With state legislative season in full swing, several states adopted provisions reducing income tax rates, evaluating their income tax conformity policy to the Internal Revenue Code, and creating or adjusting pass-through entity tax regimes. In the courts, a New York decision addressed the applicability of the reduced corporate income tax rates on manufacturers, and a Washington court decision denied a Business & Occupation tax deduction for investment income. Find out more about these and other stories in our roundup of SALT news for April 2023.
Arizona advances IRC conformity, clarifies applicable tax rate for PTE tax
In March 2023, Arizona enacted legislation, S.B. 1171, advancing the IRC conformity date, and S.B. 1473, which clarifies the tax rate that applies to entities that make the pass-through entity (PTE) tax election.
For taxable years beginning from and after Dec. 31, 2022, S.B. 1171 generally adopts the IRC as in effect on Jan. 1, 2023. Under existing law, for taxable years beginning from and after Dec. 31, 2021 through Dec. 31, 2022, Arizona generally adopts the IRC as in effect on Jan. 1, 2022. Under S.B. 1171, Arizona expressly adopts for the 2022 tax year the provisions of the Chips and Science Act of 2022 (P.L. 117-167), Inflation Reduction Act of 2022 (P.L. 117-169), and the Consolidated Appropriations Act, 2023 (P.L. 117-328) that are retroactively effective for the 2022 tax year.
On March 28, 2023, Arizona enacted legislation, S.B. 1473, clarifying that partners or shareholders of a flow-through business electing to be subject to Arizona’s PTE tax are taxed at the highest Arizona individual income tax rate. Prior to amendment, the PTE tax was imposed at the individual income tax rate, but there was no indication that the highest individual income tax rate applied. This legislation is effective 91 days after adjournment of the legislative session.
Arkansas reduces income tax rates, phases out throwback rule
On April 10, 2023, Arkansas enacted legislation reducing corporate and individual income tax rates for the 2023 tax year and beyond, and phasing out the throwback rule over a period of several years. S.B. 549 reduces the top corporate income tax rate imposed on both domestic and foreign corporations from 5.3% to 5.1%, and reduces the top income tax rate for individuals, trusts, and estates from 4.9% to 4.7%. As Arkansas employs separate tax rate tables for standard income and upper income individual, trust, and estate taxpayers, the legislation provides adjustments to maintain a smooth transition between these tables. Further, the threshold at which an individual, trust, or estate taxpayer becomes subject to the upper income tax table has been raised from $84,500 to $87,000.
H.B. 1045 phases out the throwback rule beginning in the 2024 tax year until it is completely eliminated for tax years beginning in 2030 and thereafter. Under current law, the throwback rule provides that sales of tangible personal property are fully sourced to Arkansas if the property is shipped from Arkansas and: (i) the purchaser is the U.S. government; or (ii) the taxpayer is not taxable in the state of the purchaser. As amended, during the phase-out period, sales of tangible personal property are partially sourced to Arkansas if the property is shipped from Arkansas and the taxpayer is not taxable in the state of the purchaser. For tax years beginning in 2024, 6/7 of such sales are sourced to Arkansas and 1/7 of such sales are sourced outside the state. Each year, the portion of such sales sourced to Arkansas is reduced by 1/7, until the throwback rule is eliminated for tax years beginning in 2030. Further, the legislation eliminates (rather than phases out) the throwback rule for purchases made by the U.S. government for tax years beginning in 2024 and thereafter.
Kentucky advances IRC conformity, amends sales tax on services, enacts elective PTE tax
On March 24, 2023, Kentucky enacted major tax legislation, H.B. 360, which updated IRC conformity, clarified the treatment of certain government grants, amended sales tax provisions relating to services, and added an elective PTE tax. On March 31, 2023, Kentucky enacted legislation, H.B. 5, repealing the recently enacted PTE tax legislation and enacting a revised PTE tax.
For taxable years beginning on or after Jan. 1, 2023, H.B. 360 generally adopts the IRC as in effect on Dec. 31, 2022. Prior to amendment, for taxable years beginning on or after Jan. 1, 2022, Kentucky generally adopted the IRC as in effect on Dec. 31, 2021. For taxable years beginning on or after Jan. 1, 2020, but before March 11, 2023, Kentucky adopts the federal treatment of restaurant revitalization grants that excludes these grants from taxable income.
