Robert Spielman was the sole shareholder of a New York S corporation that did business and paid tax in two other states. One of those states called its corporate levy a 'franchise' or 'privilege' tax rather than an 'income' tax, even though the tax was actually computed based on net income. Can Spielman still claim New York's resident tax credit under Tax Law § 620(a) for the tax his S corporation paid to that state, despite the 'franchise' label?

Plain-English summary

Robert Spielman was a New York resident and the sole shareholder of "ABC," a corporation that had elected S-corporation status for both New York and federal purposes. ABC did business and paid corporate-level tax in two other states, referred to in the opinion as State X and State Y. State Y imposed a straightforward corporate income tax based on net income allocated to the state. State X, by contrast, imposed its corporate levy under the label of a "franchise" or "privilege" tax - but that tax, too, was actually computed based on net income allocated to the state, with net income in both states starting from federal taxable income and then applying state-specific modifications. Spielman asked whether he could claim New York's resident tax credit under Tax Law § 620(a) for the tax ABC paid to State X, given that State X didn't call its tax an "income" tax.

The Department worked through the mechanics of how an S corporation's income and taxes flow through to a shareholder's New York return. Under IRC § 1366(f)(2) and (3), a shareholder's federal adjusted gross income already includes their pro rata share of the S corporation's income, loss, deductions, and any reduction for taxes the corporation paid - including the taxes ABC paid to States X and Y, which ABC had deducted in computing its own trade-or-business income. Tax Law §§ 617(a) and (b) carry that pass-through treatment into the New York calculation, applying modifications pro rata and preserving each item's character. And Tax Law § 612(b)(3) requires adding back to federal adjusted gross income any income taxes - New York's own or another jurisdiction's - that were deducted in computing federal adjusted gross income and not credited against federal tax, so that a taxpayer doesn't get both a federal deduction and a state credit for the same tax without first restoring the income to the New York tax base.

The heart of the opinion turned on whether State X's "franchise" tax counted as an "income" tax under § 620(a), which by its terms covers "any income tax" paid to another state. The Department relied heavily on two precedents: its own earlier opinion to James F. Matthews (TSB-A-89(5)I), which held that an S-corp shareholder can claim the resident credit for corporate-level tax paid to another state, provided that tax is an income tax; and the Tax Appeals Tribunal's decision in Matter of Baker, issued just weeks earlier, which held that a tax's label is not conclusive - what matters is its "nature and practical effect." The Tribunal in Baker borrowed the analytical framework from the federal foreign tax credit under IRC § 901(b)(1) and its regulations (Treas. Reg. § 1.901-2(a)(1)(ii)), which likewise look past a foreign country's own label for a levy and ask whether its "predominant character" is that of a US-style income tax - i.e., whether it's likely to reach net gain in normal circumstances. Applying that test in Baker, the Tribunal held that Connecticut's Corporation Business Tax was a creditable income tax, and that New Jersey's Business Tax was also a creditable income tax despite its "franchise/privilege" label, because it too was computed on net income - though the portion of the New Jersey tax based on net worth was not, since net worth has no relationship to income or profit.

Applying Baker directly, the Department held that State Y's tax was straightforwardly an income tax for § 620 purposes, and that State X's "franchise" or "privilege" tax was also an income tax for § 620 purposes, because it was actually computed and based on net income rather than merely labeled that way. Consistent with the § 612(b)(3) add-back mechanism, the Department explained that Spielman first had to add back to his New York adjusted gross income the taxes ABC paid to States X and Y (to the extent those taxes had been deducted in arriving at federal adjusted gross income), and only then could he claim the § 620(a) resident credit for those same taxes, computed under § 620's own rules. The bottom line: Spielman could claim the New York resident tax credit for the corporate taxes ABC paid to both States X and Y, notwithstanding State X's "franchise" label, because what controlled was the tax's actual computation on a net-income base.

What this means for you

Shareholders of S corporations operating in multiple states

If your S corporation pays a corporate-level tax to another state, don't assume the tax's name determines whether you can claim New York's resident tax credit under Tax Law § 620(a). A tax labeled a "franchise" tax, "privilege" tax, or "business tax" can still qualify as a creditable "income" tax if it is, in substance, computed on a net income base. Look at how the other state actually calculates the tax - starting point (often federal taxable income), the base it's applied to, and any apportionment - rather than the title the state gives it in its statute.

