Top state and local tax stories of 2023

In developing our end-of-year summary of the top state and local tax (SALT) news of 2023, we typically try to look for a common theme running through the developments. The last couple of years revolved around the pandemic and the attempt to get back to a new normal. One could argue that the theme of 2023 …. was about arguing. Division seemed to rule the year, and extended throughout all branches of state government, as reflected in controversial legislation, guidance provided by state tax authorities that at times appeared aggressive to taxpayers, and of course, lots of contentious litigation. Given the theme, it’s not overly surprising that one of the most high-profile judicial disputes resolved this year concerned a taxpayer that ultimately agreed with a state department of revenue only to be opposed by that state’s own attorney general.

As usual practice in December, our Grant Thornton SALT team in the Washington National Tax Office reflected on and then ranked the 10 most important SALT stories of 2023 in order of perceived importance. Following due consideration, we believed that the significant tax reforms undertaken by New Jersey and Minnesota constituted the most important story of the year, but in this year of relative division, we would not be surprised if others begged to differ. It should be noted that Minnesota tax reform would not have happened but for a chaotic and divisive legislative session in which one state senator made all the difference.

As far as other events on our list, the vein of division is readily apparent. States’ reactions to the frequent changes in how federal taxable income is calculated reflect the fact that the aims intended to be achieved by federal and state tax policy are often very discordant. Apportionment disputes that usually (but not always, as noted above) pit taxpayers against the state tax authorities are, by definition, about the division of a company’s revenue among the states. The disparate methods by which states are trying to balance their budgets show their competing priorities, with some states trying to de-emphasize the income tax for all, with others enhancing it in a progressive manner, or in some cases, imposing specially tailored taxes on an extremely small number of businesses or individuals.

While we recognize that division taken to its extreme can strain relationships between the branches of state government, the states themselves, the federal and state governmental system, and taxpayers and state tax authorities, the SALT issues coming to the fore in 2023 in response to this division are some of the most intellectually interesting ones we have seen in some time. And at least some of the outcomes that we have seen this year in the state legislatures and courts, which would not have happened without some level of division, ultimately will be considered by taxpayers as very positive from a policy perspective. With that background in mind, let’s move forward, together, to our list of the top SALT stories for 2023.

1. New Jersey and Minnesota enact major tax reform legislation

While many states adopted significant tax provisions designed to address both federal changes and state-specific aims, New Jersey and Minnesota’s efforts stood out in 2023. On July 3, 2023, New Jersey enacted extensive state tax reform legislation intended to be revenue-neutral to the state, the centerpiece of which includes major changes in the Corporation Business Tax (CBT) for privilege periods ending on and after July 31, 2023.¹ The adoption of a bright-line economic nexus standard for CBT purposes, in line with standards adopted by the states for remote sellers for sales tax purposes, is notable.² The legislation also alters the taxation of foreign income by treating global intangible low-taxed income (GILTI) as dividend income and subjecting 100% of foreign derived intangible income (FDII) to CBT.³ New Jersey is changing from the Joyce to the Finnigan apportionment methodology for combined groups.⁴ Also, certain captive real estate investment trusts (REITs), regulated investment companies (RICs), and investment companies (ICs) are included in combined groups and taxed in the same manner as C corporations.⁵ The legislation also makes changes to combined group composition and the treatment of income excluded from federal taxable income by tax treaties.⁶ Furthermore, the legislation makes changes to the treatment of net operating losses (NOLs), including adoption of the current federal 80% limitation.⁷ The ordering of the NOL and prior NOL conversion carryover (PNOLCC) subtraction is changed and the remaining balance of the deductions of the combined group members may be pooled together.⁸ Finally, the historic related-party addback statute is repealed.⁹

While the legislation primarily concerns CBT, one noteworthy provision addresses Gross Income Tax (GIT) sourcing. For taxable years beginning after 2022, a taxpayer subject to GIT which conducts business within and outside New Jersey is required to source its income using CBT sourcing provisions to the extent that income from New Jersey sources cannot be readily or accurately ascertained.¹⁰

2. States react to ‘new’ IRC Sec. 174

Changes to Internal Revenue Code (IRC) Sec. 174 research and experimental (R&E) expenditure rules beginning with the 2022 tax year along with state responses to those rules presented added complexity for taxpayers with significant R&E expenditures in 2022 from a state tax compliance perspective. Prior to the 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 useful life. The TCJA amended this Sec. 174 provision with a deferred effective date, such that for amounts paid or incurred in tax years beginning after Dec. 31, 2021, all taxpayers are required to capitalize and amortize R&E expenditures and software development costs over a five-year period for domestic expenses and 15 years for foreign expenses.

