If a passive-investment limited liability company keeps its office, books and records, and securities depository in New York, is the interest income it distributes to nonresident members subject to New York personal income tax?

Plain-English summary

Attorney Jeffrey J. Pirruccello asked the Department, on behalf of a client structure, whether interest income earned by a limited liability company and distributed to its individual members - none of whom reside in or have nexus with New York - is subject to New York personal income tax under Article 22.

The "Company" is an Iowa-organized LLC considering locating its principal place of business in New York, assumed to be classified as a partnership for federal tax purposes. A multi-state corporate "Parent" indirectly owns all of the Company's common membership interests through two out-of-state subsidiaries, while unrelated third parties (some in New York, some not) hold preferred interests with no management rights. The Company exists purely as a passive investment vehicle: it issues preferred and common membership interests, lends the proceeds to Parent, and currently holds four notes receivable from Parent. Interest that Parent pays on those notes is distributed to members in proportion to their interests. Notably, the securities depository, the books and records, the principal office and mailing address, and some of the officers and directors will all be located in New York, and the Company and its subsidiaries will register to do business in New York - but the Company will do nothing else besides collecting the four notes and administering the investment for its members.

The Department concluded that a nonresident member with no other New York-source income owes no New York personal income tax on this interest. Tax Law § 601(f) makes clear that a partnership - and an LLC classified as a partnership for federal tax purposes (a "subchapter K limited liability company") - is not itself taxed under Article 22; only the partners or members are taxed, individually. For a nonresident individual, § 601(e) taxes only New York-source income, and § 632(a)(1) sources a nonresident partner's distributive share of partnership income the same way § 631 sources income for any nonresident individual. Under § 631(b)(2), income from intangible personal property - including interest - is New York-source income only to the extent it is "from property employed in a business, trade, profession, or occupation carried on" in New York. The passive holding of investment intangibles is not such an employment of property in a New York business.

The Department grounded this in two Appellate Division decisions: Delmhorst v State Tax Comm'n, where interest on an installment note was not New York-source income because the note - not the New York stock exchange seat it related to - was the income-producing property, and the note itself was never used in a New York trade or business; and Katz v State Tax Comm'n, where nonresidents' interest income from unsecured installment notes arising out of a real property sale likewise was not New York-source income because the notes were never used in a New York trade or business. The Department also invoked its own prior opinion, E. Parker Brown II (TSB-A-90(1)I), for the general rule that nonresident partners are sourced no differently than any other nonresident taxpayer: if an item of income would not be New York-source income received directly by a nonresident individual, it is not New York-source income when received through a partnership either.

Applying these rules, the interest that Parent pays to the Company on the four notes, and that the Company distributes to a member, is not New York-source income to that member - regardless of the fact that the Company's office, books and records, securities depository, and some of its officers and directors are physically located in New York. What matters is that the notes themselves are simply passive investment property, never employed in an active New York trade or business. So a nonresident individual member of the Company, with no other New York-source income, is not subject to New York personal income tax on this interest.

What this means for you

Multi-state businesses structuring passive investment or financing subsidiaries

If you're setting up an LLC or partnership purely to hold intangible investment assets - such as notes receivable from an affiliate - and to pass through the resulting interest or similar investment income to nonresident members, this opinion confirms that basing the entity's office, books and records, or securities depository in New York does not, by itself, turn that income into New York-source income for those nonresident members. What controls is whether the underlying income-producing property (the notes) is actually employed in an active trade or business carried on in New York. Simply administering a passive investment from a New York address is not that kind of employment of property. This can matter when deciding where to locate back-office functions for a financing or holding vehicle without inadvertently creating New York tax exposure for out-of-state investors.

Accountants and tax professionals advising nonresident LLC or partnership members

When advising a nonresident individual who is a member of an LLC or partner in a partnership, remember that Tax Law § 632(a)(1) sources that person's distributive share using the same rules that would apply if they received the income directly - the entity's physical presence or activities in New York do not change the character of income that is inherently passive intangible income under § 631(b)(2). Before concluding that a member's distributive share is New York-source, look at what the underlying property is and whether it is actually employed in a New York trade, business, profession, or occupation - not merely at where the entity's records or personnel happen to sit. This opinion, along with Delmhorst, Katz, and TSB-A-90(1)I, is a useful set of authorities for that analysis.

