Just in time for tax season, New York State’s tax agency just lost a major legal challenge to its policy of pursuing maximum income tax payments from wealthy vacation homeowners—even when they live elsewhere.

Earlier this month, the state Court of Appeals declined to hear an appeal of a June 2022 lower-court ruling, which in turn had nullified an attempt by state tax auditors to squeeze more than a half-million dollars in back taxes and interest from Nelson Obus, the chief investment officer of a Manhattan-based hedge fund who lives in New Jersey while maintaining a vacation home in upstate New York.

At issue in the case (as initially reported here) was the Empire State’s effort to tax the investment income, dividends, and capital gains earned by Obus in the first two calendar years following his December 2011 purchase of a $290,000 vacation home in the village of Northville, near Great Sacandaga Lake in Fulton County.

Defining “permanent abode”

Obus and his family used the Northville house for cross-country skiing in winter and visits to the Saratoga Race Track in summer. New York’s tax auditors did not dispute that Obus is actually a resident of New Jersey—nor did Obus dispute that he was subject to New York State taxation of all the wage, salary, and bonus income he earned working in his investment firm’s New York City office. However, Obus and other hedge fund managers generally receive much of their income in the form of carried interest, which is treated as capital gains for tax purposes. Capital gains and other investment income, in turn, are taxable only in a taxpayer’s state of residence. The millions of dollars Obus earned in those categories had already been taxed by Trenton—but Albany wanted its own big bite of the same apple.

To wring more money out of Obus and his wife, New York State’s auditors had to demonstrate that he met the state Tax Law’s two-part test for establishing full-time residency: (a) physical presence in the state more than 183 days a year, and (b) maintenance of a “permanent place of abode” in New York. During 2012 and 2013, the answer to (a) was yes, since Obus worked more than half the year in New York City and duly filed nonresident tax returns with Albany for income earned at his Manhattan office. But to (b), Obus insisted the answer was no. After all, as even the auditors admitted, Obus and his wife only spent two or three weeks a year at the Northville house.

Obus lost his initial tax challenge in August 2019, when Administrative Law Judge Donna M. Gardiner issued a ruling in favor of the state’s tax auditors. She described the Northville house as more than “a mere camp or cottage … suitable and used only for vacations.”  It “has year-round climate control,” she noted, and thus “can [be] and is used year-round and, as such, is considered permanent.” Gardiner’s conclusion: “The fact that [Obus and his wife] chose to use this home exclusively for vacations does not transform its characterization as a permanent place of abode.”

But the Appellate Division unanimously disagreed. Yes, the Northville house could have been used as a permanent home, Justice Stan L. Pritzker wrote for the five-judge panel, but “because petitioners did not use it in this manner, it does not constitute a permanent place of abode … and a contrary finding by the Tribunal is inconsistent with the legislative intent underlying the statute [emphasis added].”

Glenn Newman, who led a Greenberg Traurig law firm team representing Obus, described the Appellate Divison ruling as “a major change in New York’s law on statutory residency.”

“It makes clear that it is irrational to only consider the physical characteristics of the dwelling to determine whether it is a permanent place of abode,” Newman said. “Rather, the taxpayer’s use of the dwelling must be considered to determine whether someone is, ‘really and for all intents and purposes’ a resident of the state.”

Cui bono?

The number of individuals likely to be affected by the ruling is relatively small, but the revenue at stake could be a bit more significant, given New York’s heavier-than-ever dependence on taxes collected from resident income millionaires, whose income taxes were raised sharply by the Legislature and then-Governor Cuomo in 2021.

After all, more than a few wealthy Manhattanites are known to spend vacations every year at properties they own elsewhere in New York State. Prior to the Obus decision, such people knew there was little point in moving their main residence to a lower-taxed jurisdiction unless they were also willing to part with a vacation home in, say, the Hamptons or Hudson Valley.  The Obus precedent potentially opens a clearer path of escape from New York taxation at a time when more high earners than ever may be open to taking it. There’s still catch, though: another Tax law test says that “resident” status can apply to an individual who has a “permanent abode” elsewhere but “spends in the aggregate not more than thirty days of the taxable year in this state.” Obus, remember, was limiting his time in Northville to just three weeks, well within that 30-day limit.

In short, as one New Jersey-based tax advisor put it:

While the decision is certainly taxpayer-friendly, it is fact-specific. To the extent that any of the facts change, so too may any determination. Of course, New York auditors are already aware of this. For example, what if the vacation or second home was used frequently by the owner while in New York for business purposes?

Nevertheless, in light of the Obus case, a refund opportunity may exist for those who are domiciled outside of New York, have New York vacation homes and have filed as New York residents because they spend more than 183 days in New York. Taxpayers in this situation should examine their facts and speak to their tax advisors.

The bottom line: New York’s tax agency has had its hand slapped for digging a little too deeply into a particular taxpayer’s pockets.  But don’t expect it to stop reaching in other ways into plenty of other pockets.