LEONARD I. HOROWITZ - DETERMINATION - 09/15/04. In the Matter of LEONARD I. HOROWITZ TAT(H) 99-3(UB) ET AL. - DETERMINATION

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1 LEONARD I. HOROWITZ - DETERMINATION - 09/15/04 In the Matter of LEONARD I. HOROWITZ TAT(H) 99-3(UB) ET AL. - DETERMINATION NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION UNINCORPORATED BUSINESS TAX - PAYMENTS BY PETITIONER S UNINCORPORATED BUSINESS OF ONE HALF OF HIS FEDERAL SELF-EMPLOYMENT TAX, THE COST OF HIS SELF-EMPLOYED HEALTH INSURANCE PREMIUMS AND CONTRIBUTIONS TO A DEFINED BENEFIT PLAN ARE AMOUNTS PAID OR INCURRED TO A PROPRIETOR FOR HIS SERVICES. ACCORDINGLY, THE DEPARTMENT OF FINANCE CORRECTLY DENIED DEDUCTIONS TO PETITIONER FOR THESE AMOUNTS. SEPTEMBER 15, 2004

2 NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION : In the Matter of the Petitions : : DETERMINATION of : : TAT(H) 99-3(UB) et al. LEONARD I. HOROWITZ : : Murphy, A.L.J.: Petitioner Leonard I. Horowitz timely filed four Petitions for redetermination of deficiencies of New York City ( City ) Unincorporated Business Tax ( UBT ) asserted by the City Commissioner of Finance (the Commissioner or Respondent ) under Chapter 5 of Title 11 of the City Administrative Code ( Code ) for the calendar years 1996, 1998, 1999 and 2000 (the Tax Years ). Petitioner appeared pro se. George P. Lynch, Esq., Assistant Corporation Counsel, represented Respondent. On May 16, 2003, the parties requested in writing that the four petitions be consolidated and this matter determined on submission, without the need for a formal hearing, pursuant to Section 1-09(f) of Rules of Practice and Procedure ( Rules ) of the City Tax Appeals Tribunal ( Tribunal ). On May 20, 2003, an order was issued consolidating the petitions as TAT(H) 99-3 (UB) et al., and granting the request for the matters to be heard on submission. A Stipulation of Fact with exhibits was filed on August 9, Petitioner submitted his Brief on November 5, 2003, and Respondent filed her Brief on December 17, On January 26,

3 2004, Petitioner filed a Reply Brief, and on March 15, 2004, Respondent filed a Sur-Reply Brief. ISSUE Whether Petitioner Leonard I. Horowitz is entitled to deduct from his unincorporated business income: one-half of his federal self-employment tax; the premiums paid for his self-employed health insurance; and his defined benefit plan contributions. STATEMENT OF FACTS 1. Petitioner, Leonard I. Horowitz, a Connecticut resident, is an attorney engaged in the unincorporated business of the practice of law as a sole proprietor in the City and in Connecticut. 2. During the Tax Years, Petitioner derived the majority of his unincorporated business income from City sources. 3. Petitioner timely filed City UBT Tax Returns (Forms NYC 202) for the Tax Years (the Returns ). He requested a UBT refund for 1996 in the amount of $1,000; reported no UBT due nor requested any refund for 1998 and 1999; and initially reported $229 UBT due for the 2000 period, and then, in a subsequently filed amended return, requested a refund of $ On Schedules B of the Returns, Computation of Total Income, Petitioner reported the following subtraction modifications to unincorporated business income: for 1996, $51,322; for 1998, $105,215; for 1999, $99,877; and, for 2000, $228,618. 2

4 5. In an attachment to each of the Returns, Petitioner explained that he was adjusting unincorporated business income by subtracting the following amounts representing certain items of deduction which he had reported on Federal Forms 1040, U.S. Individual Income Tax Returns, filed for each of the Tax Years: (a) one-half of his federal self-employment tax; (b) an amount equal to a self-employed health insurance deduction; and (c) an amount representing contributions made to a defined benefit plan. 6. For 1996, the subtraction modification was comprised as follows: one-half of Petitioner s self employment tax of $720; a self-employed health insurance deduction of $607; and a defined benefit plan contribution of $49,995. For 1998, the subtraction modification was comprised as follows: one-half of Petitioner s self-employment tax of $5,817; a self-employed health insurance deduction of $1,028; and a defined benefit plan contribution of $109,801. Petitioner applied a percentage of to the total 1998 subtraction modification, with the written explanation that the calculation represented the percentage that 1998 City gross income bore to total 1998 gross business income from all sources. For 1999, the subtraction modification was comprised as follows: onehalf of Petitioner s self-employment tax of $6,585; a self-employed health insurance deduction of $1,438; and a defined benefit plan contribution of $120, Petitioner applied a percentage of 0.78 to the 1999 subtraction modification amount. And for 2000, the subtraction modification was comprised as follows: one-half of Petitioner s self-employment tax of $8,433; self-employed health insurance deduction of $1,805; and a defined benefit plan contribution of $240,000. Petitioner applied a percentage of to the 2000 subtraction modification amount. 3

