Doing Business In and Out of the City – Tax Planning Opportunities

Is your business located in New York City?  Do you live outside of the City?  As you know, New York State/City has some of the highest combined taxes in the country.  However, certain planning steps may be able to be taken to reduce some of the impact of New York City's taxes if your company can arrange to do business, at least to some degree, both in and out of the City.

The City's Extra Tax Burden
New York State, New Jersey and Connecticut each tax the income of companies doing business in state.  C corporations pay a full state tax, while partnerships, including limited liability companies (LLCs), and S corporations don't pay state tax; rather, their partners, members or shareholders pay state personal income tax (as do sole proprietors).  New York City residents also pay New York City personal income tax on their share of such business income.

New York City has two extra taxes on income.  First, S corporations (as well as C corporations) are subject to full corporate income tax at an 8.85% rate.  Second, most unincorporated businesses (including sole proprietorships, LLCs and partnerships) pay an unincorporated business tax (UBT) at a 4% rate.  (Real estate businesses and investment businesses generally are excepted from the UBT.)  It is these New York City taxes that potentially can be reduced through proper planning, particularly by businesses owned by individuals who are not New York City residents.  The New York State and City taxes imposed on businesses and their owners are illustrated by the following chart: 

1 In connection with an increase in New York State's personal income tax rate, New York's 1.25% corporate level tax on S corporations has been eliminated for 2003, 2004 and 2005. 
2   On distributed dividends. 
3   A New York City resident effectively pays double NYC income tax (corporate and personal) on S corporation earnings.

Save Taxes by Planning
State and local taxes and tax compliance are a real burden on all businesses, large and small.  Although the issues magnify the larger the business is, the basic concept of what activities cause state and local taxes are the same regardless of business size.  As with many areas of tax law, planning and awareness of the rules for state and local taxes can save unpleasant surprises and can sometimes yield substantial savings.

Take the case of a small business owner (say, an IT consultant) who lives on Long Island and commutes into Manhattan to her business office.  Let's say her clients are mostly in Manhattan, but some are on Long Island.  Assuming the business is not owned by a C corporation, she will pay New York State personal income taxes on her net income because she lives and works in New York State.  The business also will pay the 4% New York City UBT (or 8.85% New York City corporate tax, if the business is an S corporation) on all of the IT consulting income. 

What happens if she opens a home office or otherwise does business outside of New York City?  If she does it right, she can allocate a portion of the IT consulting income out of New York City, saving a proportionate amount of UBT or NYC corporate tax.  If her share of the earnings is $200,000 per year and 25% of that income can be moved out of New York City, she saves $2,000 or more.  Not much, but better than nothing. 

How to Do it Right
Doing it right requires some effort and business reality, but is not as hard as it used to be.  After the law changed in 1996, merely  "doing business" outside the City suffices for allocating some income out of the City.  This "doing business" rule applies both to corporations and unincorporated businesses. 

Although the standard for allocating income out of the City has been relaxed compared with the old days, it has not been eliminated.  Just doing some paperwork  at home or making a few phone calls to clients or suppliers probably would not be sufficient to justify any significant allocation of income out of the City. 

However, if a real home office is established, with an address on business cards and stationery (along with the Manhattan address and phone number) with a business phone number that is locally listed, a company has gone a long way to showing that it does business out of the City.  Seeing clients occasionally at the home office would put it over the top.  (However, neighbors or local zoning officials might not be as happy as your accountant and bank account.)  On site consulting, meetings and follow up work out of the City also should suffice for moving some income out of the City. 

How to Allocate
The first step in being able to allocate income out of the City is to keep accurate and detailed books and records.  The general allocation formula is the same for all businesses, whether incorporated or not.  A somewhat complicated three factor allocation formula is used to allocate income to New York City. 

New York City payroll/total payroll
+  New York City property/total property
+  New York City receipts/total receipts

New York City allocation percentage