New York Advisory Opinion TSB-A-87 (5)I: May an S corporation qualify as a 'new business' so an investor can use the Tax Law § 612(o) capital-gain exclusion or the § 612(p) reinvestment deferral for money invested in it?

Plain-English summary

Beverly Grillo had realized long-term capital gains from selling capital assets and wanted to reinvest the proceeds in a new business she planned to run as an S corporation. She asked the Department whether an S corporation could qualify as a "new business" for two related, but separately defined, investment-incentive provisions in the Tax Law: the section 612(o) exclusion from taxable income for gains on a "new business investment," and the section 612(p) deferral of capital gain reinvested in a "New York new business."

For the section 612(o) exclusion, the answer was no - at least not while the corporation is an S corporation. Section 612(o)(1)(B) requires, among other things, that the business be "subject to taxation (whether or not any amount is owing) under Article 9-A" at the date it adopts its new-business plan. But section 660 lets an S corporation elect out of Article 9-A tax, and section 209(8) confirms that an electing S corporation "shall not be subject to the tax under [Article 9-A]" for any year the election is in effect. Since an S corporation is, by definition, not subject to Article 9-A tax, it cannot satisfy section 612(o)(1)(B)'s subject-to-tax requirement at the plan-adoption date - though the Department noted section 612(o) doesn't prohibit electing S status at a LATER date, after the new-business plan has already been adopted while the corporation was still taxable under Article 9-A.

For the section 612(p) deferral, the answer was yes. Section 612(p) has its own, separate seven-part definition of "new business" - covering things like how long the business has been an Article 22 taxpayer, ownership concentration, similarity to a prior taxable business, in-state asset and employee thresholds, passive-income limits, and a minimum gross-income floor - and none of those seven requirements mentions being subject to Article 9-A tax. So an investment in an S corporation can satisfy the section 612(p) "new business" definition even though it could never satisfy section 612(o)'s.

The Department also directly rejected Grillo's argument that the Legislature simply never considered S corporations when writing section 612(o) (since S corporations "did not exist" in New York tax law at the time). It noted that section 660 (the S election) and section 612(o) were enacted together, in the same 1981 statute (Chapter 103 of the Laws of 1981), as two pieces of one coordinated investment-incentive plan - so the Legislature must be presumed to have been aware of how the two provisions would interact, and to have intended the resulting limitation.

What this means for you

Entrepreneurs planning to reinvest capital gains into a new S corporation

Know that the two "new business" reinvestment incentives are NOT interchangeable when it comes to S corporations. If you want the section 612(o) exclusion (excluding gain on sale of the new-business investment itself), your business must be subject to Article 9-A tax - meaning NOT an S corporation - at the date you adopt your new-business plan; you can elect S status later. If instead you want the section 612(p) deferral (deferring gain reinvested into the new business), an S corporation can qualify from the start, since section 612(p) has no Article 9-A subject-to-tax requirement.

Business owners sequencing an S election around a new-business plan

If preserving eligibility for the section 612(o) exclusion matters to you, consider adopting your written new-business plan BEFORE making the S election, since the statute only requires Article 9-A tax status at the plan-adoption date, not permanently - the Department confirmed there's no prohibition on electing S status afterward.

Accountants structuring reinvestment transactions for clients

Walk through both the section 612(o) and section 612(p) definitions separately for any S-corporation-related reinvestment plan - they share the "new business" label but have materially different qualification tests, and conflating them (as this Petitioner initially did) can lead to wrongly assuming a blanket S-corporation exclusion from both incentives.

Common questions

Q: Can my new business qualify for the section 612(o) capital-gain exclusion if it's organized as an S corporation?
A: Not while the S election is in effect at the date the new-business plan is adopted, because section 612(o)(1)(B) requires Article 9-A subject-to-tax status at that date, and an electing S corporation is exempt from Article 9-A tax under sections 660 and 209(8). You could still adopt the plan first (while subject to Article 9-A tax) and elect S status afterward.

Q: Can I use an S corporation for the separate section 612(p) reinvestment deferral instead?
A: Yes. Section 612(p)'s own seven-part "new business" definition has no requirement that the business be subject to Article 9-A tax, so an investment in an S corporation can satisfy it even though the same corporation couldn't satisfy section 612(o)'s definition.

Q: Doesn't it seem unfair that section 612(o) excludes S corporations, given S corporations didn't exist when older parts of the Tax Law were written?
A: The Department rejected that argument here. It noted that section 660 (the S election) and section 612(o) were both enacted in the same 1981 law as part of one coordinated investment-incentive package, so the Legislature is presumed to have known how the two provisions would interact and to have intended the resulting limitation.