Congressional efforts to delay or repeal the new capitalization and amortization requirements under Sec. 174 have all but failed in 2023. The absence of federal legislation addressing Sec. 174 created additional uncertainty for taxpayers in determining whether states conform to the federal changes to Sec. 174. In most cases, states that adopt the IRC on a rolling basis generally conform to the post-2021 R&E expenditure rules in Sec. 174 unless they specifically decoupled from that federal provision. Additionally, many static conformity states – those that adopt the IRC as of a certain date – enacted legislation to advance their conformity dates to the IRC as in effect on Jan. 1, 2022, or later, therefore bringing their own state tax laws into conformity with the “new” federal Sec. 174 provisions.

In contrast, several states enacted legislation in 2023 that specifically decoupled from the federal capitalization and amortization requirements under current Sec. 174. For example, Georgia and Indiana enacted legislation specifically decoupling from the federal changes to Sec. 174 effective retroactively for the 2022 tax year.¹⁹ Mississippi enacted similar legislation decoupling from current Sec. 174, but not appliable until tax years beginning on or after Jan. 1, 2023.²⁰ To further complicate matters, as part of its tax reform legislation described above, New Jersey now decouples from current Sec. 174 for tax years beginning on or after Jan. 1, 2022, but only for taxpayers with New Jersey qualified research expenditures (QREs) that actually claimed the New Jersey research and development (R&D) tax credit.²¹ If no New Jersey R&D credits are claimed by the taxpayer, the state follows the Sec. 174 amortization and capitalization rules, and deductions occur in the same period as they would for federal income tax purposes. Finally, while Kentucky decoupled from amended Sec. 174 for the 2022 tax year based on its existing IRC conformity date, the state enacted legislation to advance its IRC conformity date, thereby bringing the state into conformity with current Sec. 174 beginning with the 2023 tax year.²²

For many taxpayers, tracking state conformity to Sec. 174 for the 2022 tax year is an important exercise especially in cases where the federal changes to Sec. 174 were sufficient to require taxpayers to report income rather than a loss, while such effect may have been fully reversed in decoupling states that continued to allow for current expensing of R&E expenditures. Specific state conformity to Sec. 174 has the potential to materially affect state tax provisions by increasing or decreasing amounts to be deducted currently or accounted for as deferred tax assets to be realized in future years. Moreover, state conformity to the Sec. 174 rules may potentially impact state R&D credit calculations in those states with state-specific R&D credits. Finally, the state income tax impact of Sec. 174 changes could also change the calculation of other limited deductions such as the Sec. 163(j) business interest expense deduction. Noting that the federal changes to Sec. 174 and the state responses have created a spate of ancillary effects for impacted taxpayers during the 2022 tax year, taxpayers will need to continue to track potential state decoupling responses to Sec. 174 in 2023 and beyond.

3. Trend of adopting elective pass-through entity taxes continues

The adoption of pass-through entity (PTE) regimes as a workaround to the federal $10,000 SALT deduction limitation adopted under the TCJA continued to gain pace this year, with 37 jurisdictions now offering this option to PTEs and their owners.²³ Back in 2018, states began enacting elective PTE tax regimes to work around the SALT deduction cap. Under these regimes, the PTE is permitted to deduct state and local income taxes paid at the entity level for federal income tax purposes, followed by a deduction for the tax on the distributive share of the PTE owners’ income. Depending on the structure of the PTE tax, the owner may claim a corresponding tax credit against their personal income tax liability or an exclusion on the portion of the owner’s pass-through income subject to the entity tax.