Accountants and tax professionals computing multi-state resident credits for S-corp shareholders

Remember the two-step mechanic this opinion walks through: first, under Tax Law § 612(b)(3), add back to the client's New York adjusted gross income any portion of the other state's corporate tax that the S corporation deducted in computing federal taxable income (since that deduction already reduced the shareholder's pass-through income under IRC § 1366(f)(2)/(3)); only after that add-back can the client claim the § 620(a) resident credit for the same tax. Skipping the add-back and going straight to the credit would give the shareholder a double benefit - a federal deduction and a New York credit for the identical tax. Also apply the Baker component test if a state's tax combines multiple bases (for example, a net-income component and a separate net-worth or capital component): only the portion actually measured by net income is creditable.

Common questions

Q: Does the label a state gives its corporate tax - "franchise tax," "privilege tax," "business tax," "income tax" - determine whether it's creditable under Tax Law § 620(a)?
A: No. Following the Tax Appeals Tribunal's decision in Matter of Baker, the Department looks past the label to the tax's "nature and practical effect." If the tax is actually computed and based on net income, it counts as an "income tax" for resident-credit purposes even if the state calls it something else, because the credit's purpose is to prevent double taxation on the same income regardless of what the other state names its levy.

Q: Why did the Department look to the federal foreign tax credit for guidance in a New York state-tax case?
A: The Tax Appeals Tribunal in Baker found the federal foreign tax credit under IRC § 901(b)(1) to be the closest analogous provision, since it serves the same purpose (avoiding double taxation on the same income) and federal courts likewise refuse to let a foreign country's own label control - they ask instead whether the foreign levy's "predominant character" is that of a US-style income tax under Treas. Reg. § 1.901-2(a)(1)(ii). The Tribunal imported that same substance-over-label approach into the New York resident credit analysis.

Q: If a state's corporate tax combines a net-income component with something else, like a net-worth or capital component, is the whole tax creditable?
A: Not necessarily. Baker held that where a tax is the sum of separately computed components, each component is tested independently. In Baker itself, New Jersey's net-income-based component qualified as a creditable income tax, but the separate portion of that tax computed on entire net worth did not, because net worth bears no relationship to income or profit.

Q: Why did Spielman have to add the corporate taxes back to his income before claiming the credit, instead of just claiming the credit outright?
A: Because ABC, as an S corporation, had already deducted the taxes it paid to States X and Y when computing its own trade-or-business income, and that deduction flowed through to reduce Spielman's federal adjusted gross income under IRC § 1366(f)(2) and (3). Tax Law § 612(b)(3) requires adding those taxes back to arrive at New York adjusted gross income to the extent they were deducted federally and not credited against federal tax. Only after that add-back restores the income to the New York tax base can Spielman claim the § 620(a) credit - otherwise he would get both a federal deduction and a New York credit for the same dollar of tax.

Q: Does this opinion apply beyond S corporations, to any resident taxpayer claiming the § 620 credit for tax paid to another state?
A: The substance-over-label principle from Baker that this opinion applies - that a state's characterization of its own tax doesn't control, and that net-income-based taxes are creditable regardless of label - comes from a case about individually-paid Connecticut and New Jersey corporate taxes, and the Department applies it here to a pass-through S-corporation context. The core holding on how to classify a tax as an "income tax" is a general resident-credit principle; the S-corporation-specific pass-through and add-back mechanics under §§ 612(b)(3) and 617(a)/(b) are what make this opinion specifically relevant to S-corp shareholders.

