New York State and City Corporate Tax Reform: Implications for S-Corporations and Partnerships

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By Michael Zargari, Tina Tsao, and Gregory A. Lee


Michael Zargari is a director, Tina Tsao is a senior associate, and Gregory A. Lee is a managing director with PricewaterhouseCoopers LLP's State and Local Tax practice in New York, where they specialize in state and local tax consulting and audit defense.

In 2014, New York state enacted comprehensive corporate tax reform and, in 2015, enacted legislation that significantly conformed the New York City Administrative Code to the state corporate tax reform provisions. While the rules affecting S-corporations and their nonresident shareholders have changed for the state as a result of corporate tax reform, the city's treatment of S-corporations has not changed. The state and city treated S-corporations differently even before the recent corporate tax reform; however, the differences between the two have multiplied as a result of the fact that the state's corporate tax reform applies to S-corporations and the city's corporate tax reform does not. Furthermore, even though corporate tax reform did not result in any changes to the state and city statutes that govern partnerships, corporate tax reform nevertheless affects partnerships with corporate partners. While the tax treatment of C-corporations will likely be simplified for state and city purposes, the tax treatment of S-corporations and partnerships may be highly complicated and may result in confusion and additional administrative burdens for taxpayers as pre-reform rules will persist in conjunction with new rules.

New York State S-corporation Treatment

Eligible federal S-corporations are not automatically treated as S-corporations in New York. The shareholders of an eligible corporation must make a separate state election for New York state tax purposes by filing a Form CT-6.1 Otherwise eligible corporations that have not made the New York S-election will nevertheless be deemed to have made that election under tax law section 660(i) if the corporation's investment income is more than 50 percent of its federal gross income for that year.2

The term “investment income” for this purpose is substantially broader than the term “investment income” under article 9-A, and taxpayers should be careful not to confuse the two. For purposes of section 660, the term “investment income” means the sum of an eligible S corporation's gross income from interest, dividends, royalties, annuities, rents and gains derived from dealings in property, including the corporation's share of such items from a partnership, estate or trust, to the extent such items would be includable in federal gross income for the taxable year.3 The term “gains derived from dealings in property” is not defined, but, in the authors' experience, the New York State Department of Taxation and Finance (department) interprets it broadly. For the purposes of corporate tax reform under article 9-A, the term “investment income” is narrowly defined as income, including capital gains in excess of capital losses, from “investment capital,” less any attributable interest deductions.4 “Investment capital” is defined as investments in stocks that (i) are treated as capital assets under Internal Revenue Code (I.R.C.) section 1221, (ii) are held by the taxpayer for investment for more than one year, (iii) the dispositions of which are, or would be, treated as generating long-term capital gains or losses under the I.R.C., (iv) have never been held for sale to customers if acquired on or after Jan. 1, 2015, and (v) are clearly identified in the taxpayer's records as stock held for investment in the same manner as required under I.R.C. section 1236(a)(1) before the close of the day they were acquired.5 “Investment capital” does not include stock in a corporation that is conducting a unitary business with the taxpayer or is included in a combined report with the taxpayer as a result of the commonly-owned group election of section 210-C(3).6 Taxpayers may, therefore, inadvertently find themselves treated as S-corporations for state purposes in certain years in which their article 22 investment income is greater than 50 percent of their federal gross income, even though they may have little or no article 9-A investment income.

If the separate New York S-election is not made and is not deemed to have been made, then the corporation is treated as a C-corporation and is subject to the corporate tax reform rules under article 9-A of the tax law. As such, it is subject to the $1 million economic nexus threshold and may pay tax on business income and apportion its business income using customer-based sourcing rules (assuming business income is the largest of the tax bases); further, it may be required to file a combined report, and it may be subject to the Metropolitan Commuter Business Tax Surcharge (MTA surcharge). Nonresident shareholders of the corporation would not be subject to New York personal income tax on dividends received from the corporation, except insofar as such stock is employed in a business carried on in the state.7 However, if the shareholders are New York residents, then they will pay personal income tax on actual distributions of cash or other property from the corporation rather than on their pro rata share of the S corporation pass-through items, as all their income would be sourced to their state of residence.8