Seven states had enacted PTE taxes by November 2020,²⁴ when the IRS announced that state PTE tax regimes would be respected for federal purposes, thus providing a framework for partnerships and S corporations to deduct PTE taxes at the entity level.²⁵ States moved rapidly to adopt their own elective PTE regimes in response, with 15 doing so in 2021.²⁶ The trend continued in 2022, with eight additional jurisdictions adopting PTE tax regimes.²⁷ The effort did not subside in 2023, with seven states acting to adopt such regimes.²⁸ In particular, Nebraska stood out with its creation of a PTE tax regime with retroactive effect to tax years beginning on or after Jan. 1, 2018, joining Colorado in this effort and presenting additional complexity for PTEs looking to make retroactive PTE elections without clear guidance from the IRS on the specific federal implications.²⁹ With 37 jurisdictions having enacted PTE tax regimes to date, only six jurisdictions that impose a personal income tax have yet to enact such regimes.³⁰ While three of those six jurisdictions proposed PTE tax bills in 2023 that failed to pass this year, it will be interesting to see whether such legislation gains traction in 2024.³¹

States continued to enact important corrective legislation in 2023 to address significant and often unintended technical shortcomings in their PTE tax regimes that became apparent during the first years of their implementation. Notably, as the only state with a mandatory PTE tax in place, Connecticut enacted legislation to make its PTE tax regime elective beginning with the 2024 tax year, in addition to removing the standard base method of calculating the PTE tax base.³² Virginia expanded eligibility for electing PTEs by removing the requirement that a qualifying PTE be 100% owned by natural persons, replacing this requirement with an eligible owner requirement, under which a direct owner of a PTE who is a natural person, estate or trust is eligible for a refundable PTE tax credit.³³ Similarly, North Carolina legislation expanded the list of eligible PTEs to include partnerships and S corporation as permissible PTE owners effective beginning with the 2022 tax year.³⁴

4. Maryland digital advertising tax remains in effect, with litigation continuing

Back in February 2021, Maryland became the first state to enact a tax on gross proceeds derived from digital advertising services in the state.³⁵ Enacted by the state legislature following an override of a veto by the Maryland governor, the tax is imposed on entities with global gross revenues of at least $1 billion.³⁶ Businesses with annual gross revenues derived from digital advertising services in Maryland of at least $1 million in a calendar year are required to file a tax return. The tax rate ranges from 2.5% to 10% based on the amount of the company’s global gross revenue. The tax was enacted with the intent of targeting large technology companies with digital advertising operations.

The digital advertising tax has been mired in litigation since the date of enactment. Lawsuits were filed in both state and federal court alleging violations of the Internet Tax Freedom Act (ITFA), the Commerce Clause and the Due Process Clause of the U.S. Constitution, and the First Amendment to the U.S. Constitution.³⁷ Comcast and Verizon sought a declaration in a state trial court that the tax was illegal under the ITFA, also alleging Commerce Clause, Due Process and First Amendment violations. In October 2022, the trial court struck down the tax in a bench ruling, declaring that the tax discriminates against companies providing digital advertising services, targets out-of-state companies and interstate commerce by using worldwide gross revenues to calculate the tax, and singles out certain companies for selective taxation in a way that is not content-neutral.³⁸

On direct appeal to the Maryland Supreme Court, the Maryland Comptroller argued that the state trial court lacked jurisdiction to hear the state lawsuit because the plaintiffs had failed to exhaust their administrative remedies before filing the lawsuit in state court. In May 2023, the Maryland Supreme Court issued an order vacating the trial court’s order, concluding that the trial court lacked jurisdiction to hear the case because the plaintiffs failed to exhaust their administrative remedies.³⁹ In an opinion explaining its earlier order restoring the tax, the court explained that the administrative remedy requirement may be satisfied by paying the tax and commencing a refund action that could be considered by the Maryland Tax Court, or appealing a tax assessment to the Tax Court.⁴⁰ The Maryland Supreme Court did not address the merits of the arguments concerning the validity of the tax. 

In response to the Maryland Supreme Court’s decision dismissing the earlier state lawsuit, Apple Inc. filed an appeal with the Maryland Tax Court in August 2023, arguing that it is due a refund on digital advertising tax paid to Maryland for the 2022 tax year.⁴¹ Similar to Comcast and Verizon, Apple argued that the tax is illegal under the ITFA, also alleging Due Process, Commerce, and Supremacy Clause violations. Apple further argued that it had exhausted its administrative remedies by filing a refund claim, which the Comptroller had subsequently denied. In response to the Comptroller’s motion to dismiss the case, the Maryland Tax Court ruled that Apple’s case could proceed, finding that it satisfied the requirements for a valid refund claim. Meanwhile, more than a dozen large technology companies filed similar litigation in the Maryland Tax Court in November protesting similar refund denials of estimated digital advertising tax payments. The litigation before the Maryland Tax Court represents the first attempt to challenge the tax according to the administrative procedure dictated by the Maryland Supreme Court.

