25 N.Y.3d 732
N.Y.2015Background
- Plaintiffs were nonresident former shareholders of JBS Sports, Inc., a Tennessee S corporation, who sold their JBS stock in 2007 to Yahoo and elected treatment of the transaction as a § 338(h)(10) deemed asset sale for federal tax purposes.
- Under S-corp rules, gains flowed through to shareholders who reported and paid federal tax on their pro rata shares; plaintiffs did not report or pay New York tax on those gains.
- New York audited and assessed state income tax on the New York-source portion of the deemed-asset gains under Tax Law § 632(a)(2) (amended 2010), treating the gains as New York-source income allocated consistent with Article 9-A methods.
- Plaintiffs paid the assessment, sought refunds, and sued claiming Article XVI, § 3 of the New York Constitution precludes New York from taxing nonresidents’ gains from intangible property (stock) not employed in NY.
- Supreme Court granted summary judgment to the State; the Court of Appeals affirmed, holding Article XVI, § 3 does not bar income taxation of New York-source pass‑through gains from a deemed asset sale.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Article XVI, § 3 forbids NY from taxing nonresidents' gains from sale of intangible property (stock) not employed in NY | Burton: Section 3's situs rule and prohibition on ad valorem/ownership-based excise taxes mean intangible property of nonresidents is domiciled out-of-state and income from it is untaxable by NY | State: Section 3 prohibits location-based ad valorem or ownership excise taxes on intangibles but does not bar income taxes on New York‑source income; plaintiffs also elected federal deemed-asset treatment | Held: Section 3 does not prohibit NY from taxing New York‑source income realized by nonresident shareholders; the tax here is an income tax, not an ad valorem or ownership-based excise tax, so the assessment is constitutional |
| Whether federal §338(h)(10) deemed-asset characterization prevents NY taxation or was a waiver of challenge | Burton: The deemed-asset election is a federal fiction that should not change NY's inability to tax nonresident intangibles | State: The election changes how gain is realized and sourced; plaintiffs voluntarily chose the election and federal characterization controls state treatment under Tax Law conformity provisions | Held: The deemed-asset election legitimately changed the character and sourcing of the gain; New York may tax the New York‑source portion of the pass‑through income |
Key Cases Cited
- Ampco Printing-Advertisers' Offset Corp. v. City of New York, 14 N.Y.2d 11 (N.Y. 1964) (interpreting Article XVI, § 3 and distinguishing ad valorem/ownership taxes from other taxes)
- Matter of Carey v. Morton, 297 N.Y. 361 (N.Y. 1948) (courts give constitutional language its ordinary meaning)
- Matter of Brown, 274 N.Y. 10 (N.Y. 1937) (discusses mobilia sequuntur personam principle)
- Guardian Life Ins. Co. v. Chapman, 302 N.Y. 226 (N.Y. 1951) (definition and scope of ad valorem taxation)
- Gen. Mills, Inc. v. Commissioner of Revenue, 440 Mass. 154 (Mass. 2003) (treating §338(h)(10) as a legal fiction that changes realization and character of gain)
- Valentino v. Franchise Tax Board, 342 Cal. Rptr. 2d 304 (Cal. Ct. App. 2004) (source of shareholder's pro rata S-corp income is characterized by reference to corporate income-producing activities)