Taxes and Snowy Weather?

How many of you awoke Saturday to find that the winter storm about which we had heard so much during the preceding days had lived up to its hype?

What was your first thought? “Fudge,” right? Time to shovel the driveway and clean off the car. Slippery sidewalks and roads. Ultimately, slush.

A few of you may have mused aloud about moving to Florida, perhaps oblivious to the cold that visited that state over the weekend.[i]

I’ll admit that I immediately wondered whether some enterprising individuals would show up, armed with the latest in snow removal technology, to offer their services.

Which brings me to another confession: I tried to recall whether snow removal services were subject to New York sales tax. A quick check and, “sugar” – turns out they are.[ii]

Tax Storm for NYC Business

New York State certainly knows how to tax folks, I thought to myself; then I remembered that New York City was no slouch when it came to taxes.

There are so many different taxes imposed for the “privilege” of residing or operating a business in the city, it is no wonder that so many businesses and individuals are thinking about moving to other jurisdictions.[iii]

Some of these taxes have counterparts at the state level, while others are unique to the city. Some of these taxes are collected by the city, while the state collects others on behalf of the city.

Among the city’s abundance of taxes, the following may be of special interest to business owners: personal income tax (on city residents), real property tax, sales and use tax, metropolitan commuter transportation mobility tax, real property transfer tax, mortgage recording tax, commercial rent tax,[iv] business corporation tax (C corps), general corporation tax (S corps), unincorporated business tax (“UBT”),[v] hotel room occupancy tax, and parking garage tax.

Although these are distinct taxes, the administration of one tax will sometimes lead to the imposition of another. Specifically, the return on which each tax is reported often requires the disclosure of information that may point to liability for another tax; for example, the New York City Unincorporated Business Tax Return[vi] asks for the taxpayer-business’s location within the city and the amount of New York City rent deducted.[vii] The state Resident Income Tax Return[viii] asks whether the individual taxpayer or their spouse maintains “living quarters” in the city and the number of months lived in the city.[ix]

Increased UBT Activity?

Over the last couple of years, the IRS has been telling the tax community that it plans to increase its audit activity with respect to partnerships. The federal tax authorities have identified the underreporting of business income by partnerships and their individual members as a major contributor to the so-called “tax gap.”[x] Just last week, Sen. Warren called for an increase in the IRS’s enforcement budget to assist the agency with closing the gap.[xi]

Query whether New York City will follow suit and increase its enforcement efforts with respect to the UBT. I am not aware of any official announcements to this effect, but it stands to reason the city will at least piggyback on the long-anticipated efforts of the federal government.

Although it is probably a coincidence, in just the past few weeks I have been introduced to taxpayers with issues relating to the city’s UBT. The most interesting of these involved a partnership’s treatment for UBT purposes of its payments to a former partner – i.e., an individual who has withdrawn from the partnership.

At this point, a brief description of the UBT is in order.

The UBT – In General

The UBT is imposed on the unincorporated business taxable income (“UBTI”) of every unincorporated business (such as a partnership) that is wholly or partly carried on within the city. The tax is imposed at a rate of 4 percent of the business’s UBTI.[xii]

Any entity classified as a partnership[xiii] for federal income tax purposes, that carries on a trade, business, profession, or occupation wholly or partly within the city, and has a total gross income from all business, regardless of where the business is carried on, of more than $95,000 (prior to any deduction for cost of goods sold or services performed), must file an Unincorporated Business Tax Return with the city.[xiv]

This is to be compared to the treatment of a partnership as a pass-through entity for purposes of the federal, state and city income taxes imposed on the members of the partnership; the partnership itself does not pay an entity-level income tax[xv] – rather, its income “passes through” to its partners, each of whom takes into account their distributive share of the partnership’s income in determining their own income tax liability.[xvi]

Personal Income Tax

The city’s UBT is an “entity-level” tax. However, because of the pass-through nature of a partnership for state income tax purposes – from which the city’s personal income tax on resident individuals is derived – the partnership’s income is subject not only to the UBT but also to the city’s personal income tax.

