Governor Cuomo signed a far-reaching tax reform package back in March that overhauled the state’s corporate tax regime and made several other significant changes that will impact nearly all of the state’s tax payers in one form or another. Additionally, more out of state businesses will be added to the States’ tax rolls. (Welcome to New York!) This article will focus on one aspect of the new law that could both help, or hurt, New York State businesses that generate income from services, and that have operations or customers in multiple states outside of their home state of New York.
The key to the issue is understanding the concept of apportionment of income. Apportionment is the method by which a particular state will determine how much of a multi-state business’ income will be taxed by them, versus other states.
Up until January, 2015 New York apportioned income for services to New York if the people performing the services did them primarily in New York. This is referred to as the “cost of performance” rule.
Starting in 2015, New York State is switching to a “market based” sourcing regime. Under market based sourcing, services are allocated to the state where the benefit is received by customers. Currently, 17 states other than New York employ a market based sourcing methodology for taxing services.
Let’s take a look at AB Services company, a C corporation (more on that later) based in Rochester, NY that does environmental testing and consulting for industrial customers located around the country. AB’s employees do not leave the state to perform their services. Customers send samples and data to AB for analysis, and reports are then sent back to the customer.
Up until 2015, New York State would require AB to allocate all its income to New York, as all the services were performed by in-state employees, subjecting all AB’s income to New York State taxes under the “cost of performance” rule.
Presume that in 2014, AB’s customers are all located in “market based” states. The result is 100% double taxation- those states will want a piece of the pie as AB’s customers are located in their jurisdiction In essence, AB will be paying state taxes on the same income in both New York, and in the states where its’ customers are located.
Now, let’s look ahead to 2015. Assuming, for arguments sake, that none of AB’s customers that year are located in New York, and all its customers are located in “cost of performance” states. Under the new “market based” apportionment rules, none of the service income would be allocated to New York State, and AB would owe no New York State income tax. In addition, no income would be due to the other states either, as no services were performed there- a zero tax situation.
This is of course a simplified, and an extreme “all or nothing” scenario. A more typical situation would involve a mix of customers and employees located in numerous jurisdictions, some market based and some cost of performance based. Also, many states outside of New York use an apportionment calculation that uses multiple factors beyond sales, such as wages paid in-state or property and equipment situated in-state, to apportion income.
Additionally, the above example looks at a C corporation, versus a pass-through entity like a partnership or S corporation, which would require additional considerations.
The message is clear however- if you are a New York State service business of any kind that has customers in multiple states, you need to meet with your tax advisor early in 2105 to review the impact to your state tax situation. Your company could pay more, or have an opportunity to pay less, depending on where your customers are located and where your employees are performing their services.
And, of course, all states and localities are looking to broaden their revenue base and add businesses to their tax rolls, so continuing to review your state and local tax profile is critical. There is only one Uncle Sam to keep track of, but many, many other jurisdictions are out there looking at ways to make sure they are getting what they see as their fair share of your tax burden, so don’t neglect to monitor your state and local tax landscape as well as your federal to avoid any unwelcome surprises come tax time.
Jeffrey Corey is senior counsel based out of our Rochester, NY office.