Sales Apportionment and Tax Considerations for NY-Based Service Companies
According to the U.S. Census Bureau, in 2018 there were approximately 547,000 business establishments in New York State. This ranks among the top five in the country. Additionally, according to the New York City Department of Taxation and Finance, there were approximately 220,000 business establishments in New York City alone. It is critical that all of these businesses and their tax advisors understand the various nuances of how business receipts are required to be sourced for sales apportionment purposes on both New York State and New York City tax return filings. Not only are there major differences in the rules between New York State and New York City, but also between different types of business entities, as well as between product- and service-oriented businesses. Here we will focus on service businesses. Let’s assume that all of the work performed by these businesses is based out of its home office in New York and not by business owners and/or their employees working remotely from a different state.
New York State
For New York State tax purposes, both S corporations and partnerships/LLCs are flow-through entities whose income flows to the individual shareholders or partners and is taxed on their individual tax returns. For apportionment purposes, both C corporations and S corporations employ a single sales factor for calculating the state apportionment factor. For purposes of sourcing receipts from services, New York State stipulates that both C corporations and S corporations should source their receipts according to “market-based sourcing.” This means that the receipts are sourced to the location of the customer who receives the benefit of the services provided. In other words, if a C or S corporation whose office is located in New York State renders services to a client located in California, the receipts should be sourced outside of New York (to California).
For partnerships and LLCs, the state employs an evenly weighted three-factor formula for apportionment purposes, consisting of sales, property and payroll. Additionally, New York State requires that the partnership source its receipts to the office where the sale was negotiated/consummated—or where the agent was based. For example, if a partnership or LLC with its office located in New York State renders services to a customer located in California, the sales must still be sourced to New York State. However, one caveat is that a partnership with a corporate partner uses a single sales factor sourcing method for apportionment purposes for that partner, which is presented accordingly on that partner’s K-1.
It is also important to note that New York State also taxes C corporations, S corporations and partnerships/LLCs differently. C corporations pay the highest of three New York State tax bases: (1) the business income tax on net income at a 6.5% tax rate; (2) the business capital base on capital at a 0.05% tax rate; and (3) a fixed-dollar minimum tax on receipts sourced to New York State. S corporations only pay New York State a fixed-dollar minimum tax, while partnerships/LLCs pay New York State a fee based on receipts similar to the fixed-dollar minimum tax. Additionally, unlike for C corporations, there is no MTA income tax return for S corporations.
New York State Service Businesses Summary
||C Corporation||S Corporation||Partnerships/LLCs|
|Apportionment Formula||Single sales factor||Single sales factor||Three factor formula (sales, property, payroll)|
|Sourcing of Service Receipts||Market-based sourcing||Market-based sourcing||Office where sale was negotiated/ consummated|
||Highest of income tax, capital tax and fixed-dollar minimum tax based on receipts||Fixed-dollar minimum tax based on receipts||LLC fee based on receipts|
|Income Tax Rate||6.5%||N/A||N/A|
|Capital Tax Rate||0.05% limited to $5M||N/A||N/A|
New York City
With respect to New York City service businesses, while C corporations, S corporations and partnerships/LLCs all employ a single sales factor for apportionment purposes, the method of sourcing receipts differs.
C corporations that render services to clients located out of NYC source those receipts outside of NYC to the location of the client who is the ultimate beneficiary of the services (“market based sourcing”). However, for S corporations and partnerships/LLCs, such receipts must be sourced to the place of performance or, in our case, New York City.
This difference between New York City C and S corporations may come as a surprise to many, since New York City does not recognize S corporations and considers them to be C corporations for most tax purposes. However, for the purposes of sourcing of receipts for service businesses, they do treat S corporations differently than C corporations.
New York City also taxes C corporations, S corporations and partnerships/LLCs differently. For C corporations, like New York State, the New York City tax is calculated as the highest of three tax bases. These three tax bases are (1) net income at a tax rate ranging from 6.5% to 8.85% (“business income base”); (2) capital at a 0.15% tax rate (“business capital base”); and (3) a fixed minimum tax based on receipts sourced to New York City (“fixed dollar minimum tax”).
For S corporations, like C corporations, the tax is also calculated as the highest of the same three methods indicated above. However, one major difference from C corporations is that the New York City S corporation tax rate is a flat 8.85%—as opposed to a range of 6.5% to 8.85%.
For partnerships, New York City has a flat tax rate on net income of 4%. This is known as the New York City Unincorporated Business Tax (“UBT”).
New York City Service Businesses Summary
|Item||C Corporations||S Corporations||Partnerships/LLCs|
|Single sales factor||Single sales factor||Single sales factor|
|Sourcing of Service Receipts||Market-based sourcing||Place of performance||Place of performance|
|Tax Formula||Highest of income tax, capital tax ($10,000 tax exemption) and fixed dollar minimum tax based on receipts||Highest of income tax, capital tax (no exemption) and fixed dollar minimum tax based on receipts||
|Income Tax Rate||6.5% to 8.85%||8.85%||4%|
|Capital Tax Rate||0.15%||0.15% limited to $1M||N/A|
Owner Payments Deductible Against Regular Tax
|Owner Payments Deductible Against AMT Tax||N/A||No||N/A|
As one can see, it is imperative that taxpayers and their financial advisors are well versed in all of the differences in the rules for New York State and New York City taxes with respect to different types of business entities. Pay careful attention to the correct methodology for sourcing New York State and New York City receipts to avoid any errors and for proper tax planning. There is not a one-size-fits-all approach. Certain businesses or entities of a certain size may not be subject to the general rules as outlined here.
Additionally, it is important that taxpayers understand all of the federal rule changes as a result of the 2020 Coronavirus Aid, Relief, and Economic Security (“CARES”) Act as well as the 2021 Consolidated Appropriations Act and how they impact their New York State and New York City tax returns. Both New York State and New York City have decoupled from most of these provisions. Finally, give special consideration as to how telecommuting during a public health crisis may impact sourcing of receipts. It is critical that tax professionals and their clients closely monitor updates on regulations in our ever-changing tax environment.
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