In April 2022, Kentucky enacted legislation, H.B. 8 (Laws 2022), which significantly expanded Kentucky’s sales and use tax base to include 35 new types of taxable services effective Jan. 1, 2023. Under this legislation, the specified services are subject to Kentucky’s full 6% sales and use tax rate. H.B. 360 makes numerous amendments to the sales and use tax provisions on services that are retroactively applicable to Jan. 1, 2023. The new legislation includes various changes to definitions that are intended to assist with the administration of the tax on services, and refines the scope of some of the services that would have been taxable under the original legislation. As an example, the legislation removes marketing services from the list of taxable services and confirms that separately stated onsite security guard services are excluded from taxable security system monitoring services. The legislation clarifies that “testing services” subject to tax are laboratory testing services and exclude laboratory testing required by state, local, or federal governments. Also, taxable “prewritten computer software access services” exclude services sold to a retailer that develops prewritten computer software for print technology and uses and sells prewritten computer software access services for print technology. Finally, the imposition of tax on the rental of space for short-term social events (like meetings, conventions and weddings) excludes the sublease or subrental of the space if the tax is paid by the primary lessee to the lessor.
For taxable years beginning on or after Jan. 1, 2022, H.B. 5 enacts a PTE tax election. An authorized person (able to bind the electing entity or sign returns on its behalf) may elect annually to have the individual income tax imposed upon the electing entity and based upon the ordinary income and the separately stated items of income calculated under the statute for filing PTE returns. The statute includes provisions for making the election. A refundable PTE tax credit is available which is: (i) equal to 100% of the entity owner’s proportionate share of the tax paid by the PTE for the taxable year; (ii) claimed against individual income tax; and (iii) based on the pro rata share of the entity owner’s income from the PTE.
Mississippi allows research expensing, amends elective PTE tax
On March 27, 2023, Mississippi enacted legislation, H.B. 1733, which allows research and experimental (R&E) expensing, 100% bonus depreciation, and codifies IRC Sec. 179 property expensing for tax years beginning in 2023 and thereafter. On the same day, Mississippi enacted separate legislation, H.B. 1668, amending the elective PTE tax. The Mississippi Department of Revenue has released updated guidance to address the PTE tax legislation.
Under IRC Sec. 174, prior to enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers were allowed the option to currently deduct R&E expenditures or treat such expenditures as deferred expenses to be capitalized and amortized over their life. As amended by the TCJA, for amounts paid or incurred in tax years beginning in 2022 and thereafter, all taxpayers are required to capitalize R&E expenditures over a five-year period for domestic expenses and 15 years for foreign expenses. H.B. 1733 expressly decouples from this treatment for tax years beginning in 2023 and beyond, allowing taxpayers in Mississippi to immediately deduct R&E expenditures that are paid or incurred in connection with their trade or business. This deduction is allowed notwithstanding any federal changes that may be made in the future that are related to the depreciation of R&E expenses. However, taxpayers may elect to follow the R&E depreciation provisions under IRC Sec. 174. This is a significant development because few states have enacted legislation that expressly decouples from IRC Sec. 174 and allows taxpayers to continue to deduct R&E expenses. However, there is a one-year gap in the effective dates between the federal change and the Mississippi decoupling legislation.
The TCJA provided 100% bonus depreciation under IRC Sec. 168(k) for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The federal bonus depreciation deduction will be phased out in 20% annual increments, with a complete elimination of bonus depreciation beginning in 2027. As added by H.B. 1733, for tax years beginning in 2023 and thereafter, expenditures for business assets that are qualified property or qualified improvement property will remain eligible for 100% bonus depreciation in Mississippi and may be deducted as an expense in the tax year the property is placed in service, notwithstanding any changes to federal law related to cost recovery. Consistent with the election to continue to follow federal R&E depreciation provisions, the taxpayer may separately elect to depreciate the business assets under IRC Sec. 168 instead of applying 100% bonus depreciation.
