Lionel E. and Maxine Gordon, Florida residents who sold a Long Island telephone-answering business, ask whether payments Lionel Gordon received from the buyer under a noncompetition agreement are New York source income to him as a nonresident, even though he receives them in monthly installments long after the sale.

Plain-English summary

Lionel E. and Maxine Gordon had been Florida residents since the early 1980s. Lionel Gordon was the sole shareholder of Answerite, Inc. and Telephone Answering Exchange of Lynbrook, Inc., two New York corporations that ran a telephone-answering business principally in Lynbrook, Long Beach, and Woodmere on Long Island. In December 1986, an unrelated competitor, Telephone Answering Exchange of Hempstead, Inc., bought all the assets (except cash) of Answerite and Lynbrook. The two selling corporations were then liquidated under section 337 of the Internal Revenue Code, distributing cash to Gordon as sole shareholder.

As part of the deal, Hempstead didn't just buy the customer accounts and lists - it also signed a separate Restrictive Covenant Agreement with the selling companies and with Lionel Gordon personally. Because Gordon had inside knowledge of the customer accounts Hempstead was acquiring, Hempstead wanted assurance he wouldn't undercut the value of what it bought. Gordon agreed not to disclose information about the transferred accounts, not to solicit or accept business from them, and not to compete with Hempstead for five and a half years in Nassau County, New York. In exchange, Hempstead agreed to pay him a stated sum in 66 monthly installments - payments that would keep arriving for more than five years after Gordon had already moved his life to Florida.

The Department asked whether those installment payments counted as New York-source income to Gordon, a nonresident. Under Tax Law § 631(a), a nonresident's New York source income is the net of federal-adjusted-gross-income items derived from or connected with New York sources. Section 631(b)(1)(B) says such items include those attributable to a business, trade, profession, or occupation carried on in New York, and Reg. § 131.4(a) explains that a business is "carried on" in New York when a nonresident's affairs there are conducted systematically and regularly, or with a fair measure of permanency and continuity - not limited to maintaining a fixed office or desk space.

Relying on its own prior opinions (Leon Bonfiglio, TSB-H-80(520)I; Matter of Garry J. Hearn, TSB-H-84(193)I; Matter of Raymond Krinsky and Sylvia Krinsky, TSB-H-79(326)I), the Department reasoned that consideration paid for a restrictive covenant is income includible in federal gross income, and represents the surrender of an intangible asset or property right directly connected with the sale of the business. Because the covenant derives its entire significance and value from the transaction it protects, payment for it is treated as income or gain "from liquidation of the business" itself - not as a separate, freestanding payment unconnected to New York. Since Answerite and Lynbrook's telephone-answering business was carried on in New York, the restrictive-covenant payments tied to its sale and liquidation were New York-source income to Gordon, who had to report each installment in the year received, regardless of his Florida residency or how long after the closing the payments arrived.

This 1991 opinion later became the Department's own touchstone for how it sources non-compete payments: it was cited by name - "Lionel E. and Maxine Gordon, Adv Op Comm T&F, Jan. 29, 1991, TSB-A-91(2)I" - as precedent in TSB-A-92(10)I, the Mark Silverman opinion addressing a similar non-compete payment question. That later ruling treated Gordon as the controlling authority for the proposition that restrictive-covenant payments tied to a New York business sale remain New York-source income to a nonresident recipient.

What this means for you

Business owners selling a New York business and moving out of state

If you sell a business that operated in New York and, as part of the deal, you personally sign a non-compete or non-disclosure covenant with the buyer, expect the payments you receive under that covenant to be treated as New York-source income - even after you've relocated permanently to another state and even if the payments stretch out over many years. The Department views the covenant as inseparable from the underlying sale of the New York business, so its geographic source follows the business, not your new residence.

Accountants and tax professionals structuring a business sale with a personal restrictive covenant

When a New York business sale includes a separate restrictive covenant agreement with an individual shareholder (as opposed to only the selling corporation), plan for New York nonresident tax withholding or estimated payments on the installment stream for as long as it lasts. The sourcing analysis under Tax Law § 631(b)(1)(B) and Reg. § 131.4(a) looks to where the underlying business was carried on, not where the covenant is signed or where the seller lives when each payment arrives.

