown Brothers Harriman & Co., a New York limited partnership operating as a "private banker" under Article IV of the New York Banking Law, conducted traditional banking activities (taking deposits, making commercial loans) and also maintained a portfolio of U.S. Treasury securities whose interest is exempt from New York tax. For 1982-1984, it asked whether it (or, more precisely, its partners, since a partnership itself isn't subject to Article 22 tax) had to add back interest deducted on its banking-related indebtedness - bank deposits, federal funds transactions, and repurchase agreements - under Tax Law § 612(b)(4), which requires adding back interest on debt incurred to purchase or carry tax-exempt securities.

The Department's answer turned entirely on federal conformity. Section 612(b)(4) was "modeled upon" and intended to "mirror" IRC § 265(2), the federal provision denying a deduction for interest on debt incurred to purchase or carry tax-exempt obligations. Under Tax Law § 607(a), terms in Article 22 carry the same meaning as under comparable federal law unless a different meaning is clearly required, and it is "beyond question" that a federal interpretation established through a Revenue Ruling or Revenue Procedure will be followed for New York personal income tax purposes too. Here, federal Rev. Proc. 70-20 (as modified by Rev. Proc. 83-91), confirming a position first taken by the Bureau of Internal Revenue in 1924, holds that indebtedness incurred by a bank in the ordinary course of its banking business is NOT treated as debt incurred to purchase or carry tax-exempt securities under IRC § 265(2) - so the bank's normal banking interest remains federally deductible under IRC § 163(a) even while it holds tax-exempt bonds.

Because § 612(b)(4) mirrors § 265(2), the Department extended the same ordinary-banking-business exception to New York: to the extent the partnership's banking-business interest is allowed as a federal deduction and not disallowed under § 265(2) per Rev. Proc. 70-20, it likewise isn't added back under § 612(b)(4), and the partnership's partners don't need to make that modification on their New York returns. The Department drew a sharp line, however, at the partnership's separate brokerage activities: any interest incurred there would still be disallowed under § 612(b)(4), since the ordinary-banking exception doesn't extend to non-banking lines of business.

What this means for you

Banks and private bankers holding both loan/deposit business and tax-exempt securities

If your banking entity's interest expense arises from ordinary banking activities (deposits, federal funds, repos) rather than from financing the purchase of tax-exempt bonds specifically, you likely don't need to add that interest back under Tax Law § 612(b)(4), even while your institution separately holds a portfolio of tax-exempt U.S. Treasury or municipal securities - New York follows the same federal ordinary-banking-business carve-out under Rev. Proc. 70-20.

Financial partnerships with both banking and brokerage operations

Don't assume the banking-business interest exception covers your whole operation. This opinion draws a clear line: interest tied to ordinary banking activities gets the exception, but interest incurred in a separate brokerage line of business does not - it remains subject to the § 612(b)(4) addback if it's connected to carrying tax-exempt securities.

Accountants preparing partnership returns with mixed banking/brokerage income

When determining whether a partner's distributive share requires a § 612(b)(4) modification, trace the specific source of the interest expense - banking-business debt (protected by the federal ordinary-course exception) versus brokerage-related debt (not protected) - rather than treating the entity's overall interest expense as a single category.

Common questions

Q: Our bank holds tax-exempt bonds and also has ordinary banking interest expense - do we have to add that interest back on our New York return?
A: Not if the interest is on indebtedness incurred in the ordinary course of banking business (deposits, federal funds transactions, repurchase agreements). Federal Rev. Proc. 70-20, as modified by Rev. Proc. 83-91, already exempts such interest from the federal tax-exempt-interest disallowance rule, and the Department applies the same result under the mirroring New York provision, Tax Law § 612(b)(4).

Q: Why does a federal Revenue Procedure control the New York State tax result here?
A: Because Tax Law § 607(a) says Article 22 terms carry the same meaning as under comparable federal law, and section 612(b)(4) was expressly modeled on and intended to mirror IRC § 265(2). The Department treats federal interpretations of that provision - including Revenue Procedures - as controlling the parallel New York question.