IRC Sec. 179 allows taxpayers to expense certain types of depreciable business assets during the tax year that the property is placed in service. The TCJA increased the IRC Sec. 179 expensing limit to $1 million for tax years beginning after 2017 and increased the start of the phaseout to $2.5 million. Under a new provision added by H.B. 1733, in any taxable year in which any IRC Sec. 179 property is placed in service, a taxpayer may elect to treat the cost of such property as an expense which is not chargeable to a capital account, and any cost so treated is allowed as a deduction for that year. The legislation provides that Mississippi’s treatment of this deduction conforms to the provisions of IRC Sec. 179 for that year. In 2019, the Mississippi Department of Revenue issued Notice 80-19-001, confirming that the state follows IRC Sec. 179 and the changes enacted by the TCJA. The guidance cited a Mississippi regulation that adopts IRC Sec. 179. This legislation codifies Mississippi’s conformity to this federal provision.
For income tax returns with an original due date on or after Jan. 1, 2023, H.B. 1668 amends the elective PTE tax. On April 5, 2023, the Mississippi Department of Revenue issued updated guidance, Notice 80-23-001, which addresses the recent legislation. The legislation changes the method by which a flow-through entity makes a PTE tax election. As amended, the election must be made by the due date of the return for the tax year, or by the date the return is filed, whichever is later. The pro rata share of each owner of an electing PTE is used in computing the taxpayer’s gross income tax liability. Any additional income tax credits generated by the electing PTE pass through to the owners on a pro rata basis and may be claimed on the returns of those taxpayers. If the aggregate credits exceed the income tax liability of the owner, the excess is carried forward as an overpayment or refunded at the election of such person. Any carryforward limitations applicable to credits generated by the electing PTE, other than the credit for income taxes paid by the electing PTE, apply at the owner level.
New York ALJ rules manufacturer not entitled to use reduced corporate tax rates
On March 16, 2023, a New York Division of Tax Appeals (DTA) Administrative Law Judge (ALJ) ruled in Matter of Raytheon Co. that Raytheon (and its combined group) was ineligible to use the reduced corporate franchise tax rates that were available to certain manufacturers during the 2010-2015 tax years at issue. While the standard corporate franchise tax rate during the years at issue was 7.1% on entire net income, qualified New York manufacturers could use a 6.5% rate (in 2010-2013) or 0% rate (in 2014-2015), eligible qualified New York manufacturers could use a 3.25% rate (in 2012-2014), and qualified emerging technology companies (QETC) could use a 5.9% rate (in 2014) and 5.7% rate (in 2015).
During the tax years at issue, a corporation (or combined group) was considered a “qualified New York manufacturer” if: (i) it was a manufacturer (receipts and activities tests); (ii) it had manufacturing property in New York eligible for the investment tax credit and principally used to produce goods; and (iii) either the adjusted basis of that property for federal income tax purposes was at least $1 million or all of the manufacturer’s real and personal property was located in New York.
Raytheon is a defense contractor primarily engaged in manufacturing state-of-the art products for the U.S. military, various intelligence agencies, and international governments. During the years at issue, Raytheon had employees and offices in New York and its combined group manufactured approximately 95% of the products that it sold through its business segments. However, neither Raytheon (nor any members of its combined group) had at least $1 million of manufacturing property in New York. As a result, the ALJ denied Raytheon’s use of the reduced tax rates as it did not meet the requirements to be considered a qualified New York manufacturer or an eligible qualified New York manufacturer.
The ALJ also rejected Raytheon’s argument that its status as a QETC (on a standalone basis) permitted its entire combined group to use the reduced tax rates available to qualified New York manufacturers (2010-2013) and QETCs (2014-2015). For the 2010-2013 tax years, the definition of a qualified New York manufacturer also included a QETC. The ALJ concluded that each member of a combined group must meet the definition of a QETC to qualify, despite acknowledging that Raytheon reported 95% of the combined group’s activity and otherwise met the definition. Raytheon’s alternative request to compute its tax due on a separate entity basis also was denied.
In its petition, Raytheon’s primary argument centered around a violation of the Dormant Commerce Clause of the U.S. Constitution. State laws may violate the Dormant Commerce Clause by discriminating against or placing an “undue burden” on interstate commerce. In general, state tax laws may not favor local businesses, products, or activities. Here, Raytheon argued that the law requiring a corporation (or combined group) to have manufacturing property in New York to qualify for the reduced tax rates violates the Commerce Clause (on its face and as applied) because it creates a competitive disadvantage for certain manufacturers.