Buyers negotiating installment payments tied to a non-compete

If you are structuring deferred payments to a seller under a restrictive covenant protecting a New York business you acquired, be aware the Department treats those payments as New York-source income to the seller for withholding and reporting purposes, which can affect how the deal is papered and how the seller expects to be taxed on the payment stream.

Common questions

Q: Why did the Department treat the non-compete payments as New York income if Gordon lived in Florida the whole time?
A: Because New York sources a nonresident's income to the location of the underlying business activity that generated it, not to the nonresident's state of residence. The restrictive covenant existed only because of, and derived its entire value from, the sale of a business that Lionel Gordon carried on in New York (through Answerite and Lynbrook). The Department treated the covenant payments as part of the gain from liquidating that New York business, so they stayed New York-source income no matter where Gordon lived when each installment arrived.

Q: Does it matter that the payments came in over 66 months, well after the business was sold and liquidated?
A: No. The opinion holds that Gordon must include each payment in his New York source income "for the taxable year in which each payment is received." The timing of receipt doesn't change the source of the income - it just determines which tax year each installment is reported in.

Q: What if the restrictive covenant had been signed only by the corporations being sold, not by Gordon personally?
A: This opinion specifically addresses payments made in consideration for Gordon's own personal promise not to compete, disclose information, or solicit the transferred accounts. The Department's reasoning rests on that covenant being inseparable from - and deriving its value from - the sale of a business carried on in New York, so a personally-signed covenant tied to a New York business sale is treated the same as if the payment had gone to the selling corporation itself.

Q: Is this opinion still cited by the Department today?
A: Yes. A later advisory opinion, TSB-A-92(10)I (the Mark Silverman opinion), cites this Gordon opinion by name as the governing precedent for how the Department sources non-compete payments tied to the sale of a New York business, showing this 1991 ruling became a standing reference point for later opinions raising the same question.

Q: What test determines whether a business is "carried on" in New York for sourcing purposes?
A: Under Reg. § 131.4(a), a business is carried on in New York when a nonresident's affairs are systematically and regularly conducted there - occupying an office, shop, store, warehouse, factory, or similar place - but that definition isn't exclusive. A business is also carried on in New York if its in-state activities are conducted with a fair measure of permanency and continuity, even without a fixed physical location.

Citations and references

• Tax Law § 631(a) - defines a nonresident's New York source income as the net of federal-adjusted-gross-income items derived from or connected with New York sources
• Tax Law § 631(b)(1)(B) - treats items attributable to a business, trade, profession, or occupation carried on in New York as New York-source income
• Reg. § 131.4(a) - explains when a nonresident's business is "carried on" in New York (systematic/regular conduct, or a fair measure of permanency and continuity)
• Leon Bonfiglio, Adv Op St Tax Comm, September 16, 1980, TSB-H-80(520)I - restrictive covenant payments tied to a business sale are gain from liquidation of the business
• Matter of Garry J. Hearn, Dec St Tax Comm, October 5, 1984, TSB-H-84(193)I - cited in support of the Bonfiglio rule
• Matter of Raymond Krinsky and Sylvia Krinsky, Dec St Tax Comm, November 9, 1979, TSB-H-79(326)I - cited in support of the Bonfiglio rule

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1991.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a91_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-91 (2) I
Income Tax
January 29, 1991

