A Conversation with Timothy P. Noonan, Partner and Tax Residency Practice Leader at Hodgson Russ LLP
Hosts & Guests
Stacey Roberts, State and Local Tax Director
Timothy P. Noonan, Partner and Tax Residency Practice Leader at Hodgson Russ LLP
Topics Discussed in this Episode:
- The need for expertise in transaction tax matters during big deals
- What is the 2018 Wayfair case?
- Tax implications of private equity and hedge fund transactions
What You Will Discover:
- [2:10] State and Local Tax Considerations for Private Equity Firms
- [8:07] Understanding Nexus and State Tax Implications for Business Transactions
- [11:54] Residency Rules and Tax Audits in Different States
- “State tax issues and private equity deals are an underrated issue. You and I think it’s the most important issue because that’s what we do every day. But we’ve gotten called in on both sides of these deals where someone’s getting acquired and they haven’t collected sales taxes in many years. We have to clean that up and figure out if your sales are taxable in this many states. We clean that up through voluntary disclosure.”- Timothy Noonan [04:22]
- “With the Wayfair case in 2018, you now have all these sellers who might not be watching what happens at the Supreme Court level and don’t realize that every state has come out and said if you have a certain amount of sales in the state, which isn’t very high threshold, you should be collecting sales tax in 46 different states and thousands of local taxing jurisdictions. So that can be messy.”- Timothy Noonan [07:11]
- “The rules in most states are either similar or the same. Someone leaving Colorado has the same residency test as someone leaving New York. There’s a domicile test. California’s rule is a little bit different, but they all sort of sound like the same concepts of this domicile test. So in that sense, the rules are the same.”- Timothy Noonan [12:02]
- “A lot of wealth creation that happens for folks in the private equity world is through pieces of their target companies they acquire and then they sell again. It is carried interest. It is the piece of these companies that are treated as capital gain. It’s intangible. So in addition to that capital gain benefit of carried interest, it has an important effect on state taxes too.“- Timothy Noonan [16:34]
TaxOps Home – www.taxops.com
Stacey Roberts: Hi everybody. It's Stacy from Saltovation. I have a special guest with us today. You're not just getting the usual crew of us here at Tax Ops. I have Tim Noonan with me today, who is a partner at Hodgson Ross in New York. And he and I actually have had the opportunity to speak together recently for a private equity stakeholder group. And so, we thought we'd invite Tim here to kind of talk about the things that he sees in his practice and how some of items or issues from a state perspective bubble up, not just for businesses, but also for the individuals that might own those businesses. But before we launch into that, I'm going to go ahead and let Tim introduce himself so that everybody knows who he is.
Timothy P. Noonan: All right. Well, thanks Stacy. Glad to be a part of this today. So, I'm a tax lawyer. I'm not an accountant, so don't, don't hold that against me. My practice is all state and local taxes. It's all shapes and sizes, represent a lot of high-net-worth individuals. A lot of businesses on income tax, corporate tax, sales, tax, all sorts of issues, mostly in sort of the Northeast.
But in the residency area, sort of the personal individual tax, that's been an area that our firm and me in particular have focused a lot on. So, both from a planning perspective as most able-bodied New Yorkers have left New York in the past couple of years, so helping a lot of people move.
But a huge part of my practice is defending taxpayers who are getting audited, mostly in New York, but also California, Connecticut, other states as well. But in the residency space, we handled thousands of cases of, individuals who left New York and defending taxpayers in audits is a big part of our practice and litigating cases. We've litigated some of the bigger residency cases in New York over the years. So, lots of fun stuff.
Stacey Roberts: Yeah, lots of fun. That's what we like to say. State and local tax. Right.
Timothy P. Noonan: Sometimes it's actually fun, but.
Stacey Roberts: Yeah. No, I hear you. I've been doing this a long time too. So, we do have some things that are more fun than others, but again, we've been doing this a long time, both of us. So, it keeps us busy and can be challenging too. It's like big puzzle pieces you put together.
But one of the things I just wanted to let the viewers know, like when we did this presentation to our private equity stakeholder groups a few weeks ago, it seemed that some of the things that came up in our presentation, not to mention, and I'll let Tim talk about this stuff from his perspective in a little bit. Private equity firms, if they're targeting certain companies, what kind of things might they need to look at from a tax perspective, from a state tax perspective? Some of the things we talked about were Nexus, right? Where are those target companies operating and do, they even know where they're operating?
