ALBANY, N.Y. (CN) - New York's scheme for taxing out-of-state residents exposes them to unconstitutional double taxation, a Connecticut couple claim in court.
Husband-and-wife Richard Chamberlain and Martha Crum lived primarily in Mystic, Conn., but both worked for a time in New York City and kept a residence there, according to their lawsuit. He was president of a public relations firm and she was an assistant professor at Hunter College, part of the City University of New York.
Because they spent more than 183 days a year in New York and had an in-state residence, the state considered Chamberlain and Crum "statutory residents" who owed both state and New York City personal income taxes.
So they filed joint New York nonresident income tax returns and paid the taxes owed to the state and the city. As permanent residents of Connecticut, they also filed joint tax returns in that state.
When the sale of Chamberlain's business gave them a combined earned payout of $14.7 million as shareholders, the couple reported it to both states as a capital gain for 2010, but did not count it as New York-sourced income for tax purposes.
That sparked an audit by New York tax authorities, who looked at their returns for 2009 to 2011 and determined they owed an additional $2.7 million in taxes.
The audit found the earned payout was intangible income that would not count as nonresident state income in New York. But because the payout could not be pegged to another state under New York rules, the couple did not receive a credit for the taxes paid on it to Connecticut, prompting them last week to file suit.
"Plaintiffs argue that because New York taxes 'statutory residents' on their worldwide income from all sources but fails to provide a credit for taxes paid to other states on investment and intangible income, the taxing scheme subjects such residents to double taxation in violation of the dormant Commerce Clause," the complaint in Albany County Supreme Court states.
Chamberlain and Crum say New York similarly denied them credits for taxes paid to Connecticut on other intangible income - interest, dividends and capital gains - during the audit years because the income "was intangible income, not allocable or 'sourced' to any other state."
The couple paid New York the $2.7 million in additional taxes due, but under protest, according to the complaint.
New York assesses personal income taxes on "resident individuals" - defined as people who maintain their primary residence in the state and those who qualify as "statutory residents" whose prime residence is out-of-state but who have a "permanent place of abode" in New York and live or work in the state for more than 183 days a year.
Under the tax law, "resident individuals" pay taxes on their "worldwide income, regardless of the source," according to Chamberlain and Crum's complaint.
But the law offers a credit for personal income taxes paid to another state on income derived from that state. The credit does not extend to intangible and investment income taxed by another state, though.
Chamberlain and Crum contend that latter provision "violates internal consistency" in the tax law, "unconstitutionally exposing such [statutory] residents to the risk of multiple taxation."
The provision also favors individuals who live and work in a single state, they claim, contending that a tax "which by its operation imposes greater burdens on out-of-state activities than on in-state activities is discriminatory under the dormant commerce clause" - a limit to state power over interstate commerce.
The complaint says that states in the Northeast recognized years ago that they should have uniform credits for taxes paid by dual residents - workers drawn to New York City's jobs but living on its suburban fringes in neighboring states.
The states drafted a proposed Cooperative Agreement on Determination of Domicile - which even allowed for a credit on taxes paid on income from intangible property, according to the complaint - but New York failed to pass it.
New York's high court took up the question of whether the tax law's statutory residency provisions violated the dormant commerce clause, but upheld its constitutionality in 1998, Chamberlain and Crum say.
They note that the U.S. Supreme Court found differently in May 2015.
In Comptroller v. Wynne, the court held that Maryland's residency-based income tax laws violated the dormant commerce clause "under the internal consistency test because the tax scheme denied residents a full resident credit for taxes paid to other states in the circumstances of that case," Chamberlain and Crum say.
The ruling means the earlier finding by New York's Court of Appeals "is no longer viable," they contend.
Chamberlain and Crum want New York's statutory residency provisions declared discriminatory and unconstitutional. They also want the additional taxes they paid under protest returned.
Timothy Noonan and Michelle Merola of Hodgson Russ in Albany represent the couple.
Geoffrey Gloak, a spokesman for the state Department of Taxation and Finance, said the agency does not comment on pending litigation.
The department and its chief, Commissioner Jerry Boone, are the named defendants.
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