Because the DTA lacks jurisdiction to consider the facial validity of statutes, Raytheon’s Commerce Clause arguments were not addressed in this decision. Raytheon has until mid-April to appeal this decision to the New York Tax Appeals Tribunal. However, its Commerce Clause challenge cannot be ruled on until the appeal reaches the New York Supreme Court’s Appellate Division. In many cases, if state tax benefits or incentives are deemed unconstitutional, one of two remedial approaches will apply: give them to everyone or take them away from everyone. Manufacturers should monitor this appeal to see how the situation will be remedied should the law be deemed unconstitutional.
North Carolina updates IRC conformity, expands PTE tax election
On April 3, 2023, North Carolina enacted legislation, S.B. 174, which advances the IRC conformity date, clarifies the apportionment method for sole proprietorships, creates a 10-year statute of limitations on tax collections by the North Carolina Department of Revenue, and significantly amends the elective PTE tax. On April 4, 2023, the Department issued guidance, Important Notice: Session Law 2023-12, which discusses the PTE tax amendments.
Effective on the day of enactment, North Carolina advanced its IRC conformity date from April 1, 2021, to Jan. 1, 2023. Also, legislation clarifies that sole proprietorships follow the apportionment methodology used by corporations. Existing law requires PTEs to follow the same rules as multistate corporations for dividing income among states. The Department currently requires multistate sole proprietorships to follow the same rules as multistate PTEs. This legislation codifies the Department's current practice.
S.B. 174 creates a 10-year statute of limitations on tax collections by the Department that is effective on April 3, 2023. The 10-year statute of limitations begins on the date the taxes become collectible by the Department and may be tolled under certain circumstances. If the tax is not collected by the Department within the statute of limitations, the remaining liability is abated. As explained by the legislative summary, prior to this legislation, there was no codified statute of limitations on taxes that became collectible by the Department unless a certificate of tax liability was docketed. In this case, the Department would have 10 years from the date it was docketed to collect the tax. The legislation creates a 10-year statute of limitations from the date the taxes become collectible regardless of whether a certificate of tax liability has been docketed.
In November 2021, North Carolina enacted an elective PTE tax that is available for taxable years beginning on or after Jan. 1, 2022. S.B. 174 recently made numerous changes to the PTE tax. As discussed below, some of the changes are effective retroactively for taxable years beginning on or after Jan. 1, 2022. The Department’s notice explains that some taxpayers may need to file an amended return for the 2022 tax year. Other amendments, however, are effective for taxable years beginning on or after Jan. 1, 2023.
Effective for taxable years beginning on or after Jan. 1, 2022, S.B. 174 expands the PTEs that may make a PTE tax election by adding partnerships and S corporations to the permissible owners of a partnership. Prior to amendment, North Carolina did not allow a partnership to make the election if a partner was part of a tiered partnership structure, or was an S corporation. Also, tiered partnerships that make the PTE tax election are required to withhold tax on behalf of nonresident partners. The instructions to the 2022 North Carolina partnership return have been updated to assist partnerships that are owned by a pass-through partner.
S.B. 174 also expands the individual income tax credit for taxes paid to another state by a PTE. Existing law allows an individual who is both a resident of North Carolina and subject to another state’s income tax to claim a credit for the income tax that the individual pays to the other state. North Carolina law provided a limited exception for a resident shareholder of an S corporation, but there was no exception for a resident partner of a partnership. Effective for taxable years beginning on or after Jan. 1, 2022, S.B. 174 enacts provisions allowing a North Carolina resident individual owner of a partnership or S corporation to claim the credit for taxes paid to another state when the income tax is paid by the partnership or S corporation. Under the new provisions, a resident owner only may claim the credit if the PTE does not make the PTE tax election in North Carolina. The Department’s guidance provides instructions for claiming the credit and for amending North Carolina partnership and individual income tax returns for the 2022 tax year.
Effective for tax years beginning on or after Jan. 1, 2023, S.B. 174 modifies the calculation of the PTE tax by excluding certain income from the entity-level tax calculation. Income sourced outside North Carolina is no longer included in the PTE’s taxable income. The legislation also makes the PTE tax election irrevocable.