Citations and references

• Tax Law § 620(a) - allows a New York resident a credit against Article 22 tax for any income tax imposed by another state, DC, or a Canadian province on income both derived there and subject to New York tax
• Tax Law § 611 - defines New York taxable income of a resident individual as federal adjusted gross income with § 612 modifications, less deductions and exemptions
• Tax Law § 612(b)(3) - requires adding back to federal adjusted gross income any income taxes deducted in computing federal adjusted gross income and not credited against federal tax
• Tax Law § 617(a) - applies modifications under §§ 612(b)/(c)/(d) or 615(c)/(d)(2)/(3) to S corporation pass-through items on a pro rata basis
• Tax Law § 617(b) - preserves the federal character of S corporation income, loss, and deduction items for Article 22 purposes
• IRC § 1366(f)(2) and (3) - includes a shareholder's pro rata share of S corporation income, loss, deduction, and tax reduction items in federal adjusted gross income
• IRC § 901(b)(1) - the federal foreign tax credit provision the Tax Appeals Tribunal used as an analogy in Baker
• Treas. Reg. § 1.901-2(a)(1)(ii) - sets the "predominant character" test for whether a foreign levy is a creditable US-style income tax
• James F. Matthews, TSB-A-89(5)I (June 14, 1989) - held an S-corp shareholder may claim the resident credit for corporate-level tax paid to another state, provided the tax is an income tax
• Matter of William A. Baker, Jr. and Lucelle D. Baker, NYS Tax Appeals Tribunal (Oct. 11, 1990) - held a tax's label is not conclusive for resident-credit purposes; its nature and practical effect (whether it is measured by net income) controls, and each component of a combined tax is tested separately

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_13i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-90 (13) I
Income Tax
November 30, 1990

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I891204B

On December 4, 1989, a Petition for Advisory Opinion was received from Robert Spielman
c/o Mahoney Cohen Paul & Company PC, 111 West 40th Street, New York, New York 10018.
The issue raised by Petitioner, Robert Spielman, is whether a New York State resident is
allowed a resident tax credit for corporate tax paid to another state by his wholly owned "S"
corporation where the other state's corporate tax is termed a "franchise" tax although it is actually
computed and based on net income.
A taxpayer who is a New York State resident is the sole shareholder of ABC, a New York
State and federal S corporation. ABC does business and pays taxes in States X and Y. State X
imposes a corporation business tax described as a "franchise" or "privilege" tax which is measured
by net income allocated to the state. State X imposes a direct corporate income tax that is also based
on net income allocated to the state. Net income in both states is generally determined by federal
taxable income with modifications.
Section 620(a) of the Tax Law provides that a resident shall be allowed a credit against the
tax otherwise due under Article 22 for any income tax imposed for the taxable year by another state
of the United States, a political subdivision of such state, the District of Columbia or a province of
Canada, upon income both derived therefrom and subject to tax under Article 22 of the Tax Law.
Section 601 of the Tax Law imposes the personal income tax on the New York taxable
income of resident individuals. Section 611 of the Tax Law provides that the New York taxable
income of a resident individual is computed by subtracting from the individual's New York adjusted
gross income, the individual's New York deduction and New York exemptions. The New York
adjusted gross income of a resident individual is the individual's federal adjusted gross income with
the modifications required by section 612 of the Tax Law. An individual's federal adjusted gross
income includes a shareholder's pro rata share of a S corporation's income, loss, deduction and
reduction for taxes, described in section 1366(f)(2) and (3) of the Internal Revenue Code.
Section 617(a) of the Tax Law provides that when computing New York adjusted gross
income and New York taxable income of a resident shareholder of an S corporation not subject to
tax under Article 9-A, any modification described in section 612(b), (c) or (d) or section 615 (c) or
(d)(2) or (3) of the Tax Law which relates to an item of S corporation income, loss or deduction shall
be made in accordance with the shareholder's pro rata share, for federal income tax purposes, of the
item to which the modification relates. Section 617(b) of the Tax Law provides that each item of
S corporation income, loss or deduction shall have the same character for a shareholder under Article
22 as for federal income tax purposes.

