Commuter Tax Held Unconstitutional -- What Now?

Published: April 11, 2000
Source: R & H Letter to Clients & Friends

On Tuesday, April 4, 2000, in a case Roberts & Holland LLP has been litigating since last spring, the New York State Court of Appeals issued its unanimous ruling that the imposition of the New York City "Commuter Tax" on nonresidents of New York State was unconstitutional. As a result of this decision, the Commuter Tax has now been repealed in its entirety, effective July 1, 1999.

The Court of Appeals upheld the State's 1999 legislation against a home rule challenge by the City, concluding that the State Legislature had the power to repeal the Commuter Tax on State residents notwithstanding the City's objection. But the Court also held that the continued imposition of the tax on nonresidents of New York State violated the Privileges and Immunities Clause and the Commerce Clause of the U.S. Constitution. New York State could not constitutionally repeal the Commuter Tax for its own resident commuters, while continuing to collect that tax from nonresident commuters.

New York State has announced that it will not appeal this decision. Moreover, anticipating the Court's decision and the need to assist nonresidents in obtaining refunds of Commuter Tax paid after June 30, 1999, New York State's Department of Taxation and Finance has now promulgated several new "Important Notices" that reflect the full repeal of the Commuter Tax. These Notices (N-00-6, N-00-7, N-00-8, N-00-10 and TSB-M-99(6.2)I) have been posted on the State's website, and are currently being mailed. The Notices advise nonresident taxpayers, their employers, estates, trusts, partners, and partnerships, of the procedures they are to follow now that the tax has been repealed in full.

The new procedures can be summarized as follows:

1. Individual nonresident taxpayers who have not yet filed their 1999 New York State income tax returns should complete their forms NYC-203 using the new set of instructions being mailed to them. Generally, these tax return instructions provide that nonresident wage-earners and the self-employed should report only income earned between January 1 and June 30, 1999, and nonresident partners should report one-half of 1999 partnership income (but see paragraph 7, below). These are now the same rules as apply to resident commuters.

2. Individual taxpayers who have already filed their 1999 New York State income tax returns, and who need to amend their returns to reflect the June 30 repeal of the Commuter Tax, can file a 1999 form NYC-203-X. This form is a simplified amended return designed solely to address the Commuter Tax repeal, and takes the place of a full-blown amended return.

3. Individuals with commuter tax withheld in 2000 will be receiving a new form NYC-203-R, which will enable them to claim immediate refunds of any withheld tax. This new form is an important innovation, for it permits taxpayers to claim refunds of overwithheld tax much earlier than the filing of their year 2000 income tax returns (which could easily be one year from now). To file this special refund claim, individuals will need to know the exact amount of Commuter Tax their employers withheld from their 2000 wages. Since employers have no obligation to provide this information, employees may need to make this computation themselves, by applying the 0.25% Commuter Tax rate nominally in effect for 2000 to the wages earned in the period from January 1, 2000 to the date when the employer ceased Commuter Tax withholding. Employees who choose not to follow the special refund procedure can either claim an overpayment when filing their 2000 tax return, or take the overpayment into account in determining the future withholding or estimated tax payments they will make to New York for the rest of this year.

4. Individuals who pay estimated tax cannot obtain refunds of overpaid 2000 estimated taxes, but should instead reduce future estimated tax payments by any such overpayments. In addition, the amount of any overpayment of 1999 tax that is credited against 2000 estimated tax should be recalculated to reflect the July 1, 1999 effective date of the full Commuter Tax repeal.

5. Employers have now been instructed to cease withholding Commuter Tax on nonresidents. Importantly, however, Commuter Tax that has already been withheld is required to be reported and paid to New York under the usual procedures -- employers are not authorized to refund such monies directly to their employees.

Along the lines of last summer's instructions, employers have been advised that they can determine that an employee is a nonresident, and stop withholding, based on (i) the employee's home address as shown on the employer's withholding, employment or tax records; (ii) an employee's IT-2104.2 Certificate of City Nonresidence (either the new version or an old version already on file); (iii) a form IT-2104.1 Certificate of New York State Nonresidence filed by the employee (either currently or in the past); or (iv) a form NYC-2104-E Certificate of Exemption already on file (that form has now otherwise become obsolete).

To assist employees in obtaining refunds of Commuter Tax withheld in 2000, the State has also told employers that it would be "very helpful" if they would notify their employees of the exact date on which they cease withholding. Employers have also been given instructions on the proper preparation of forms W-2 and IT-2102 for the year 2000.