Common questions

Q: Does locating the LLC's office, books and records, and securities depository in New York make its interest income New York-source to nonresident members?
A: No. The Department found that these facts do not change the analysis. What matters under Tax Law § 631(b)(2) is whether the income-producing property - here, the notes receivable - is employed in a business, trade, profession, or occupation carried on in New York, not where the entity's administrative functions are physically located.

Q: Why isn't lending money to Parent and collecting interest on the notes considered "carrying on a business" in New York?
A: The Company's only activity is collecting the four notes and administering the investment for its members' benefit - a passive holding of investment intangibles. Under Delmhorst v State Tax Comm'n and Katz v State Tax Comm'n, passively holding notes and receiving interest on them, without more, is not the "employment" of that property in an active trade or business.

Q: Does it matter that the Company is an LLC rather than a traditional partnership?
A: No. Tax Law § 601(f) expressly extends partnership treatment under Article 22 to a "subchapter K limited liability company" - an LLC classified as a partnership for federal income tax purposes. The Company here is assumed to be such an entity, so it is treated the same as any partnership for sourcing purposes.

Q: Would the answer change if a member also had other New York-source income?
A: The opinion's conclusion is limited to a nonresident member who has no other New York-source income for the taxable year; such a member owes no New York tax on this interest. The opinion doesn't address how this interest would combine with a member's other New York-source income for purposes of computing the New York source fraction under § 601(e) if such other income existed.

Q: What's the difference between how a resident and a nonresident member of the Company would be taxed on this interest?
A: This opinion addresses only nonresident members. A New York resident member would be taxed on all of their income regardless of source under Article 22's resident taxation rules; the New York-source limitation discussed here applies only to nonresidents under Tax Law § 601(e).

Q: What authority did the Department rely on for treating nonresident partners the same as nonresident individuals?
A: The Department cited its own prior advisory opinion, E. Parker Brown II (TSB-A-90(1)I), for the principle that the rules for determining whether income is New York-source are no different for nonresident partners than for other nonresident taxpayers, and applied that principle through Tax Law § 632(a)(1).

Citations and references

• Tax Law § 601(e) - imposes personal income tax on a nonresident individual's New York-source taxable income
• Tax Law § 601(f) - a partnership, including a subchapter K limited liability company, is not itself taxed under Article 22; only the partners/members are taxed in their individual capacities
• Tax Law § 631(b)(2) - income from intangible personal property (including interest) is New York-source income only to the extent from property employed in a business, trade, profession, or occupation carried on in New York
• Tax Law § 632(a)(1) - sources a nonresident partner's distributive share of partnership income under the same rules applicable to nonresident individuals under § 631
• Delmhorst v State Tax Comm'n, 92 AD2d 981 (1983), aff'd 60 NY2d 628 - interest on an installment note never used in a New York trade or business was not New York-source income, even though the note related to a New York stock exchange seat
• Katz v State Tax Comm'n, 110 AD2d 1029 (1985) - nonresidents' interest income from unsecured installment notes arising from a real property sale was not New York-source income because the notes were never used in a New York trade or business
• E. Parker Brown II, TSB-A-90(1)I (Jan. 3, 1990) - the rules for sourcing income to New York are no different for nonresident partners than for other nonresident taxpayers

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1995.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a95_4i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-95 (4) I
Income Tax
March 15, 1995

