MoFo New York Tax Insights, Volume 3, Issue 6, June 2012

ALJ Holds New Resident's Gain on Sale of Former Connecticut Home is Subject to New York Income Tax

By Irwin M. Slomka

An individual who sold her out-of-state home and moved into New York has received an unusual welcome—a New York State and City income tax bill on her gain from the sale of her former home. In a case of first impression at the Division of Tax Appeals, an Administrative Law Judge held that the individual's gain from the sale of her Connecticut home, the closing for which took place 20 days after she moved into New York, accrued to her New York resident period and was therefore subject to New York State and City resident income tax. Matter of Glenna Michaels, DTA No. 823370 (N.Y.S. Div. of Tax App., Apr. 12, 2012). The Tax Law contains a section dealing specifically with "accruals upon change of residence." Under Tax Law § 639(b), an individual that changes his or her status from a nonresident to resident must "accrue to the period of nonresidence items of income, gain, loss or deduction . . . accruing prior to the change of [resident] status." Capital gains must be computed for the respective resident and nonresident periods "on the same basis as if the taxable year of such individual . . . for Federal income tax purposes were limited to the taxable period covered by the applicable New York State income tax return." 20 NYCRR 154.7(a).

Glenna Michaels was a resident of Greenwich, Connecticut, where she owned a home since 1973. In September 2004, she entered into a contract to sell her home for $14 million, with a designated closing date of November 8, 2004. At the time of contract, the buyer paid a $1.4 million down payment, and Ms. Michaels executed a "mortgage deed," held in escrow, as collateral security for her obligations under the contract. The designated closing was delayed beyond November 8. In the meantime, on November 9, Ms. Michaels closed on, and began permanently residing in, a New York City condominium, thereby becoming a State and City resident. The closing on her Connecticut home eventually took place on November 29, 2004, 20 days after Ms. Michaels became a State and City resident. She recognized a capital gain from the sale of her home of nearly $12 million.

For the tax year 2004, Ms. Michaels filed an income tax return as a part-year resident of Connecticut from January 1 through November 9, and as a part-year resident of New York State and City from November 10 through December 31. She reported the gain as having accrued during her Connecticut residency period, resulting in approximately $576,000 of Connecticut income tax. She did not report the gain on her part-year resident return for New York State and City. Following an audit, the Department of Taxation and Finance determined that the capital gain accrued when the closing took place on November 29, during her New York residency period, and assessed tax, interest and penalty on the gain.

At the Division of Tax Appeals, Ms. Michaels argued that the gain accrued during the period of her Connecticut residency, specifically in September 2004, where she entered into the sales contract. She claimed that she had a fixed right to the sale proceeds on that date, and thus for purposes of the "accrual rule" contained in Tax Law § 639(b), a completed sale occurred at that time. The Department took the position that the presence of various certain contingencies in the sales contract, and the fact that Ms. Michaels continued to bear the burdens and benefits of ownership until the closing, meant that she did not have a fixed right to the income until the closing date, which was after she became a State and City resident.

The ALJ began by noting that Tax Law § 639 requires conformity with the federal income tax rules for accruals, particularly "in the absence of New York case law." The ALJ thus applied the federal income tax "all events test" to determine when income is recognized. Under that test, an item must be included in income when all of the events have occurred which fix the right to receive such income and the amount can be determined with reasonable accuracy. The ALJ held that, applying the all events test, there was no completed sale until the closing, with all risk of loss having been retained by Ms. Michaels until the closing. While a completed sale can occur under the all events test even if legal title has not yet passed, the ALJ noted that this only occurs when the benefits and burdens of ownership pass to the purchaser, which did not occur here until the closing. The mortgage deed given by Ms. Michaels in September 2004 did not change this conclusion, because its only purpose was as security for the substantial down payment given by the purchaser.

The ALJ also addressed the taxpayer's argument that an example in the Department's regulations (contained in 20 NYCRR § 154.10(d)) was inconsistent with the Department's position, and should be controlling in this case. The ALJ concluded that "to the extent the example . . . is not consistent" with the accrual rules under Tax Law § 639 and the federal tax precedent, "it is rejected and will not be considered or relied upon for guidance herein."

The ALJ did find reasonable cause for the waiver of penalties, finding this to be "a case of first impression" and holding that "the confusion raised by [the example in the regulations] must be construed most favorably" to the taxpayer.

Additional Insights. The decision is a reminder of the importance of timing of transactions when an individual changes his or her state of residency. Clearly, had the closing taken place before Ms. Michaels became a New York resident, the gain would not have been taxable in New York. Moreover, had Ms. Michaels simply resided in temporary quarters outside New York for the 20-day delay in the closing on her Connecticut home, she would not have become a New York domiciliary, since that requires two conditions to be met: (i) abandoning her former domicile and (ii) adopting a new domicile.

The decision does not indicate whether Ms. Michaels could still timely claim a refund of the Connecticut tax paid on the gain, or whether a resident tax credit was available for the Connecticut tax paid. Interestingly, there is no mention in the decision regarding the 165 Departmental emails concerning the accrual rule, which the same ALJ last year ruled could be subpoenaed by Ms. Michaels' attorney (discussed in the August 2011 issue of New York Tax Insights).

Tribunal Reinstates Peter Madoff Petition

By Hollis L. Hyans

Reversing a decision of an Administrative Law Judge, the New York State Tax Appeals Tribunal has overturned the dismissal of Peter Madoff's petition as untimely and remanded the matter for further proceedings. Matter of Peter Madoff, DTA No. 823411 (N.Y.S. Tax App. Trib., Apr. 19, 2012).

The petition was filed to challenge a Notice of Determination dated May 4, 2009, arising from an audit of Bernard L. Madoff Investment Securities, LLC, assessing sales and use taxes of over $900,000. The Notice was issued to Peter Madoff and, according to the Department, mailed to his home address. Mr. Madoff claimed he never received the Notice, and that the first knowledge he had of the assessment was a Notice and Demand dated August 27, 2009. On September 3, 2009, within a week of receipt of the Notice and Demand, Mr. Madoff's representative filed a request for a conciliation conference, which was dismissed as untimely, since it had not been filed within 90 days of the May 4 Notice date. Mr. Madoff then filed a petition for a hearing with the Division of Tax Appeals, alleging that the May 4 Notice was not received or properly served, and also challenging the computation of tax and interest.

As reported in the October 2011 issue of New York Tax Insights, the ALJ dismissed the petition, relying on evidence of timely mailing submitted by the Department, including copies of the records of mailing, two affidavits from its employees, and an affidavit from a U.S. Postal Service employee. The documents set forth the usual practice and procedure for processing statutory notices, identified the items that were mailed on September 4, 2009, including the one at issue, and explained the processes used. The ALJ held that the evidence established proper mailing.

The Tribunal disagreed. First, it noted that a presumption of delivery arises when sufficient evidence of mailing has been profferred, and that the Department, in order to establish proper mailing, must first prove standard mailing procedure by testimony of an individual with personal knowledge, and must then prove that the standard procedure was followed in the case at issue. Here, the Department relied on affidavits from its employees, and the Tribunal reviewed the...