As state legislative sessions continued this month, Indiana, New York, and Tennessee enacted significant tax legislation addressing a variety of corporation income tax issues. Indiana advanced its Internal Revenue Code conformity but specifically decoupled from federal research and experimental expenditure provisions. The New York budget legislation extended its higher corporate franchise tax rate for larger taxpayers. Tennessee adopted single sales factor apportionment, following a longstanding trend. State tax authorities were active as well, with Minnesota considering adoption of the Multistate Tax Commission’s revised guidance on P.L. 86-272, and Washington providing guidance on the meaning of “domicile” for purposes of the state’s long-term capital gains tax. Find out more about these and other stories in our roundup of SALT news for May 2023.
California launches unclaimed property voluntary compliance program
Holders of unclaimed property (such as uncashed checks or unused customer credits) that is due to California owners may apply to remit past-due liabilities under the state’s unclaimed property voluntary compliance program (VCP). Completing a VCP may help holders avoid future audit, which is a growing risk for taxpayers that must disclose their last unclaimed property report on certain California business tax returns, and obtain a waiver of the otherwise mandatory 12% interest.
Though the VCP was authorized in September 2022, the California State Controller has only recently formalized the VCP procedures that will be followed by the state. A holder can visit the Controller’s website to complete a VCP interest form, disclose its name, address, and state of domicile, and indicate whether it has submitted an unclaimed property report in the previous three years. If eligible, California will then mail the company a VCP application form. If its VCP application form is accepted, the holder must participate in an unclaimed property educational training program provided by the Controller within three months of enrollment, review its books and records for unclaimed property for the previous 10 years, and make reasonable efforts to notify property owners (by mail or electronically, as applicable) no less than 30 days prior to submitting the report to the Controller. The report must be submitted within six months after enrollment, though a holder may be able to obtain an extension up to 12 additional months. While avoiding future audit and obtaining a waiver of the 12% interest is a positive development for holders that are eligible for such relief under the VCP, holders should carefully consider the potential risks of participating as well.
California Supreme Court declines to review decision dismissing FBA litigation
On April 26, 2023, the California Supreme Court declined to review a California Court of Appeal’s decision, Grosz v. California Department of Tax and Fee Administration, which dismissed litigation seeking a declaration that the California Department of Tax and Fee Administration (DTFA) had a duty to collect sales and use tax from Amazon for products sold through the Fulfillment by Amazon (FBA) program. Under this program, Amazon contracts with merchants who supply the products ordered by consumers on Amazon’s website. As part of this arrangement, Amazon provides advertising, packaging, delivery of the products, and processes payments for sales on behalf of the FBA merchants. The taxpayer filed an action seeking a ruling that Amazon was required to collect sales and use tax on these FBA transactions prior to the state’s enactment of marketplace facilitator legislation that became effective on Oct. 1, 2019. Under California law, “retailers” are required to collect sales and use tax. The DFTA determined that the FBA merchants rather than Amazon were the responsible “retailers” in this case.
The trial court concluded that the taxpayer had no standing to seek a declaration that the DFTA must collect sales and use tax from Amazon because California law provides the DTFA with discretion to determine whether the FBA merchant or Amazon is the “retailer.” On Jan. 9, 2023, in a published opinion, the California Court of Appeal affirmed the trial court’s order dismissing the complaint. The appellate court addressed the taxpayer’s argument that if the court dismissed his case, the DFTA’s determination of the “retailer” could not be judicially reviewed. In rejecting this argument, the court explained that California sales and use tax law has a detailed procedure enabling a taxpayer to challenge the DFTA’s determinations through a refund process, and ultimately in court.
The California Supreme Court’s decision to allow the dismissal of the taxpayer’s efforts to seek the DFTA to require Amazon to collect tax prior to enactment of the marketplace facilitator laws is adverse for the FBA merchants. However, as explained by the appellate court, the FBA merchants still have an avenue to challenge the DFTA’s conclusion that the FBA merchants are the “retailers” responsible to collect the tax. In addition, similar issues involving the California sales tax treatment of the FBA structure are concurrently being litigated in federal court, in Online Merchants Guild v. Maduros.
Illinois amends apportionment regulation to provide guidance on vendor allowances
Effective April 12, 2023, the Illinois Department of Revenue amended an apportionment regulation, Ill. Admin. Code tit. 86 Sec. 100.3380, to provide guidance for when certain sales-inducing payments from vendors to retailers should be included in or excluded from the sales factor. The amended regulation defines the different types of vendor allowances and provides useful guidance and examples of their sales factor treatment.