At the same time, federal litigation continues. Several business groups sought a declaration and injunction from a Maryland federal district court against enforcement of the tax. In 2022, the federal court dismissed much of the lawsuit, ruling that the federal Tax Injunction Act (TIA) bars a challenge to the tax itself because Maryland state courts provide a speedy remedy to challenge the tax. However, the federal court ruled that the plaintiffs could still challenge the provision that prohibits companies from directly passing the cost of the tax onto customers on the grounds that it violated the First Amendment. In December 2022, the federal district court issued an order dismissing the case on the grounds that the pass-through provision had become moot in light of the state trial court’s decision to invalidate the tax.⁴² The plaintiffs appealed the dismissal to the U.S. Court of Appeals for the Fourth Circuit.⁴³

As the Maryland state and federal litigation continues to run its course, companies subject to the digital advertising tax must continue making estimated payments given that the tax still stands, and the Maryland Tax Court has yet to fully consider the substantive arguments in support of invalidating the tax. Like Apple and the other similarly situated technology companies with cases currently before the Maryland Tax Court, impacted businesses may consider filing protective refund claims that may proceed pending the outcome of the litigation before the Maryland Tax Court. While this litigation is likely to be drawn out over the coming years, other states that have considered similar digital advertising taxes may continue to watch and wait until a final decision is reached.

5. Apportionment litigation galore

2023 will be remembered from a SALT perspective as a year in which many intriguing apportionment disputes were addressed by state courts and administrative authorities. The high courts in Pennsylvania, Maine, and Michigan all decided significant apportionment cases. Two of the cases concerned the sourcing of service revenue, while the other case involved the tax treatment of income from a business sale and alternative apportionment. Also, there were lower court or administrative decisions in Florida and California considering important apportionment issues.

In Synthes USA HQ, Inc. v. Commonwealth, the Pennsylvania Supreme Court upheld a Pennsylvania Department of Revenue policy sourcing sales of services to the location where the benefit is received under the pre-2014 corporate net income tax (CNIT) sourcing statute.⁴⁴ The taxpayer sourced sales to Pennsylvania using tradition cost-of-performance (COP) rules. Based on the Pennsylvania Department of Revenue’s interpretation of the sourcing statute, the taxpayer sought a refund by recalculating its sales using benefits-received rules. The Department took the position that sales are sourced using benefits-received rules, but the Pennsylvania Office of Attorney General argued that sales are sourced using traditional COP rules. The Pennsylvania Supreme Court held that the Department’s benefits-received interpretation controlled because the pre-2014 statute was ambiguous.

Although the Synthes decision appears to be limited to interpreting a CNIT sourcing statute that is no longer in effect, the decision continues to be relevant because the court applied administrative deference to Department policy in the absence of clear statutory definitions and interpretive regulations. Beyond the CNIT, the result leaves open the question of whether the Department will seek to apply its benefits-received sourcing interpretation to pass-through entities governed under the state’s personal income tax rules, which still employ a COP analysis. Finally, taxpayers should consider the long-term impacts this ruling may have on calculating their Pennsylvania sales factor and the resulting effect on tax attributes such as NOLs utilized in open tax years and tax credits, particularly out-of-state companies that may be able to increase NOLs during pre-2014 tax years using market-based sourcing. 

In Express Scripts Inc. v. State Tax Assessor, the Maine Supreme Judicial Court held that a taxpayer must source its receipts from providing prescription benefit management (PBM) services to where the individuals fill their prescriptions at retail pharmacies.⁴⁵ Under Maine law, receipts from the performance of services are sourced to the state where the services are received. The Maine Tax Assessor successfully argued that the individual members receive the services when they fill prescriptions at retail pharmacies. The taxpayer unsuccessfully argued that because it contracts with only its clients (such as health insurers or employers) rather than the individual members, the ultimate recipient of its services is the client, even though it is the member who initiates the claim at the retail pharmacy.⁴⁶ The court held that the receipts should be sourced to Maine because the claims-processing services were received by members at retail pharmacies in Maine, and the receipts at issue were derived from these services. 

