Perspectives

Recent legislation ensures New York State can tax gain from I.R.C. section 338(h)(10) transactions involving S corporations

In this discussion, Russell W. Banigan and Mary Jo Brady of Deloitte Tax LLP review the relevant I.R.C. section 338(h)(10) provisions. Then, they discuss how those provisions interest with the provisions of the New York state franchise tax (Article 9-A) and how that, in turn, impacted the result for nonresidents under the New York State personal income tax (Article 22), both before and after legislation passed in 2010. Lastly, ​they comment on the validity of the retroactive application of the recently adopted law.

IRC §338(h)(10) transactions

Some of the most interesting tax situations in recent years have involved the extent to which the gains from I.R.C. section 338(h)(10) transactions of S corporations are taxable in New York State, both for purposes of the corporation franchise tax and the individual income tax. The New York State Department of Taxation and Finance has attempted, in two separate cases, to impose tax on such gains at the S corporation level during the years in which New York taxed S corporations on an entire net income basis and on the gains realized by nonresident shareholders.

In both situations, taxpayers successfully challenged the department.

First, one taxpayer did so with respect to the S corporation level tax. Then, building off that success, another set of taxpayers prevailed with respect to I.R.C. section 338(h)(10) gains realized by nonresident shareholders of S corporations. However, the latter victory was short lived due to a recent statutory change enacted as part of the New York 2010-2011 budget legislation.

That statutory change is given retroactive effect, so as to preclude nonresident taxpayers from following the successful litigation mentioned above.

By Russell Banigan and Mary Jo Brady of Deloitte Tax LLP | Originally published in Bloomberg BNA "Tax Management Multistate Tax Report" on February 25, 2011
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