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In a recent case, a New York City Administrative Law Judge (“ALJ”) determined that the City’s unincorporated business tax (“UBT”) did not impose a second, discrete requirement that a deduction need be directly connected with business conduct without reference to the federal income tax deduction standard.&nbsp;<a href="https://www.nyc.gov/assets/taxappeals/downloads/pdf/2032DET0724.pdf">In the Matter of the Petition of A&amp;E Television Networks, LLC</a>, TAT(H)20-32(UB) (July 2, 2024). The ALJ found that if the deduction was allowable for federal income tax purposes, it was also allowable under the UBT.

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Facts:&nbsp;A&amp;E Television Networks, LLC (“A&amp;E”) is a limited liability company classified as a partnership for federal income tax purposes and subject to the City’s UBT. A&amp;E filed City UBT returns and federal partnership returns for the tax years 2012–2014 (“Audit Period”) taking certain interest expense deductions. The IRS audited A&amp;E’s federal return for 2012, and while it made certain adjustments, the IRS did not adjust the interest expense deductions at issue. The New York City Department of Finance (“DOF”) audited A&amp;E’s UBT returns for the Audit Period and adjusted A&amp;E’s interest expense deductions by 94 percent, finding them “not business related.”

The Decision: The ALJ analyzed the statutory provision regarding UBT deductions which defines such deductions as “the items of loss and deduction directly connected with or incurred in the conduct of the business, which are allowable for federal income tax purposes for the taxable year” subject to enumerated modifications. The ALJ noted that the parties did not dispute that the interest expense was deductible for federal income tax purposes and that none of the enumerated modifications applied to the interest expense.

The ALJ then rejected the DOF’s interpretation that the phrase “directly connected with or incurred in the conduct of the business” imposed a discrete requirement that should be interpreted without reference to the phrase “allowable for federal income tax purposes for the taxable year.” Notably, under federal regulations, deductions are permitted only if they are directly connected with the taxpayer’s trade or business. The ALJ found that the DOF’s interpretation was contrary to the plain language of the statute, the legislative history, and prior case law.

The City UBT is modeled after the former State UBT. The phrase “allowable for federal income tax purposes for the taxable year” was added to the State UBT in 1960 to conform State UBT deductions to the federal standard. The governor’s memorandum accompanying the 1960 amendment stated that the reform “brings substantial conformity with federal provisions to our law imposing the tax on unincorporated business income.” Moreover, a memorandum from the State Department of Taxation and Finance included in the bill jacket to the legislation states that the bill “revises the unincorporated business tax and bases it on the same business income and deductions as are used for federal income tax purposes[.]”

Perhaps sealing the deal, the ALJ cited a State Tax Appeals Tribunal decision,&nbsp;Matter of New York Yankees Partnership, which held that when a payment is deductible for federal purposes, it is also deductible for UBT purposes, unless an enumerated modification applies.

Takeaway:&nbsp;While the determination may render the “directly connected with” language under the UBT superfluous, the ALJ noted that the preference for avoiding surplusage is not absolute, and the ultimate goal of statutory construction is to discern the intent of the legislature. The ALJ found the legislative intent clear that the federal standard and the UBT standard for deductions were the same. It remains to be seen whether the DOF will appeal the determination and, if so, whether the Appeals Division will uphold the determination. Stay tuned.

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This update is one in a series of updates written for the August 2024 edition of <a href="https://admin.blankrome.com/wp-content/uploads/2024/08/br-state-and-local-tax-spotlight-august-2024.pdf_0.pdf" id="https://admin.blankrome.com/wp-content/uploads/2024/08/br-state-and-local-tax-spotlight-august-2024.pdf_0.pdf">The BR State + Local Tax Spotlight</a>.

© 2024 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.

New York City ALJ Rules That Deductions Allowable for Federal Income Tax Purposes Are Also Allowable under the UBT

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New York City ALJ Rules That Deductions Allowable for Federal Income Tax Purposes Are Also Allowable under the UBT

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