Express Scripts may create opportunities for taxpayers that provide PBM services. For example, a PBM service provider headquartered in a state but has comparatively few individual members filling prescriptions in the state would benefit from this decision. Conversely, a PBM service provider that is not headquartered in a state but has many members filling prescriptions in a state would be required to apportion more income to the state.

The Michigan Supreme Court decided a case concerning the apportionment treatment of income from the sale of a business and alternative apportionment. In Vectren Infrastructure Services Corp. v. Department of Treasury, the court held that for purposes of the former Michigan Business Tax (MBT), the Michigan Department of Treasury properly treated the taxpayer’s gain from a significant asset sale as business income, excludible from the taxpayer’s sales factor.⁴⁷ According to the court, the apportionment formula, as applied, was constitutional because it did not impermissibly tax income outside the scope of the state’s taxing powers. The Michigan Supreme Court reversed the Michigan Court of Appeals’ judgment that alternative apportionment was necessary because the statutory formula created a grossly disproportionate result when applied to the asset sale. On Nov. 20, 2023, the U.S. Supreme Court denied certiorari to hear this case.

Despite the repeal of the MBT, this case has important implications for taxpayers doing business in Michigan, given the fact that the state’s current corporate income tax regime relies on a tax base calculation and apportionment rules similar to those under the previous MBT regime. Out-of-state businesses should carefully evaluate the possible Michigan corporate income tax consequences of selling assets that are not normally held for sale to customers, or for the sale of a business unit. This decision also reflects the court’s belief that there is a high burden of proving that alternative apportionment is necessary, even where alternative apportionment seems to be warranted.

Besides the state high court decisions discussed above, two lower court or administrative rulings considered interesting apportionment issues. In Billmatrix Corp. v. Department of Revenue, a Florida circuit court granted a group of related taxpayers’ motion for summary judgment, and held that state law required the use of the COP method to source the taxpayers’ service revenue.⁴⁸ Because the plain language of the Florida apportionment regulation provides for the use of COP sourcing,⁴⁹ the circuit court rejected the Florida Department of Revenue’s application of market-based sourcing (MBS).⁵⁰ This decision is consistent with the same court’s Target Enterprise, Inc. v. Department of Revenue decision in 2022,⁵¹ but the court in Billmatrix provides a deeper analysis of the underlying regulation to support a COP methodology.   

Over the past several years, there has been significant uncertainty in Florida concerning whether to source receipts from services using a COP or MBS methodology. While the Department has promulgated a regulation providing for COP sourcing, the Department has issued multiple Technical Assistance Advisements (TAAs) which interpret this regulation to apply MBS principles.⁵² Service providers that incur a greater proportion of their costs to perform their services outside Florida, but that have a significant market presence in Florida, may want to determine whether this case provides sufficient support for COP sourcing. At the same time, there will be instances in which MBS will be a more favorable approach than applying COP, particularly for businesses that have substantial physical presence in Florida in comparison to other states, but do not have a comparable Florida customer base.

In August 2023, the California Office of Tax Appeals (OTA), in Southern Minnesota Beet Sugar Cooperative, released a decision holding that deductible income received from a unitary group member must be included in the sales factor calculation.⁵³ The OTA declined to follow a longstanding position of the California Franchise Tax Board (FTB) articulated in Legal Ruling 2006-01 that certain deductible items that do not factor into taxable net income should be excluded from the sales factor.⁵⁴

The holding in Southern Minnesota Beet Sugar may create an opportunity for taxpayers to include in the sales factor calculation certain deductible items from the measure of taxable net income. In relevant part, Legal Ruling 2006-01 provided a fact pattern in which a water’s-edge group that receives a dividend from an excluded foreign affiliate that is subject to a 75% DRD should not reflect this income in the apportionment formula because it was excluded from the measure of tax. The OTA’s refusal to give deference to the FTB’s position may encourage certain water’s-edge filers that had followed the ruling to file amended returns. A water’s-edge filer that received dividends from an excluded foreign affiliate that was subject to a 75% DRD may want to file an amended return seeking to depart from the ruling and include the full dividend received in the sales factor denominator.