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_5i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-87 (5) I
Income Tax
October 20, 1987

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I870714A

On July 14, 1987, a Petition for Advisory Opinion was received from Beverly A. Grillo, 187
Shirley Avenue, Buffalo, New York 14215.
The issue raised is whether an "S Corporation" may qualify as a "new business" for purposes
of subsections (o), (p) and (q) of section 612 of the Tax Law.
Petitioner has realized long-term capital gains from the sale of capital assets and intends to
reinvest the proceeds in a "new business" in New York State. The business will be conducted in the
form of an S Corporation .
Section 660 of the Tax Law provides that if a corporation which is an S corporation for
federal income tax purposes is subject to tax under Article 9-A of the Tax Law, the shareholders
may, by fulfilling certain requirements, elect to treat the corporation as an S corporation for state tax
purposes.
Section 209(8) of Article 9-A of the Tax Law provides that "[a] taxpayer which is an S
corporation for federal income tax purposes shall not be subject to the tax under this article for any
taxable year for which an election is in effect pursuant to subsection (a) of section six hundred sixty
of this chapter."
The Tax Law provides two personal income tax incentives designed to encourage investment
in new businesses in New York State. These are: (1) full or partial exclusion from taxable income
for capital gains realized upon the sale of a "new business investment" (Tax Law § 612(o)); and (2)
deferral of capital gain realized on the sale of a capital asset for the period that the proceeds are
reinvested in a "New York new business" (Tax Law § 612(p)).
However, to qualify as a new business for purposes of section 612(o), a corporation or
partnership must meet the requirements specified in section 612(o)(1)(B). Pursuant to section
612(o)(1)(B), a corporation or partnership must, among other requirements: (1) adopt a plan on or
after July 1, 1981 and before January 1, 1988 to conduct a new business and issue new business
investments; (2) be subject to taxation (whether or not any amount is owing) under Article 9-A of
the Tax Law or under certain other sections or articles of the Tax Law at the date of adoption of such
plan; (3) have the first taxable period for which the new business becomes subject to tax on or after
July 1, 1981 and before January 1, 1988, such first taxable period to include the date of adoption of
such plan; and (4) if not so subject to taxation at such date of adoption, the new business must be
subject to taxation under such sections or articles for the first time within one year from the date of
adoption of such plan.

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 (5) I
Income Tax
October 20, 1987

Accordingly, for purposes of qualifying as a new business for purposes of section 612(o), a
corporation cannot be an S corporation at the date of adoption of its new business plan because an
S corporation is not subject to tax under Article 9-A of the Tax Law at the date of adoption of the
new business plan as required by the statute. However, section 612(o) contains no prohibition against
election of S corporation status at a date subsequent to the date of adoption of the new business plan.
Subsection 612(p) of the Tax Law provides a new business investment deferral for taxable
years beginning before January 1, 1988.
Definitions governing the new business investment deferral differ from those pertaining to
the exclusion for new business investment gains. To qualify for the new business investment
deferral, a new business is a business enterprise that meets all of the following requirements as set
forth in § 612(p) of the Tax Law:
1.

The business has been a taxpayer under Article 22 for no more than three taxable
years, including short taxable years, and

2.

Over fifty percent of the number of shares of stock that entitle holders to vote for the
election of directors or trustees is not owned, directly or indirectly, by a taxpayer
subject to taxes under § 184, 185 or 186 of Article 9 of Chapter 60 of the Tax Law,
or under Article 9-A, 32 or 33 of the same chapter, and

3.

The business is not substantially similar in operation or ownership, directly or
indirectly, to a business entity taxable, or previously taxable, under the above named
corporation taxes, or would have been taxable under the unincorporated business tax,
or the income (or losses) of which is (or was) includable under article twenty-two
whereby the intent and purpose of this subsection would be evaded, and

4.

The business locates and employs at least ninety percent of its assets in the state, and

5.

The business employs principally in New York State eighty percent of its employees,
with the exclusion of general executive officers and partners, and

6.

The business must derive less than forty percent of its gross income from dividends,
interest, royalties (other than mineral, oil or gas royalties, or copyright royalties) and
annuities, and

7.

The business reports at least twenty-five hundred dollars in gross income in any
taxable year.

Section 612(p) contains no requirement that a corporation which is to qualify as a new
business must be subject to tax under Article 9-A of the Tax Law. Accordingly, an investment in an
S corporation may qualify for the new business investment deferral.

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TSB-A-87 (5) I
Income Tax
October 20, 1987

Additionally, Petitioner asserts that investment in S corporations should not be excluded from
the benefits afforded by section 612(o). Petitioner argues that ". . .it appears as if the legislature did
not intend to exclude investments in S corporations from qualification, but just never considered the
issue since S corporations did not exist at the time of enactment".
It is noted that section 660 of the Tax Law and 612(o) of the Tax Law were both enacted by
Chapter 103 of the Laws of 1981. It is apparent from a reading of the Governor's Approval
Memorandum that sections 660 and 612(o) were two elements of a single plan to provide "targeted
tax reductions and innovative investment incentives to assure continued economic growth in the state
. . . ." (New York Legislative Annual 1981, p. 81.). As such, it must be presumed that the
Legislature was aware of the interplay of the two provisions and intended the result achieved by the
provisions of the statute.

DATED: October 20, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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