As spring arrives, state legislatures are in session and beginning to enact tax legislation. The first wave of fresh tax laws is accompanied by new judicial decisions as well as expanded administrative guidance. The Alabama Tax Tribunal decided a case in favor of the taxpayer and held that the state’s subject-to-tax exception to its addback statute applied. In California, the Franchise Tax Board issued new and expanded guidance on changing accounting periods or methods. The Michigan Court of Appeals held that individual income tax rate reductions triggered by certain state economic factors are temporary and do not apply to subsequent tax years. New Mexico enacted some of the first major tax legislation this year that changes the corporate income tax to a flat tax rate and removes the deduction for Subpart F income. Finally, the Utah Supreme Court held that the state’s “access interruption statute” that allows property tax adjustments did not apply to interruptions caused by the COVID-19 pandemic. Each of these developments is covered in our March 2024 summary of SALT news.
Alabama Tax Tribunal holds taxpayer entitled to addback exception
On Feb. 26, 2024, the Alabama Tax Tribunal held in Huhtamaki, Inc. v. Department of Revenue that the taxpayer proved it was entitled to the subject-to-tax exception to the addback statute. The Tax Tribunal determined that the interest payments that the taxpayer made directly to its U.S. parent company, and which were then paid to foreign affiliates, were “attributed to” those foreign jurisdictions and not subject to addback.
The taxpayer was a C corporation that was a wholly-owned subsidiary of a U.S. parent company. Both entities were commercially domiciled in Kansas and indirectly owned by a Finland parent company that was considered to be a related member. For the relevant tax years, the taxpayer made certain interest payments directly to the U.S. parent. In turn, the U.S. parent made these interest payments to foreign affiliates that were related members located in Hungary, Switzerland, and Luxembourg. The Finland parent company and the foreign affiliates were all located in countries subject to income tax treaties with the U.S. for the relevant tax years.
Alabama generally requires corporations to add back certain interest and intangible expenses paid to related members that would otherwise be deductible for tax purposes. However, an addback exception is available in certain instances, including when the corresponding item of income is subject to a tax based on or measured by a related member's net income by a foreign nation which has in force an income tax treaty with the U.S., if the recipient was a resident of the foreign nation. The portion of an item of income that is attributed to a taxing jurisdiction having a tax on net income is considered subject to tax even if no actual taxes are paid on the income in the taxing jurisdiction by reason of deductions, or otherwise.
The Alabama Tax Tribunal held that the taxpayer satisfied the subject-to-tax exception from the addback statute for the interest payments indirectly paid to the foreign affiliates. As the taxpayer argued, the relevant Alabama regulation describes a situation in which a corporation makes a direct payment to a second, related corporation, which then makes a direct payment to a third, related corporation. The regulation classifies the payment from the initial corporation to the third corporation as an indirect payment. Furthermore, the Tax Tribunal noted that the addback statute repeatedly uses the phrases “direct or indirect” and “directly and indirectly” in referring to payments and transactions. Finally, the Tax Tribunal rejected the Alabama Department of Revenue’s request to reconsider a prior Tribunal ruling supportive of a taxpayer utilizing the subject-to-tax exception, because it believed that decision to be correct and the decision was being evaluated by the Montgomery Circuit Court on appeal.
California FTB issues guidance on changing accounting periods or methods
On Feb. 27, 2024, the California Franchise Tax Board (FTB) issued guidance, Notice 2024-01, providing expanded information on filing elections to change an accounting period or method. This notice supersedes and replaces prior guidance, Notice 2020-04, which the FTB issued in 2020.
The notice provides procedures for making the election in two situations: (i) deemed California consent; and (ii) different California election. For purposes of deemed California consent, if a taxpayer changes an accounting period or method for federal income tax purposes, the change will apply for California purposes without any action by the taxpayer if California conforms to the underlying federal law being applied. This type of change is mandatory for California purposes unless the taxpayer makes a different California election to either: (i) maintain its existing California accounting period or method, or (ii) change to a different accounting period or method than the period or method that was elected for federal purposes. When a deemed California consent applies, a request to either continue the use of the taxpayer's previous California accounting method or change to a different accounting method is treated as a different California election.
A valid California election based on deemed consent remains valid to the extent California conforms to the underlying federal statute and allows the same method for California purposes. The taxpayer files a copy of the approved federal election on its original California tax return, and the taxpayer does not separately file federal Form 1128 (Application to Adopt, Change, or Retain a Tax Year) or federal Form 3115 (Application for Change in Accounting Method) with the FTB. Deemed consent does not apply where California does not conform to the federal statute that provides for the new federal method. In situations where a taxpayer is required to change its federal accounting method because of a federal statute that is not followed by California, and that taxpayer continues to retain the California accounting method, the taxpayer does not have to obtain FTB consent because of the change in federal accounting method. The notice provides three examples illustrating the procedures to follow for deemed California consent.
For purposes of a different California election, the notice provides that a taxpayer that: (i) cannot rely on a federally approved request to change an accounting period or method for California tax purposes; (ii) wants to obtain California treatment other than that elected for federal purposes, or (iii) wants to change for California tax purposes only must file a completed federal Form 1128 or federal Form 3115 with the FTB. If there is a request to change an accounting period or method for California tax purposes only, the FTB will grant automatic consent if the change would be eligible for automatic consent by the Internal Revenue Service and California conforms to the applicable federal law. In contrast, a request to change an accounting period or method for California tax purposes only that would not be eligible for automatic consent requires FTB consent. The notice explains that FTB consent is limited to the change of an accounting period or method and does not constitute approval of the taxpayer’s use of the accounting period or method.
Notice 2024-01 is more thorough than the prior notice issued in 2020 and provides additional examples. Because the notice provides detailed instructions, taxpayers that are planning to file an election to change an accounting period or method are advised to carefully review this notice.
