The Noto decision and double state income taxation of dual residents
By Edward Zelinsky
Lucio Noto worked for Mobil and ExxonMobil in Virginia and Texas before retiring in 2001. In his retirement, Mr. Noto and his wife Joan maintain homes in Greenwich, Connecticut and in East Hampton, New York. For state income tax purposes, the Notos are residents of both Connecticut where they are domiciled and New York where they spend at least 183 days annually at their second home.
During his employment in the oil industry, Mr. Noto earned stock options and deferred compensation. In 2005 and 2006, he exercised these stock options at considerable gain and also received the deferred compensation he had earned earlier during his employment. Both New York and Connecticut taxed the resulting income in full without providing a credit for the income tax levied by the other. Consequently, the Notos, as dual residents of both the Empire State and the Nutmeg State, paid double state income taxes on their stock option and deferred compensation income.
The New York Supreme Court (the Empire State’s trial court) recently upheld this double state income taxation by holding that New York could tax the Notos’ income in full, even though Connecticut taxed that income as well. The Noto court correctly applied the tax and constitutional law as it today governs dual state residents like the Notos. While double taxation of dual state residents is currently legal, such double taxation is neither fair nor economically efficient.
In a recent article in the Florida Tax Review, I argue that, as a matter of both tax policy and constitutional law, it is time to apportion state personal income taxes to eliminate the double state income taxation of dual residents like the Notos. As to income which two or more states tax only on the basis of residence, such states should apportion, based on the dual resident’s relative presence in each state of residence. This apportioned approach would eliminate the double taxation of dual residents’ incomes and would comport better with modern patterns of residence and mobility.
The Noto decision illustrates the need to eliminate the double state income taxation of dual residents. In a case like the Notos’, New York and Connecticut should each tax only a pro rata share of the Notos’ option-derived and deferred compensation income based on the days the Notos spend in each of these two states of residence.
On days when a dual resident lives in his second state of residence, the first state provides no services which justify taxing the part of the individual’s income properly apportioned to the time in his second state of residence, the state which provides services on those days. Part-year benefits do not justify full-year taxation. The status quo is economically inefficient as the specter of double residence-based taxation causes unproductive tax-motivated behavior to avoid such taxation. Such economically unproductive behavior inhibits individuals from moving across state lines as they would without interference by tax considerations.
So far, the US Supreme Court has been unwilling to declare unconstitutional the kind of double state taxation imposed upon dual state residents like Mr. and Mrs. Noto. Moreover, most states have been unwilling to abate such double taxation by extending a credit for the tax imposed by the taxpayer’s second state of residence. The result is the kind of double taxation imposed on the Notos by New York and Connecticut.
It is easy to dismiss this type of double state income taxation as a quandary of the proverbial one percent. However, the problem of double residence-based personal income taxation, once limited to the very rich, is moving down the income scale as more individuals maintain second residences in different states, e.g., the Baby Boomer retiree who establishes a winter home in a warm climate; the dual career couple that balances the demands of work and family by maintaining two homes in different states.
In this environment, the traditional acquiescence to double state income taxation of dual residents is no longer acceptable. Congress could eliminate this double taxation through a federal law requiring states to apportion income when taxpayers are residents of two or more states. The US Supreme Court could reach the same result by requiring under the Constitution’s Commerce and Due Process Clauses that states apportion the income of dual residents. The states could, on their own, move toward such apportionment, either by unilateral adoption of rules of apportionment (including tax credits) or by mutual agreement.
The kind of double state income taxation imposed upon dual state residents like the Notos is an anomaly in the 21st century. In the interests of fairness and economic efficiency, this anomaly should be eliminated by requiring states to apportion the income of dual residents.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. His monthly column appears on the OUPblog.