Texas Comptroller amends service sourcing regulation
Effective March 14, 2023, the Texas Comptroller of Public Accounts amended the apportionment regulation concerning the sourcing of service revenue in response to the Texas Supreme Court's decision in Sirius XM Radio, Inc. v. Hegar from March 2022. In this case, the court rejected the Comptroller’s use of the location of the “receipts-producing, end-product act” test to source revenue as provided in the Comptroller’s regulation. The court determined that the service revenue should be sourced to the state where the service is performed. Specifically, the court held that a satellite radio producer and distributor should source its subscription receipts based on the location where the radio programming was produced rather than where its subscribers received the radio signal.
The amended regulation deletes the “receipts-producing, end-product act” test and provides that a service is performed at the location or locations where the taxable entity’s personnel or property are doing the work that the customer hired the taxable entity to perform. Activities that are not directly used to provide a service are not relevant when determining the location where a taxable entity performs a service. The regulation continues to provide that if services are performed both inside and outside Texas for a single charge, the receipts are sourced to Texas on the basis of the fair value of the services that are performed in the state. The cost of performing a service does not necessarily represent its value. The regulation is amended to clarify that if costs are considered, costs should be limited to the direct costs of doing the work that the customer hired the taxable entity to perform and should not include any costs that are not directly used to provide a service to the customer. Taxpayers will need to consider whether their historic and current sourcing methodology for sales of services is consistent with the Sirius decision and the new regulation.
Virginia adopts significant corporate / PTE tax legislation
Virginia enacted legislation during March and April 2023 addressing its conformity to the IRC, providing targeted changes to the corporate income tax apportionment formula and filing methods, and modifying the elective PTE tax.
On April 12, 2023, Virginia enacted legislation, H.B. 2193 and S.B. 1405, which for taxable years beginning after Jan. 1, 2023, generally adopts the IRC as currently amended rather than the IRC as of a fixed date (earlier this year, Virginia moved its IRC conformity date from Dec. 31, 2021 to Dec. 31, 2022). The legislation prevents Virginia from automatically adopting federal amendments via rolling conformity under certain conditions, albeit with a variety of exceptions. The first restriction prevents Virginia from automatically adopting singular federal amendments enacted on or after Jan. 1, 2023, that would increase or decrease Virginia General Fund revenues by more than $15 million in the fiscal year in which the amendment is enacted or in any of the following four fiscal years. Beginning Jan. 1, 2024, the $15 million threshold will be annually adjusted for inflation. However, this decoupling provision does not apply if the Virginia legislature subsequently adopts the federal amendment or there is a “federal extender” that extends the expiration date of a federal tax provision to which Virginia already conforms.
The second restriction is applicable for federal amendments enacted on or after Jan. 1, 2023 that occur between adjournment of the Virginia legislature’s previous regular session and the first day of the Virginia legislature’s subsequent regular session. Virginia does not adopt amendments if their cumulative impact would increase or decrease Virginia General Fund revenues by more than $75 million in the fiscal year in which the amendments were enacted or in any of the following four fiscal years. However, this decoupling provision does not apply to any federal income tax amendment that is: (i) subsequently adopted by the Virginia legislature; (ii) a federal tax extender; or (iii) enacted before the date on which the cumulative projected impact is met.
Note that Virginia continues to decouple from federal provisions such as: (i) bonus depreciation allowed for certain assets under federal income taxation; (ii) the five-year carryback of certain NOLs generated in tax years 2008 and 2009; (iii) the tax exclusions related to cancellation of debt income; (iv) the tax deductions related to the application of the applicable high-yield debt obligation rules; and (v) certain business provisions of the federal CARES Act. The general adoption of the IRC as currently amended should accelerate Virginia’s adoption of certain federal amendments, but the state will need to develop a process to determine whether enacted federal changes will exceed the revenue thresholds.