6. Estates and Trusts are subject to the New York City nonresident fiduciary earnings tax in much the same fashion as individuals. Notice N-00-8 sets forth procedures for estates and trusts to follow, for both 1999 returns and 2000 tax payments, that are essentially the same as those described in paragraphs 1-4, above. This notice includes a revised form NYC-206 1999 tax return for those who have not yet filed; explains the filing procedures for an amended 1999 IT-205X; explains estimated tax payment procedures; and explains how trusts and estates should complete form IT-113-X to claim early refunds of year 2000 withholding.

7. Partners and Partnerships have unique problems due to the mid-year repeal of the Commuter Tax. With the Court of Appeals decision extending repeal to nonresident partners as well, all commuting partners must now address the proper taxation of 1999 partnership income under the Commuter Tax. Unfortunately, this issue has been made even more confusing by an announcement that appeared today on the Department's website.

The issue is most easily illustrated by comparing partners in two different partnerships, each with a different taxable year. A is a partner in Alpha Co., a calendar year partnership. B is a partner in Beta Co., which files its partnership returns using a March 31 taxable year. What portion, if any, of the partnership income is subject to the Commuter Tax? Specifically, for the 1999 tax year, how much of the income of Alpha Co., which relates to the period January 1 - December 31, 1999, does A treat as subject to Commuter Tax? How much of the income of Beta Co., which relates to the period April 1, 1998 to March 31, 1999, does B treat as subject to Commuter Tax?

In a mailing dated January 31, 2000, we explained the difference between the effective date of Commuter Tax repeal as set forth in the statutory language, and the more recent interpretations set forth in the tax return instructions issued after the Tax Appeals Tribunal decision in Greig. (DTA No. 815529.) Based on the language of the statute itself, one could conclude, as the Department did in TSB-M-99(6)I, that since Alpha Co.'s taxable year ended after June 30, 1999, none of A's 1999 partnership income would be subject to Commuter Tax. By contrast, since Beta Co.'s tax year ended before June 30, 1999, B would pay Commuter Tax on all of the Beta Co. income from the year ended March 31, 1999.

The 1999 tax return instructions, however, informed both A and B to pay Commuter Tax on "one-half" of their 1999 partnership income; and TSB-M-99(6.1)I announced that TSB-M-99(6)I was "no longer applicable." Consistent with this approach, the State's new Notice N-00-10 advises partnerships filing group returns for nonresident partners that one-half of their partners' 1999 income is subject to Commuter Tax, and advises partnerships which have not yet filed group returns to complete a Revised Form IT-203-GR-ATT-B and IT-203-GR-ATT-C reporting one-half of the partners' 1999 New York City earnings.

Today, however, TSB-M-99(6.2)I, was posted on the Department's website. This TSB-M announces that, under the Court of Appeals decision, the Commuter Tax has been "completely eliminated." That is correct. It then goes on to provide, however, that "the material contained in TSB-M-99(6)I and TSB-M-99(6.1)I is obsolete and should no longer be used." At this point, the proper treatment of 1999 partnership income is completely unclear. The statute supports A in treating none of the Alpha Co. earnings as subject to Commuter Tax. The instructions support B in reporting only one-half of the Beta Co. earnings. The most recent TSB-M says that both of the two prior TSB-M's are obsolete. Until the confusion is resolved, well-advised taxpayers may well use the State's conflicting positions to advantage.

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The repeal of the Commuter Tax has been roundly criticized as an ill-considered political gambit with little tax policy justification. Whatever one's position on the merits of repeal, there can be no question that the manner in which the Commuter Tax was repealed was most unfortunate. The mid-year effective date of repeal, and the continued collection of unconstitutional tax from nonresident commuters, has created administrative and compliance burdens for taxpayers and the Department that are vastly out of proportion to the amounts involved. Fortunately, New York's courts handled the case expeditiously, allowing our litigation to proceed from filing to finish in less than one year. And the State's Tax Department also is to be commended for its responsiveness in preparing Announcements, Notices, Forms and Instructions to apprise taxpayers of the State's positions, and for rapidly implementing the Court of Appeals decision. It can only be hoped that the confusion engendered by this legislation will resonate, at least for a time, with New York lawmakers, and stand as an example of how not to write the tax law.

If you have any questions about the Commuter Tax, its repeal, or our litigation, please contact Carolyn Joy Lee (903-8761), Glenn Newman (903-8759), or Lary Wolf (903-8719). We also invite you to visit our Website to keep abreast of further developments.