If an S-election is made, or is deemed to have been made, then the New York S-corporation is required to file a Form CT-3-S.9 Most of the corporate tax reform rules of article 9-A apply to New York S-corporations. For example, the state's $1 million economic nexus standard applies to determine whether a New York S-corporation has a filing obligation, and customer-based sourcing rules are used to determine whether the $1 million threshold has been reached.10 Under the pre-reform rules applicable for tax years prior to 2015, corporations sourced their service receipts to New York to the extent the services were actually performed in the state.11 By contrast, using the new customer-based method, service receipts are generally sourced to the “location of the customer,” which is defined as where the “benefit is received.”12 Unlike C-corporations, New York S-corporations may not be included in a combined report, are not subject to the MTA surcharge, and are only subject to the fixed dollar minimum tax based on New York receipts, which is capped at $4,500 (i.e., S corporations do not pay tax based on business income or capital).13 Instead of imposing an entity level tax on New York S-corporations, the state instead passes through the tax liability to an S-corporation's shareholders.

Resident shareholders pay state personal income tax on their pro rata share of the New York S-corporation pass-through items of income, gain, loss, and deduction that are includable in their federal adjusted gross income.14 Nonresident shareholders pay tax only on their pro rata share of such S-corporation items derived from state sources.15 To determine their New York source income, nonresident shareholders must apply the New York S-corporation's business allocation percentage (BAP), computed using the article 9-A customer-based sourcing rules, to all of the S-corporation's items of income, gain, loss, and deduction that are included in New York adjusted gross income.16 The department has recently published guidance that states that all of the New York S-corporation items entering into a nonresident shareholder's federal adjusted gross income are subject to apportionment in computing New York taxable income using the BAP, even if there are amounts that would have otherwise qualified as exempt investment income or other exempt income for an article 9-A New York C corporation filer.17 This is in contrast to the pre-tax reform rules, where the S-corporation's income could be reduced by its investment income, which, instead of being a category of exempt income, was allocable using an investment allocation percentage (IAP).18 The department has released draft regulations to provide guidance with respect to sourcing other business receipts and receipts from digital products. As of the date of this article, draft financial transaction sourcing regulations have not yet been released. There is considerable ambiguity as to how to apply the draft sourcing regulations, which have yet to be formally proposed. It is therefore to be expected that there will continue to be uncertainty when determining customer location, and, as a result, when determining a nonresident shareholder's New York source income from an S-corporation.

New York City S-Corporation Treatment

New York City has never recognized the federal or state S-election, and it continues to treat S-corporations as C-corporations under tax reform.19

New York City adopted much of the state's tax reform legislation by adding a new Subchapter 3-A to the city's Administrative Code. Significantly, Subchapter 3-A does not apply to S-corporations, which continue to be taxable under the pre-reform rules of Subchapter 2 of the Administrative Code.20 Accordingly, S-corporations are treated like C-corporations under the pre-tax reform rules, while C-corporations are now taxed under the corporate tax reform rules.

Under the pre-reform rules of Subchapter 2, C-corporations computed their tax liability on the highest of four bases (entire net income, capital, income plus compensation, and a fixed dollar minimum) plus a tax on subsidiary capital.21 Business income and capital were allocated using a three-factor BAP (which is being phased out by 2018 to a single sales factor), while investment income and capital were allocated using an IAP.22 Receipts from services were sourced to the city based on the location of performance.23 The IAP represented how much of a taxpayer's investment income or capital was allocable to New York.24 To allocate their investment income, taxpayers had to use the IAP of the issuer or obligor of the stock, bond or other security, which represented the degree of the issuer's or obligor's economic presence in New York.25

Under the tax-reform rules of Subchapter 3-A, the General Corporation Tax (GCT) is now computed on the highest of three bases (business income, capital, and a fixed dollar minimum).26 The subsidiary capital tax and the “income plus compensation” base have been eliminated. Unlike the state, the business capital tax is preserved and the corporate tax rate has not been reduced. Moreover, the city continues to use a three-factor BAP until it is phased out, though it has shifted to a customer-based sourcing methodology.27 The city has also not adopted the state's economic nexus provisions (except for credit card companies) and continues to use a physical presence nexus standard.28

Because S-corporations were specifically excluded from the city tax reform rules of Subchapter 3-A, they continue to be subject to the pre-reform rules of Subchapter 2. As such, they continue to source receipts from services based on the location of performance of the service, whereas C-corporations now utilize a customer-based sourcing methodology. Because the location of performance methodology benefits taxpayers located outside of the city (insofar as they perform their services outside of the city), S-corporations based outside of the city will continue to benefit from this apportionment standard. New York-based S-corporations, however, are unable to utilize the favorable customer-based sourcing methodology that New York-based C-corporations can now enjoy.

