State and local tax news for May 2024

During the past few weeks, state legislatures enacted budget bills amending a variety of tax provisions and noteworthy tax legislation that decouples from major federal tax changes such as bonus depreciation and the deduction of research and experimental expenses. First, the Kentucky Department of Revenue announced that Gov. Andy Beshear’s line-item vetoes of certain provisions of the state’s budget legislation remain in effect despite an earlier belief by the state’s legislature that the vetoes had been rejected. Nebraska enacted legislation that includes 60% bonus depreciation, the current deduction of research and experimental expenses, and mobile workforce provisions. New York enacted budget legislation that contains a few notable sales tax and credit and incentives items that taxpayers should consider. The City of Cleveland took a positive step for remote workers located outside Ohio by deciding not to appeal a trial court decision that rejected the imposition of municipal income tax on a nonresident employee during the COVID-19 pandemic. In the area of sales tax, the Pennsylvania Commonwealth Court decided that Perrier bottled water should be taxed as a soft drink. Finally, the Virginia Tax Commissioner issued two rulings that clarify the application of the subject-to-tax exception to the addback requirement. All these developments are discussed in the May 2024 summary of SALT news.

Kentucky DOR announces governor’s line-item vetoes remain in effect

In April 2024, Kentucky enacted budget legislation, H.B. 8, which amended multiple areas of Kentucky tax law. On April 9, 2024, Kentucky Gov. Andy Beshear line-item vetoed provisions concerning a sales tax exemption for currency and bullion as well as an unfunded mandate for a tax amnesty program. The Kentucky legislature immediately acted to override these vetoes. The legislature later indicated on its website that H.B. 8 became law on April 10, 2024, without the governor’s signature, apparently on the basis that the legislature rejected the governor’s vetoes because he did not have authority to line-item veto revenue items. We included a story in the April 2024 State and Local Thinking newsletter reporting that the legislature had overridden the vetoes.

In early May 2024, the Kentucky Department of Revenue issued a notice announcing that the legislature did not in fact override these line-item vetoes, leaving them intact. According to the Department, currency and bullion continue to be subject to sales and use tax, and the Department will not implement the tax amnesty program. It remains to be seen whether such decision is challenged by the Kentucky legislature, or by another interested party that is affected by the position taken by the governor and the Department.

Nebraska enacts legislation addressing bonus depreciation, research expensing

On April 23, 2024, Nebraska enacted legislation, L.B. 1023, which decouples from federal law by allowing 60% bonus depreciation and research and experimental (R&E) expensing. This legislation follows a trend of other states enacting provisions decoupling from these federal items during 2023. Also, the legislation includes mobile workforce provisions eliminating the requirement for nonresident individuals who are briefly in the state to attend a conference or training to pay individual income tax.  

The Tax Cuts and Jobs Act of 2017 (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. Under L.B. 1023, for tax years beginning or deemed to begin on or after Jan. 1, 2025, taxpayers in Nebraska are allowed to immediately deduct 60% of the cost of expenditures for business assets that are qualified property or qualified improvement property under Internal Revenue Code (IRC) Sec. 168 during the tax year the property is placed in service, notwithstanding any changes to federal law related to depreciation beginning Jan. 1, 2023, or on any other date. This 60% deduction applies to property placed in service after Dec. 31, 2024, and remains in effect while federal bonus depreciation is reduced and eliminated. The deduction will be allowed only to the extent that such cost has not already been deducted in determining federal taxable income. If the taxpayer does not fully expense the costs in the tax year in which the property is placed in service, the taxpayer may elect to depreciate the costs over a five-year irrevocable term.