In March 2023, Virginia enacted two industry-specific provisions with respect to the use of special apportionment formulas. For taxable years beginning on or after Jan. 1, 2023, H.B. 1978 and S.B. 1346 allow an affiliated group of corporations with 80% or more of its sales derived from retail company activities to elect to apportion its income using the single sales factor on a Virginia consolidated return. This election is available even if one or more members of the affiliated group would be required to use different apportionment factors if filing separate returns. The election only is effective in years during which the 80% or more of sales test is met, and the election cannot be changed without permission of the Virginia Department of Taxation. Prior to amendment, such affiliated groups were required to use a combination of single sales factor apportionment for the retail companies, and three-factor (double-weighted sales factor) apportionment for other companies, to determine their income subject to Virginia corporate income tax if they contained at least one member that was not a retail company.
In addition, as enacted by H.B. 1481 and S.B. 1349, for taxable years beginning on or after Jan. 1, 2023, internet root infrastructure providers use a hybrid sales factor in their income apportionment calculations provided they meet certain criteria and choose to enter into a memorandum of understanding with the Virginia Economic Development Partnership Authority. For sales other than sales of tangible personal property, the hybrid sales factor uses a market-based sourcing rule for sales of services and the standard cost of performance rule for all other non-service sales. An “internet root infrastructure provider” is defined as an entity and its affiliates that are designated to operate one or more of the 13 internet root servers of the Internet Assigned Names Authority (IANA) root and function as the authoritative directory for one or more top-level domains. The term does not include an internet service provider, cable service provider, or similar company.
With respect to filing method changes, on March 26, 2023, Virginia enacted legislation, H.B. 1405 and S.B. 796, making it marginally easier for an affiliated group to elect to change its filing status. The legislation removes the condition that the group’s tax liability for the previous tax year not be decreased by such a change in filing status, namely the prior year test. The legislation retains the other current requirements, including the requirement that the electing affiliated group has filed on the same basis for the preceding 12 years. Also, the legislation retains the “greater of the two rule” providing that the affiliated group agrees to file returns computing its Virginia income tax liability under both the new filing method and the former filing method and will pay the greater of the two amounts for the taxable year in which the new election is effective and for the following taxable year.
Finally, on March 27, 2023, Virginia enacted legislation, H.B. 1456 and S.B. 1476, making changes to its elective PTE tax retroactive to the 2021 taxable year. On March 29, 2023, the Virginia Department of Taxation issued guidance, Tax Bulletin 23-3, on this PTE tax legislation. The legislation replaced the qualifying PTE requirement with a new eligible owner requirement. Previously, the qualifying PTE requirement provided that a PTE could only make the election if it was 100% owned by natural persons or persons eligible to be shareholders of an S corporation, which served to exclude many PTEs with mixed individual / business ownership. The new eligible owner requirement restricts eligibility to participate in the PTE tax regime at the owner level, so that only a direct owner of a PTE who is either a natural person subject to the Virginia individual income tax, or an estate or trust subject to the state’s fiduciary income tax is eligible for a refundable PTE tax credit. As a result of these amendments, all PTEs may make the PTE tax election, and only the pro rata or distributive share of income, gain, loss, or deduction attributable to eligible owners is subject to the PTE tax. Unless the PTE is extending the time for filing its original 2022 PTE tax return, all PTEs choosing to make the election should file this return and pay the amount shown on the return by the original filing deadline. The return should be completed based upon changes to the PTE tax computation made by this legislation. Those seeking to make the election for the 2021 tax year should continue to follow Tax Bulletin 22-6.
Washington court holds investment income did not qualify for B&O tax deduction
On April 11, 2023, in Antio, LLC v. Department of Revenue, the Washington Court of Appeals held that 16 limited liability companies (LLCs) could not deduct investment income from their Business & Occupation (B&O) tax bases. The LLCs were investment funds with investment income as their only source of revenue. After paying B&O taxes on the revenue, each of the LLCs applied for a refund from the Washington Department of Revenue under a statute allowing a deduction for amounts derived from investments. The LLCs sought a refund of 100% of the B&O taxes paid, claiming that all their revenue was investment income that was subject to the statutory deduction. The Department denied the refund requests because all the revenue that the LLCs received was investment income. According to the Department, only investment income that is less than 5% of a taxpayer’s gross income qualified for the deduction. The LLCs subsequently filed a tax refund action in superior court.
