An Administrative Law Judge (“ALJ”) with the New York State Division of Tax Appeals recently struck down an aggressive attempt by the New York State Department of Taxation and Finance (the “Department”) to tax the income of a nonresident attorney that was earned for legal services performed entirely in the state of Florida.¹ A copy of the ALJ decision is attached here. According to the Department, the income was subject to New York state personal income tax because the taxpayer was licensed to practice law in New York, and appeared before the courts in Florida on the basis of a pro hac vice admission (i.e., the taxpayer was granted special permission to participate in a particular case even though he was not licensed to practice law in Florida). The ALJ strongly rejected the Department’s position as without merit and contrary to the Department’s own regulations.

The taxpayer in Carr is an attorney who was admitted to practice law in New York in 1964 and in New Jersey in 1987. During the audit years, the taxpayer resided in Florida. He maintained his New York and New Jersey law licenses, but maintained an office in Florida where he continued to perform some legal services. In 2001, the taxpayer was admitted pro hac vice to represent a client before the Sarasota County Circuit Court. During the audit years, the taxpayer received income for the legal services he rendered in the Florida proceedings. He filed a federal income tax return reporting a Florida home address and reported the income on Schedule C of his tax returns.

The Department argued that all of the income attributable to the legal services performed in Florida was subject to New York State personal income tax. The Department asserted that the income was attributable to a profession carried out in New York, even though it conceded the taxpayer did not maintain an office or perform any services in New York. According to the Department, the income was fully taxable in New York because the taxpayer maintained a New York law license, whereas the income was received in Florida on the basis of a pro hac vice admission.

In rejecting the Department’s position, the ALJ distinguished the taxpayer’s case from two other cases cited by the Department, Carpenter v. Chapman and Matter of Vigliano.² The ALJ noted that in Carpenter and Vigliano, the taxpayers were licensed to practice law only in New York, had New York offices, maintained law practices in New York, and did not have law offices outside of the state. In contrast, the taxpayer in Carr maintained an office only in Florida and his legal services were performed solely in Florida. His only connection with New York was the retention of his New York law license.

The ALJ also rebuked the Department for seeking to tax 100% of the taxpayer’s income in a manner that was inconsistent with its own regulations. Under the regulations, a nonresident’s income must be apportioned within and without New York, based on the percentage of business carried on systematically and regularly in the state. As the ALJ noted, if the Department wishes to deviate from its rules and create a new set of rules for nonresident attorneys licensed to practice law in New York, it must seek to implement the change through legislation or new regulations.

Reed Smith Observations New York is notorious for aggressively auditing professionals, corporate executives, athletes, entertainers, and other high-net-worth individuals who live in other states, but maintain homes and business ties to New York. Typically, the Department seeks to assert that the individual is really a resident of New York so that it may tax 100% of the individual’s income. The Department tends to be particularly aggressive in situations in which the individual recognizes large capital gains that New York would not be able to tax if the individual were a nonresident.³ Indeed, in the Carr case, the taxpayer’s audit began as a residency audit. It was only when the Department determined it could not tax the taxpayer’s legal services income on the basis of residency that it aggressively argued the income was taxable as New York source income.

The taxpayer in Carr should never have been forced to expend time, energy and resources contesting and litigating the Department’s assessment of tax and interest. The Department’s position was aggressive—and, as the ALJ noted—inconsistent with its own regulations. Nonetheless, Carr serves as a reminder that taxpayers should plan ahead. Individuals who are planning to establish residency outside of New York or who will receive significant income after a change of residency should consult with their tax advisor in advance to ensure that appropriate tax planning is undertaken. If an audit is commenced, obtaining adequate representation early in the process is crucial to defending against a potential tax assessment and prevailing in any appeals that ensue.

1. See Matter of Patrick J. Carr, Admin. Law Judge (July 23, 2015).
2. Carpenter v. Chapman, 276 A.D. 634 (3d Dep’t 1950); Matter of Vigliano, Tax Appeals Trib. (Jan. 20, 1994).
3. See Jack Trachtenberg, “Defending New York Residency Audits that Target Capital Gains,” Tax Stringer, Vol. 5, No. 2 (Feb. 2014)

Client Alert 2015-222