Under the regulation, rebates and other buying allowances generally are considered reductions to the cost of goods sold and, therefore, are excluded from the sales factor numerator and denominator. Examples of these items include cash discounts for prompt payment, trade discounts for a specified volume of purchase, markdown participation allowances to cover shortfalls in the sales prices received by the retailer, defective or damaged merchandise allowances, and sales-based allowances for short-term promotions.
In contrast, merchandising allowances are part of the product's selling price and may be reportable as gross income. Thus, merchandising allowances are included in the sales factor to the extent they promote sales that likewise are included in the numerator and denominator of the sales factor. Types of merchandising allowances include cooperative advertising, salary or payroll allowances, and up-front cash payments and agreements that compensate the retailer for a commitment to purchase a targeted volume of goods. The taxpayer is able to elect to determine the amounts included in the numerator based on either: (i) the ratio of the number of retail locations in Illinois over the total number of retail locations; or (ii) the ratio of the gross receipts from retail locations in Illinois over the total gross receipts.
In addition to its guidance on vendor allowances, the Department has adopted a provision regarding the sales factor treatment of certain cost sharing agreements, as well as cost-plus service contracts. Specifically, payments received under a cost sharing agreement in exchange for intercompany services provided to a foreign person who would be a member of the same unitary business group but for the fact the foreign person’s business activity outside the U.S. is 80% or more of the foreign person’s business activity are excluded from the sales factor calculation. In a cost sharing agreement, related parties share the costs and risks of development as well as the anticipated benefits. However, a cost sharing agreement may also include a markup over costs, which may be considered receipts from sales of services. Under a cost-plus service contract, the service provider bears none of the economic costs and risks associated with development, and does not share in the anticipated benefits. In a cost-plus service contract arrangement, the payment that the service provider receives for the services rendered is considered receipts from the sale of services.
Indiana advances IRC conformity, decouples from federal R&E expenditure provisions
On May 4, 2023, Indiana enacted omnibus tax legislation, P.L. 194 (S.B. 419), which advances the state’s IRC conformity date, allows research and experimental (R&E) expensing, provides a corporate income tax deduction for broadband expansion grants, amends the computation of net operating losses (NOLs), creates an income tax exemption for the compensation of nonresidents who work in the state for no more than 30 days during the calendar year, and adds a sales and use tax exemption for solar and wind equipment.
Effective retroactively to Jan. 1, 2023, Indiana advances its IRC conformity date from March 31, 2021, to Jan. 1, 2023. This update includes the changes in federal law made by the Inflation Reduction Act of 2022 and Consolidated Appropriations Act of 2022.
The legislation decouples from the federal provisions concerning the treatment of R&E expenditures. 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. For tax years beginning after Dec. 31, 2021, Indiana decouples from this federal provision by providing a deduction for “specified research or experimental expenditures” for the tax year and an addition for the amount deducted under the federal provision requiring that R&E expenditures be capitalized. As explained in the legislative summary, this amendment could expedite the deduction and lower the taxable income of businesses that have qualified R&E expenditures during the tax year. Indiana is the latest state to decouple from IRC Sec. 174 this year. Mississippi enacted legislation, H.B. 1733, in March 2023 which decoupled from the federal R&E expensing provisions. On May 2, 2023, Georgia also enacted legislation, S.B. 56, decoupling from IRC Sec. 174.
For tax years beginning after Dec. 31, 2021, the legislation provides a corporate income tax deduction for federal, state, or local grants received by a taxpayer, as well as discharged federal, state, or local indebtedness incurred by the taxpayer, for purposes of providing or expanding access to broadband services in Indiana. The legislative summary notes that this could have a significant impact on corporate income tax revenue because federal legislation has provided for a substantial amount of federal grants to expand broadband.
Effective retroactively to Jan. 1, 2023, various technical amendments are made to the calculation of NOLs. As explained in the legislative summary, most of these changes are clarifications of the existing treatment of NOLs. However, certain amendments to the NOL calculations may change or limit taxpayers’ annual NOLs that offsets their income. These amendments apply to corporate income tax, individual income tax, and financial institutions tax.