Michigan court holds individual income tax rate reduction was temporary
The Michigan Court of Appeals held on March 7, 2024, in Associated Builders and Contractors v. State Treasurer, that the individual income tax rate reduction for the 2023 tax year triggered by certain state economic conditions was temporary and does not apply to future tax years. Accordingly, the rate will revert to the original 4.25% rate for the following tax year.
Michigan individual income tax law provides that for each tax year beginning on and after Jan. 1, 2023, the current tax rate is reduced if the percentage increase in the state’s general fund from the prior fiscal year is greater than the inflation rate for the same period. Under this legislation, Michigan lowered its individual income tax rate from 4.25% to 4.05% for the 2023 tax year. The central question in this case was whether the reduction for the 2023 tax year meant that 4.05% becomes the new default rate beginning with the 2024 tax year or the rate instead reverts to a default rate of 4.25% subject to possible reduction each year if certain economic conditions exist.
Prior to the announcement of the 2023 rate reduction, the Michigan Department of Treasury asked the Michigan Attorney General whether a tax rate reduction under the relevant statute was limited to one tax year or a permanent change that applied to subsequent tax years. The Attorney General issued a formal opinion concluding that any rate reduction only applied to one tax year. If the rate is reduced for a particular year, the rate returns to 4.25% in the subsequent year. After the Attorney General’s opinion was released, the Department announced that the rate was reduced to 4.05% for the 2023 tax year.
Plaintiffs consisting of taxpayer advocacy groups, state legislators, and individual taxpayers commenced litigation and argued that the income tax rate is now capped at 4.05% unless the legislature modifies the rate. The trial court agreed with the Department that the advocacy groups and legislators lacked standing to challenge the Department’s interpretation of the rate reduction statute. Also, the trial court determined that the plaintiffs’ claims were not ripe because the rate for the 2024 tax year had not been determined. Because the plaintiffs’ claims could become ripe in the near future, the trial court considered the merits of the litigation and agreed with the Department that the tax rate reverts back to 4.25%. The plaintiffs appealed to the Michigan Court of Appeals.
On appeal, the appellate court agreed with the trial court that the reduced tax rate only applies to one tax year. Because the individual taxpayers had standing, the court was not required to determine whether the advocacy groups and legislators had standing. The case was ripe for adjudication because the Department announced on Feb. 28, 2024, that the tax rate for the 2024 tax year was 4.25%. In rejecting the plaintiffs’ arguments, the court noted that the statute contains no language indicating a legislative intent to make the rate reduction permanent. However, the 4.25% rate could be reduced in a future tax year if the triggering event occurs.
New Mexico enacts corporate income tax legislation
On March 6, 2024, New Mexico enacted legislation, H.B. 252, which made several noteworthy corporate income tax amendments. The most significant changes concern the adoption of a flat tax, different treatment of Subpart F income, and the composition of a water’s-edge group. The amendments discussed below first apply to the 2025 tax year.
As amended, the corporate income tax will be imposed at a flat rate of 5.9% of taxable income. Prior to amendment, the state has a two-tier marginal rate structure of 4.8% for taxable income under $500,000 and 5.9% for taxable income of $500,000 or more.
The legislation also amends the corporate income tax laws to remove the subtraction of Subpart F income from the taxable base. Under Subpart F, certain types of income earned by a controlled foreign corporation (CFC) are taxable to the U.S. shareholders in the year earned even if the CFC does not distribute the income to its shareholders in that year.
The statute concerning which filers can file as a water’s-edge group is changed. As amended, a water's-edge group only excludes corporations organized or incorporated outside the U.S. or its possessions or territories that have less than 20% of their property, payroll, and sales sourced to locations within the U.S., following the Uniform Division of Income for Tax Purposes Act (UDITPA) sourcing rules. Prior to amendment, this exclusion applied to corporations wherever organized or incorporated. Thus, the 80/20 exclusion will be limited to foreign corporations.
Utah Supreme Court denies property tax adjustment for pandemic
On March 7, 2024, the Utah Supreme Court held in Larry H. Miller Theatres, Inc. v. Utah State Tax Commission that the “access interruption statute” that allows for an adjustment of a property’s fair market value if access to the property is interrupted due to circumstances beyond the owner’s control did not apply to the COVID-19 pandemic. Because the pandemic was not identified in the statute or by rule, the taxpayers could not invoke the statute to seek adjustments to the fair market value assessments of their properties.
The taxpayers, comprised of several brick-and-mortar businesses, ranging from a movie theater chain to malls and retailers, argued that the Utah State Tax Commission erred in concluding that the pandemic was not a qualifying event under the access interruption statute. In a unanimous decision, the Utah Supreme Court agreed with the Tax Commission that pandemics are not one of the 13 “enumerated events” that would qualify businesses for relief under the law. The Tax Commission had not promulgated an administrative rule adding the pandemic as a circumstance that could interrupt access. Exercising its administrative discretion, the Tax Commission did not view the pandemic as an event “similar to” those enumerated in the law, which lists road closures, construction, and various natural disasters affecting access to businesses that could reduce their property value, and therefore qualify them for property tax relief.
In the initial summary judgment challenged in court, the Tax Commission also argued that the pandemic did not physically impede accessing taxpayers’ properties, though the court did not expressly rule on that aspect. Utah’s governor did not order business closures in 2020, which may have factored into the Tax Commission’s rationale for not providing relief.
Ultimately, the court deferred to the Tax Commission to decide whether to promulgate a rule to expand the list of qualifying events for purposes of the access interruption statute to include a pandemic. This case is relatively consistent with decisions from courts in other states that did not allow property tax reductions due to the pandemic.
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