117 A.D.3d 168
N.Y. App. Div.2014Background
- Plaintiffs (Florida residents) sold all stock of TMC (an S‑corp) on Feb. 1, 2007, with purchase paid largely by promissory notes in installments and an IRC §338(h)(10) election treating the deal as an asset sale for federal tax purposes.
- Under the installment method and IRC §453(h)(1)(A), plaintiffs recognized gain on receipt of installment payments and reported gains on their 2007–2008 federal returns; they did not report those gains as New York source income on their New York nonresident returns.
- In 2009 administrative rulings (e.g., Matter of Mintz), ALJs held similarly that such payments were not New York source income; the Tax Department sought legislative change to overturn those rulings.
- In Aug. 2010 the Legislature amended N.Y. Tax Law §632(a)(2) to treat gains from payments on installment obligations distributed by S‑corporations (and gains tied to §338(h)(10) elections) as New York source income, and made the amendment retroactive to taxable years beginning on or after Jan. 1, 2007.
- In Feb. 2011 the Tax Department issued a notice of deficiency assessing additional tax for 2007–2008; plaintiffs sued claiming retroactive application violated federal and state due process; the motion court ruled for defendants, but the appellate court reversed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether retroactive application of the 2010 Tax Law amendment to plaintiffs’ 2007–2008 years violates due process | Plaintiffs reasonably relied on pre‑2010 law (and federal treatment) and had no forewarning; retroactivity (3.5 years) is excessive and public purpose (raising revenue) is insufficient | DTF had a longstanding, though unpublished, policy of parallel treatment; the amendment was curative and rationally applied to open years to prevent loopholes and revenue loss | Court held retroactive application as to these plaintiffs violated due process and enjoined enforcement of the deficiency |
| Whether plaintiffs had forewarning or detrimental reliance | Plaintiffs relied on the law as written (no provision taxing these payments) and had no notice of any contrary DTF policy; they need not identify an alternative transaction structure | Defendants contend plaintiffs should have known DTF’s practice (and could have sought an advisory opinion) and failed to prove they would have acted differently | Court found no forewarning, and plaintiffs’ reliance on the prior law was reasonable |
| Whether the 3.5‑year retroactive period was excessive | Plaintiffs: period is long, longer than period invalidated in James Sq., so it frustrates repose and is oppressive | Defendants: retroactivity to open years is reasonable for a curative measure and to avoid widespread unfair consequences | Court held the 3.5‑year retroactivity was excessive and weighed against the State |
| Whether the public purpose justified retroactivity | Plaintiffs: budgetary revenue aims are insufficient to justify retroactivity when reliance and length factors favor taxpayers | Defendants: amendment was curative of erroneous admin rulings, closed a loophole, and served legitimate revenue and fairness goals | Court found the stated public purpose (raising revenue/curative label) was not sufficiently compelling to overcome the other factors |
Key Cases Cited
- James Sq. Assoc. LP v. Mullen, 21 N.Y.3d 233 (N.Y. 2013) (reaffirmed three‑part balancing test for retroactive tax statutes)
- Matter of Replan Dev. v. Department of Hous. Preserv. & Dev. of City of N.Y., 70 N.Y.2d 451 (N.Y. 1987) (articulated reliance/length/public‑purpose framework for retroactivity)
- Matter of Lacidem Realty Corp. v. Graves, 288 N.Y. 354 (N.Y. 1942) (invalidated four‑year retroactive tax as harsh and oppressive)
- United States v. Carlton, 512 U.S. 26 (U.S. 1994) (discussed validity of retroactive tax measures and curative statutes)
- Matter of Varrington Corp. v. City of N.Y. Dept. of Fin., 85 N.Y.2d 28 (N.Y. 1995) (upheld retroactivity where taxpayer lacked detrimental reliance)
- Prince v. State Dept. of Revenue, 55 So.3d 273 (Ala. Civ. App. 2010) (affirmed treatment of §338 election as asset sale for state tax purposes)