Effective Jan. 1, 2024, compensation is exempt from adjusted gross income tax if: (i) the individual is not an Indiana resident during the calendar year in which the employee performs employment duties; and (ii) the individual receives compensation for employment duties performed in Indiana for 30 days or less during the calendar year. Employers are not required to withhold taxes from compensation paid to employees that meet these requirements. The exemption does not apply to compensation paid for employment duties performed by a professional athlete, professional entertainer, or public figure. This new provision, which is based on proposed federal mobile workforce legislation that has not passed Congress to date, should provide relief to nonresident employees who work for 30 days or less in Indiana.
Effective July 1, 2023, a sales tax exemption is provided for tangible personal property that is a component of a solar energy system or wind energy system that is acquired by a: (i) public utility that furnishes or sells electrical energy; (ii) power subsidiary that furnishes or sells electrical energy to a power utility; or (iii) business that furnishes or sells electrical energy to a public utility, power subsidiary, or to a renewable utility grade solar electricity or wind facility that is used to generate electricity for resale to consumers or wholesalers. This exemption does not apply to tangible personal property that: (i) is used to store or consume usable energy, electricity, or heat; (ii) is used to convey, transfer, or alter generated electricity; or (iii) will be used to produce energy for the purchaser’s residential use.
Minnesota considering adoption of MTC’s guidance on P.L. 86-272
On April 25, 2023, the Minnesota Department of Revenue issued a draft revenue notice for public comment that would adopt and apply the current guidance from the Multistate Tax Commission (MTC) on the scope of internet business activities performed by out-of-state sellers that are protected by Public Law 86-272 (P.L. 86-272). Enacted in 1959, P.L. 86-272 is a federal law that protects out-of-state sellers of tangible goods from state income tax when their in-state activities are limited to soliciting sales of tangible goods from an out-of-state location. The MTC issued revised guidance in August 2021 to determine what constitutes protected or unprotected activities under federal law, specifically addressing activities conducted using the internet. The MTC’s revised statement has generated controversy because the MTC’s position on internet business activities arguably narrows the protections of the law in many cases. This position has led to questions regarding the MTC’s interpretation of a federal law that could subject businesses to income tax filing obligations by engaging in certain internet activities in a state even though they have no physical presence there.
During 2022, California and New York became the first states to react to the MTC’s revised statement. On Feb. 14, 2022, the California Franchise Tax Board (FTB) released administrative guidance, Technical Advice Memorandum (TAM) 2022-01, which is consistent with the MTC’s position. Note that litigation has been filed in California superior court to challenge California’s guidance. In April 2022, the New York Department of Taxation and Finance posted a revised draft regulation adding “[n]ew provisions, largely modeled after the MTC model statute” that “address PL 86-272 and activities conducted via the internet.” The guidance and draft regulation issued by California and New York do not provide an effective date and could be applied retroactively. If the Minnesota Department of Revenue adopts its proposed revenue notice following public comment, it will be the third state to formally address the MTC’s revised statement on P.L. 86-272. Similar to the California guidance and the New York draft regulation, the Minnesota draft revenue notice does not provide an effective date.
New York budget legislation extends higher corporate franchise tax rate
On May 3, 2023, New York enacted budget legislation, Ch. 59 (A.B. 3009/S.B. 4009), which made numerous changes to tax law, including an extension of the higher corporate franchise tax rate on certain taxpayers, the permanent adoption of the Metropolitan Transportation Business Tax Surcharge (MTA surcharge) rate, technical corrections to the New York State and New York City elective pass-through entity (PTE) taxes, and an amendment allowing the state to appeal decisions of the New York Tax Appeals Tribunal (TAT). On the same day, New York enacted budget implementation legislation, Ch. 58 (A.B. 3008/S.B. 4008), which increases the Metropolitan Commuter Transportation Mobility Tax (MCTMT) rate for certain taxpayers.
Applicable to tax years beginning in 2021, 2022 and 2023, New York’s 2021 budget legislation temporarily increased the corporate franchise tax rate that is imposed on the New York State business income base from 6.5% to 7.25% for any taxpayer with New York State apportioned income for the taxable year of more than $5 million. The 7.25% tax rate applies to all income subject to tax if the $5 million apportioned income base is exceeded. In addition, under the 2021 budget legislation, the capital base tax rate, which was previously scheduled to fall to 0% in 2021, was retained at 0.1875% for tax years beginning in 2021, 2022 and 2023. The 2023 budget legislation extends the 7.25% corporate franchise tax rate on the business income base, and the 0.1875% tax rate on the capital base for an additional three years so that these increased tax rates will apply to tax years beginning in 2024, 2025 and 2026.
