California Allows OSTC for New York Metropolitan Commuter Transportation Mobility Tax

The state of California’s position regarding the ability for residents to claim an Other State Tax Credit (OSTC) for the New York Metropolitan Commuter Transportation Mobility Tax (MCTMT) has changed following a decision by the Office of Tax Appeals for the State of California in February 2024. As ruled in the Matter of the Appeal of Mather v. Franchise Tax Board, OTA Case No. 18093787 (Cal. Office of Tax Appeals, Feb. 16, 2024), California residents may take a credit for the MCTMT paid if the liability is calculated in substantially the same manner as California’s individual income tax. Also worth noting is that the OTA affirmed the State’s position that city taxes, such as the New York City Unincorporated Business Tax, are not creditable for California residents. The decision is not precedential; however, the State does not appear to plan to appeal the decision.  

Pass-through entities that do substantial business in both California and New York and have California resident partners may be impacted by this ruling. While the ruling appears favorable for California resident taxpayers, it may have unintended tax implications for residents striving to minimize double taxation of state-sourced income outside California.

Under R&TC section 18001(a), residents are allowed the OSTC against California’s net tax for “net income taxes” imposed by and paid to another state. In applying the principles of whether a tax is characterized as an income tax, the OTA concludes the MCTMT’s self-employment tax is based on net income. However, in the Matter of the Appeal of Mather, the OTA disallowed the appellant’s OSTC, stating the appellants had not met the burden of demonstrating the correct amount of the OSTC allowed under California’s statutory OSTC limitation formula.

The OSTC amount allowed must be calculated “on income derived from sources within that state,” which is determined by applying California’s nonresident sourcing rules under R&TC section 17951. The taxpayer is allowed a credit equal to the lesser of the tax the taxpayer would have paid, if any, to the other state using California’s nonresident sourcing rules or the tax actually paid to the other state. At issue in the Appeal of Mather, which ultimately led to the denial of the appellant’s OSTC by the OTA, is that California requires using a single-sales factor formula and market-based sourcing. In contrast, the MCTMT is calculated using a three-factor, equally-weighted formula composed of property, payroll, and gross receipts within the metropolitan commuter transportation district (MCTD) divided by property, payroll, and gross receipts everywhere, with gross income within the MCTD determined by cost of performance (i.e. the location where the income-producing activities are performed).

While the OTA’s decision may be favorable for California resident taxpayers, the ruling presents an unexpected challenge to pass-through entities to ensure that they have provided partners, members, or shareholders the appropriate information to calculate the OSTC under California’s nonresident sourcing rules.

Typically, pass-through entity owners are provided state Schedules K-1 that disclose state-sourced income and/or loss, withholding or composite taxes paid on the owner’s behalf, and, although less common, the property, payroll, and gross receipts attributable to the state, as used for apportionment purposes. What the states do not require be disclosed on the Schedules K-1 are gross income calculated under different sourcing methodologies; for example: market-based versus cost of performance sourcing. Therefore, the pass-through entity would have to provide substantially more information to Schedule K-1 recipients for California resident taxpayers to recalculate tax liabilities paid to other states under California’s nonresident sourcing rules before claiming the correct OSTC.

It has become increasingly imperative that pass-through entities that have multistate activity and California resident owners take into consideration all applicable information that may be required for California residents to calculate the correct OSTC. This is essential to avoid double taxation and to prepare for what is sure to be the FTB’s greater scrutiny of taxpayers’ OSTC claims.

Finally, California resident partners should consider filing refund claims for all open tax years to claim credit for MCTMT taxes paid to New York on their self-employment income. However, taxpayers must use caution before filing refund claims if they believe that the OSTC claimed for New York state may have been calculated based on New York’s sourcing rules versus California nonresident sourcing rules.