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Tax Appeals Tribunal

State of New York

*1 IN THE MATTER OF THE PETITION OF PETER F. AND BARBARA D. MCSPADDEN

FOR REDETERMINATION OF A DEFICIENCY OR FOR REFUND OF NEW YORK STATE AND NEW

YORK CITY PERSONAL INCOME TAX UNDER ARTICLE 22 OF THE TAX LAW AND THE NEW YORK

CITY ADMINISTRATIVE CODE FOR THE YEAR 1988.

DTA No. 810895

TSB-D-94(32)I

September 15, 1994

Opinion

The Administrative Law Judge held that petitioner possessed a right to future employment through December 31, 1990 secured by his employment contract with DFS, the remaining term value of which was an item of intangible personal property. The Administrative Law Judge then concluded that the lump-sum payment of $1,850,000.00 was received for petitioner's relinquishment of this right and, thus, was not taxable by New York. The Administrative Law Judge held that this lump-sum payment was not taxable as compensation for personal services because it was neither an amount received in connection with the termination of employment, an amount received upon early retirement for past services, an amount for consultation services, nor an amount received in consideration for a covenant not to compete.

*5 On exception, the Division asserts that the lump-sum payment was a taxable New York source income because it was an amount: (1) received in connection with the termination of employment; (2) received upon early retirement for past services rendered; (3) received upon retirement for consultation services; or (4) received upon retirement in consideration for a covenant not to compete. In the alternative, the Division argues that if the lump-sum payment was received in exchange for petitioner's relinquishment of his right to future employment, the right to future employment was secured by consideration having a connection with New York State and, thus, properly taxable by New York.

In response, petitioner asserts that the lump-sum payment was not attributable to personal services rendered in the past or to be rendered in the future. Instead, petitioner contends that the lump-sum payment was received in exchange for his relinquishment of the right to future employment and this right had no connection to New York sources. Petitioner also takes offense to the different litigation positions taken by the Division with respect to the characterization of the lump-sum payment in this case compared to that of Matter of Laurino (Tax Appeals Tribunal, May 20, 1993). Finally, petitioner argues that no amount of the lump-sum payment be allocated to the covenant not to compete because there was no amount assigned to this covenant in the termination agreements nor is it likely the covenant not to compete would have been enforceable.

We affirm the determination of the Administrative Law Judge for the reasons set forth below.

Tax Law § 601(e) imposes a tax on the New York source income of a nonresident individual. New York source income of a nonresident individual is defined as "the sum of the net amount of items of income, gain, loss and deduction entering into his federal adjusted gross income . . . derived from or connected with New York sources . . . " (Tax Law § 631[a], emphasis added).

Petitioner argues that under Matter of Donahue v. Chu (104 AD2d 523, 479 NYS2d 889), the lump-sum payment received by petitioner, a nonresident of New York, from petitioner's former employer was consideration for the relinquishment of his right to future employment and is not subject to taxation by New York. We agree.

Petitioner's employment contract provided petitioner with employment through December 31, 1990. Petitioner and his employer negotiated a settlement wherein it was agreed petitioner would relinquish his contractual rights under the employment agreement in exchange for a lump-sum payment of $1,850,000.00. Petitioner's rights under the employment agreement were originally secured by consideration having no connection to New York, i.e., petitioner's promise to work for DFS in the future (Matter of Donahue v. Chu, supra; Matter of Laurino, supra). Therefore, the lump-sum payment received by petitioner is not taxable by New York.

*6 The Division, citing Matter of Donahue v. Chu (supra), argues that had petitioner continued in the employ of DFS, the contract rights would have been exercised in New York and, thus, are subject to taxation by New York. The Division points to paragraph 6 of the employment agreement which provided that petitioner would "not be required to perform duties which require that his principal office, or his residence be maintained outside the City of New York, New York, or its vicinity . . . " (Amended and Restated Employment Agreement, July 1, 1987). The Division, however, overlooks the fact that this provision of the employment agreement was DFS' promise to petitioner and not a promise made by petitioner to work in New York. Furthermore, the employment agreement provided that petitioner could have consented to work outside of New York if he so desired.

Additionally, the Division asserts that because it was elicited from petitioner on cross-examination that petitioner would have continued to work in New York had he continued in the employ of DFS (Tr., p. 54), the lump-sum payment is taxable by New York. We reject this argument. The evidence the Division relies on is speculative at best and does not support a conclusion that petitioner's contractual rights would have been exercised in New York had his employment continued (see, Matter of Donahue v. Chu, supra).

Next, we address whether the lump-sum payment was received in consideration for the covenant not to compete.

The Division argues that the lump-sum payment petitioner received was an amount received upon retirement under a covenant not to compete and, thus, taxable as compensation for personal services pursuant to 20 NYCRR 131.4(d). We disagree.

The termination agreement stated that in consideration of the lump-sum payment and notwithstanding any of the other provisions, the restrictive covenant dated January 1, 1986 would remain in effect. While the Division asserts that the covenant was such an integral part of the termination agreement so as to subject the lump-sum payment to tax, we disagree. The restrictive covenant referenced in the termination agreement was already secured by consideration. Specifically, in the restrictive covenant, petitioner agreed that in consideration of his continued employment, he would abide by the terms of the restrictive covenant during the duration of his employment and for a period of two years thereafter. "A covenant to do what one is already under a legal obligation to do is not sufficient consideration for another contract" (Ripley v. International Rys. of Cent. Am., 8 NY2d 430, 209 NYS2d 289, 295). Because it appears that petitioner was already legally bound by the terms of the restrictive covenant executed on January 1, 1986, we conclude that petitioner's promise to abide by the terms of the restrictive covenant was not consideration for the lump-sum payment. Instead, as discussed, we agree with petitioner that the lump-sum payment was an amount received in exchange for relinquishment of future contractual rights.

*7 Finally, the Division argues that the lump-sum payment was received in connection with the termination of employment, received upon early retirement in consideration of past services, or received upon retirement for consultation services. Likewise, we reject this argument.

The Division merely makes these allegations and does not direct the Tax Appeals Tribunal to any evidence in support of their contentions. In fact, as the Administrative Law Judge noted in his determination, the facts do not support a conclusion that the lump-sum payment represented any of these things.

Accordingly, it is ORDERED, ADJUDGED and DECREED that:

1. The exception of the Division of Taxation is denied;

2. The determination of the Administrative Law Judge is affirmed;

3. The petition of Peter F. and Barbara D. McSpadden is granted to the extent indicated in the Administrative Law Judge's conclusion of law "E" but is otherwise denied; and

4. The Division of Taxation is directed to modify the Notice of Deficiency dated December 6, 1990 in accordance with paragraph "3" above and refund to petitioner such sum computed in accordance with this recomputation.