Supreme Court Declares NY Tax Statute Unconstitutional (July 1998)

On certiorari, the Supreme Court, in a 6-3 decision written by Justice O’Connor, voided New York Tax Law § 631(b)(6), which the Court held violated the Privileges and Immunities Clause of the Constitution by effectively denying only nonresidents of New York a state income tax deduction for alimony paid. In annulling the statute, the Court, in a carefully worded decision, reversed and remanded a unanimous decision of the NY Court of Appeals written by Chief Judge Kaye. The decision (in effect) reinstated the unanimous decision of the 3rd Department, which had also found the statute unconstitutional. Justices Rehnquist, Ginsberg and Kennedy dissented in the Supreme Court decision. Lunding et ux. v. New York Tax Appeals Tribunal et al, No. 96-1462 (1998).

New York requires nonresidents to pay tax on net income from New York real or tangible personal property and net income from employment or business, trade, or professional operations in New York. N.Y. Tax Law § 631(a), (b). In computing the income tax nonresidents owe, nonresidents must first compute their tax “as if” they were residents. In computing this “as if” amount, a deduction is allowed for alimony paid, pursuant to IRC  §215.  Nonresidents then apply an “apportionment percentage” to the “as if” tax previously calculated.

The numerator of the apportionment percentage is New York source income which, by operation of Tax Law  § 631(b)(6), did not allow a deduction for alimony paid. The denominator, federal AGI, includes a deduction for alimony paid. Since there is no upper limit on the apportionment percentage, a nonresident could be required to pay more than the “as if” tax if all of the taxpayer’s income was sourced in New York.

In a CPLR Article 78 proceeding which it converted to a declaratory judgment action, the 3rd Department held that although a “disparity in treatment is permitted if valid reasons exist, the [Constitution] proscribes such conduct as discriminatory against nonresidents where there is no substantial reason for the discrimination beyond the mere fact that [taxpayers] are citizens of other states.” 639 N..Y.S.2d 519.

The New York Court of Appeals, however, declared that the Constitution does not mandate “absolute equality in tax treatment,” and upheld the statute, stating that there was a “substantial reason” for the difference in treatment, and that the discrimination bore a substantial relationship to the State’s objective. Applying “well established” principles, the Court concluded that “disparate” treatment was permissible since NY residents were taxed on all income from whatever sources, while nonresidents were taxed only on NY source income.

The Supreme Court disagreed,  observing that the “object of the Privileges and Immunities Clause is to … plac[e] the citizens of each State upon the same footing with the citizens of other States.” While recent cases, according to the Court, did allow States “a considerable amount of leeway in aligning the tax burden of nonresidents to in-state activities,” those decisions could not be held to “categorically deny” personal deductions to a nonresident absent a “substantial justification.”

The Court distinguished the case from earlier cases upholding disparate treatment. Constitutionally, the statute was fatally flawed in that it invariably denied nonresidents the benefit of a deduction allowed to residents. The statute also resulted in a “double-taxation windfall” to New York when a NY resident received alimony from a nonresident New York taxpayer, since the recipient must pay taxes on the alimony but the nonresident could claim no deduction.

In closing, the Supreme Court noted that although the Constitution does not bar States from allocating income and deductions based on in-state activities, States may not disallow nonresident taxpayers “every manner of nonbusiness deductions.”

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