On May 17, 2021, the New York Tax Appeals Tribunal (“Tribunal”) ruled that a determination must be made as to whether a New York C company must be treated as an S company based on the investment ratio test provided by New York Tax Act 660 (i) requires such a review that "Federal Gross Income" uses the same definition as used in the Internal Revenue Code ("IRC") and federal tax returns for the company.
In 2012, a third taxpayer acquirer purchased all of the outstanding shares of Lepage, Inc. and Bakeast, Inc. Both Lepage and Bakeast had chosen to be treated as Subsection S companies for federal income tax purposes. However, neither company submitted the election for the New York S Corporation. In connection with the sales, valid elections were conducted under IRC § 338 (h) (10) and thus the Lepage and Bakeast sales were treated as considered asset sales, followed by a liquidating distribution of the consideration to taxpayers.
Upon review, the Tax Department (“Department”) determined that NY Tax Law Section 660 (i) requires both Lepage and Bakeast to be treated as New York S Corporations for the 2012 tax year. NY Tax Law Section 660 (i) provides an investment ratio test that requires a New York S corporation election if a Federal S corporation's investment income in any tax year exceeds 50% of its “federal gross income” for that year. Because the Lepage and Bakeast sales were treated as asset sales under IRC § 338 (h) (10), the division concluded that portions of the profit from such sales that met the definition of investment income were included in determining federal gross income were from Lepage and Bakeast. As a result of including these amounts in federal gross income, both Lepage and Bakeast exceeded their 2012 investment quota, and the division therefore claimed that they should be treated as a New York S company.
Taxpayers argued that Lepage and Bakeast did not exceed the investment quota and therefore did not meet the criteria for the mandatory New York S Corporation election. As part of their argument, taxpayers argued that the term "federal gross income" should not include income that would not have been included in federal gross income had the companies been treated as C companies for federal income tax purposes. Although both Lepage and Bakeast reported profits from the sales of assets when reporting federal gross income at the federal level for the purpose of reporting income attributable to New York, both Lepage and Bakeast reported amounts of federal taxable income that were related to the profit on the supposed sale of assets. The taxpayers justified the reduction by stating that, since Lepage and Bakeast C companies were in New York, their "federal gross income" for the calculation under the NY Tax Law § 660 (i) should be limited to items that are classified as "federal gross income", as if the corporations were also treated as C companies for federal income tax purposes. Taxpayers further argued that NY Tax Law Section 660 (i) should follow a similar standard, limiting the meaning of federal gross income to only amounts that would be treated as federal gross income if the company were treated as a C company for federal income tax purposes .
The Tribunal dismissed the taxpayers' arguments, finding that nothing in NY Tax Law Section 660 (i) indicated that "federal gross income" should be so capped. The Tribunal upheld the finding that both Lepage and Bakeast had compulsory New York S corporation status and that taxpayers as shareholders of S corporation were liable for profits from the sales.