TAX LAW | State can't tax ex-partner's profits

A New York administrative law judge has ruled that New York state can't collect personal income tax on retirement moneys that a former Coudert Brothers partner, now living in Florida, receives out of his former firm's profits.

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A New York administrative law judge has ruled that New York state can’t collect personal income tax on retirement moneys that a former Coudert Brothers partner, now living in Florida, receives out of his former firm’s profits. Matter of McDermott, No. 820099. The ruling by the New York State Division of Tax Appeals said that the federal State Taxation of Pension Income Act of 1995, codified as 4 U.S.C. � 114, barring state taxation of retirement income paid to nonresidents, applies not only to accounts set aside for retirees, but also to those linked to partnership profitability. John E. McDermott, now 74, retired from now-dissolved Coudert Brothers in 1997 after 33 years with the firm. Under a partnership agreement, Coudert Brothers partners, like partners of many other law firms, are entitled upon retirement to a continuing number of profit shares based on their years of service and productivity. McDermott, who resided in Connecticut for most of his working life, received his first installment, about $118,600, in 1998, and paid Connecticut tax on that income. New York then demanded its share, maintaining that since McDermott still had an interest in the partnership profits, the monies he received could not be considered retirement income. Administrative Law Judge Thomas C. Sacca overruled the state and held that New York is precluded under federal law from taxing the Coudert profit shares. Sacca noted that � 114 is premised on two conditions: First, the retirement plan must establish a legally binding right to compensation that may not be unilaterally reduced or eliminated; and, second, the income must be part of a series of similar periodic payments over a period of not less than 10 years. Sacca said that the Coudert plan met the criteria. “Although the amount paid to petitioner each year will be different, the method employed to determine that amount is consistent throughout the period of the retirement payments, and therefore the series of payments is to be considered a substantially equal series of periodic payments made for a period of not less than 10 years,” he said. McDermott also relied on a 1996 advisory opinion that the state tax authority issued in a matter involving Merrill Lynch & Co. Inc. Merrill had an executive compensation program in which officials could designate a certain portion of their following year’s salary to a retirement account. Those monies were not actually set aside, but documented as a bookkeeping entry and hypothetically invested in Merrill Lynch mutual funds. The annual retirement benefit was based on the performance of those funds and the amount the retiree had designated. In Technical Services Bureau Advisory Opinion TSB-A-96(7)I, the division concluded that nonresident retirees of Merrill Lynch could not be taxed by New York. Sacca said that “The Division recognized in its advisory opinion that payments based on profits will undoubtedly be unequal, but as long as the method used to determine those payments is uniform, such payments are to be considered a series of substantial[ly] equal periodic payments.” Sacca determined that even though McDermott’s income was based on partnership profits, and even though he did maintain a capital account at Coudert Brothers, all of the rights and duties he enjoyed as a partner expired upon his retirement. Consequently, Sacca said, McDermott was no longer a partner for tax purposes.

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