This is part one of a three-part series focusing in nonresident issues that have been seen since the COVID-19 pandemic.

For years, I have helped taxpayers change their tax residency to locations outside of New York State. It remains one of the largest components of my practice. And efforts to change one’s tax residency only increased in the months and years following the COVID-19 pandemic, where IRS data shows that New York lost $25 billion in adjusted gross income from migration out of the state in 2021, up from the $20 billion the state lost in 2020. But changing your tax residency is hard. A New York State residency audit is onerous. The audit process is invasive and time consuming. This article is therefore the first in a three-part series meant to ensure that ex–New York State residents achieve more than a Pyrrhic victory following their residency battles. Or, to put it differently—for those not interested in Roman military history—this series, entitled “After the Move,” is intended to make sure the juice is worth the squeeze when leaving New York State.

The reason a New York State change of residency can be so valuable is relatively simple. New York State residents are taxed on one thing: everything. New York State nonresidents, however, are taxed only on income that is derived from or connected with New York sources. The comparison between New York City residents and nonresidents is even starker, since New York City does not impose any type of nonresident tax. This means that New York City personal income tax is all or nothing based on residency. This “After the Move” series therefore examines what qualifies as New York source income, in the hope that taxpayers and practitioners can better understand their potential New York State tax savings (or exposure) following a move away from the state. Each article highlights one in a series of issues on which our firm has had to focus in the wake of the post-COVID exodus of New York State taxpayers.

Part One focuses on employment compensation, with an overview of general nonresident wage allocation, telecommuting rules (including the “convenience of the employer” rule), and the proper sourcing methodologies for various types of deferred compensation. Part Two will discuss how nonresidents must source the gains on sales of interests in multistate businesses, including flow-through entities such as partnerships and S corporations. Finally, Part Three will look at what happens when a taxpayer who has left New York decides they may want to return—either temporarily or permanently—with a focus on the post-move burden of proof issues related to changes of domicile. Each of the three articles is meant to provide an overview of these various nonresident tax issues, along with real world examples and practical advice for navigating the nuances of New York State’s income allocation rules.

There are many valid reasons individuals decide to either remain in or leave a particular location. But if you are motivated to leave New York because of tax considerations, this series highlights what awaits on the other side of a potentially bumpy exodus from New York. 

Nonresident Wage Allocation

One of the most common post-move tax planning conversations we have had in recent years revolves around New York State’s nonresident wage allocation rules and, in particular, New York’s "Convenience of the Employer" test. The classic hypothetical is as follows: A highly compensated W-2 wage employee, who was previously assigned to a New York State office, decides to relocate to sunny Florida. The employee’s change of residency case is strong. The employee consults with their attorneys and therefore properly considers all of the relevant domicile factors, while also understanding and following New York’s statutory residency, or “183-day” rules. The employee’s expectation is therefore that even if they have to endure a grinding residency audit, they will eventually secure their change of residency to Florida. But before realizing any significant New York State tax savings, and before knowing whether it will be worth it to jump through all of the necessary residency hoops, the employee (and their advisors) must also confront New York State’s wage allocation rules.

A nonresident’s New York source income includes income attributable to a business, trade, profession or occupation carried on in New York State; this includes W-2 wage income earned while working in New York State. There is a schedule included with New York State’s Nonresident and Part-Year Resident Income Tax Return meant to allocate wage and salary income to New York State using a general calendar year workday fraction. The basic formula is that days worked in New York State go in the numerator, days worked both in and out of New York State go in the denominator, and the resulting fraction gives you a New York State wage allocation percentage. Those are the easy cases.

The difficult applications, especially for those like our hypothetical employee, who has so diligently planned his move but who also remains assigned to a New York State office, is that section 132.18(a) of New York State’s personal income tax regulations provides, in relevant part, that “any allowance claimed for days worked outside New York State must be based upon the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer”(emphasis added). This is what is known as New York State’s infamous “convenience of the employer” test. And while there are currently ongoing challenges to the state’s convenience of the employer test, the Tax Department has, to date, taken a hardline approach on what qualifies as “convenience,” going so far as to say in published guidance (as well as in thousands of audit letters) that days spent telecommuting from outside of New York State, even during the midst of the COVID-19 pandemic, are still considered to qualify as “convenience” days and therefore qualify as days worked in New York State. You will have to work very hard to convince me that someone telecommuting under a government-mandated stay-at-home order was telecommuting for their own “convenience,” but COVID shutdown or no COVID shutdown, our hypothetical employee leaving New York needs to understand that there may be little to no state tax savings following their move if the majority of their wages are sourced back to New York State under the convenience of the employer test.

But no one wants to read an article filled with doom and gloom. And one of the goals of this series is to help practitioners and taxpayers maximize the benefits of a change of residency by knowing how to properly navigate New York State’s nonresident income allocation rules. So when it comes to the convenience of the employer test, what can be done to mitigate New York’s ability to claw back workdays spent outside of New York State?

