Barry N. Wish, a founding partner of a merchant-banking and securities dealer/trader partnership, reported large net short-term capital gains from trading regulated futures contracts as part of his 1986 self-employment income, and treated that income as 'personal service income' eligible for New York's Maximum Tax on Form IT-250. Do Wish's partnership distributive share and, in particular, his regulated-futures-contract trading gains, qualify as personal service income under former Tax Law § 603-A?

Plain-English summary

Barry N. Wish was a founding partner of 880 Associates, a partnership in the merchant-banking and securities dealer/trader business. For 1986, Wish claimed total "personal service income" of $966,072 for purposes of New York's now-repealed Maximum Tax on personal service income (computed on Form IT-250 under former Tax Law § 603-A). That figure was built from self-employment income from 880 Associates of $991,262, minus $30,000 in Keogh contributions, plus $4,810 of other consulting income. Buried inside the $991,262 self-employment figure were an ordinary loss of $(186,675), guaranteed payments of $50,004, dividend income of $48,997, and net short-term capital gains of $997,982 - the bulk of which came from trading regulated futures contracts, a category of gain that IRC § 1402(i) treats as net earnings from self-employment for federal self-employment tax purposes. Wish argued that because his futures gains counted as self-employment earnings under federal law, they should also count as New York personal service income, relying on the repealed federal maximum-tax provision (IRC § 1348) and IRC §§ 401(c)(2), 1402(a).

The Department disagreed with Wish's core legal theory but stopped short of deciding several underlying factual questions that were already under audit. On the law, former Tax Law § 603-A(b)(1)(B) borrowed its earned-income definition from IRC § 401(c)(2)(C), which Congress designed to cover self-employed people whose personal efforts directly create property - the classic examples being an author, artist, or inventor. Trading and dealing in regulated futures contracts isn't that kind of personal-effort-creates-property activity, so Wish's futures gains are not "earned income" under § 401(c)(2)(C) or § 603-A(b)(1)(B). It made no difference that those same gains counted as net earnings from self-employment under IRC § 1402(i) for federal self-employment tax purposes, because § 1402(i) was enacted after § 1348 (the provision § 603-A's definition traces back to) had already been repealed, and § 1348 never cross-referenced the self-employment-earnings clause of § 401(c)(2)(A) in the first place - only the personal-effort-creates-property clause of § 401(c)(2)(C), which doesn't fit Wish's trading activity.

On the facts, though, the Department declined to rule. Under Tax Law § 617(b), a partner's distributive share of partnership income keeps the same character it would have had if the partner realized it directly from the same source and in the same manner as the partnership - so merely performing services for a partnership doesn't convert income that is unearned at its source into earned income. Whether Wish's distributive share was earned or unearned at its source is a factual question the Department cannot resolve in an Advisory Opinion. Likewise, whether capital (in addition to personal services) was a material income-producing factor in 880 Associates' business, and if so what portion of Wish's income represented a "reasonable allowance" for his actual personal services under Reg. § 100.4(c)(1)(v), are fact-intensive questions that must be worked out case by case - and because these questions had already arisen in the context of an ongoing audit, the Department left them to be resolved there rather than deciding them in this opinion.

What this means for you

Partners and self-employed traders claiming the (now-repealed) NY Maximum Tax

Although Tax Law § 603-A was repealed effective for years after 1987, this opinion still illustrates how New York analyzed "earned income" for self-employed individuals under IRC § 401(c)(2)(C): trading gains and similar returns on capital or market activity generally do not qualify as earned income just because they're subject to federal self-employment tax. Earned income under that provision is reserved for income directly resulting from the personal creative effort of the individual - the author/artist/inventor model - not from dealing or trading, even where the individual is heavily involved in day-to-day operations.