Thus, in the case of an individual city resident who is a partner in a partnership that is subject to the UBT, the resident’s share of the entity’s UBTI will also be included in the resident’s taxable income for purposes of determining their personal income tax liability to the city.

Thankfully, the city allows a credit to a resident partner against their personal income tax for at least some of the UBT paid by the partnership to the city, though the amount of the credit allowed is reduced as the resident’s taxable income increases.[xvii]


Assuming a partnership is engaged in a taxable[xviii] unincorporated trade or business within the city, its UBTI for a taxable year is equal to its unincorporated business gross income for such year that is allocated to the city, less its unincorporated business deductions for the year.[xix]

In general, the term “unincorporated business gross income” is the sum of the items of income and gain of the business includible in the partnership’s gross income and gain from any property employed in the business.[xx]

If an unincorporated business is carried on by the partnership both within and without the city, a portion of its business income must be allocated to the city for purposes of the UBT; the portion so allocated is subject to the UBT, while the portion allocated outside the city escapes the UBT.[xxi] In determining that portion of a partnership’s unincorporated business income that is allocable to the city, the partnership need only consider the source of its gross receipts.[xxii]

Amounts Paid to a Partner

A partnership’s unincorporated business deductions generally include the items of loss and deduction directly connected with, or incurred in the conduct of, the business which are allowable for federal income tax purposes for the taxable year, with certain modifications.[xxiii]

For example, payments of reasonable compensation to employees are deductible; the same is true for other ordinary and necessary expenses paid or incurred by a business.[xxiv]

However, the city limits a partnership’s ability to deduct – for purposes of determining the entity’s UBT – amounts paid to a partner for their services or for the use of their “capital.” For example, a partnership may not deduct more than $10,000 of compensation paid to a partner for their personal services in any taxable year; the partner must be actively engaged in the partnership’s business; the compensation must be reasonable for the services rendered; and the aggregate amount of such deductions with respect to all such partners cannot exceed 20 percent of the partnership’s UBTI (computed without any deductions).[xxv]

Beyond this limited deduction, the partnership is generally not allowed to deduct for UBT purposes any other amount paid or incurred to a partner for services or for the use of capital.[xxvi]

Moreover, the capacity in which the partner is providing the service for which they are being compensated by the partnership is irrelevant for purposes of the UBT deduction.[xxvii] Thus, even if the partner were acting other than in their capacity as a partner, the deduction would be disallowed.[xxviii] According to the state, the focus should be on whether the person in question is a partner; once their status as a partner has been determined, no payment made to such person “for services or for use of capital” (in whatever capacity) is deductible.[xxix]

Which brings us to the question raised earlier: what about amounts paid by the partnership to a former partner, including amounts paid in liquidation of the partner’s interest – are such amounts deductible, or are they subject to the above-stated limitations?

To better understand New York City’s treatment of such payments for purposes of the UBT, it would behoove us to briefly review the federal income tax treatment of “liquidating” payments by a partnership to one who has withdrawn from the partnership.

Liquidation of a Partner’s Interest – Federal Tax Overview[xxx]

When payments are made by a partnership to a withdrawing partner in liquidation of their entire interest in the partnership,[xxxi] the amounts paid must be allocated between (i) payments for the value of such partner’s interest in partnership assets,[xxxii] and (ii) other payments.[xxxiii]

In general, the amounts paid for the departing partner’s interest in partnership assets are treated in the same manner as a distribution in complete liquidation of the partner’s interest.[xxxiv] The remaining partners are not allowed a deduction for these payments since they represent either a distribution or a purchase of the withdrawing partner’s capital interest by the partnership.[xxxv]

The portion of the payments made to a withdrawing partner that are otherwise not treated as having been made in exchange for the partner’s interest in partnership assets will be considered either: a distributive share of partnership income, if the amount of payment is determined with regard to income of the partnership;[xxxvi] or a guaranteed payment,[xxxvii] if the amount of the payment is determined without regard to income of the partnership.[xxxviii]