6. State budget dichotomy causing tax rate fluctuations

7. States expand indirect tax base to non-traditional transactions

8. State consideration of MTC statement on P.L. 86-272

In August 2021, the Multistate Tax Commission (MTC) made state and local tax headlines when it revised guidance interpreting longstanding federal protections against state income tax to reflect the modern economy and internet business activities.⁷¹ Notably, the MTC approved an updated statement on Public Law 86-272 (P.L. 86-262), the 1959 federal law that limits the state taxation of income from sales of tangible personal property if the taxpayer’s only business activities in the state are the solicitation of orders that are approved and shipped from outside the state.⁷²

In particular, the revised statement includes a new subsection to specify what constitutes protected or unprotected activities under the federal law, specifically addressing activities conducted using the internet. Generally, when a business interacts with a customer via the business’s website or app, it is engaged in “business activity” within the customer’s state that exceeds P.L. 86-272 protection. In contrast, if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state. The statement provides a listing of 11 different activities conducted by internet businesses and explains whether they are protected or unprotected for P.L. 86-272 purposes. Importantly, states are not bound by the MTC’s revised statement and are responsible for individually adopting its model rules.

Several states took additional action to adopt the MTC’s revised statement in some form during 2023. For example, the New Jersey Division of Taxation recently released updated nexus guidance that added 12 modern business activities that, in the Division’s view, exceed P.L. 86-272 protection, along with a list of 13 additional protected activities.⁷³ The Division’s treatment of internet activities is consistent with the MTC’s revised guidance but does not specifically reference the MTC guidance. Additionally, the New York State Department of Taxation and Finance updated its proposed corporate income tax reform regulations that address the application of P.L. 86-272 to internet-based activities largely based on the MTC statement.⁷⁴ Finally, the Minnesota Department of Revenue in April 2023 issued a draft revenue notice that would adopt and apply the current MTC guidance on the scope of internet business activities performed by out-of-state sellers protected and not protected by P.L. 86-272.⁷⁵

Meanwhile, litigation challenging state authority to adopt the MTC rules continues in California. In August 2022, the American Catalog Mailers Association (ACMA) filed a lawsuit in California superior court arguing that that the California FTB’s adoption of the MTC guidelines was invalid because it was done without the formal notice and comment procedures required under the state’s Administrative Procedure Act.⁷⁶ Although the trial court recently denied the ACMA’s motion for summary judgment on the basis the ACMA failed to show that the FTB guidance narrowed the application of P.L. 86-272 on its face, the litigation will proceed to the discovery and trial phase, meaning that the court will consider the scope of the FTB guidance with a developed factual record.⁷⁷

The MTC statement continues to be a source of controversy as taxpayers and practitioners alike question the MTC’s authority to interpret a federal law that could subject businesses to additional income tax filing obligations by engaging in certain internet activities in a state without having any physical presence there. In many cases, taxpayers should be aware of states taking more aggressive P.L. 86-272 positions on audit even where they have not formally adopted the MTC statement. As other states look to adopt the MTC guidance, whether formally or informally, many will be closely watching the California litigation to determine the extent to which states may limit the scope of P.L. 86-272 protections in the case of internet activities.

9. Washington Supreme Court upholds individual capital gains tax

In 2021, the state of Washington enacted legislation imposing a 7% tax on the Washington-allocated long-term capital gains (LTCG) of individuals over $250,000 resulting from the sale of certain capital assets.⁷⁸ The tax was enacted to supplement the state’s revenue due to its lack of a traditional income tax. While the LTCG tax did not become effective until the 2022 tax year, legal challenges to the tax were filed prior to its enactment. A law firm preemptively filed a lawsuit in a Washington superior court on behalf of several taxpayers, alleging the tax is a property tax on income, in violation of the uniformity and levy limitations on property taxes in the Washington Constitution.⁷⁹ The superior court granted the plaintiffs’ motion for summary judgment and held that the LTCG tax violates the Washington Constitution as a property tax on income.⁸⁰

On March 24, 2023, the Washington Supreme Court reversed the superior court and held that the LTCG tax constitutes a valid excise tax levied on the sale or exchange of capital assets that does not violate Washington state constitutional provisions, or the Dormant Commerce Clause of the U.S. Constitution.⁸¹ The court applied the key principles developed in several property and excise tax cases to conclude that the LTCG tax “falls squarely on the excise side of the line because it taxes transactions involving capital assets—not the assets themselves or the income they generate.” Also, the court explained that the LTCG tax is “wholly unlike” the broad-based net income taxes that the court struck down in a prior case. As a result of this decision, LTCG tax filings and payments for the 2022 tax year proceeded on schedule, though the Washington Supreme Court decision is currently being appealed by the taxpayers affected by the LTCG tax to the U.S. Supreme Court.