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

PETITION NO. I941110C

On November 10, 1994, a Petition for Advisory Opinion was received from
Jeffrey J. Pirruccello, McGrath, North, Mullin & Kratz, 222 South 15th Street,
Suite 1400, Omaha, Nebraska 68102.
The issue raised by Petitioner, Jeffrey J. Pirruccello, is whether interest
income, which is derived from a limited liability company and distributed to its
individual members who do not reside or have nexus in New York State, is subject
to New York State personal income tax under Article 22 of the Tax Law.
A limited liability company (the "Company") is considering locating its
principal place of business in New York State.
The Company is a limited
liability company organized under the laws of Iowa. Parent ("Parent"), a multi­
state business, indirectly owns all of the common interests in the Company
through two wholly-owned subsidiaries, both of which are corporations organized
in a jurisdiction other than New York (the "Subsidiaries"). Preferred interests
in the Company are held by various parties unrelated to Parent who are located
both within and without New York. The holders of preferred interests have no
right to manage the Company.
The Company exists solely for the purpose of issuing preferred and common
membership interests ("securities") and lending the proceeds from the issuance
to Parent.
Thus, the Company is simply a passive investment vehicle.
The
Company currently holds four notes due from Parent. The interest paid by Parent
to the Company is distributed to the Company's members based upon each member's
proportionate interest in the Company.
The entity acting as the securities depository for the preferred securities
is located in New York. The books and records related to the Company and the
Subsidiaries will be kept in New York. The principal office and mailing address
of the Company and the Subsidiaries will be in New York. The company will engage
in no other activity except as needed to collect the four notes and to administer
this investment for the benefit of its members. Certain officers of the Company
and the Subsidiaries as well as the directors of the Subsidiaries will reside in
New York. Further, the Company and the Subsidiaries will qualify to do business
in New York.
This advisory opinion assumes that the Company is a limited liability
company that is treated as a partnership for Federal income tax purposes.
Section 601(f) of the Tax Law states:
A partnership as such shall not be subject to tax under [Article
22]. Persons carrying on business as partners shall be liable for
TP-9 (9/88)

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March 15, 1995

tax under
[Article 22] only in their separate or individual
capacities. As used in [Article 22], the term "partnership" shall
include, unless a different meaning is clearly required, a
subchapter K limited liability company. The term "subchapter K
limited liability company" shall mean a limited liability company
classified as a partnership for federal income tax purposes. The
term "limited liability company" means a domestic limited liability
company or a foreign limited liability company, as defined in
section one hundred two of the limited liability company law.
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 the New
York source fraction, the numerator of which is the individual's New York source
income and the denominator of which is the individual's New York 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 and deduction entering into his federal adjusted
gross income, as such portion shall be determined under regulations of the
[Commissioner of Taxation and Finance] consistent with the applicable rules of
section six hundred thirty-one.
Section 631(b)(2) of the Tax Law states that in determining the New York
source income of a nonresident individual, "[i]ncome from intangible personal
property, including annuities, dividends, interest, and gains from the
disposition of intangible personal property, shall constitute income derived from
New York sources only to the extent that such income is from property employed
in a business, trade, profession, or occupation carried on in this state."
It is established that the passive holding of investments by a nonresident
is not the employment of property in a business, trade, profession or occupation
carried on in New York State. In Delmhorst v State Tax Com'n, (1983) 92 AD2d
981, aff'd 60 NY2d 628, it was held that since the income producing intangible
personal property was an installment note, upon which interest was paid, and not
the stock exchange seat covered by the note, and since the installment note was
never used in a business, trade, or profession or occupation carried on in New
York as required under applicable tax provisions, the interest income received
from the installment note by the taxpayers for the years in which they were
nonresidents was not taxable as New York income. Also, in Katz v State Tax
Com'n, (1985) 110 AD2d 1029, it was held that nonresidents' interest income from
unsecured installment notes arising out of the sale of real property was not
taxable, as the notes themselves were never used in a New York trade or business.
In general, the rules for determining whether or not an item of income is
derived from or connected with New York sources are no different for nonresident
partners than for other nonresident taxpayers. Thus, in accordance with section
632(a)(1) of the Tax Law, if an item of income would not be derived from or
connected with New York sources for a nonresident individual then such item of
income would not be considered to be derived from or connected with New York
sources for a nonresident partner. See, E. Parker Brown II, Adv Op Comm T & F,
January 3, 1990, TSB-A-90(1)I.
Under the facts as set forth herein, if the interest payments on the notes
had been received by a nonresident individual, such interest income would not be

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considered income derived from or connected with New York sources within the
meaning and intent of section 632(a)(1) of the Tax Law. Therefore, where such
interest payments are received by a nonresident partner they must be accorded the
same treatment; that is, such interest income is not considered to be derived
from or connected with New York sources.
Pursuant to section 601(e)and 632(a)(1) of the Tax Law, if the Company is
a limited liability company classified as a partnership for Federal income tax
purposes, the interest paid by Parent to the Company, on the notes held by the
Company that is distributed by the Company to an individual who is a member of
the Company, is interest income of the individual that is not considered to be
derived from or connected with New York sources. Accordingly, if such individual
member of the Company is a nonresident of New York State and has no other New
York source income for the taxable year, such nonresident individual is not
subject to personal income tax in New York State.

DATED: March 15, 1995

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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