Under Wash. Rev. Code Sec. 82.04.4281(1)(a), a deduction is provided from the B&O tax base for “[a]mounts derived from investments.” Also, Wash. Rev. Code Sec. 82.04.4281(1)(c) allows a deduction for “[a]mounts derived from interest on loans between subsidiary entities and a parent entity or between subsidiaries of a common parent entity, but only if the total investment and loan income is less than five percent of gross receipts of the business annually.” The statute does not define “investments,” but the Washington Supreme Court determined in 1986 in O’Leary v. Department of Revenue that the term “investments” as used in a former B&O statute was limited to investments that were incidental to the main purpose of the taxpayer’s business.
In superior court, the Department filed a summary judgment motion, arguing that the LLCs did not meet the definition of “investments” as defined in O’Leary. The Department also repeated its reasoning that the 5% limitation applies to the deduction for amounts from investments. In response, the LLCs submitted internal emails from the Department indicating that the investment amounts were deductible, and cited language from the Department’s website that investment funds are allowed the B&O tax deduction for amounts derived from investments. Despite this evidence, the superior court granted the Department’s motion for summary judgment and declined to look at the Department’s website. The LLCs filed an appeal of this order with the Washington Court of Appeals.
The Court of Appeals affirmed the superior court’s order after deciding that the LLCs were not entitled to the deduction based on the definition of “investments” in O’Leary. After acknowledging that the plain meaning of the deduction statute was supportive of the LLCs’ position, the court considered the language in O’Leary stating that the investments must be incidental to the main purpose of the taxpayer’s business to be eligible for the deduction. In the instant case, the LLCs’ investment activities could not be considered incidental because all of their income was investment income. The court rejected the LLCs’ argument that O’Leary was no longer applicable because the relevant statutes were amended after O’Leary was decided. According to the court, O’Leary remains good law and establishes that the LLCs are not entitled to the deduction.
The court also disagreed with the LLCs’ argument that the court should adopt the Department’s interpretation of investment funds and the application of the investment deduction on its website. The Department argued that the guidance cited by the LLCs addressed a completely different issue than the meaning of “investments” for purposes of the deduction. The LLCs provided no authority for the proposition that the Department’s guidance on its website controls the statutory language and the Washington Supreme Court’s decision interpreting the language. The court concluded that the information on the Department’s website was “immaterial to the resolution of this case.” Note that the language providing that investment funds “are allowed the B&O tax deduction for amounts derived from investments” continues to be posted under the “investments” discussion on the Department’s website. The decision is a cautionary tale for taxpayers that point to and rely upon the Department’s website guidance when such guidance might not be consistent with the underlying law and regulations.
West Virginia enacts elective PTE tax, subtraction for net deferred tax liability
On March 28, 2023, West Virginia enacted legislation, S.B. 151, allowing taxpayers to make a PTE tax election. For taxable years beginning on and after Jan. 1, 2022, a PTE may elect to be subject to individual income tax at the entity level. A “pass-through entity” is defined as any partnership or other business entity that is not subject to the corporation net income tax. The rate of tax imposed on an electing PTE equals the top marginal individual income tax rate and it is imposed on the entity's apportioned West Virginia income. In addition, the legislation allows for a credit against a taxpayer’s aggregate individual income tax liability for a taxpayer who is an owner of an electing PTE. The credit equals the owner’s proportionate share of the tax levied and remitted by the owner’s electing PTE for the taxable year.
On March 29, 2023, West Virginia enacted legislation, H.B. 3286, providing a subtraction for net deferred tax liability before apportionment for the 10-year period beginning with the taxpayer’s taxable year that begins on or after Jan. 1, 2033. This legislation is in response to the statutory changes in the apportionment formula that apply for tax years beginning on or after Jan. 1, 2022 (single sales factor apportionment, market-based sourcing for service revenue, and the elimination of the throwout rule). A taxpayer is entitled to a subtraction in computing West Virginia taxable income equal to one-tenth of the amount necessary to offset the increase in the net deferred tax liability or decrease in the net deferred tax asset, or the aggregate net change, from a net deferred tax asset to a net deferred tax liability. Only publicly traded companies, including affiliated corporations participating in the filing of a publicly traded company’s financial statements prepared in accordance with generally accepted accounting principles, are eligible for this subtraction. This legislation is in line with the trend of states providing a form of financial accounting relief to publicly traded taxpayers that are subject to additional taxes following a significant change in a corporate income tax regime.
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