5 7. On June 26, 1997, Respondent issued to Petitioner the requested refund for Respondent thereafter performed desk audits of the Returns. 9. On March 4, 1998, Respondent issued a Notice of Determination of UBT due for 1996, asserting additional UBT of $1,721.80, with interest of $156.56, computed to April 3, 1998, for a total amount due of $1, (the 1996 Notice ). 10. On September 10, 2002, Respondent issued a Notice of Determination of UBT due for 1998, asserting additional UBT due of $3,869.87, with interest of $1,191.50, computed to October 10, 2002, for a total amount due of $5, (the 1998 Notice ). 11. On September 10, 2002, Respondent issued a Notice of Determination of UBT due for 1999, asserting additional UBT due of $4,509.34, with interest of $929.24, computed to October 10, 2002, for a total amount due of $5, (the 1999 Notice ). 12. On September 10, 2002, Respondent issued a Notice of Determination of UBT due for 2000, asserting additional UBT due of $9,781.53, with interest of $1,009.70, computed to October 10, 2002, for a total amount due of $10, (the 2000 Notice ). 13. The basis for each of the Notices was Respondent s determination that Petitioner was not entitled to the requested subtraction modifications described in Finding of Fact 5, supra. 14. On June 15, 1998, with respect to the 1996 Notice, Petitioner filed a request for Conciliation Conference with the Department of Finance s Bureau of Conciliation. On November 17, 4

6 1998, the Conciliation Bureau issued a Conciliation Decision in this matter, discontinuing the proceeding. 15. On February 4, 1999, Petitioner filed a Petition with the Tribunal requesting a redetermination of the 1996 Notice. Respondent filed her Answer on March 23, On November 29, 2002, Petitioner filed Petitions with the Tribunal requesting a redetermination of the 1998, 1999 and 2000 Notices. On February 7, 2003, Respondent filed her Answers to these Petitions. STATEMENT OF POSITIONS Petitioner asserts that in computing UBT due for the Tax Years, he is entitled to modify City unincorporated business gross income by subtracting amounts representing the following deductions taken on his Tax Years Federal income tax returns: (a) one-half of his self-employment tax; (b) an amount representing self-employed health insurance; and (c) the amount of contributions made to a defined benefit plan. Respondent asserts that Petitioner is not entitled to the above modifications, as they represent amounts paid or incurred to a proprietor for services or for the use of capital pursuant to Code (3). CONCLUSIONS OF LAW The income which Petitioner earned during the Tax Years from his unincorporated practice of law is subject to the City UBT. Code (a). The Code defines unincorporated business taxable 5

7 income as the excess of... unincorporated business gross income over... unincorporated business deductions, allocated to the city.... Code Section defines unincorporated business gross income to be the sum of the items of income and gain of the business... includible in gross income for the taxable year for federal income tax purposes with specific statutory modifications. See, Code (b). Unincorporated business deductions are defined generally as items of loss and deduction directly connected with or incurred in the conduct of the business, which are allowable for federal income tax purposes with specific statutory modifications. See, Code (1)-(22). The starting point for computing City unincorporated business gross income is the individual s reported federal gross income, modified by specific UBT provisions. See, generally, Code The deductions from unincorporated business gross income permitted under the Code generally include ordinary and necessary expenses of the unincorporated business. 1 See, e.g., Code (2) which allows a deduction for net operating losses. Further, the Code specifically provides that the federal gross income base must be modified by exclusion of several items which are otherwise 2 deductible under the Internal Revenue Code ( IRC ). See, e.g., 1 Deductions, as exemptions, are to be strictly construed in favor of the taxing authority. Royal Indemnity Co. v. Tax Appeals Tribunal, 75 N.Y. 2d 75, 78; Mobil Oil Corp. v. Finance Admin., 58 N.Y.2d 95, 99 (1983). A deduction is a matter of grace on the part of the taxing authority, and a taxpayer must prove entitlement. Colt Industries v. Department of Finance, 66 N.Y.3d 466, 471 (1985). Petitioner is required to establish that he is unequivocally entitled to modify his unincorporated business income base by the asserted deductions. 2 Neither State nor City statutory provisions require complete federal conformity. A common adjustment to the federal tax base is a modification altering Internal Revenue Service audit changes (see, e.g., Code ), and it is noted that State cases consistently articulate the principal that a local taxing authority may always conduct an independent audit or investigation. See, e.g., Matter of Peter A. Bakal, State Tax Commission, TSB-H-83(105)I (May 6, 1983). This principal has also been cited to support disallowing specific federal deductions. See, e.g., Matter of James R. Shorter, Jr., NYS Tax Appeals 6

