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PC Partners Face NY Tax Challenge: Will Other States Follow?
Last year, we informed LFPBR readers of the rediscovery by some partners in multi-state partnerships of the benefits of becoming a professional corporation ('PC') partner in their law firms, primarily to obtain state income tax savings. See, Banoff, 'To PC or Not to PC: The Rise and Fall and Rise (Again) of Professional Corporation Partners in Law Firms,' LFPBR, Vol. 12, No. 9 (Oct. 2006), p. 1. We observed that some firms have accommodated (and in some cases encouraged) some of their partners to consider the incorporation alternative. As discussed below, New York recently enacted legislation that would potentially adversely affect that strategy, including those who incorporated long before the legislation was passed, and it is unclear whether other states may follow.
Anecdotal evidence indicates a rebirth in recent years in the use of PCs for partners of profitable multi-state law partnerships, to provide aggregate (multi-state) income tax savings for some or many of the firms' highly paid partners. The PC structure is particularly useful for highly profitable law firm partnerships, limited liability partnerships ('LLPs'), and limited liability companies ('LLCs') ' taxable as partnerships that have a substantial amount of their income attributable to offices in states having high income tax rates applicable to individual partners.
In a typical favorable scenario, the firm will have at least one office located in a zero or low individual income tax rate state (e.g., Florida, Texas, or Illinois) and at least one other office in a relatively high tax bracket state (e.g., California or New York). Due to long-established rules on apportionment of a partnership's income for state income tax purposes, those partners who physically reside and practice primarily in the zero or low tax rate state nonetheless are subject to a substantial out-of-state tax liability. If a substantial portion of the firm's income is allocable to high-rate states, the problem is magnified.
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