Avoiding the Convenience of the Employer Test

There are at least three paths forward to help employees avoid having to source 100% of their wages back to New York State under the convenience of the employer test.

First, like any nonresident, our newly Florida-based employee could request a reassignment to an actual employer office that is located at or near their new residence. As explained in the Tax Department’s Technical Memorandum on the application of the convenience of the employer test, “days worked at home are considered New York work days only if the employee’s assigned or primary work location is at an established office…in New York State (emphasis added).” In other words, if the employee’s assigned or primary work location is at an established office or other bona fide place of business outside New York State, then any normal work day spent telecommuting from home would be treated as a day worked outside New York State. The first option for avoiding the convenience of the employer test is therefore a reassignment to an established office or other bona fide place of business of the employer at or near the employee’s new residence. This approach, however, may involve difficult conversations with the employer’s human resources, accounting and/or legal divisions, all of whom will be focused on satisfying the employer’s tax withholding obligations and may therefore be less interested in accommodating the requests of the employee.  

The second option for our hypothetical employee is to spend zero workdays in New York State during the calendar year in question. This option should not be confused with New York State’s 14-day threshold for withholding tax purposes. New York’s 14-day withholding tax grace period does not apply for purposes of a nonresident employee’s personal income tax obligations (it only covers the employer). But case law, along with Tax Department’s own Nonresident Allocation Guidelines, provide that the convenience rule does not apply where an employee works entirely out of state and performs no services within New York. This means that the convenience rule kicks in only when a nonresident taxpayer works both within and outside the state. So if our hypothetical employees are out of New York for good, with zero future New York workdays, they may be spared under the convenience test.

Options one and two are both viable paths for avoiding the convenience of the employer test. But what about the employees moving to a new, remote location where the employer does not maintain an office and where the employees are expected to return periodically to their former New York offices? To be honest, this is the classic, post-move example that we have had to navigate over the past few years. Whether it’s the beaches of south Florida or the mountains of Big Sky Montana, we’ve seen countless clients relocate to remote areas where their employer has no physical footprint. And even in instances where these clients are able to establish a clear change of residency, we still have to navigate the convenience of the employer test in order to avoid any wage claw back as a result of the employer’s New York office. Here is where we really have to start jumping through some hoops.

Under an administratively created safe harbor, if a taxpayer can show that they have established a home office that qualifies as what is known as a “bona fide employer office,” then days worked from home may be treated as days worked outside New York. In other words, if our hypothetical employees are able to establish a bona fide employer office within their new Florida or Montana homes, the employees can avoid the convenience rule. The problem with this approach is that taxpayers must satisfy a long list of outdated (and, in some cases, bizarre) factors. But, as outlined in the chart below, if a taxpayer can meet 4 out of 6 of the relevant “secondary factors” and 3 out of 10 of the relevant “other factors,” the taxpayer’s home office should qualify as a bona fide employer office.

As you can see, there is no shortage of issues with these factors. Some (e.g., establishing a bona fide business purpose for the home office) may be difficult to prove. Others (e.g., the nonexistent home office expense deduction) are actually impossible to satisfy. But with proper planning, and the right amount of legal documentation, whether it be updated employment agreements or employer verification letters, we have helped many taxpayers successfully establish a bona fide employer office in their new home, thereby limiting the number of relevant New York workdays to only those days on which the employee is physically working in New York.

For our hypothetical employees leaving New York State, it is critical they properly navigate the convenience of the employer test. Although I’m sure there is no shortage of advantages to living in Florida, dealing with a New York State residency audit is not one of them. And if our employees want to be rewarded for their efforts, they must properly consider nonresident wage allocation as an important component of any residency planning discussion.

Deferred Compensation

There are other reasons to carefully navigate New York State’s nonresident wage allocation rules when leaving the state. Specifically, the state’s workday allocation rules (including the convenience of the employer test) do not impact just the sourcing of current year wages earned by nonresidents. Instead, New York State also has the authority to tax a variety of types of deferred compensation recognized by nonresidents if the compensation was earned previously while working either fully or partially in New York State. So similar to our W-2 wage employees moving out of New York State with the expectation of receiving significant future wage payments, any employee leaving New York State with the expectation of receiving significant amounts of deferred compensation must also understand the relevant post-move income allocation rules in order to properly quantify and maximize the tax savings associated with a change of residency.

The two most common forms of deferred compensation that ex–New Yorkers receive are bonuses and equity-based compensation. The rules for both of these categories are outlined below, along with a discussion of New York’s general catch-all provision for income received by a nonresident that is related to a business, trade, profession, or occupation previously carried on within New York State.