Under IRC Sec. 174, prior to enactment of the 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 or deemed to begin on or after Jan. 1, 2025, L.B. 1023 allows a Nebraska taxpayer to elect to treat R&E expenditures which are paid or incurred by the taxpayer during the taxable year in connection with its trade or business as expenses (i.e., not capitalized). The expenditures will be allowed as a deduction, notwithstanding any changes to the IRC related to the amortization of R&E expenditures. The deduction will be allowed only to the extent that such R&E expenditures have not already been deducted in determining federal taxable income. If the taxpayer does not fully deduct the R&E expenditures in the tax year in which the expenditures are paid or incurred, the taxpayer may elect to amortize the expenditures over a five-year irrevocable term.

For tax years beginning or deemed to begin on or after Jan. 1, 2025, the legislation adopts mobile workforce provisions addressing nonresidents who attend a conference or training in Nebraska. Specifically, compensation paid to a nonresident individual does not constitute income derived from sources within Nebraska and subject to the state’s individual income tax if all the following conditions apply: (i) the compensation is paid for employment duties performed by the individual while present in Nebraska to attend a conference or training; (ii) the individual is present in Nebraska for no more than seven employment duty days in the tax year; (iii) the individual performed employment duties in more than one state during the tax year; and (iv) total compensation while in Nebraska does not exceed $5,000 in the tax year. “Employment duty days” are days where an individual is earning wages for work being performed for an employer. An employer is not subject to penalties or interest for failing to deduct and withhold income taxes if, when determining whether withholding was required, the employer met either of the following conditions: (i) the employer maintains a time and attendance system designed to allocate employee wages among all taxing jurisdictions in which an individual performs employment duties for the employer; or (ii) the employer uses other reliable methods to track the number of days that an employee works in Nebraska. This legislation should greatly simplify individual income tax withholding and compliance for employees who are briefly in the state to attend a conference or training. 

New York enacts budget amending sales tax, adding credits     

New York enacted budget legislation, Ch. 56 (A.B. 8806 / S.B. 8306) and Ch. 59 (A.B. 8809 / S.B. 8309), on April 20, 2024, which includes a variety of tax changes. Of most significance to taxpayers, the legislation addresses sales and use tax, credits and incentives, and metropolitan commuter transportation mobility tax (MCTMT) provisions.

Ch. 59 (A.B. 8809 / S.B. 8309) enacts provisions necessary to implement the state fiscal plan for the 2024-2025 state fiscal year. The legislation extends by one year the sunset dates applicable to the existing sales and use tax exemption for specific sales of property or services between certain financial institutions and their subsidiaries that are related to the federal Dodd-Frank Wall Street Reform and Consumer Protection Act. As amended, the exemption is applied to sales made, services rendered, or uses occurring up to June 30, 2025, but the exemption is available until June 30, 2028 for sales made pursuant to a binding contract. Also, the sales tax exemption for certain food and beverages that are sold through vending machines is extended for one year, to May 31, 2025.

The legislation also clarifies the filing of amended sales tax returns for periods beginning on and after Dec. 1, 2024. A new statutory provision allows taxpayers to amend a return if it will not reduce or eliminate past-due tax liability. A person required to collect sales tax may amend a return within 180 days of the date the return was due if the past-due liability was self-assessed and reported by that person. If there is no past-due tax liability, an amended return that would result in the reduction or elimination of tax due is deemed a claim for credit or refund. If the New York Commissioner of Taxation and Finance has determined the amount of tax due, an original return may be filed within 180 days after mailing the notice of the determination. An assessment of tax, penalty and interest, including recovery of a previously paid refund, attributable to a change or correction on a return, may be made at any time within three years after the return is filed. Any person who willfully files or amends a return that contains false information to reduce or eliminate a liability is subject to a penalty up to $1,000 per return in addition to any other penalty provided by law. The commissioner must provide notice of these statutory amendments to parties required to collect tax by Sept. 1, 2024.  

For the 2024 and 2025 tax years, qualified businesses are allowed a $3,000 commercial security tax credit for each retail business location in the state. The credit, which is intended to encourage retail theft prevention measures, may not exceed $5 million per calendar year for all taxpayers. Businesses must file Article 9 (corporation tax), Article 9-A (corporation franchise tax), or Article 22 (individual income tax) returns to be eligible to receive the credit.