For tax years beginning on or after Jan. 1, 2024, the legislation establishes a permanent MTA surcharge rate of 30% of the rate of the New York corporate franchise tax. Prior to amendment, the New York State Department of Taxation and Finance was required to adjust the surcharge rate each year depending on certain state financial projections. Most recently, the Department announced the MTA surcharge rate was 30% for tax years beginning in 2023. Thus, the 30% rate remains the same but it will no longer be subject to annual adjustments.
The legislation makes technical corrections to the New York State and New York City elective PTE taxes. Specifically, electing partnerships are required to add all PTE taxes to the extent that, for federal income tax purposes, the taxes were paid and deducted in the tax year, and they are included in the partners’ or shareholders’ taxable income. Because these amendments apply retroactively to the original effective dates of the elective PTE taxes, they are effective for tax years beginning in 2021 and thereafter for purposes of the state PTE tax and for tax years beginning in 2022 and thereafter for purposes of the city PTE tax. For tax years beginning in 2023 and beyond, the definition of “city taxpayer” for purposes of the city PTE tax is amended to mean a city resident individual and a city resident trust or estate.
Effective May 3, 2023, the Department is authorized to appeal decisions of the TAT. Specifically, the Department, in consultation with the attorney general, may petition for the judicial review of a TAT decision that is premised on an interpretation of the state or federal constitution, international law, federal law, the law of other states, or other legal matters that are beyond the purview of the state legislature. Thus, the Department is not authorized to appeal decisions concerning New York state law. Prior to this legislation, only taxpayers could appeal decisions of the TAT. As a result, TAT decisions that were favorable to taxpayers were final and not subject to judicial review. This change may increase the litigation costs of taxpayers and prolong final decisions that would otherwise be favorable to taxpayers.
For tax quarters beginning on or after July 1, 2023, the legislation increases the MCTMT rate for specified taxpayers. For employers who engage in business within the Metropolitan Commuter Transportation District (MCTD), in the counties of Bronx, Kings, New York, Queens, and Richmond (the five boroughs of New York City), the top tax rate is increased from 0.34% to 0.6% in two stages. For tax years beginning in 2023, the tax on individuals in these counties is increased from 0.34% to 0.47% of the net earnings from self-employment attributable to the MCTD. For tax years beginning in 2024 and thereafter, the rate on individuals in these counties is increased from 0.47% to 0.6%. The tax on individuals in suburban counties in which the MCTMT is applicable will remain at 0.34%.
Tennessee enacts major tax legislation, including single sales factor apportionment
On May 11, 2023, Tennessee enacted significant legislation, Ch. 377 (H.B. 323/S.B. 275), which provides for the adoption of single sales factor apportionment, conforms to federal bonus depreciation provisions, extended credit carryforward periods and includes new sales tax sourcing rules. This legislation, termed the Tennessee Works Tax Act, provides approximately $400 million in tax cuts. The Tennessee Department of Revenue quickly issued a series of notices following enactment of the legislation to provide further guidance.
For corporate excise tax purposes, Tennessee is phasing from a three-factor apportionment formula with a triple-weighted sales factor to a single sales factor over a three-year period. Specifically, for tax years ending on or after Dec. 31, 2023, but before Dec. 31, 2024, net earnings are apportioned using a three-factor formula with a quintuple-weighted sales factor. For the following year, the three-factor formula includes a sales factor that is weighted 11 times. For tax years ending on or after Dec. 31, 2025, a single sales factor is used. Manufacturers that are already electing to use a single sales factor will continue to use that formula during the phase-in period. Taxpayers have the option to use the previous three-factor formula with a triple-weighted sales factor if it results in a higher apportionment ratio and the taxpayer has net earnings rather than a net loss. As noted by the Department, a taxpayer might choose this option to fully utilize existing tax credits. The phasing-in of the single sales factor also applies to the Tennessee franchise (net worth) tax.
Tennessee historically has decoupled from federal bonus depreciation provisions for excise tax purposes. For assets purchased on or after Jan. 1, 2023, this legislation adopts the current federal business depreciation provisions as amended by the TCJA. Federal law provides for 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 is being phased out in 20% annual increments, with a complete elimination of bonus depreciation beginning in 2027. For assets purchased on or before Dec. 31, 2022, bonus depreciation deductions continue to be disallowed in Tennessee. Because Tennessee now adopts the TCJA bonus depreciation provisions, without a further state-specific amendment, the state would be following the federal phase-out of bonus depreciation. This amendment to Tennessee law provides a temporary benefit to taxpayers until bonus depreciation is completely phased out under federal law for assets acquired in 2027 or thereafter (as currently planned).