Payments, to the extent considered as a distributive share of partnership income, are taken into account in the income of the withdrawing partner and thus reduce the amount of the distributive shares of the remaining partners. Payments, to the extent considered as guaranteed payments, are deductible by the partnership as a business expense and are taxable as ordinary income to the recipient.[xxxix]

Having set out the general approach toward determining the federal income tax treatment of a payment to a departing partner, one business asset in particular warrants additional consideration: goodwill. A payment for a partner’s interest in goodwill is treated as a payment in exchange for a partner’s interest in partnership property only if (i) capital is not a material income-producing factor for the partnership,[xl] (ii) the partner was a general partner (or its equivalent), and (iii) the partnership agreement provides for a payment with respect to goodwill. If any of these conditions is not satisfied, the payment will be deductible by the partnership.

How does the UBT treatment of payments by a partnership to a former partner compare to their treatment for federal income tax purposes?

“Liquidating” Payments Under the UBT

In short: not favorably, at least insofar as the partnership is concerned.

According to one court, for example, the fact that a payment is made to a partner after the partner has ceased to be actively engaged in the conduct of the partnership business is of no significance – the deduction is still disallowed. The retirement payments in question constituted deferred compensation for services performed by the payee while they were actively engaged in the conduct of the partnership business. The disallowance of the deduction for UBT purposes is not limited to payments made while the payee was still an active partner.[xli]

In another case,[xlii] the partnership treated the payments to a former partner as payments for “past services” (i.e., guaranteed payments) for federal income tax purposes – to secure a federal income tax deduction – but tried to argue for UBT purposes that the payment was actually made for the former partner’s interest in the goodwill of the business and, thus, not subject to the addback. You know that did not go well.

A different partnership tried a similar approach and had a similar outcome.[xliii] The partnership agreement expressly prohibited payments for goodwill. In addition, there was substantial evidence that the subject payments were for services rendered by the retiring partners. The partnership’s contention that the payments were made to compensate the retiring partners for their contribution to the intangible value of the firm was “unavailing,” the court stated, “because a contribution to the intangible value of the firm has its basis in the doing of work and the performing of services. Further, the calculation of the payments to the retiring partners takes into account their earnings and years of services. Thus, the payments fit squarely within the plain language” of the disallowance rule.

The court also determined that the partnership’s contributions to deferred compensation plans on behalf of active partners – for which the partnership claimed federal tax deductions – were not deductible for UBT purposes; although the payments were not made to the partners but directly to the plans, they were clearly for the direct benefit of the partners.[xliv]

Another court[xlv] considered whether payments made in liquidation of partnership interests, which constituted the retiring partners’ pro rata share of the partnership’s unrealized receivables, were payments “for services or for use of capital” and thus not deductible from the partnership’s UBGI. The partnership asserted that the payments were made in liquidation of the retired partners’ interests in the partnership and were merely measured by their pro rata shares of the partnership’s unrealized receivables. According to the partnership, that the unrealized receivables were generated by the partnership’s services to its clients was irrelevant because the payments issued to the retiring partners were not compensation for services they had rendered but were liquidation payments made in exchange for an intangible asset.

The court disagreed, finding that the liquidation payments were not deductible because they were, in substance, compensation for the retiring partners’ services to the partnership. The court recognized that partners generally were not compensated through a fixed wage or salary for specified services. Rather, the most common method of compensating partners for their services to a partnership was through profit-sharing. According to the partnership agreement, the court continued, reports prepared on an accrual basis as of the quarter in which the partner retired were determinative of the partner’s profits and losses for “remuneration” purposes and for the valuation of the retiring partner’s capital account. In other words, the payments represented money not yet paid from the partner’s accrual basis account, which constituted remuneration for their services to the partnership. Thus, the payments were not deductible.