New York imposes the MCTMT on certain employers and self-employed individuals engaging in business within the Metropolitan Commuter Transportation District (MCTD) that encompasses New York City and the surrounding suburbs. For the 2024 and subsequent tax years, the legislation clarifies that for individuals, the tax is imposed at a rate of 0.34% of the net earnings from self-employment attributable to the MCTD, in the counties of Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk, and Westchester (as well as New York City), if the earnings attributable to the MCTD exceed $50,000 for the tax year.

Ch. 56 (A.B. 8806 / S.B. 8306) enacts provisions necessary to implement the state education, labor, housing and family assistance budget for the 2024-2025 state fiscal year. For the 2025 through 2027 tax years, this legislation provides a newspaper and broadcast media tax credit that may be taken against corporation franchise tax and individual income tax. The credit has the following components: (i) the new job creation component allowing a credit of $5,000 per net new job (limited to $20,000 per business entity); and (ii) the existing jobs component that allows a credit to support the costs related to the retention of jobs equal to 50% of the wages of the eligible employee. The existing jobs component may only be applied to up to $50,000 in wages paid annually per eligible employee (limited to $300,000 per business entity). The total amount of the credit may not exceed $30 million for all taxpayers, for each year the credit is available.

Cleveland decides not to tax nonresident remote worker  

On April 25, 2024, the City of Cleveland, Ohio, filed a motion to voluntarily dismiss the appeal of a trial court decision, Morsy v. Dumas, concerning the imposition of municipal income tax on a nonresident remote worker during the COVID-19 pandemic. This case concerned the application of temporary emergency legislation, H.B. 197, enacted in 2020 providing that during the health emergency and for 30 days after the conclusion of the emergency, “any day on which an employee performs personal services at a location, including the employee’s home, to which the employee is required to report for employment duties because of the declaration shall be deemed to be a day performing personal services at the employee’s principal place of work.”

In 2022, the Cuyahoga County Court of Common Pleas ruled in Morsy that the City of Cleveland was required to refund municipal income tax collected from a nonresident employee who worked remotely from Pennsylvania during most of the 2020 tax year. The trial court concluded that Ohio could not authorize its cities to engage in extraterritorial taxation under temporary emergency legislation permitting municipalities to tax the income of employees that worked in those cities prior to the pandemic but worked remotely from a different location for most of 2020.

This same emergency legislation also recently was considered by the Ohio Supreme Court in a case involving an employee who worked remotely from a different location within Ohio. On Feb. 14, 2024, the court held in Schaad v. Alder that this law directing Ohio workers to pay municipal income tax based on their “principal place of work” rather than the municipality where they actually performed the work did not violate the Due Process Clause. The Ohio Supreme Court explained that the federal cases imposing a limitation on interstate taxation under the Due Process Clause have never been applied to matters of intrastate taxation. The court also held that the enactment of the legislation was a valid exercise of the legislature’s constitutional authority. On April 22, 2024, in Price v. City of Cincinnati, the Ohio Board of Tax Appeals expressly followed Schaad and held that the days the taxpayer worked remotely in a Cincinnati suburb were subject to the city’s municipal income tax.

There is a significant distinction in the facts of these cases. In Morsy, the City of Cleveland attempted to tax a nonresident employee who worked remotely from Pennsylvania. In contrast, the employees in Schaad and Price worked in an Ohio suburb of the City of Cincinnati. By deciding not to appeal Morsy, the City of Cleveland is signaling that the emergency legislation may not be used to impose municipal income tax on an employee who works remotely outside Ohio. This is a positive development for nonresident employees of Ohio businesses who worked outside the state during the pandemic. Although Morsy involved a temporary Ohio statute that no longer is in effect, the case continues to have significance in the taxation of remote workers and the application of due process requirements. States such as New York have a “convenience of the employer” rule, under which the income of employees is sourced to the state or locality if employees work remotely for their own convenience rather than as a requirement of the employer that is located in the taxing state. The due process arguments accepted by the court in Morsy could potentially be used to support challenges to state convenience of the employer rules where employees work remotely from outside the state. 