8 Code (3) through (7). Section (3) particularly excludes any deduction representing amounts paid or incurred to a proprietor for services or for the use of capital. [Emphasis added.] See, New York Yankees Partnership v. Carol O'Cleireacain, 83 N.Y.2d 550, (1994); In the Matter of Buchbinder Tunick & Company v. Tax Appeals Tribunal, 100 N.Y.2d 389 (2003). As Petitioner notes, pursuant to the IRC, an individual taxpayer s reported federal income may be modified by the three deductions in issue, namely, half of Petitioner s self-employment tax, the cost of his personal health insurance, and contributions made by the business to a defined benefit (i.e. retirement) plan for the proprietor. See, generally, IRC 162(l), 164(f), and 404. Petitioner adjusted his federal taxable income for the Tax Years accordingly. The question presented is whether these federal deductions are proper UBT deductions or whether they represent amounts paid to or incurred by a proprietor for services or for the use of capital. Each of the items of deduction at issue is remuneration for services Petitioner rendered to his unincorporated business. Therefore, Respondent correctly modified Petitioner s unincorporated business income by disallowing the deduction of these amounts. Buchbinder, supra. The unincorporated business s payment of Petitioner s selfemployment tax obligations is clearly an item of compensation for his services. The self-employment tax is an obligation imposed on Petitioner pursuant to IRC When this obligation was Tribunal, DTA No , 97-1A NYTC T-1031 (July 31, 1997). 7

9 discharged by the unincorporated law practice on Petitioner s behalf, it is in essence consideration paid to him or incurred by the business for his services. Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 729 (1929) (distinguished on other grounds). In Old Colony Trust, the United States Supreme Court held that an employer s payment of an employee s income tax liability constituted income to the employee. The Court stated: the payment of the tax by the employers was in consideration of the services rendered by the employee... The form of the payment is expressly declared to make no difference.... The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed. 279 U.S. at The Court further noted: The taxes were paid upon a valuable consideration, namely, the services rendered by the employee and as part of the compensation therefor. We think therefore that the payment constituted income to the employee. 279 U.S. at 729. Therefore, payments by the unincorporated law practice of Petitioner s self-employment taxes were payments made on behalf of Petitioner to satisfy his personal federal income tax obligations. Petitioner has not offered any other business purpose (besides 3 Petitioner argues that since the taxes were paid to a third party (e.g., the federal government) and not directly to him, the amounts cannot be considered payment for services. This same contention was raised in Old Colony, supra, where the Court noted that it was immaterial that the taxes were directly paid over to the Government. at 729. [Emphasis supplied.] Clearly, any payment of a pre-existing obligation should be treated as income or at the least as a form of remuneration to an obligor, that is, as a payment for services. To characterize these payments as other than income to Petitioner based on what entity receives the monies exhalts form over substance in a manner generally rejected by the courts. 8

10 compensation for services) for which the payments could have been made. As they are payment for Petitioner s provision of services to the business, they are not deductible from the unincorporated business gross income. Code (3). The remaining two items of deduction also are appropriately characterized as amounts paid or incurred to a proprietor for services, and no credible argument can be made otherwise. While payments of health insurance premiums might be federal deductions allowed to a business entity, they still are not deductible under the UBT. Petitioner has offered no business purpose for these payments other than as compensation for his services. Finally, the nature of pension plan contributions belies any characterization as a necessary expense of Petitioner s law practice. See, e.g., Gale v. United States of America, 768 F. Supp (ND Ill) (1991), where the District Court for the Northern District of Illinois noted: Nowhere has Congress mandated... that a selfemployed individual's contribution to a Keogh plan constitutes a deduction attributable to his trade or business.... Neither the legislative history nor the language of the relevant provisions of the tax code indicate that this was the intent of Congress. 768 F. Supp. at Moreover, it is axiomatic that contributions to defined benefit pension plans are specifically tied to work performed by the individual for whom the plan is established. See, generally, IRC 404 (where the Code speaks equally of compensation and contribution ); ERISA provisions at 29 USCS 1002; and, Vons 9

11 Companies, Inc. v. The United States, 55 Fed. Cl. 709 (2003). Petitioner s annual contributions to a defined benefit plan are compensation for his services which are not deductible for UBT purposes. Each of the three items of modification therefore represents compensation to Petitioner for services. As the Court of Appeals noted in Buchbinder, supra, when disputed payments fall squarely within the meaning of section (3), [they] are... not deductible. Id. at 393. ACCORDINGLY, IT IS CONCLUDED THAT payments by Petitioner s unincorporated business of one-half of his federal self-employment tax, the cost of his self-employed health insurance premiums and contributions to a defined benefit plan, are non-deductible as amounts paid or incurred to Petitioner for his services. Thus, Respondent correctly denied the deductions and included the amounts in Petitioner s unincorporated business income. Therefore, the petitions of Leonard I Horowitz are denied. The Notices of Determination dated March 4, 1998 and September 10, 2002, are sustained. DATED: September 15, 2004 New York, New York ANNE W. MURPHY Administrative Law Judge 10