Partners whose distributive share mixes personal services and capital

If you're a partner in a business where both your personal services and capital contributed by the partnership are material income-producing factors, only a "reasonable allowance" for your actual services (capped at the business's net profits) can be treated as personal-service-type income; the rest is treated according to its character at the source. There is no fixed regulatory formula for what counts as a "reasonable allowance" - relevant factors include the nature and scope of your work, your qualifications, the size and complexity of the business, how your compensation compares to other partners' or employees', and prevailing rates for comparable positions. You bear the burden of proving what portion qualifies.

Taxpayers whose issue is already under audit

This opinion is a reminder that the Advisory Opinion process resolves questions of law applied to undisputed facts - it does not adjudicate open factual disputes, especially ones already being examined in an ongoing audit. If your case turns on how to characterize a distributive share, whether capital is a material income-producing factor, or what's a "reasonable allowance," expect those determinations to be made in the audit (or subsequent proceedings), not in an Advisory Opinion.

Common questions

Q: Did Wish win or lose?
A: Neither, entirely. The Department ruled against him on the pure legal question - his regulated futures contract trading gains are not "earned income" or personal service income under IRC § 401(c)(2)(C) or Tax Law § 603-A(b)(1)(B), because trading isn't the kind of personal-effort-creates-property activity that provision covers. But the Department did not decide the broader factual questions about how the rest of his distributive share from 880 Associates should be characterized, or what portion (if any) constituted a reasonable allowance for his personal services - those were left to the ongoing audit.

Q: Why didn't it matter that Wish's futures gains counted as self-employment income for federal self-employment tax purposes?
A: Because that categorization comes from a different, unrelated provision - IRC § 1402(i) - which determines net earnings from self-employment for self-employment tax purposes and was enacted only after the federal maximum-tax provision (IRC § 1348) had already been repealed. Section 1348, which is what New York's former § 603-A definition traces back to, only ever incorporated the "personal effort creates property" earned-income clause of § 401(c)(2)(C), never the self-employment-earnings clause of § 401(c)(2)(A). So the fact that the IRS taxes those gains as self-employment earnings for SE-tax purposes has no bearing on whether they're "earned income" for personal-service-income purposes.

Q: What is former Tax Law § 603-A, and does it still apply today?
A: Section 603-A was New York's Maximum Tax on personal service income, computed on Form IT-250, mirroring a similar federal maximum-tax regime that once existed under IRC § 1348. It was repealed by Chapter 28 of the Laws of 1987, so it no longer applies to current tax years; this 1990 opinion addresses a 1986 return governed by the pre-repeal law.

Q: What is the "reasonable allowance" test under Reg. § 100.4(c)(1)(v), and who has the burden of proof?
A: Where both personal services and capital are material income-producing factors in an unincorporated business, only a "reasonable allowance" as compensation for the individual's actual services (not exceeding the business's net profits) is personal service income. There's no single regulatory formula for calculating it - the Department looks at factors like the nature and scope of the taxpayer's work, qualifications, the size and complexity of the business, comparisons to other employees' or partners' compensation, and prevailing rates for comparable positions, on a case-by-case basis. The taxpayer bears the burden of proving what portion qualifies as a reasonable allowance.

Q: Why couldn't the Department just decide whether Wish's partnership income was earned or unearned at its source?
A: Under Tax Law § 617(b), a partner's distributive share keeps the same character - earned or unearned - that it would have had if realized directly from the underlying source in the same manner as the partnership realized it. Determining that source-level characterization is a factual inquiry into how 880 Associates actually generated its income, and Tax Law § 171 Twenty-fourth and 20 NYCRR § 901.1(a) limit Advisory Opinions to applying the law to an agreed, specified set of facts - they cannot resolve disputed factual questions, particularly ones (like this one) already at issue in a pending audit.

