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(1) Ordinary and necessary expenses, other than interest expense on borrowed money (see subdivision [i] of this section), paid or incurred during the taxable year for (i) the production or collection of income which is subject to New York State personal income tax but exempt from Federal income tax (including that portion of an exempt-interest dividend, as described in section 852[b][5] of the Internal Revenue Code, that is taxable for New York State personal income tax purposes), or (ii) the management, conservation or maintenance of property held for the production of such income, and the amortizable bond premium for the taxable year on any bond the interest income on which is subject to New York State personal income tax but exempt from Federal income tax; to the extent that such expenses and premiums are not deductible in determining Federal adjusted gross income and are attributable to a trade or business carried on by the taxpayer. Expenses and amortizable bond premium otherwise allowable which are directly attributable to any class of income (either taxable or exempt for New York State personal income tax purposes) must be allocated to the class to which they relate, and if an item of expense or premium is attributable to both taxable and exempt income, a reasonable portion thereof, based on all facts and circumstances, must be allocated to each class. (See section 612[c][10] of the Tax Law.)
(2) Income which is subject to New York State personal income tax but exempt from Federal income tax consists primarily of interest income on obligations of other states and their municipalities (see section 112.3[a] of this Part) and of certain Federal authorities, commissions and instrumentalities which the laws of the United States exempt from Federal income tax but not from state income taxes. (See section 112.2[b] of this Part.) Expenses, other than interest expense, which are attributable to the production or collection of such income or the management of such securities are fully deductible in determining Federal adjusted gross income, provided they are business expenses. Consequently, no modification of adjusted gross income will ordinarily be allowable with reference to such expenses. Where expenses of this type are nonbusiness expenses, as in the case of an individual investor, a modification of Federal itemized deductions will be allowable; see section 115.3(c) of this Article.
(3) With reference to any amortizable premium on bonds whose interest is exempt from Federal income tax, a modification of Federal adjusted gross income is allowable under this section, provided such amortizable premium for the taxable year is attributable to a trade or business carried on by the taxpayer. An individual engaged in business as a building contractor owns state and local bonds (other than bonds issued by New York municipalities) which such individual posts as security in lieu of performance bonds to guarantee completion of contracts entered into in the course of business operations. Where such bonds are purchased at a premium, the taxpayer is required to amortize the premium under the Internal Revenue Code even though no deduction for the amortized premium is allowed in determining Federal adjusted gross income. Since the bonds are used in the taxpayer's contracting activities, the premium which is amortized is attributable to a trade or business carried on by such taxpayer, and the amount allocable to the taxable year, computed in accordance with the Federal rules regarding amortization of bond premiums, is to be deducted from Federal adjusted gross income in determining New York adjusted gross income.