Three years ago, this column discussed the sales tax consequences of intercompany book entries among a group of affiliated companies. See Joseph Lipari and Aaron Gaynor, Recent Case Demonstrates Risk of Sales Tax in Affiliate Transactions, NYLJ (Sept. 6, 2018). As that entry noted, there is often “a degree of casualness” in the case of transactions between affiliated parties, and that casualness can lead to unexpected tax consequences. A recent Division of Tax Appeals determination, Sion Misrahi and Esther Misrahi-Elting, DTA Nos. 828818 and 828822 (N.Y. Div. Tax App., March 11, 2021), engages with similar issues in the income tax context, and serves a reminder that good form matters.
Although Misrahi was decided under the state tax law, the issues followed federal law. As a general matter, for federal and New York state purposes, there is no corporate-level income tax on S corporations, but, rather, the corporation’s shareholders pay tax on the income that “flows through” from the corporation. See generally I.R.C. §1363, et seq.; and N.Y. Tax Law §§210.1 and 612. (Although not relevant in this matter, it is worth noting that New York City imposes its General Corporation Tax on S corporations. See N.Y.C. Admin. Code 11-602, et seq.) Additionally, the shareholders of an S corporation recognize gain on distributions to the extent that the distributions are in excess of the shareholders’ basis in the stock of the corporation. See I.R.C. §1368(b).