And I think in both of our practices, we help companies with that. That's kind of like step one, right? Where do those targets have filing obligations? And then, if they are flow through entities right, then the shareholders or owners have obligations as well.
Those were some of the things that we talked about in our presentation as well as then just, what happens when you do in a private equity firm or in another acquisition, acquisitive kind of firm, may acquire a company. What do you do from a sourcing perspective for the gain on the sale. Those are kind of high points for companies that are looking to acquire. But I guess from your perspective, what, what are you seeing with some of your clients in that space?
Timothy P. Noonan: State tax issues and private equity deals are sort of an underrated issue. Obviously, you and I think it's the most important issue, because that's what we do every day. But we've gotten called in on both sides of these deals where someone's getting acquired and oops, they haven't collected sales taxes. the past forever years, so, yep. The, the private equity company that's buying them doesn't like that. Right? We got to clean that up and figure out have you been, are your sales taxable in this many states and how do we clean that up?
The voluntary disclosure. So, these state tax issues definitely can sort of rear their ugly head and not necessarily screw up these deals. I think that will happen regardless but from the buyer's perspective, it's certainly something on due diligence where they're looking at this, it's not 40, 50% federal tax, but 5, 6, 8, 10% taxes on billion-dollar deals is still a big number.
So, the buyers counsel and accountants are digging into state tax issues on the, on the due diligence side and then, when we've been again representing the sellers, we're just kind of playing defense sometimes, but you end up getting into debates with the buyer's counsel about whether something is taxable, the buyer's counsel sometimes takes on the role of the government to say, oh, you should have been paying tax in all these different states. So again, not anything that really screws up a deal, but just there's an expertise there for the SALT folks out there where they definitely have become needed in a lot of these big deals.
Stacey Roberts: Yeah, I agree. At our firm, we also represent from an accountant perspective buyers or sellers. And we see some of the same things. And we, I think, go through and try to protect the buyers so that they are not stuck holding the bag for some exposure that they, , are acquiring.
Uh, but to your point, I don't think. It's always maybe top of mind, particularly when it comes to like transaction taxes. Maybe they're focus on the income taxes, right? Because those are maybe a little bit more prevalent or out there because there could be third parties, other CPAs or whatever that are working on the income tax filings.
But a lot of sales tax and transaction taxes are handled internally. So those may not be things that are always. At least where a buyer or seller has that much or a buyer rather, would have that much visibility to it.
Timothy P. Noonan: Yeah. And look with the Wayfair case in 2018, you mentioned nexus, like now you have all these sellers who might not be watching what happens at the Supreme Court level and don't realize.
Pretty much every state has come out and said, well, if you have certain amount of sales in the state, which isn't very high a threshold, you should be collecting sales tax in 46 different states and thousands of taxing juris, local taxing jurisdiction. So, sure that can be messy. Particularly again, prior to the Wayfair case.
Oh, we only have Nexus in one state or something like that, which was probably bogus too. Like, it's not right. Doesn't take a lot to create Nexus, so. Correct. Lots of these companies on a multi-state basis probably had Nexus all over the place. Anyway, the Wayfair case just sort of made it obvious that, uh, oh, now we have Nexus, like everywhere, right?
And that's got to get cleaned up in these deals, if the deals are going to go.
Stacey Roberts: Well, and then, so that's kind of like on the business side of it, right? The entity side of things. So, then I guess, kind of circling back to your practice, I guess, what are you seeing if you're, , if you're helping maybe some of those shareholders or individual owners, I guess, what are, other than maybe residency, kind of what are, what are some of the things that you're seeing in your practice that they should, should be aware of?
Timothy P. Noonan: Yeah. A lot of these questions will start with kind of the residency question. It's fun stuff for us because it's on both sides. Like we are Sure. We have, I have lots of clients who are selling their businesses and they want to maximize their take from the business and state taxes is a piece of that.
Then of course there's the, the folks who run these private equity companies who, I don't know if you've noticed, they make pretty good money too, right? So the individual state income tax on the players in these companies is a big deal. So, if someone's selling their company calls a lot, which is, we’ve got a letter of intent we're going to sell.
I'm, I live in New York City and my accountant just told me there's a 14% tax on a hundred million deal. That's 14 million. I don't want to pay that. We spent all this time in Florida already, like, I, I don't want to pay the tax. So, helping the, the sellers in that instance, Hey, just get it, get out of town.