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I901023A

On October 23, 1990, a Petition for Advisory Opinion was received from
Lionel E. and Maxine Gordon, c/o E. Parker Brown, II, Esq., Hiscock & Barclay,
Financial Plaza, P.O. Box 4878, Syracuse, New York 13221-4878.
The issue raised by Petitioners, Lionel E. and Maxine Gordon, is whether
payments received by a nonresident individual under a noncompetition agreement
entered into with the purchaser of the assets of a New York business are New York
source income.
Since the early 1980s, Petitioners have been residents of the State of
Florida. Petitioner, Lionel Gordon, was the sole shareholder of Answerite, Inc.
("Answerite") and Telephone Answering Exchange of Lynbrook, Inc. ("Lynbrook"),
New York corporations providing telephone answering services principally in
Lynbrook, Long Beach and Woodmere, Long Island. In December of 1986, all the
assets (except cash) of Answerite and Lynbrook were purchased by Telephone
Answering Exchange of Hempstead, Inc. ("Hempstead"), an unrelated competitor of
the selling companies.
Thereafter, Answerite and Lynbrook were liquidated
pursuant to section 337 of the Internal Revenue Code and cash was distributed to
the shareholder, Lionel Gordon.
In connection with Hempstead's purchase of Answerite and Lynbrook,
Hempstead entered into a Restrictive Covenant Agreement with the selling
companies and with Lionel Gordon personally. The Agreement noted that Hempstead
had purchased telephone answering service accounts and lists of customers from
Answerite and Lynbrook and that Gordon had knowledge concerning these assets.
Hempstead wanted to protect the confidentiality of the accounts and lists.
Accordingly, it contracted with the sellers and Lionel Gordon not to disclose
information, solicit or accept business from transferred accounts or compete with
Hempstead for 5 1/2 years in Nassau County, New York. In consideration for
Gordon's promise, Hempstead agreed to pay him a stated amount of money in 66
monthly installments.
Section 631(a) of the Tax Law provides that the New York source income of
a nonresident individual shall be the sum of the net amount of items of income,
gain, loss and deduction entering into the individual's federal adjusted gross
income derived from or connected with New York sources.
Section 631(b)(1)(B) of the Tax Law provides that items of income, gain,
loss and deduction derived from or connected with New York sources are those
items attributable to a business, trade, profession or occupation carried on in
New York State.
Section 131.4(a) of the Income Tax Regulations provides:

TP-9 (9/88)

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TSB-A-91 (2) I
Income Tax
January 29, 1991

(1) The New York adjusted gross income of a nonresident
individual includes items of income, gain, loss and
deduction entering into his Federal adjusted gross
income which are attributable to a business, trade,
profession or occupation carried on in New York State.
(2) A business, trade, profession or occupation (as
distinguished from personal services as an employee) is
carried on within New York State by a nonresident when
such nonresident occupies, has, maintains or operates
desk space, an office, a shop, a store, a warehouse, a
factory, an agency or other place where such
nonresident's affairs are systematically and regularly
carried on, notwithstanding the occasional consummation
of isolated transactions without New York State. This
definition is not exclusive. Business is carried on
within New York State if activities within New York
State in connection with the business are conducted in
New York State with a fair measure of permanency and
continuity.
The consideration received in exchange for a restrictive covenant
constitutes income includible in gross income for federal income tax purposes.
Such a covenant constitutes the surrender of an intangible asset, property right
or right of value directly connected with the sale of the business. Inasmuch as
the covenant derives its significance and value from the entire transaction, it
follows that the payment therefor constitutes income or gain ". . .from
liquidation of the business.
. . ." Leon Bonfiglio, Adv Op St Tax Comm,
September 16, 1980, TSB-H-80(520)I. (See, Matter of Garry J. Hearn, Dec St Tax
Comm, October 5, 1984, TSB-H-84(193)I; Matter of Raymond Krinsky and Sylvia
Krinsky, Dec St Tax Comm, November 9, 1979, TSB-H-79(326)I.)
Therefore, payments received with respect to a restrictive covenant entered
into in connection with the sale of a business that was carried on in New York
State are items of income derived from or connected with New York sources
pursuant to section 631(b)(1)(B) of the Tax Law and section 131.4(a) of the
Income Tax Regulations.
Herein, the payments received in consideration for the restrictive covenant
agreement entered into by Lionel Gordon in connection with the sale and
liquidation of Answerite and Lynbrook are income attributable to a business
carried on in New York. Accordingly, pursuant to section 631(b)(1)(B) of the Tax

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TSB-A-91 (2) I
Income Tax
January 29, 1991

Law, Petitioner, Lionel Gordon, must include in New York source income, the
payments received with respect to such restrictive covenant for the taxable year
in which each payment is received.

DATED: January 29, 1991

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory 0pinions
are limited to the facts set forth therein.