Citations and references

• Tax Law § 603-A (repealed by L.1987 ch.28) - former New York Maximum Tax on personal service income, computed on Form IT-250
• Tax Law § 603-A(b)(1) (as amended by L.1981 ch.1043) - three-part definition of "New York personal service income" (compensation for services; gains from property created by personal effort; certain pension/annuity income)
• Tax Law § 617(b) - a partner's share of partnership income keeps the same character as if realized directly by the partner from the partnership's source
• Tax Law § 171 Twenty-fourth - Advisory Opinions apply statutory/regulatory provisions to a specified set of facts, not disputed factual questions
• 20 NYCRR § 901.1(a) - implementing regulation for Advisory Opinion procedure
• Reg. § 100.4(c)(1)(v) - reasonable allowance for personal services is personal service income where both services and capital are material factors, capped at net profits
• IRC § 401(c)(2)(C) - defines earned income for a self-employed individual whose personal efforts created the property generating the income (the author/artist/inventor model)
• IRC § 911(b) - earned income definition incorporated into Tax Law § 603-A(b)(1)(A)
• IRC § 1348(b)(1) (repealed for years after 1981) - former federal maximum-tax definition of "personal service income" that New York's § 603-A originally borrowed from
• IRC § 1402(a) - defines net earnings from self-employment
• IRC § 1402(i) - added after § 1348's repeal; includes regulated futures contract gains/losses in net earnings from self-employment for dealers/traders
• Zalman C. and Elaine K. Bernstein, TSB-A-87(10)I (Dec. 15, 1987) - non-exhaustive list of factors relevant to a "reasonable allowance" determination
• Antonio and Frances Coppola, Joseph and Marie Coppola, TSB-H-86(44)I (Feb. 18, 1986) - taxpayer bears the burden of proving a reasonable allowance for services
• Migliore v. Commissioner, 36 TCM 1004 (1977) - applying former IRC § 1348's earned-income definition, substantially similar to Tax Law § 603-A
• Paula Construction Co. v. Commissioner, 58 TC 1055 (1972) - burden of proof for reasonable compensation allowance

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1990.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a90_10i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-90 (10) I
Income Tax
August 14, 1990

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I900418C

On April 18, 1990, a Petition for Advisory Opinion was received from Barry N. Wish and
Judith Wish, c/o Oxford Financial Group, Northbridge Tower I, 515 North Flager Drive, West Palm
Beach, Florida 33401.
The issue raised by Petitioner, Barry N. Wish and Judith Wish, is whether certain income of
Petitioner, Barry N. Wish, for 1986 constitutes personal service income for purposes of computing
New York State Maximum Tax on Form IT-250.
Mr. Wish was a founding partner of 880 Associates, a partnership involved in the merchant
banking and security dealer/trader business. In 1986, Mr. Wish's personal services were a significant
factor in the profit of the business as he was heavily involved in the day to day operations of the
business. 880 Associates participates in security dealer/trader transactions and Mr. Wish claims total
personal service income of the following:
Self employment income from 880 Associates
Keogh contributions
Other consulting income
Total

$991,262
( 30,000)
4,810
$966,072

Included in the $991,262 of self employment income from 880 Associates were the following
items:
Ordinary (loss)
Guaranteed payments
Dividend income
Net short term capital gains

$(186,675)
50,004
48,997
997,982

Mr. Wish states that the self employment income from 880 Associates represented a
reasonable allowance as compensation for the services rendered by Mr. Wish in connection with his
work for the partnership. Mr. Wish also states that not all the gains were treated as self employment
income. The gains that were treated as self employment income were from regulated future contracts
as described in section 1402(i) of the Internal Revenue Code (hereinafter "IRC").
Mr. Wish contends that under the repealed section 1348 of the IRC, personal service income
included "earned income" for self employed individuals and that any income subject to self
employment tax would normally qualify as personal service income. Mr. Wish refers to sections
401(c)(2), 1348(b)(1) and 1402(a) of the IRC. Therefore, Mr. Wish believes that the gains from
regulated futures contracts should be allowed as personal service income for New York State
personal income tax purposes.

