A nonresident alien partner in a New York law firm works entirely from the firm's London office and receives fixed annual 'guaranteed payments' under IRC section 707(c), on top of his distributive share of partnership income. Are those guaranteed payments taxable as New York source income, even though he performs no services in the United States?

Plain-English summary

Francis Fitzherbert-Brockholes is a citizen, domiciliary, and resident of the United Kingdom with no place of abode in New York. He is a partner in a New York law partnership but is a resident partner of the firm's London office, meaning he performs all of his legal services outside the United States. In exchange for agreeing to an indefinite assignment to London, the firm agreed to pay him fixed annual "guaranteed payments," set each year by a separate letter agreement, that qualify as guaranteed payments under Internal Revenue Code section 707(c). Because they are section 707(c) payments, the firm deducts them before calculating the net income distributable to partners. On top of the guaranteed payments, Petitioner is also credited with his distributive share of the partnership's net income. The share of the partnership's worldwide net income that came from New York sources varied year to year - about 80% for 1988 through 1990. Petitioner reported his New York-source distributive share on his New York nonresident income tax returns, but the guaranteed payments raised a separate sourcing question.

New York taxes a nonresident individual on New York source income under Tax Law section 601(e), using a fraction that puts New York source income in the numerator and federal adjusted gross income in the denominator. For a nonresident partner, Tax Law section 632(a)(1) says New York source income includes only the New York-source portion of items that enter the partner's federal adjusted gross income - so if an item never shows up in federal AGI, it can't be pulled into New York source income by state law alone. Section 632(b) adds that a partnership agreement's own characterization of a payment (as compensation for services versus a return on capital) doesn't control the state sourcing analysis. Section 632(d)(1), together with section 617(b), says the character of a partnership item for a nonresident partner follows its federal income tax character. The New York Court of Appeals reinforced all of this in Webster v Tully, 56 NY2d 532, holding that New York source income cannot include an item that is not includible in federal adjusted gross income unless a Tax Law section 612(b) modification specifically brings it in.

Applying these rules, the Department held that if a guaranteed payment to a nonresident partner is not includible in federal adjusted gross income, it is not includible in New York source income. But if some or all of a guaranteed payment is includible in federal adjusted gross income, that includible amount - multiplied by the percentage of the partnership's income sourced to New York for that year - becomes New York source income, and belongs in the numerator of the section 601(e) allocation fraction; the full federal-AGI-includible amount goes into the denominator. Importantly, the Department stopped short of deciding the threshold question of whether a nonresident alien partner's guaranteed payment for services performed entirely outside the United States is includible in federal adjusted gross income in the first place - that is a federal tax question outside the Department's jurisdiction. The ruling answers only the New York sourcing consequence that follows once, and if, that federal question is answered in the affirmative.

What this means for you

Nonresident alien partners with a New York firm who work entirely outside the United States

Whether your section 707(c) guaranteed payments are taxable by New York turns first on a federal question this ruling doesn't answer: whether those payments are includible in your federal adjusted gross income at all, given that your services are performed entirely abroad. If a competent federal analysis concludes they are not includible in federal AGI, New York cannot tax them either, because New York source income cannot exceed what federal law brings into AGI absent a specific Tax Law section 612(b) modification. If they are includible, expect New York to tax only the portion equal to the partnership's New York-source income percentage for that year, not the full guaranteed payment - and expect the full federal-AGI-includible amount to appear in the denominator of your section 601(e) allocation fraction, which affects your overall New York effective tax rate.

Accountants and tax professionals advising partnerships with resident-abroad or nonresident alien partners

Before applying New York sourcing rules to a partner's guaranteed payments, resolve the federal inclusion question first - this ruling makes clear the Department treats New York sourcing as strictly derivative of federal treatment for nonresident partners. Don't rely on how the partnership agreement labels the payment (as compensation for services or otherwise); Tax Law section 632(b) disregards that characterization for sourcing purposes. If a payment is federally includible, apply the partnership's New York-source percentage for that specific tax year to the includible amount, since that percentage can (and here did) vary meaningfully from year to year.

Common questions

Q: Did the Department decide whether Petitioner's guaranteed payments were subject to New York tax?
A: Not definitively. The Department declined to resolve the underlying federal question of whether a nonresident alien partner's guaranteed payment for services performed entirely outside the United States is includible in federal adjusted gross income - that's a federal tax determination outside the Department's purview. Instead, the ruling is conditional: it explains what New York tax result follows depending on how that federal question is answered.

Q: If the guaranteed payment turns out to be includible in federal adjusted gross income, how much of it does New York tax?
A: Not the full amount. New York taxes the includible amount multiplied by the percentage of the partnership's net income that was derived from New York sources for that particular taxable year. For 1988-1990, that New York-source percentage was approximately 80%, but the ruling notes it varies year to year, so the calculation must be redone annually.

Q: Does it matter that the partnership called these "guaranteed payments" rather than a distributive share?
A: No. Tax Law section 632(b) specifically provides that in sourcing a nonresident partner's income, no effect is given to a partnership agreement's characterization of a payment as being for services or for the use of capital. What matters is federal tax characterization (which the payments retain here as IRC section 707(c) guaranteed payments) and federal includibility, not the label used internally.

Q: What happens to the guaranteed payment in the denominator of the New York tax allocation fraction if it's not includible in federal AGI?
A: If the guaranteed payment is not includible in federal adjusted gross income, it is excluded from both the numerator (New York source income) and the denominator (federal adjusted gross income) of the Tax Law section 601(e) allocation fraction - it simply doesn't enter the New York tax calculation at all.