Unless the U.S. Supreme Court takes the case and overrules the Washington Supreme Court, however, taxpayers must comply with the LTCG tax. As discussed above, individuals who recognize more than $250,000 in Washington-allocated LTCG during a tax year may be subject to the LTCG tax. Allocation rules depend on whether the individual is a Washington resident and whether the underlying assets resulting in the LTCG are tangible or intangible assets.⁸² Although the LTCG tax is not imposed on PTEs, the LTCG tax may apply to individual owners of PTEs that sold tangible or intangible assets creating Washington-allocated LTCG.⁸³ Accordingly, PTEs that have engaged in transactions resulting in more than $250,000 in Washington-allocated capital gains in a tax year may need to provide information to affected individual owners for them to determine whether they are subject to the LTCG tax.   

10. Colorado Supreme Court considers property revaluation due to pandemic

The COVID-19 pandemic had a dramatic effect on the real property tax values of commercial property in many instances. Retailers closed locations and the property became “dark” or inactive. Substantially increased vacancy levels in office buildings due to employers reducing their office space also lowered property values. As a result, taxpayers have contended that for purposes of the real property tax, property should be revalued to reflect these changes.  

On May 30, 2023, the Colorado Supreme Court decided four cases holding that the pandemic and the various health orders issued during the 2020 property tax year were not “unusual conditions” that required the revaluation of commercial property prior to the standard assessment date.⁸⁴ In two of the cases, MJB Motels LLC v. County of Jefferson Board of Equalization⁸⁵ and Hunter Douglas Inc. v. City and County of Broomfield Board of Equalization,⁸⁶ the court determined that the pandemic was not an unusual condition. In the other two cases, Larimer County Board of Equalization v. 1303 Frontage Holdings LLC⁸⁷ and Educhildren LLC v. County of Douglas Board of Equalization,⁸⁸ the court also addressed the timing of the revaluation during the property tax assessment cycle.

Colorado law generally requires that property valuations be conducted once every two years. In the cases at issue, 2019 was the assessment year and 2020 was the second, or intervening, year in the property tax cycle. Assessors are instructed to revalue property before the next assessment date under certain limited circumstances, including where “unusual conditions in or related to any real property . . . would result in an increase or decrease in actual value.”⁸⁹ The unusual conditions are expressly limited to certain events that include, in relevant part, “any new regulations restricting or increasing the use of the land” or “any detrimental acts of nature.”⁹⁰ In MJB Motels, the taxpayers argued that the COVID-19 pandemic was a detrimental act of nature and the public health orders issued in response to the pandemic constituted new regulations restricting the use of the land.⁹¹

The Colorado Supreme Court held that the pandemic was not an unusual condition requiring a revaluation of the property. The court considered the “acts of nature” provision and determined that the unusual condition must be both an “act of nature” and “in or related to any real property.” According to the court, the pandemic was not an act of nature such as earthquakes, floods, or tornadoes. Also, the pandemic was not “in or related to any real property” because even though COVID-19 may have infected people who were on the property, it did not infect the property itself. Furthermore, the court determined that the public health orders were not regulations restricting the use of the land because they regulated the operation of commercial activity on the land rather than the use of the land itself. Finally, the court explained that its conclusion that the pandemic did not constitute an unusual condition was consistent with cases holding that changed economic conditions did not constitute unusual conditions for purposes of the statute.

Taxpayers should note that these cases concern the valuation of property in the interim period prior to the standard assessment date. Despite these decisions, taxpayers in Colorado presumably still could argue that their property should be revalued on the standard assessment date. Also, the property tax valuation standards differ among states. Property owners still should consider seeking revaluations due to the pandemic when properties are assessed.