Own a Second Home in New York? Prepare for a Higher Tax Bill.

The state of New York seems to have found a novel way to raise the revenue needed to close its substantial budget gap:  tax people who don't live there.

A New York court ruled last month that all income earned by a New Canaan, Conn., couple is subject to New York state taxes because they own a summer home on Long Island they used only a few times a year. They have been hit with an additional tax bill of $1.06 million.

Tax experts and real estate brokers say this ruling could boost the tax bill for thousands of business executives who own New York City apartments they use only occasionally. It could also hurt sales in the Hamptons and New York's other vacation-home communities.

"People will think twice about spending any summer time in New York," says Robert Willens, a New York-based tax consultant. "The amount of tax they could be subjected to is likely to outweigh the benefit."

A spokesman for the state Taxation Department issued a written statement that said it was "pleased" with the decision. "However, these cases are fact-intensive and as such each case stands on its own specific fact pattern," it said.

For years, New York law stated that residents of another state who spend more than 183 days a year in New York have to pay taxes on any income they make in this state. But they generally haven't had to pay New York taxes on income they make outside of the state or on their spouses' income if they work elsewhere.

Under the recent ruling, this might change for many out-of-state residents who own vacation homes or apartments here. In effect, it reinterprets what counts as a permanent residence.

In defining a "permanent place of abode," New York tax code specifically excludes "a mere camp or cottage, which is suitable and used only for vacations." New York tax experts say the new ruling is the first they recall that counts summer homes as permanent residences.

"This is going to open up a Pandora's box," says Eric Kramer, a tax attorney in Uniondale, N.Y. "I don't think anyone previously thought vacation homes would count as a permanent residence."

Income that now could be taxed by New York includes capital gains, dividends and securities, attorneys said. In the event of an audit, these homeowners would also be responsible for back taxes, plus interest and penalties, as a result of their New York property.

Judge Joseph Pinto, a New York administrative law judge, made the novel ruling in a 2009 case that was affirmed last month on appeal by the New York state tax appeals tribunal. Mr. Pinto seized on what is meant by a permanent residence, which is the benchmark for whether all, or just the in-state portion, of an individual's income is subject to New York state tax.

Mr. Pinto ruled that the couple's Long Island vacation home qualifies under the law as a permanent abode because it was suitable for living year-round--whether or not the couple actually stayed in the home wasn't relevant. Under the ruling, if an owner doesn't spend a single a day in a home it could still count toward a permanent residence.

I'm told that, rather hilariously, the New York state tax department used to spy on one of the Rockefellers, hoping to catch him in his New York abode for more than the 180 days he was legally allowed to spend there without paying taxes on out-of-state income.  As far as I know, they never did catch him.

This seems like an even more heroic long shot.  These people don't live in the state, yet now the state thinks that it's supposed to take a substantial slice off the top even of income that wasn't earned in the state, because one person works in the city, and they bought a house in the Hamptons?  It seems a little odd to tax people based on where they vacation.  And I expect that the primary effect will not be to generate new revenue for the state--though I imagine that there will be a temporary windfall as the state revenue department combs through real estate records in Manhattan and the Hamptons.  Rather, I expect a massive sell-off of second homes.  New York has some of the highest tax rates in the country.  No one is going to voluntarily subject themselves to such rates just for the dubious privilege of having their own apartment in New York.  There are hotels for that.

I don't even see how New York can assert the authority to tax the same income after Connecticut has already (quite properly) levied its full income tax on legal residents of the state.  I presume it envisions a situation like its revenue-sharing deal with New Jersey, or the US federal tax on corporate income earned abroad.  But as I understand it, the revenue sharing deal means that people who live in one state and work in another pay the same as, or less than, they would otherwise in taxes.  In this case, New York seems to be trying to levy a gratuitous 2% income tax on wealthy vacationers. 

On a positive note, small New York apartments and large Hamptons beach homes should be more plentiful and affordable than they have been in years . . .