Q: What is the legal basis for tying New York source income so tightly to federal adjusted gross income?
A: Webster v Tully, 56 NY2d 532, a New York Court of Appeals decision, held that in applying Tax Law section 632(a), New York source income cannot include an item that isn't includible in federal adjusted gross income unless a specific modification under Tax Law section 612(b) brings it in. Tax Law section 632(a)(1) codifies the same limitation for nonresident partners' distributive shares of partnership items.

Citations and references

• Tax Law § 601(e) - imposes New York personal income tax on a nonresident's New York source taxable income, computed as a fraction of New York source income over federal adjusted gross income
• Tax Law § 612(b) - the modifications that can bring an item into New York source income even when it would otherwise be excluded
• Tax Law § 617(b) - the character of a partnership item for New York income tax purposes is the same as its federal income tax character
• Tax Law § 632(a)(1) - limits a nonresident partner's New York source income to the New York-source portion of partnership items entering the partner's federal adjusted gross income
• Tax Law § 632(b) - disregards a partnership agreement's characterization of payments as being for services or for the use of capital when sourcing a nonresident partner's income
• Tax Law § 632(d)(1) - directs that the character of partnership items for a nonresident partner is determined under Tax Law § 617(b)
• Internal Revenue Code § 707(c) - defines the "guaranteed payments" at issue, deductible by the partnership before computing distributable net income
• Webster v Tully, 56 NY2d 532 - New York Court of Appeals holding that New York source income cannot include an item not includible in federal adjusted gross income absent a § 612(b) modification

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1993.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a93_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-93 (2) I
Income Tax
April 2, 1993

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

PETITION NO. I921230A

On December 30, 1992, a Petition for Advisory Opinion was received from
Francis Fitzherbert-Brockholes, 66 Gresham Street, London EC2V 7LB England.
The issue raised by Petitioner, Francis Fitzherbert-Brockholes, is whether
guaranteed payments made by a New York partnership to a nonresident alien partner
for services rendered outside the United States is included in New York taxable
income of such nonresident alien partner.
Petitioner is a citizen, domiciliary and resident of the United Kingdom.
He has no place of abode in New York. Me is a partner of a New York partnership
engaged in the practice of law. He is a resident partner of the firm's London
office and accordingly, performs all of his services as a lawyer outside of the
United States. In consideration of his agreement to be assigned to the firm's
London office indefinitely, the firm has agreed to provide guaranteed payments
of certain amounts which are fixed each year by separate letter agreement. Such
guaranteed payments qualify as such under section 707(c) of the Internal Revenue
Code of 1986 (hereinafter "IRC") and accordingly, are deducted by the firm before
determining the amount of net income distributable to partners. As a partner,
Petitioner is credited with his distributive share of such net income of the
partnership. The amount of the partnership's net income from New York sources
as a percentage of its worldwide net income varies from year to year; for the
years 1988-1990 such New York percentage was approximately 80%. Petitioner
included in his New York personal income tax returns his share of the
partnership's net income from New York sources.
Section 601(e) of the Tax Law imposes a personal income tax for each
taxable year on a nonresident individual's taxable income which is derived from
sources in New York State. The tax is equal to the tax computed as if the
individual were a resident, reduced by certain credits and multiplied by a
fraction, the numerator of which is the individual's New York source income and
the denominator of which is the individual's federal adjusted gross income.
Section 632(a)(1) of the Tax Law provides, in pertinent part, that
[i]n determining New York source income of a nonresident
partner of any partnership, there shall be included only
the portion derived from or connected with New York
sources of such partner's distributive share of items of
partnership income, gain, loss or deduction entering
into his federal adjusted gross income .... (emphasis
added).
Section 632(b) of the Tax Law provides, in pertinent part, that "[i]n
determining the sources of a nonresident partner's income, no effect shall be
given to a provision in the partnership agreement which (1) characterizes
payments to the partner as being for services or for the use of capital .... "
TP-9 (9/88)

-2­

TSB-A-93 (2) I
Income Tax
April 2, 1993

Section 632(d)(1) of the Tax Law provides that the character of partnership
items for a nonresident partner is to be determined under section 617(b) of the
Tax Law
which provides that the character for New York income tax purposes shall be the
same as for federal income tax purposes.
In Webster v Tully, 56 NY2d 532, the Court of Appeals held that in applying
the provisions of section 632(a) of the Tax Law, New York source income does not
include an item that is not includible in federal adjusted gross income for
federal income tax purposes, unless the inclusion is permitted by a modification
contained in section 612(b) of the Tax Law.
Accordingly, if the amount of a guaranteed payment received by a
nonresident partner is not includible in federal adjusted gross income, such
amount would not be includible in New York source income. However, if part or all
of the amount of a guaranteed payment received by a nonresident partner is
includible in federal adjusted gross income, such includible amount would also
be includible for New York State personal income tax purposes to the extent that
the partnership's income is derived from New York sources.
Herein, if the guaranteed payment made by a New York partnership to a
nonresident alien partner, such as Petitioner, is includible in the partner's
federal adjusted gross income, the amount of such payment multiplied by the
percentage of the partnership's income derived from New York sources for that
taxable year would be includible in the partner's New York source income, which
is the numerator of the tax allocation fraction contained in section 601(e) of
the Tax Law. The total amount of the payment includible in the partner's federal
adjusted gross income would be includible in the denominator of such tax
allocation fraction.
However, if the guaranteed payment received by the
nonresident alien partner is not includible in the partner's federal adjusted
gross income, such payment would not be includible in the denominator of the tax
allocation fraction and would not be includible in the partner's New York source
income, which is the numerator of the tax allocation fraction.

DATED: April 2, 1993

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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