With regard to bonuses earned in previous tax years, section 132.4(c) of New York State’s personal income tax regulations states, “If personal services are performed within New York State, whether or not as an employee, the compensation for such services…constitutes income from New York State sources, regardless of the fact that (1) such compensation is received in a taxable year after the year in which the services were performed,….” For employees receiving significant bonus payments in years following a move, this rule can create a surprising New York income tax liability if the employee had a significant number of New York work days during the prior year (or years) in which the bonus was earned.

This same general principle applies also to equity based compensation, with the key difference being that many of these categories have longer earning periods that may stretch across multiple tax years. New York State actually uses a separate allocation form, Form IT-203-F, for these types of multi-year allocations. And for those types of equity compensation that are taxed, for federal purposes, as ordinary income (e.g., stock options or restricted stock units (RSUs) where no 83(b) election was made), the general allocation period includes the workdays between (i) the date the option or RSU was granted and (ii) the date the option or RSU vested—i.e., the date at which all service-related conditions necessary for the exercise of the option were met. Again, for employees expecting to recognize significant amounts of equity-based compensation following a move out of New York State, these rules can create unexpected tax headaches that greatly minimize the potential tax savings associated with a complicated change of residency.

Take, for example, the following hypothetical: an employee moves out of New York State and New York City in mid-2023 expecting to recognize substantial nonqualified stock option income in early 2024. The options were granted on April 1, 2020 and vest April 1, 2024. The employee expects to report the income on their 2024 W-2. Let’s assume that the total number of work days during the grant to vest period will be 960 (240/year multiplied by 4). As mentioned in the introduction, New York City does not impose any type of nonresident tax, so by leaving New York City before recognizing the income, the employee will achieve clear New York City tax savings. But for New York State purposes, if the employee previously worked primarily or exclusively in New York during the three years prior to the mid-2023 move, there are, unfortunately, only so many relevant remaining post-move work days (i.e., from the date of the move until the April 1, 2024 vest date) on which employees can impact their eventual allocation percentage—and this assumes the post-move work days are not clawed back to New York State under the convenience of the employer test. So, in this example, while there are clear New York City tax savings associated with the move, there may be only marginal New York State tax savings, and taxpayers will again want to properly quantify these savings in order to best understand whether their move out of New York is worth the hassle.   

The nonqualified stock option example above also highlights the importance of planning ahead when considering a change of residency. Had, for example, the employees considered a move in mid-2021, they would have had two more years (or approximately 480 more work days) on which they could have impacted their eventual New York State wage allocation percentage. And this same strategy of planning ahead also holds true for other general forms of deferred compensation. With the 2010 enactment of section 631(b)(1)(F) to the Tax Law, New York State now applies a general catchall provision for taxing “income received by nonresidents related to a business, trade, profession or occupation previously carried on in this state.” This new provision includes income types such as covenants not to compete and termination agreements, but we have also seen New York attempt to apply this catch-all to unrelated types of income such as the significant sums of nonqualified deferred compensation that was required to be included in gross income for federal tax purposes during tax year 2017 under section 457A to the Internal Revenue Code.

Like employees receiving nonqualified stock option income with a multiyear grant to vest period, New York State has instructed that employees who receive general deferred compensation, such as income under a covenant not to compete or termination agreement, also use a multi-year fraction to determine the amount of their federal income that is related to past employment in New York State. The numerator of the relevant fraction is the employee’s total amount of New York source wage compensation related to their prior three years of employment (plus the portion of the tax year prior to the termination). The denominator of the fraction is the total amount of compensation from that employment includable in federal income during the same period. This multi-year allocation period means there can again be significant eventual tax savings to planning ahead in order to minimize the amount of prior New York source wage income, which will eventually impact how various types of deferred compensation are sourced to New York.

Conclusion

Anyone considering a move out of New York State must properly consider and apply New York’s various residency rules. But as this article shows, winning the difficult residency battle doesn’t necessarily mean total victory if the taxpayer leaving New York is left with significant amounts of New York source wage income. In other words, like each article in this series, understanding New York State’s sourcing rules for telecommuting and deferred compensation shows that, when thinking about effective residency planning, it is just as important to consider what comes After the Move.

K. Craig Reilly, Esq., is a partnerat Hodgson Russ. Craig counsels businesses and individuals in a range of state and local tax issues, with a focus on New York State, New York City, New Jersey, and multistate tax issues. Craig advises clients on all aspects of state and local tax from planning and compliance to controversy and litigation. He represents clients in disputes with the New York State Department of Taxation and Finance, New York City Department of Finance, and New Jersey Division of Taxation and is experienced in handling sales tax, corporate franchise tax, personal income tax, and residency audits. Craig works closely with remote retailers and cloud-based software vendors on a variety of multistate tax compliance issues, including filing requirements, sales and use tax collection obligations, income allocation and apportionment, tax registrations, and applications for voluntary disclosure and other amnesty programs. Craig also spends significant time counseling businesses and individuals in the financial services sector on various multistate tax planning topics, including residency planning, income apportionment and allocation, state and city entity level taxes, and entity restructuring.