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Section 617(b) of the Tax Law provides that each item of partnership income, gain, loss or
deduction shall have the same character for a partner under Article 22 of the Tax Law as for federal
income tax purposes. In addition, where an item is not characterized for federal income tax
purposes, it shall have the same character for a partner as if realized directly from the source from
which realized by the partnership or incurred in the same manner as incurred by the partnership.
Therefore, earned income cannot include items of income or gain that would be characterized as
unearned income if realized by the taxpayer directly from the source from which realized by the
partnership.
Accordingly, a partner's distributive share of income is to be determined as "earned" or
"unearned" at its source. The fact that a partner performs services for the partnership would not alter
the character of income determined to be "unearned" at its source. The characterization of such
income is a factual question.
Questions of fact are not susceptible of determination in an Advisory Opinion. An Advisory
Opinion merely sets forth the applicability of pertinent statutory and regulatory provisions to "a
specified set of facts" Tax Law, S171, subd. twenty-fourth; 20 NYCRR 901.1(a). Therefore a
determination cannot be made in this advisory opinion as to whether the income in question was
"earned" or "unearned" at its source.
Section 603-A of the Tax Law, prior to its repeal by Chapter 28 of the Laws of 1987,
provided for a maximum rate on New York personal service taxable income. Section 603-A(b)(1),
as amended by Chapter 1043 of the Laws of 1981, defined "New York personal service income" as:
(A) wages, salaries, or professional fees, and other amounts received as
compensation for personal services actually rendered, but does not include that part
of the compensation derived by the taxpayer for personal services rendered by him
to a corporation which represents a distribution of earnings or profits rather than a
reasonable allowance as compensation for the personal services actually rendered.
In the case of a taxpayer engaged in a trade or business in which both personal
services and capital are material income-producing factors... a reasonable allowance
as compensation for the personal services rendered by the taxpayer shall be
considered as earned income,
(B) gains (other than any gain which is treated under any provisions of chapter one
of the internal revenue code as gain from the sale or exchange of a capital asset) and
net earnings derived from the sale or other disposition of, the transfer of any interest
in, or the licensing of the use of property (other than good will) by an individual
whose personal efforts created such property, and

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(C) any income which is an amount received as a pension or annuity which arises
from an employer-employee relationship or from tax-deductible contributions to a
retirement plan, to the extent such items of income are includible in New York
adjusted gross income, plus the amount of the modifications which must be added
to federal adjusted gross income pursuant to paragraphs seven, eight and nine of
subsection (b) of section six hundred twelve. "New York personal service income"
does not include any amount which would have been excludible from personal
service income for federal income tax purposes for the taxable year ending December
thirty-first, nineteen hundred eighty-one had the income been includable in federal
gross income for such year.
When section 603-A was added to the Tax Law in Chapter 70 and amended in Chapter 729
of the Laws of 1978, "New York personal service income" was defined as items of income includible
as personal service income for purposes of section 1348 of the IRC, an analogous federal maximum
tax provision. Section 1348(b)(1)(A) of the IRC, prior to its repeal effective for taxable years
beginning after December 31, 1981, defined "personal service income" as any income which is
earned income within the meaning of section 401(c)(2)(C) of the IRC or section 911(b) of the IRC
or which is an amount received as a pension or annuity which arises from an employer-employee
relationship or from tax deductible contributions to a retirement plan.
After section 1348 of the IRC was repealed in 1981, section 603-A of the Tax Law was
amended to incorporate substantially the same definition of earned income that was contained in
section 401(c)(2)(C) of the IRC (section 603-A(b)(1)(B) of the Tax Law), section 911(b) of the IRC
(section 603-A(b)(1)(A) of the Tax Law) and the pension and annuity provision of section
1348(b)(1) of the IRC (section 603-A(b)(i)(C) of the Tax Law.) Therefore, in determining whether
Mr. Wish's 1986 income is New York personal service income, it is appropriate to apply precedent
set under sections 1348, 401(c)(2)(C) and 911(b) of the IRC with regards to the definition of earned
income as well as the provisions contained in section 603-A of the Tax Law.
Section 401(c)(2)(C) was intended to encompass the income of a self employed individual
which directly resulted from the individual's efforts; for example, the income of an author, an artist
or an inventor. See S. Rep. No. 1707, 89th Cong., 2d Sess., reprinted in 1966 U.S. Code Cong. &
Ad. News 4446, 4507-09. Herein, Mr. Wish's personal efforts did not create property as
contemplated by such section. Accordingly, Mr. Wish's income from regulated futures contracts is
not earned income pursuant to section 401(c)(2)(C) of the IRC or section 603-A(b)(1)(B) of the Tax
Law.
It should be noted that subparagraph (A) of section 401(c)(2) of the IRC provides that "earned
income" means the net earnings from self employment, as defined in section 1402(a) of the IRC, and
section 1402(i) of the IRC provides that "in determining the net earnings from self employment of
any options dealer or commodities dealer, there shall not be excluded any gain or loss (in the normal
course of the taxpayer's activity of dealing or trading in section 1256 contracts [regulated futures
contracts]) from such section 1256 contracts or property related to such contracts." However, section
1402(i) was added to the IRC after section 1348 of the IRC was repealed and, in any event, section