Like move, get themselves set up so that they're not a resident of, of New York or wherever of California. When that deal hits like that, that's massive. So planning for those moves, has always been, been a large part of our practice. It's tougher when there's a transaction closing in three months and someone calls me and.
I mean, it just happened the other day. I'm selling my company for 40 million, transaction's going to close in Q1 2023. Okay. Well, where are you right now? In my big New York City apartment? Like, do you have anything in Florida? No, I don't like, all right. Okay. Let's get to work. Right? So, yep, so that's sort of on the seller side, there's those issues and then just like, how are our estate going to tax the gain on the sale? Yeah. Right. If you, if the seller sells stock, then theoretically they only owe tax in their state of residence, what I've seen, and I don't know if this is just the deals I see, I don't really see a lot of just straight up stock sales, right?
Like most people will sell assets Yep. Or they'll sell stock, but the, the buyer will want a three third day 10 election, so it gets treated on sale of assets. So, it's really sale of assets. Yep. Well then, that seller might have, they, they could set up shop in Florida just fine, but they could. Gain could be allocated to all these different states.
So, Correct. And again, that actually sometimes becomes a negotiated point on the buyer's side, I'm sorry, on the, on the seller side. And these deals like, wait a minute, wait a minute, I'm in Florida. If I sell stock, right, I don't pay any tax. You wanted me to sell assets. Well now I got to pay tax in 46 states.
What gives? So that becomes a negotiating point. Pay me more for my company because you're screwing me over. I got to pay all the state tax.
Stacey Roberts: No, absolutely. Absolutely. So, from a residency perspective, because we have enough work of our own here in at tax ops about that. But I guess in your opinion, or I guess, do you feel like there's a lot of differences between like some of the states with respect to, I, I know New York's very aggressive.
Right. But I guess from a. technical perspective on like the residency rules. Do you feel like New York's a little bit more like they're a tougher state to claim or to prove non residency than maybe another state? Yeah, I mean that's, I know that's kind of a loaded question because I, we sometimes get questions about like, is this state better than this state?
And yeah. , there's always gray, but the rules in most states are, are, are either similar or really the like someone leaving Colorado Yes.
Timothy P. Noonan: Yes. Is the same sort of you. Same residency test as someone leaving New York, there's a domicile test. There's like a day count test, like, so that California's rules are a little bit different, but they all sort of sound in the same concepts of this domicile thing.
So in that sense, the rules are the same. I think New York just being so aggressive, they don't have different tests really. They just, they're, they're more aggressive in enforcing those tests. The, the benefit is because of that and because there's such a long history in New York, sort of fighting these cases and there's like 300 tax auditors who do this work, there is lots of guidance out there as to what matters in these cases and what doesn't? There's, there's tons of cases. Sure. There's a hundred pages of audit guidelines where they sort of like, like the IRS has an audit manual. They have that for residency cases and non-resident allocation cases. It's awesome. Right? So, I mean, you have all this material out there to sort of guide a practitioner when they have an audit, whereas if someone leaves Colorado or something, it's like, well there's, I knows, no, there's no sort of wealth.
Precedent, , so, right. And the reason is because, well maybe Colorado isn't chasing people for the 5% or whatever tax there, I just think that's the, that's the difference. It has allowed us to sort of practice, especially in residency on a multi-state basis because of our experience just in dealing with the nuances of the residency rules that maybe haven't come up in a California case, but sure, it's the same test.
So, we're able to sort of apply that knowledge and helping. Folks navigate some of these, some of these issues in other.
Stacey Roberts: I could see that. Yeah, because I mean, and you got to think that even like a Colorado, which again may not be as aggressively pursuing residency audits at least today. Right, they would potentially look to some of those others.
I mean, and this happens all the time, not regardless of, , really what kind of ty type of tax it is or what the issue is, but they do look to other states for guidance as to Okay, how would they apply those rules? And we do the same thing in our practices. Yep. So, yes.
Timothy P. Noonan: Connecticut is their income tax is newer. It has been in place since the nineties. But there's tons of Connecticut income tax cases where the court says, well, we don't have anything on this, but there's a case in New York and since our laws are similar, similar, so there's in some sense, some instances that just, it's flat out reliant on what happens in New York.
So yeah, that's all, all helpful kind of knowledge and guidance as we're helping people manage these issues in other states. Sure.
