On May 17, 2021, the New York Tax Appeals Tribunal (“Tribunal”) tenuous that in order to determine whether a New York C corporation is required to elect to be treated as an S corporation following the investment ratio test under New York Tax Law § 660 (i), this test requires that the “Federal gross income” adopts the same definition as that provided by the Internal Revenue Code (“IRC”) and as indicated in the federal returns of the corporation.
In 2012, a third party purchaser purchased all of the outstanding shares of Lepage, Inc. and Bakeast, Inc. from taxpayers. Both Lepage and Bakeast had elected to be treated for federal income tax purposes as corporations in the subchapter S. However, neither of the two entities filed for elections for the company New York S. In connection with the sales, valid choices under IRC § 338 (h) (10) were made and the sales were therefore treated as deemed asset sales by Lepage and Bakeast, followed by a liquidation distribution of the consideration to taxpayers.
After verification, the Division of Taxation (“Division”) concluded that under Section 660 (i) of the New York Tax Act, Lepage and Bakeast should be treated as New York S corporations for the purposes of tax year 2012. The NY Tax Law § 660 (i) includes an investment ratio test that a New York S corporation election is mandatory if the investment income of a federal S corporation during d ‘A tax year exceeds 50% of its “federal gross income” for that year. Since the sales of Lepage and Bakeast were treated as sales of assets under IRC § 338 (h) (10), the division concluded that the parts of the gain from those sales which met the definition of investment income were included in the determination of federal gross income. de Lepage and Bakeast. Due to the inclusion of these amounts in federal gross income, Lepage and Bakeast exceeded the investment ratio for 2012 and the Division therefore asserted that they should be treated as New York S corporations.
The taxpayers argued that Lepage and Bakeast did not exceed the investment ratio and, therefore, the criteria for the mandatory election of the New York S corporation had not been met. As part of their argument, the taxpayers asserted that the term “gross federal income” should not include income that would not have been included in gross federal income if the corporations were treated as C corporations for the purposes of federal income tax. Although Lepage and Bakeast reported gains from the sale of assets when they reported federal gross income at the federal level for the purpose of reporting income attributed to New York, Lepage and Bakeast both reported amounts for the federal level. Federal taxable income that had been reduced from the company’s deemed asset sales gain. The taxpayers justified the reduction, arguing that, because Lepage and Bakeast were C corporations in New York, for the purposes of the calculation under New York Tax Law § 660 (i), their “federal gross income” should be limited to those items that would be counted as “federal gross income” as if corporations were also treated for federal income tax purposes as corporations C. Taxpayers further argued that Section 660 (i) of New York tax law should follow a similar standard and that the meaning of federal gross income should be limited to only those amounts that would be treated as federal gross income if the corporation were treated as a C corporation for federal income. for tax purposes.
The court rejected the taxpayers’ arguments, stating that nothing in New York Tax Law § 660 (i) stated that “federal gross income” should be so limited. The Court upheld the ruling that the New York S corporation status was mandatorily chosen for Lepage and Bakeast and that taxpayers were therefore subject to liability as S corporation shareholders for gains from sales.