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1348 of the IRC does not refer to subparagraph (A) of section 401(c)(2) of the IRC but does refer
to subparagraph (C) of section 401(c)(2) of the IRC, which is discussed herein.
Therefore, it is of no consequence that Mr. Wish's income from regulated futures contracts
is considered net earnings from self employment for purposes of section 1402 of the IRC. Such
income does not meet the definition of earned income for purposes of section 911(b) of the IRC nor
section 603-A of the Tax Law.
Section 100.4(c)(1)(v) of the Personal Income Tax Regulations provides that "[w]here an
individual is engaged in an unincorporated trade or business in which both personal services and
capital are material income-producing factors, a reasonable allowance as compensation for the
personal services actually rendered is personal service income from the trade or business." However,
such allowance cannot be more than the net profits of the business.
The Personal Income Tax Regulations do not specify any test to determine the portion of
income received from an unincorporated trade or business that represents a reasonable allowance for
salaries and other compensation for personal services actually rendered. Nor do the regulations
contain any provisions restricting "New York personal service income" to amounts reported on W-2
forms.
The determination of what represents a reasonable allowance for salaries and other
compensation for personal services actually rendered is a factual question which must be answered
on a case by case basis based upon a review of the relevant facts and circumstances of each case.
Factors which may be taken into account in arriving at a reasonable allowance include: the nature,
extent and scope of the taxpayer's work, the taxpayer's qualifications, the size and complexities of
the trade or business, a comparison of the taxpayer's compensation to the compensation of other
employees, a comparison of the taxpayer's income from the partnership to the income of other
partners of the partnership and the prevailing rates of compensation for comparable positions in
comparable companies. However, the above list is not intended to be an exhaustive list. Zalman C.
and Elaine K. Bernstein, Adv Op Comm T&F, December 15, 1987, TSB-A-87(10)I.
It should be noted that the burden of proving that income received represents a reasonable
allowance for compensation for personal services actually rendered falls upon the taxpayer. Antonio
and Frances Coppola, Joseph and Marie Coppola, Dec St Tax Comm, February 18, 1986, TSB-H­
86(44)I; Migliore v Commissioner, 36 TCM 1004 (1977) (applying the provisions of former section
1348 of the IRC relating to the definition of "earned income" which is substantially the same as
section 603-A of the Tax Law); Paula Construction, Co. v Commissioner, 58 TC 1055 (1972).

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Inasmuch as the factual questions presented herein, namely: (1) the characterization of Mr.
Wish's distributive share of the partnership's income, (2) whether capital is a material income­
producing factor and (3) if so, the determination of what represents a reasonable allowance for
salaries and other compensation for personal services actually rendered, arise within the context of
an audit, the necessary factual determination must be made within such context, in accordance with
the principles outlined above.

DATED: August 14, 1990

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.