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TSB-A-90 (13) I
Income Tax
November 30, 1990
Section 612(b)(3) of the Tax Law contains a modification increasing federal adjusted gross
income for income taxes imposed by New York State or any other taxing jurisdiction, to the extent
deductible in determining federal adjusted gross income and not credited against federal income tax.
When computing federal adjusted gross income, the taxpayer must include his pro rata share
of ABC's income, loss, deduction and reduction for taxes, described in section 1366(f)(2) and (3) of
the Internal Revenue Code. When ABC computes ordinary income from trade or business activities,
ABC is allowed a deduction for the taxes ABC paid to States X & Y. State X imposes a corporate
franchise or privilege tax, and State Y imposes a direct corporate income tax.
In an Advisory Opinion issued to James F. Matthews, it was held that a resident shareholder
of an S corporation is eligible for a resident tax credit for tax paid by the corporation in another state,
provided that such tax is an "income" tax. (James F. Matthews, Adv Op Comm T & F, June 14,
1989, TSB-A-89(5)I)
In the Matter of William A. Baker, Jr. and Lucelle D. Baker, (Dec Tax App Trib, October
11, 1990) the Tax Appeals Tribunal agreed with the Matthews Advisory Opinion. The Tribunal
found that in characterizing a tax for the limited purpose of the resident tax credit, the label of the
tax is not conclusive, but rather the nature and practical effect of the tax is determinative. This
approach was adopted because it furthers the legislative purpose behind the enactment of the resident
tax credit, that is, to avoid double taxation on the same income. The Tribunal concluded that a tax
is an "income" tax within the meaning of the resident tax credit to the extent the tax is imposed on
an income base.
In the Baker decision, the Tribunal turned to federal law for guidance in determining what
is an income tax for purposes of the resident tax credit. The Tribunal found that the most relevant
authority on point is provided by the comparable provision in the Internal Revenue Code, the foreign
tax credit. Pursuant to section 901(b)(1) of the Internal Revenue Code, a citizen of the United States
is entitled to a credit for "the amount of any income, war profits, and excess profit taxes paid or
accrued during the taxable year to any foreign country" (emphasis added). Like the resident tax
credit provided under New York law, the primary objective of the foreign tax credit is to prevent
double taxation on the same income.
The Tribunal also found that in determining whether a foreign tax is an income tax for
purposes of the foreign tax credit, the label of the tax is not determinative. The Tribunal noted that
it is further well settled that a court is not bound by the classification of the tax in question by the
imposing country. A foreign tax qualifies as a creditable income tax if the tax is "the substantial
equivalent of an income tax as that term is understood in the United States" (See Treas. Reg.
§l.901-2[a][1][ii] Ia foreign levy is an income tax if "the predominant character of that tax is that of
an income tax in the U.S. sense"]). The predominant character of a tax is that of an income tax in
the United States sense if it is likely to reach net gain in the normal circumstances

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Income Tax
November 30, 1990
in which the tax applies. Where the foreign law imposes a tax that is the sum of two or more
separately computed amounts, then each component is tested to determine if it qualifies as an income
tax.
The Tribunal held in Baker that the Connecticut Corporation Business Tax, imposed on
companies carrying on, or authorized to carry on, business in the State at ll.5% of entire net income
attributable to Connecticut, is an income tax for purposes of section 620 of the Tax Law. The
Tribunal also held that the New Jersey Business Tax, imposed on corporations for the privilege of
having or exercising its corporate franchise, or for the privilege of doing business, employing or
owning capital or property, or maintaining an office in the state and based on 9% of entire net
income allocated to the state, is an income tax for purposes of section 620 of the Tax Law.
However, the tax imposed by the New Jersey Business Tax computed on entire net worth allocated
to the state was not considered an income tax because it bore no relation to the income or profits of
the corporation.
Herein, the tax that ABC paid to State Y is an income tax for purposes of section 620 of the
Tax Law. In addition, pursuant to the Baker decision, the "franchise" or "privilege" tax that ABC
paid to State X is an income tax for purposes of section 620 of the Tax Law, to the extent that the
tax is based on net income.
Pursuant to the Baker decision, consistency of treatment between the Internal Revenue Code
and sections 620(a) and 612(b)(3) of the Tax Law requires that, before a taxpayer may claim a
resident tax credit, the amount of taxes paid by ABC to States X and Y be added back to arrive at
New York adjusted gross income to the extent such taxes were deducted in arriving at federal
adjusted gross income.
Accordingly, herein the taxpayer may claim a resident tax credit under section 620 of the Tax
Law for income taxes paid by ABC to States X & Y, when such taxes are included in the taxpayer's
New York taxable income pursuant to the modification contained in section 612(b)(3) of the Tax
Law. The amount of resident tax credit allowed must be computed pursuant to section 620 of the
Tax Law.

DATED: November 30, 1990

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory 0pinions
are limited to the facts set forth therein.