The difference between the state and city rules, however, presents a compliance burden for S-corporations filing in both jurisdictions because they need to use two different sourcing methodologies and maintain different records in order to source their receipts to the state using customer-based sourcing and to the city using location of performance. Furthermore, S-corporations must continue to calculate an IAP, which has historically been difficult and a thorny issue on audit (the definitions of “investment capital” are also substantially different pre- and post-reform). An odd result may also occur given the difference in state and city nexus rules: S-corporations with over $1 million of New York City receipts but no physical presence in the city would need to file a New York state return without being required to file a New York City return.

For example, if corporation A is an S-corporation for federal income tax purposes, but a New York C-corporation (i.e., its shareholders did not make the state S-election and it is not deemed to have made the election), then corporation A is treated as a C-corporation for New York state purposes. If it is based outside of New York and has over $1 million in New York receipts from services performed out-of-state for New York customers, then it must file a corporate franchise tax return. If it lacks any physical presence in the city, then it would not have to file a city GCT return. If it did have nexus, however, it would have to apportion its income to the city based on a BAP that would probably be much lower than the state's BAP (because the city would source the service receipts outside of the city to where the services were performed; the state would source the service receipts to the state based on its New York customers). Corporation A would still be required to calculate its IAP, and its investment capital for city purposes would differ greatly from its investment capital for state purposes. Corporation A would also have to determine its income-plus-compensation base, and its subsidiary capital. It would, in effect, be subject to both pre-reform and post-reform tax rules--it would be subject to many of the corporate tax reform rules for state purposes, but, it would be subject to pre-tax reform rules for city purposes. Its nonresident shareholders would not be subject to personal income tax in New York state on account of their stock holdings (insofar as such stock is not used in a trade or business) or New York City (because the city does not impose a personal income tax on nonresidents).

If corporation A's shareholders, however, do make the New York S-election, or if they are deemed to have done so because of the deemed S-election rules of N.Y. Tax Law section 660(i), then the results differ for New York state--the corporation would still have to file a state return, but it would only be subject to the fixed dollar minimum tax, capped at $4,500 (it would no longer be subject to the MTA Surcharge either). Its nonresident shareholders, however, would now be subject to state personal income tax on their share of the corporation's New York source income, which would be determined using the corporate tax reform rules under article 9-A. As such, the nonresident shareholders would be required to pick up their share of corporation A's income based on its New York customers. Because New York City does not recognize the S-election, the city analysis would not change.

New York State and City Partnership Treatment

The state follows the federal income tax classification of partnerships and treats them as pass-through entities.29 The corporate tax reform rules under article 9-A do not apply to partnerships because they are governed under article 22. As such, partnerships are not required to file state partnership returns if they have $1 million or more of New York receipts. Partnerships are only required to file an annual information return if they have a resident individual partner or any income derived from New York sources (the determination of whether a partnership has New York source income is generally based on whether the partnership has a physical presence in the state--and is not based on the amount of receipts it has from customers located in the state).30 Individual partners calculate their share of state source income using a three-factor allocation formula, based on property, payroll and receipts.31 Receipts for services are sourced to where they are performed.32 As corporate partners are subject to article 9-A, they will calculate their income using a single-sales factor and customer-based sourcing.

While partnerships are not subject to the corporate tax reform rules, there are nonetheless several rules that affect them. For example, corporate partners may be subject to the state corporate franchise tax if the partnership has $1 million or more of New York receipts.33 Even though the partnership may not have a filing obligation on its own, and is not required to issue a state K-1 to its corporate partner, the corporate partner may nevertheless be subject to tax on account of the partnership's receipts. In practice, this may not be an issue for a corporation holding a general partnership interest in a limited partnership or a managing member interest in a limited liability company because it may be able to compel the partnership to issue a state K-1. Passive corporate investors that hold either limited partnership interests or non-managing member interests may not be able to compel a partnership to provide a K-1; insofar as the partnership has no filing obligation on its own under article 22, the corporate partner may not be informed of whether the partnership has sufficient New York receipts to subject it to corporate taxation. Passive or minority corporate investors may therefore have a filing obligation without being aware of it.