Stacey Roberts: So I guess, what would be kind of like your, like take away for like a it doesn't even have to be like in a private equity firm who might be like going to look to acquire, but any kind of like acquirer kind of what would be, what would be kind of like the takeaway for, from your perspective for them to if they're looking to acquire a company from the sort.
Timothy P. Noonan: The, the private equity side of things? Yeah. Well, I mean, so there's, there's two aspects of it. One is, , what we talked about initially, which is make sure you're not buying a bag of goods that's got state tax problems up the ying yang. What I mean? . You got to do your due diligence there.
I mean, that's from the state tax perspective, that's what those, those folks need to have in mind. Just, just like we discussed and you get good accountants and lawyers to do your due diligence and. You'll find a lot of stuff under the rocks you uncover, but at least you're doing it before you, you buy the company and you, you ride off into the sunset.
The sort of taxation of this we talked about in our, uh, our, our seminar last week, the, the, the taxation of. So our private equity owners is interesting because they often will benefit from the sort of carried interest kind of concept, or a lot of their, , the, they'll, they'll have management sort of fee income and management fee income is, is taxable in states where the, the work is being done, even if you're not a resident of that state. A lot of the sort of wealth creation that happens for folks in the private equity world is through sort of pieces of the, of their target companies they acquire, and then when they sell, , again, it's.
Whatever that's called, I call it carried interest. But it's sort of their piece of these companies, well, that is almost always just treated as investment as capital gain. It's an, it's an intangible. So, in addition to the sort of the capital gain benefit of carried interest, which is a long, tortured thing about whether or not hedge fund folks and private equity owners should get sort of capital gains treat.
It has an important effect on state taxes too, because even though, I mean particularly like in the hedge fund context where you, you have the hedge fund owners receiving management fees and sort of incentive fees, , for their services. But yet the incentive fees are capital gain and the incentive fees aren't taxed in any non-resident states.
It's the same thing with the private equity folks who sort of sell, they have huge income events from a sale of a target. Well, they're not paying any income tax themselves personally on their piece in any states except the state where they're a resident. So, then the issue for them. So, on both sides, you could have the deal where the buyer wants to get out of New York and seller wants to get out California before this transaction happens to be 14% taxes, so you'll have both of them trying to leave. So the, the similar issue will come up on the, on the buyer side, on the, on the private equity side, just making sure that there's a real benefit to be had if you're living in a, in a no or low tax state. So that, that's a consideration that always comes up for those folks as well. Good.
Stacey Roberts: Okay. Good. We've kind of been talking about the private equity space, but one of the things that I think we as a firm do, and I'm sure that you guys do too, right, is, when we even maybe get a new client who's maybe they've been operating for a few years or whatever, we always ask about, Hey, do you, are you entertaining some kind of exit strategy?
And what is that going to be? Back to your point about planning because it's really important for things to be put in place for them to have the best tax outcome should they decide to sell.
Timothy P. Noonan: So, yeah, I was just working with a client this week and he was closely held, company S corporation, and he had sort of engaged us to help him move into Florida, wanted to make sure that sort of the way his income from this s corporation was most tax efficient, wasn't taxed in New York. And in looking at the sort of shareholders agreement and such, we're like, well, problem here is what you have set up like forget about the New York thing. New York thing's great. We got a good plan. But if the IRS ever looked at this like they'd, they'd void your US election, right? So, they were basically paying out all the salaries of the owners and it was, it wasn't great. It's a little, that kind of stuff is kind of outside my wheelhouse.
But I grabbed one of one of my federal tax partners and he was like, yeah, this is, this is super bad from an s election standpoint. But they've been around. Decades and no one's ever raised it. And , a client was like, okay, well thanks for pointing that out, but what am I going to do about it?
Like, it is what it is. And, who cares? Because the IRS hasn't brought it up. New York's probably not going to bring it up. But the issue was, well, do you want to sell? Oh yeah, we might sell in five years. Well, I tell you what, that buyer is not going to be happy that the company it's acquiring has had a blown s selection for 20 years. Right. So, knowing. The long-term picture becomes super important in, in situations like that. Agreed. Yeah.
Stacey Roberts: Okay. Well, thanks everybody for joining us today on Saltovation and a special thanks to Tim for joining us as our special guest and. We'll catch you next time. All right. Thanks for having me.
Sign up to receive email updates
Enter your name and email address below and I'll send you periodic updates about the podcast.