Add it to the List

The withdrawal or retirement of an individual partner from a partnership can be a relatively pedestrian affair, or it can be a rollercoaster ride. Much will depend upon the circumstances surrounding the partner’s departure, including the presence of a buyout or retirement agreement and an agreed-upon methodology for determining the amounts to be paid by the partnership. Closely related to these payments, and to the net economic consequences thereof, is the tax treatment of those payments – a tax-deductible payment is less expensive for the payor than one that isn’t. While most partnerships and their remaining members are focused on the federal income tax consequences of the transaction, those partnerships that are subject to the city’s UBT should be mindful of its impact and should plan accordingly.

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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] I read how “frozen” iguanas – no, it’s not a fruity drink – were falling out of trees, which raises the question: where do Floridians go when their weather turns cold?

[ii] Charges for the removal of snow are taxable as a repair and maintenance to real property. You can’t make this up.

[iii] .

[iv] In general, south of 96th Street in Manhattan.

[v] The state repealed its unincorporated business tax at the end of 1982. However, there have been sporadic discussions since then regarding the possible reintroduction of the tax; most recently, just before the release of the 2020 Executive Budget.

Although not strictly accurate, the PTET may be described as a form of UBT, at least insofar as it applies to partnerships. .

[vi] Form NYC-204, filed by tax partnerships – business entities that have at least two members, and which are not taxable as corporations/associations. IRC Sec. 761 and Treas. Reg. Sec. 301.7701-3. See 19 RCNY Sec. 28.06(d)(1)(iv) for the definition of “partner” for UIBT purposes.

The instructions to the form describe a partnership as follows: “For purposes of this form, ‘partnerships’ include syndicates, groups, pools, joint ventures, limited liability companies (other than single-member LLCs) and other unincorporated or incorporated organizations classified as partnerships for federal income tax purposes, through or by means of which any business, profession, financial operation or venture is carried on.”

[vii] I have seen UBT audits turn into commercial rent tax inquiries.

[viii] Form IT-201. A resident of the City reports both their state and City personal income tax on this form.

[ix] Many a resident of the Metro NY area who is domiciled outside the City, but whom the taxing authorities have determined should be taxed as a statutory resident of the City, began their “transformation” to a NYC taxpayer with the acquisition of a pied-a-terre in the City.

[x] . The difference between the amount of tax owed by taxpayers for a given year and the amount that is actually paid timely for that same year. It represents, in dollar terms, an estimate of the annual amount of noncompliance with the tax law.

[xi] The Administration’s Build Back Better plan included such increases. The plan remains in limbo, if not the other place. Apologies to Dante.

[xii] N.Y.C. Adm. Code Sec. 11-503. The partnership is allowed a full or partial credit if its UBT is less than $5,400.

[xiii] For purposes of this post, we will ignore sole proprietorships, including single-member LLCs.

[xiv] N.Y.C. Adm. Code Sections 11-514(a)(4) and 11-506(a)(1).

[xv] IRC Sec. 701.

[xvi] IRC Sec. 702 and Sec. 704.

[xvii] For taxpayers with city taxable incomes of $142,000 or more, the credit is 23% of the UBT imposed.

UBT that was deducted in arriving at an individual taxpayer’s federal adjusted gross income must be added back by the individual to determine their New York State adjusted gross income.

[xviii] Not all businesses are subject to the UBT; for example, leasing real estate for one’s own account.

[xix] N.Y.C. Adm. Code Sec. 11-505.

[xx] N.Y.C. Adm. Code Sec. 11-506.

[xxi] N.Y.C. Adm. Code Sec. 11-508.

[xxii] N.Y.C. Adm. Code Sec. 11-508(i)(10).

[xxiii] N.Y.C. Adm. Code Sec. 11-507.

[xxiv] IRC Sec. 162; Reg. Sec. 1.162-1, et seq.

[xxv] N.Y.C. Adm. Code Sec. 11-509.