Furthermore, in order for a corporate partner to treat its share of a partnership's dividend income as exempt investment income, the department has advised that the underlying partnership must comply with the investment capital identification requirement.34 The department recently issued a Technical Service Memorandum granting certain partnerships additional time to meet the identification requirement deadline.35 There is no statutory requirement under article 22, however, for a partnership to comply. If a corporate partner wants to be able to exclude its share of dividend income, then it must compel the partnership to comply with the article 9-A identification requirements. This may be easier said than done, however, for passive or minority corporate investors that have limited influence over the partnership. It would perhaps be more equitable for the department to permit such corporate partners to comply with the identification requirements themselves, to the extent that they have the information necessary for doing so.

The city did not conform its unincorporated business tax (UBT) to the tax reform changes adopted for corporate taxpayers. The city's unincorporated business tax is an entity-level tax on partnerships and other unincorporated businesses.36 There is no economic nexus standard and income is allocated to the city using a three-factor allocation formula, which will phase out to the single-sales factor by 2018.37 Receipts from the performance of services are generally sourced to the city based on the location of performance.38 Corporate partners of unincorporated businesses generally receive a UBT-paid credit so that they are not subject to double-taxation on their share of income that was already subject to the UBT.39 Corporate partners, however, must re-source their share of income using customer-based sourcing rules. City guidance makes it clear that partnerships must meet the investment capital identification requirements on behalf of their corporate partners, despite the fact that Chapter 5 of the city Administrative Code, which pertains to unincorporated businesses, does not contain such a requirement.40

Summary of S-Corporation Rules Under State and City Tax Reform


New York State New York City


Federal S-corp / New York C-corp Federal S-corp / New York S-corp Federal S-corp (no NYC election available)
Governing Law • Art. 9-A of NY Tax Law • Art. 9-A & Art. 22 of NY Tax Law • Subchapter 2 of NYC Admin. Code
Tax Base/Rate

• Subject to higher of business income base, capital base (which is being phased out), and the fixed dollar minimum base (which is capped at $200,000).

• Business income tax rate is 6.5 percent.

• Not subject to business income or capital base.

• Only subject to fixed dollar minimum tax, which is capped at $4,500.

• Tax will be computed under the prior GCT rules based on the highest of the four tax bases (entire net income, capital, income plus compensation, or fixed dollar minimum) plus the tax on subsidiary capital.

• Business income tax rate is 8.85 percent.

Economic Nexus? • Yes. $1 million economic nexus standard • Yes. $1 million economic nexus standard • No. Physical presence standard
Apportionment • Single-sales BAP • Single-sales BAP • Three-factor BAP, with phase out to single-sales by 2018.
Sourcing • Customer-based sourcing • Customer-based sourcing • Receipts from services sourced using location of performance
Investment Income • Narrowly-defined category of exempt income • N/A • Allocable to the city using an IAP
Subsidiary Capital • N/A • N/A • S-corporations must still calculate subsidiary capital base tax and attribute expenses to it.

Summary of Partnership Rules (not changed by State or City Tax Reform)


New York State New York City
Governing Law Article 22 of NY Tax Law Chapter 5 of the NYC Admin. Code
Tax Base / Rate Not subject to tax Tax is computed on unincorporated business taxable income. Rate is 4 percent.
Economic Nexus? No. New York source income or at least one non-corporate resident partner No. Physical presence

Three-factor formula (property, payroll, receipts) for individual partners

Corporate partners use single sales factor

Three-factor formula, with phase out to single-sales by 2018

Receipts from services sourced using location of performance for individual partners

Corporate partners use customer-based sourcing

Receipts from services sourced using location of performance

The recent New York state and city corporate tax reform may have simplified corporate tax compliance for C-corporations, but S-corporations will not navigate the new rules as easily. Those S-corporations unaware of the issues can find themselves with more complex compliance requirements for themselves and for their nonresident shareholders. Especially burdensome is the necessity to keep separate sets of records in order to comply with different rules for the state and city. Partnerships may also find that they will have to comply with certain record-keeping and reporting requirements in order for their corporate partners to determine whether they have filing obligations or exempt investment income.