Q: Does this exception extend to our brokerage business too?
A: No. The Department specifically noted that interest incurred in the course of the partnership's brokerage activities would still be disallowed under section 612(b)(4) - the ordinary-banking-business exception is limited to genuine banking activities.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1987.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a87_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-87 (1) I
Income Tax
March 2, 1987

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. I860917A

On September 17, 1986, a Petition for Advisory Opinion was received from Brown Brothers
Harriman & Co., 59 Wall Street, New York, New York 10005.
The issue raised is whether Petitioner must include in its taxable income for taxable years
1982, 1983 and 1984, pursuant to section 612(b)(4) of Article 22 of the Tax Law, interest paid on
indebtedness incurred or continued to purchase or carry United States Treasury securities, the interest
income on which is exempt from New York State personal income tax under Article 22 of the Tax
Law.
Petitioner is a New York limited partnership established as a "private banker" under Article
IV of the New York State Banking Law. As such, Petitioner has received an authorization certificate
from the New York Superintendent of Banks permitting it to engage in the general banking business
and is subject to regulation by the New York Superintendent of Banks. Petitioner conducts
traditional banking activities, including the taking of deposits and the making of commercial loans.
In addition, during each of the tax years at issue, Petitioner maintained a portfolio of U.S. Treasury
securities, the interest income from which is exempt from New York tax. Petitioner also conducts
brokerage activities, but all of the deductions in question involve interest on bank deposits, federal
funds transactions and repurchase agreements, all of which relate exclusively to Petitioner's banking
type activities.
When computing federal adjusted gross income, section 265(2) of the Internal Revenue Code
denies the deduction for interest paid on indebtedness incurred or continued to purchase or carry
obligations the interest on which is exempt from tax. However, Rev. Proc. 70-20, 1970-2 C.B. 499,
modified by Rev. Proc. 83-91, 1983-2 C.B. 618, clearly confirms the position initially taken by the
Bureau of Internal Revenue in I.T. 2028, C.B. III-l, 296 (1924) that indebtedness incurred by a bank
in the ordinary course of its banking business is not to be treated as indebtedness incurred or
continued to purchase or carry tax-exempt securities within the meaning of Internal Revenue Code
section 265(2). For federal income tax purposes, under Rev. Proc. 70-20 and for many years prior
thereto, Petitioner has regularly been allowed to deduct interest paid on its indebtedness which are
incurred in the normal course of banking activities even though the bank holds tax-exempt
obligations.
A partnership, itself, is not subject to the personal income tax under Article 22 of the Tax
Law, but the partnership must nevertheless compute its income from New York State sources. Each
partner must include in its New York taxable income, its distributive share of the partnership's
income, gain, loss and deduction. The New York taxable income of a resident or nonresident
individual is computed by subtracting from the New York adjusted gross income the individual's
New York deduction and New York exemptions.
RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

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TSB-A-87 (1) I
Income Tax
March 2, 1987

The New York adjusted gross income of a resident individual is the individual'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.
Section 617(a) of the Tax Law provides that when computing New York adjusted gross
income of a resident partner, 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 income, gain, loss or deduction shall
be made in accordance with the partner's distributive 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 income, gain, loss or deduction shall have the same character for a resident partner 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, any modification described in subsection (b) or (c) of section 612
which relates to an item of partnership income, gain, loss or deduction shall be made in accordance
with the partner's distributive 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 612(b)(4) of the Tax Law requires that there be added to federal adjusted gross
income in computing New York adjusted gross income "[i]nterest on indebtedness incurred or
continued to purchase or carry obligations or securities the income from which is exempt from tax
under this article, to the extent deductible in determining federal adjusted gross income."
Unquestionably, section 612(b)(4) of the Tax Law was modeled upon IRC §265(2). Section
612(b)(4) was intended to mirror section 265(2) and to have the same meaning and application as
section 265(2).
Section 607(a) of the Tax Law provides that "[a]ny term used in this article shall have the
same meaning as when used in a comparable context in the laws of the United States relating to
federal income taxes, unless a different meaning is clearly required." It is now beyond question that
when an interpretation of a law of the United States relating to federal income taxes is established
by the Internal Revenue Service through a Revenue Ruling or a Revenue Procedure, such federal
interpretation will be followed for New York State personal income tax purposes, as well.
Accordingly, it is determined that to the extent that interest which Petitioner incurs or
continues to purchase or carry indebtedness in the ordinary course of its banking business is allowed
as a deduction under section 163(a) of the Internal Revenue Code and is not disallowed under section
265(2) of the Internal Revenue Code pursuant to Rev. Proc. 70-20 as modified by Rev. Proc. 83-91,
such interest will also be allowed as a deduction for New York State personal income tax purposes
and will not be disallowed under section 612(b)(4) of the Tax Law. However, any such interest
incurred in the course of its brokerage activities would be disallowed under section 612(b)(4) of the
Tax Law.

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TSB-A-87 (1) I
Income Tax
March 2, 1987

Therefore, when computing New York taxable income, Petitioner's partners are not required
to make the modification required by section 612(b)(4) of the Tax Law to the extent that interest paid
on indebtedness incurred or continued to purchase or carry United States Treasury securities, the
interest on which is exempt from Article 22 of the Tax Law, is incurred or continued by Petitioner
in the ordinary course of its banking business pursuant to Rev. Proc. 70-20, as modified by Rev.
Proc. 83-91.

DATED: March 2, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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