Originally published on Forbes.com Aug 19th, 2014
Nearly two weeks ago the tax blogosphere lit up with the news that Robert Redford was fighting a $1.6 million tax bill from the state of New York. Redford’s celebrity is luminous enough to have broken the story out of the tax ghetto. I have to tip my hat to the Daily News, as their coverage included a link to the full text of Redford’s filing. I hereby promise to renounce forever my love for Tom Paxton’s song about that great metropolitan newspaper. I am not immune to jumping into these frenzies, but I generally like to have something extra to offer. I think there is are valuable lessons for planners in Redford’s current predicament. It took me a bit of reading between the lines and consultation with some SALT (state and local tax) experts to come up with this. It is important to keep in mind that we only have one side of the story at this point.
Confused At First
Some of the coverage indicated that Redford was being taxed by New York on the gain from the sale of a partnership interest in the Sundance Channel. Not long ago I had written about another case where a non-resident taxpayer had been hit with flow-through income from an inherited New York real estate partnership. He wanted to offset that with his loss on the liquidation of his partnership interest. New York did not allow the loss indicating that a partnership interest was an intangible asset which sources gain or loss to the taxpayer’s state of domicile. (New York has since changed that rule with respect to real estate partnerships). The Olsheim case, like Redford’s Sundance gain was in 2005. So how could New York be taking a different position from one that they already won on?
Similar But Not The Same
Robert Redford did not directly own an interest in Sundance Channel LLC (Channel). He owned a 100% interest in Sundance TV Inc (INC) (an S Corporation) which owned an 85.5% interest in Sundance Television Limited (Limited) which owned a 20% interest in Channel. I had a sneaking suspicion that having that S corporation in the chain of ownership might have been what created the problem] , which sent me seeking some expert help.
Sylvia Dion
Sylvia Dion runs a boutique SALT practice and by consenting to be interviewed by me once has a life sentence of being part of my brain trust. She more or less confirmed my reading of the filing.
On one hand, I can see New York’s rationale for asserting that the gain on the sale of a portion of the ownership interest in Sundance Channel (the LLC referred to as Channel in the filing) was New York source income. Redford owned 100% in an S Corp (INC.) which held an 85.5% general partnership interest in a partnership (Limited), which owned a 20% interest in an LLC (Channel) that was clearly based in and operating a trade or business in New York (operating a cable TV station). On page 6 of the filing, it discusses how the pertinent section of the NY law is intended to make clear that intangible personal property, e.g., an ownership interest in a partnership or LLC owned by a non-resident is deemed to be located at the domicile of the owner – and that any gain from the sale of the intangible would not be considered NY source income unless the ownership interest was employed by the owner in operating a trade or business in New York. (In this case, it was – although indirectly.) I think if there weren’t all the flow-through tiers separating Redford from Channel – that is, if he owned a 20% interest in the LLC directly – there’d be no question (in my mind) that the gain would be New York source income. Although he’s challenging the assessment on New York Constitutional grounds, I’m not sure this is going to be a slam dunk for him. Plus, once you get into rendering a section of a State statute unconstitutional, you open the door to other taxpayer’s challenges – something I’m sure New York wouldn’t want to happen. Now that I’ve read the filing – I’m more intrigued than ever, and will definitely be following this case.
Sylvia suggested that I might get more help from Brian Gordon.
Brian Gordon
Brian Gordon, CPA is the Director of State and Local Taxes at Sanders, Thaler Viola & Katz LLP. Like many SALT experts, he has quite a bit of experience on the other side – 30 years with the New York State Department of Taxation and Finance. He supports my theory that the S corporation in the chain is likely the source of Redford’s problem.
There is more to this case than meets the eye. Obviously New York did not all of a sudden make all gains on the sale of intangibles taxable to nonresidents – especially not retroactive to 2005. So what is going on? One possibility is this:
Keep in mind that there are two layers of entities between Sundance Channel and Mr. Redford the New York nonresident.
Sundance Television LTD. (Television) a limited partnership, sold the interest in The Sundance Channel (Channel), also a partnership. Television passes the gain to Sundance TV Inc (Inc)an S Corp. Since Inc. is an S Corporation, and Channel is a partnership, then the gain on the sale of the partnership interest is business income to the S Corporation (Inc). This is a significant point. Inc. would then compute a Business Allocation Percentage using the aggregate method and pass on the New York Source income to Mr. Redford.
Redford Is Really Getting Hosed
In 2005, there was not much of a spread between New York and Utah’s rates, so it is unlikely that anybody was really trying to get away with anything here. Utah would tax Redford on his world-wide income and give him a credit for most of the tax that he paid New York (It is possible that his income might have been otherwise sheltered, in which case he might not qualify for a credit, but I suspect that is unlikely.) Now it appears that it is too late for him to amend his Utah return, so he may end up paying both states on the same income.
That is the first lesson. You dodge non-resident state taxes, either on purpose or by accident, at the peril of missing out on a credit against the tax of your home state.
Not All Planning Is Federal Planning
Most states follow federal principles pretty closely in computing state taxable income but note well the caveats in that statement. “Most states” and “pretty closely”. It probably came as a very unpleasant surprise that inserting an S corporation into the chain of tiered entities can make a big difference in New York state’s view of the transaction, but there you have it.
If the case does not settle, we will learn more down the road, although probably not for a while. My prediction is that if it goes all the way the Department of Taxation and Finance will win. The constitutional challenge may scare them enough to offer a decent settlement, but if it plays out that way we’ll probably never know.
You can follow me on twitter @peterreillycpa.
Afternote
I have to admit that the celebrity nature of the case has me a little hooked too. I suppose everybody has their favorite Redford scenes. Partial as I am to his performance in A Bridge Too Far,
I think my favorite is the one where his character disabuses his granddaughter of the notion that he is in a gay relationship with Morgan Freeman’s character.
I have a more personal interest in Redford though. Many years ago, while doing penance for attempting to be a historian and flunking out of the famous University of Chicago, I was taking accounting courses at night and going to work after class. I was a hotel night auditor at the Sheraton Lincoln Inn, which was then the best hotel in the city of Worcester. The hotel had a couple of restaurants and a lounge with live entertainment. Two regulars at the lounge were a couple of ladies quite a bit older than I. They went to the lounge to meet the glamorous people from far-flung places who were staying at the hotel. On low occupancy nights, they would leave in disgust complaining that the lounge was full of “local yokels”. At any rate, the ladies would always stop and chat with me. They insisted that I bore a remarkable resemblance to Robert Redford. Now that I think about it, I came on at 11:00 PM, so I was probably interacting with them after they had a few rather than before.