The Tennessee legislation extends the credit carryforward periods for several excise and franchise tax credits from 15 years to 25 years. The extended credit carryforward periods apply to tax credits earned in tax years ending or after Dec. 31, 2008, providing benefit to taxpayers that otherwise may not have been able to utilize the full amount of these tax credits. Applicable credits include: (i) industrial machinery credits; (ii) brownfield property credits; (iii) job tax credits; (iv) community investment credits; (v) qualified production credits; and (vi) the Paid Family and Medical Leave credit. The Department’s guidance indicates that it will implement the new credit carryforward periods automatically and reminds taxpayers to update their records to reflect the applicable longer carryforward periods.
The legislation also creates a $50,000 standard deduction from net earnings for Tennessee excise tax for tax years ending on or after Dec. 31, 2024. The standard deduction applies to pre-apportioned net earnings and cannot create or increase an NOL. Also, for tax years ending on or after Dec. 31, 2023, the legislation increases the business tax filing threshold from $10,000 to $100,000 per jurisdiction.
Effective July 1, 2024, following the lead of several other states, the legislation adds new statutes to provide rules for sourcing transactions for sales and use tax purposes. The rules apply regardless of the characterization of a product as tangible personal property, a digital good, a service, or other taxable product and are used only to determine a seller’s obligation to pay or collect and remit tax for the retail sale of the product. As discussed below, these new statutes are intended to provide clarity in making determinations regarding the sourcing of transactions.
Cascading rules apply for sourcing a retail sale, excluding a lease or rental, of a product from out of state into Tennessee. When the product is received by the purchaser at a seller’s business location, the sale is sourced to that business location. Otherwise, the sale is sourced to where the purchaser receives the product. When these provisions do not apply, the sale is sourced to the purchaser’s address as indicated in the seller’s business records. If this does not apply, the sale is sourced to the address for the purchaser obtained during consummation of the sale. Finally, when the previous provisions do not apply, the location is determined by the address from which the tangible personal property was shipped, from which the digital good or the computer software delivered electronically was first available for transmission by the seller, or from which the service was provided.
A new statute also provides sourcing rules for the lease or rental of tangible personal property delivered into Tennessee. For a lease or rental that does not require recuring periodic payments, the payment is sourced in the same manner as a retail sale. If the lease or rental requires periodic payments, the first payment is sourced as a retail sale. Subsequent periodic payments are sourced to the primary property location. Notwithstanding the primary property location covered by a recurring periodic payment, the lease or rental of transportation equipment is sourced as a retail sale.
The sale, including lease or rental, of a product made from a place of business in Tennessee that is delivered within the state is sourced to the seller’s or lessor’s place of business in the state. Sales of products made from a place of business in Tennessee that are delivered outside the state are not sourced to Tennessee.
Washington provides guidance on domicile for capital gains tax purposes
On April 27, 2023, the Washington Department of Revenue issued an “Interim statement regarding the definition of domicile for capital gains excise tax allocation purposes.” The statement addresses the state’s new capital gains tax under which a 7% tax is imposed on an individual’s Washington-allocated long-term capital gains (LTCG) over $250,000 resulting from the sale or exchange of certain capital assets on or after Jan. 1, 2022. The statute requires allocation of LTCG to Washington in three scenarios. Under one of the scenarios, the LTCG are allocated to the state if the individual sold or exchanged intangible personal property and the individual was domiciled in Washington at the time of the sale or exchange. Because the allocation rules use the term “domicile,” the Department has released interim guidance to provide basic examples of how the allocation rules function and explain the meaning of “domicile” for purposes of the tax.
The Department’s guidance defines the term “domicile” to mean a residence in fact, coupled with an intent to make the place of residence one’s home. A domicile is presumed to continue once it is established. Thus, if an individual has been domiciled in Washington, the individual has the burden of proving his or her domicile has changed to a location outside Washington. For LTCG allocation purposes, if an individual was a Washington domiciliary at any time during a particular year, the Department will presume that the individual was a Washington domiciliary at the time personal property was sold or exchanged. Individuals should carefully consider the domiciliary rules in determining whether they are subject to the Washington capital gains excise tax.
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