[xxvi] N.Y.C. Adm. Code Sec. 11-507(3). This should be contrasted to the federal tax treatment of such payments, under IRC Sec. 707(a) and Sec. 707(c).

But see 19 RCNY Sec. 28-06(d)(1)(ii)(D): “payments to partners for services do not include amounts paid or incurred by an unincorporated business to a partner of such business which reasonably represent the value of services provided the unincorporated business by the employees of such partner, and which, if not for the provisions of paragraph (1)(i) of this subdivision (d), would constitute allowable business deductions under 19 RCNY Sec. 28-06(a). The amounts paid or incurred for such employee services must be actually disbursed by the unincorporated business and included in that partner’s gross income for Federal income tax purposes.” [emph. added]

[xxvii] Miller Tabak Hirsh & CO, TAT(E)94-173(UB), Mar. 30, 1999.

[xxviii] 19 RCNY §28-06(d)(1)(i).

[xxix] Again, compare IRC Sec. 707(a): “If a partner engages in a transaction with a partnership other than in his capacity as a member of such partnership, the transaction shall, except as otherwise provided in this section, be considered as occurring between the partnership and one who is not a partner.”

[xxx] New York generally conforms to the federal rules.

[xxxi] Including an assumption of liabilities treated as a distribution of money under IRC Sec. 752.

[xxxii] IRC Sec. 736(b). A payment for a partner’s interest in unrealized receivables or goodwill is treated as a payment in exchange for a partner’s interest in partnership property if capital is not a material income-producing factor for the partnership, the partner was a general partner (or its equivalent), and, in the case of goodwill, the partnership agreement provides for a payment with respect to goodwill. IRC Sec. 736(b)(2) and (3).

That said, payments made to a retiring partner for his interest in unrealized receivables of the partnership in excess of their partnership basis, including any special basis adjustment for them to which such partner is entitled, shall not be considered as made in exchange for such partner’s interest in partnership property; rather, such payments shall be treated as payments under IRC Sec. 736(a).

[xxxiii] IRC Sec. 736(a).

[xxxiv] Under IRC 731(a), the partner will recognize gain to the extent the amount of money distributed exceeds the partner’s adjusted basis for their partnership interest. This gain is treated as having arisen from the sale of the partnership interest, which is generally treated as the sale of a capital asset. IRC Sec. 741. However, that part of the gain that is attributable to the value of “hot assets” will be treated as ordinary income under IRC Sec. 751.

An in-kind distribution will generally not be taxable; but see, for example, IRC Sec. 704(c)(1)(B) and 737.

[xxxv] However, if the partnership has in effect or makes an election under IRC Sec. 754, the partnership’s “inside” basis for its remaining assets will be adjusted in accordance with IRC Sec. 734, which (if positive) may benefit the remaining partners. See also IRC Sec. 732(d), which may apply in the absence of a Sec. 754 election.

[xxxvi] IRC Sec. 736(a)(1).

[xxxvii] Under IRC Sec. 707(c).

[xxxviii] IRC Sec. 736(a)(2).

[xxxix] IRC Sec. 707(c).

[xl] Service businesses come to mind.

[xli] Hawkins, Delafield & Wood v. Commissioner, 67 N.Y. 2d 873 (1986). See 19 RCNY Sec. 28-08(a)(1): “Amounts paid to retired partners are not deductible.”

[xlii] Matter of Citrin Cooperman & Co., LLP v Tax Appeals Trib. of City of N.Y., 52 AD3d 228 (2008).

[xliii] Proskauer Rose, LLP v. Tax Appeals Tribunal of the City of New York, 57 A.D.3d 287 (1st Dept. 2008).

[xliv] See also Murphy & O’Connell v. Tax Appeals Tribunal, 93 A.D.3d 530 (1st Dept. 2012) (contribution made to a defined benefit plan for a partner was not deductible).

[xlv] Buchbinder Tunick & Co. v. Tax Appeals Tribunal of the City of New York, New York Court of Appeals, No. 84, 100 N.Y.2d 389 (2003).