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April 9, 2013

New York State Division of Tax Appeals Rejects State's Application of Business Allocation Percentage to Calculation of the QEZE Tax Reduction Credit

The State of New York Division of Tax Appeals granted the Petitions of Batty and Pennefeather on April 4, 2013, affirming the Petitioners' calculation of the QEZE Tax Reduction Credit as shareholders of an S corporation certified under the New York State Empire Zones Program. Hiscock & Barclay represented the Petitioners in this matter. The Determination found that the Petitioners, as New York State residents, correctly calculated their QEZE Tax Reduction Credit in which each included all of their respective income from the Qualified Empire Zone Entity ("QEZE") as set forth under Tax Law §16.

The Division of Taxation for New York State performed an audit of Petitioners' personal income tax returns for 2006 through 2008 after completing of an audit of the QEZE. As a result of its audit, the Division recalculated the Tax Reduction Credit that was claimed by each Petitioner for the years at issue, stating that they improperly included all of the QEZE's business income when calculating the tax factor portion of the Tax Reduction Credit. The Division maintained that the Petitioners should have used only the QEZE's income allocated within New York State which the Division determined as the product of the income reported on Petitioners' Forms K-1, and the QEZE's business allocation percentage as reported on its franchise tax return.

We argued that as Petitioners are residents of New York State, they are taxed on all income passed through to them from the QEZE, and therefore correctly calculated their respective Tax Reduction Credits. We further argued that the Division's application of the business allocation percentage was without statutory or regulatory authority, and that there was never any intent of the Legislature to reduce the Tax Reduction Credit because the QEZE's products, while manufactured at the certified location, were shipped out of New York State. Finally, we asserted that the Division's interpretation of Tax Law §16 violated the equal protection clauses of the United States and New York State Constitutions.

The Division argued that the business allocation percentage must be applied to determine the income allocable to New York State and argued that this position was supported by the fact that the QEZE filed a franchise tax return under Article 9-a of the Tax Law. The Division also asserted the privileges and immunities clause of the United States Constitution, stating that without the application of the business allocation percentage, residents and non-residents would be treated unequally. Finally, the Division argued that its interpretation should be given significant weight and judicial deference provided its interpretation was not irrational, unreasonable, or inconsistent with the governing statute.

Almost entirely adopting the Petitioner's arguments, the Division of Tax Appeals stated that Petitioners are shareholders of an S corporation and subject to tax under Article 22 of the Tax Law, not Article 9-a. As the Tax Reduction Credit is calculated at the individual level, the Division of Tax Appeals found that the statute was clear that there is no requirement to apply the business allocation percentage when calculating the Tax Reduction Credit. Accordingly, the petitions were granted and the Notices of Deficiency were canceled.

If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact David G. Burch at (315) 425-2788, or Angela Orlandella at (315) 425-2874,, both of the Tax Controversy team.


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