1 N.Y. Tax Law section 660(a).

2 N.Y. Tax Law sections 208.1-B and 660(i). The income of a qualified subchapter S subsidiary owned directly or indirectly by the eligible S corporation is included with the income of the S corporation, for purposes of determining whether the S corporation meets the investment income test. N.Y. Tax Law section 660(i).

3 N.Y. Tax Law section 660(i)(3).

4 N.Y. Tax Law section 208.6(a)(i).

5 N.Y. Tax Law section 208.5(a).

6 Id. If the taxpayer owns or controls, directly or indirectly, less than 20 percent of the voting power of the stock of a corporation, that corporation will be presumed to be non-unitary with the taxpayer.

7 N.Y. Tax Law section 631(b)(2).

8 N.Y. Tax Law section 612. NYS Dep't of Tax. & Finance, Publication 35--New York Treatment of S-Corporations and Their Shareholders (3100) (Please note this publication is being updated to reflect legislative changes).

9 The term “New York S-corporation” is used hereafter to refer only to federal S-corporations that are also treated as S-corporations in New York. Federal S-corporations that do not have a New York S-election in place, or are not deemed to have one, are simply referred to herein as “C-corporations.”

10 N.Y. Tax Law sections 209; N.Y. State Dept. of Tax. & Fin., Corporate Tax Reform FAQs. Available at: (as of Feb. 3, 2016).

11 N.Y. Tax Law section 210(3)(a)(2), effective for years before Jan. 1, 2015.

12 N.Y. Tax Law section 210-A(10).

13 N.Y. Tax Law sections 210-C(2)(c), 209-B(1)(a), 210(1)(d).

14 N.Y. Tax Law section 617(a).

15 N.Y. Tax Law sections 631(b)(1)(c) and 632(a)(2).

16 N.Y. Tax Law section 632(a)(2).

17 Impact of New York state Corporate Tax Reform on New York S Corporations and their Nonresident and Part-Year Resident Shareholders, New York Technical Service Bureau Memorandum No. TSB-M-15(7)C, 12/01/2015. “Other exempt income” is the sum of exempt CFC income and exempt unitary corporation dividends. N.Y. Tax Law section 208.6-a(a).

18 Id.

19 NYC Admin. Code section 11-602(8)(ii); see also NYC Finance Memorandum 99-3 (Oct. 21, 1999).

20 NYC Admin. Code section 11-651.

21 NYC Admin. Code section 11-604(1)(A).

22 NYC Admin. Code sections 11-604(3), (4) and (5).

23 NYC Admin. Code section 11-604(3)(a)(2)(B).

24 NYC Admin. Code section 11-604(3)(b).

25 Id.

26 NYC Admin. Code section 11-654.

27 NYC Admin. Code sections 11-654(3) and 654.2.

28 NYC Admin. Code section 11-653(1).

29 N.Y. Tax Law section 601(f).

30 N.Y. Tax Law section 658(c)(1).

31 20 N.Y. Comp. Codes R. & Regs. section 132.15. Partnerships must carry on a business partly within and without the state in order to have a right to apportion.

32 20 N.Y. Comp. Codes R. & Regs. section 132.15(f).

33 N.Y. Tax Law sections 209(1)(f).

34 NYS Department of Taxation and Finance Technical Memorandum No. TSB-M-15(4)C, (5)I, Investment Capital Identification Requirements for Article 9-A Taxpayers (July 7, 2015).

35 NYS Department of Taxation and Finance Technical Memorandum No. TSB-M-15(4.1)C, (5.1)I, Additional Investment Capital Identification Periods for Certain Non-Dealers for Specified Circumstances that Occur on or After October 1, 2015 (Jan. 7, 2016).

36 NYC Admin. Code sections 11-501, 502 and 503.

37 NYC Admin. Code sections 11-503 and 508.

38 NYC Admin. Code section 11-508(c)(3).

39 19 RCNY section 11-50.

40 NYC Finance Memorandum No. 15-3, Investment Capital Identification Requirements for the Corporate Tax of 2015 (July 17, 2015); No. 16-3, Additional Investment Capital Identification Periods for Certain Non-Dealers under the Business Corporation Tax (February 26, 2016).


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