Pennsylvania court holds carbonated water taxed as soft drink     

On April 23, 2024, the Pennsylvania Commonwealth Court held in Montgomery v. Pennsylvania that Perrier, the French seltzer water, qualifies as a soft drink that is subject to sales tax. The court acknowledged that water is exempt from sales tax, but Perrier constitutes “carbonated water” that falls within the definition of a taxable “soft drink.”

The taxpayer filed refund petitions with the Pennsylvania Department of Revenue after paying a total of 24 cents in sales tax on her purchase of two bottles of Perrier non-flavored mineral water from a retailer on two separate occasions. According to the taxpayer, Perrier is a natural mineral water not subject to sales tax. The taxpayer also initiated a class action complaint advancing the same argument. The Department denied the refund petitions after concluding that Perrier is “carbonated water” included in the definition of “soft drink” under Pennsylvania law. After the Pennsylvania Board of Finance and Revenue affirmed the denial of the refund petitions, the taxpayer filed an appeal with the Pennsylvania Commonwealth Court.

In affirming the denial of the refund petitions, the Commonwealth Court agreed with the state’s argument that because Perrier is carbonated, it qualifies as a soft drink subject to state sales tax. Pennsylvania law excludes from tax retail sales of water or food and beverages for human consumption, but the exclusion does not apply to the sale of “soft drinks.” A statute defines “soft drink” to include “carbonated water.” The Department has issued a statement of policy that includes “artificially carbonated water” within the definition of “soft drink.”

The taxpayer unsuccessfully argued that Perrier is exempt from sales tax because it is natural mineral water. After reviewing the process required to create Perrier, the court concluded that Perrier is carbonated during production in the same manner as soft drinks such as Coca-Cola and Pepsi are carbonated. Pennsylvania law treats “water” and “carbonated water” differently for sales tax purposes. The court determined that the exemption for water did not apply to Perrier because it constituted “carbonated water” as a matter of law that fell within the definition of “soft drink.” Also, the court rejected the taxpayer’s argument that only “artificially carbonated water” may be taxed as a soft drink. The statutory definition of “soft drink” does not contain any “natural” or “artificial” qualifications concerning carbonation. The court explained that whether the carbonation in Perrier is natural or artificial did not affect its decision. 

Virginia issues rulings on subject-to-tax exception to addback     

In April 2024, the Virginia Tax Commissioner released two rulings that considered the subject-to-tax exception to the addback requirement. Both decisions began with the same analysis of the applicable Virginia law. Taxpayers are required to add back to the extent excluded from federal taxable income the amount of any intangible expenses and costs paid, accrued, or incurred to, or in connection with transactions with one or more related members to the extent such expenses and costs were deducted in computing federal taxable income for Virginia purposes. However, an addition is not required for any portion of the intangible expenses and costs if the corresponding item of income received by the related member is subject to a tax based on or measured by net income or capital imposed by Virginia, another state, or a foreign government with a comprehensive tax treaty with the U.S. government.

In both rulings, the taxpayers argued that the plain meaning of the statute entitled them to exclude 100% of their royalty payments from the addback because all the royalties were included in the affiliated intangible holding companies’ taxable income in another state. The commissioner explained that the Virginia Department of Taxation’s position has consistently been that the exception is limited to the portion of a taxpayer’s intangible expense payments to its affiliates that correspond to the portion of the affiliate’s income subjected to tax in other states, as evidenced by the apportionment percentages shown on the affiliate’s tax returns filed with the other states. In 2018, the Virginia Supreme Court interpreted the “subject-to-tax” exception as applied to royalty payments in Kohl’s Department Stores, Inc. v. Virginia Department of Taxation. The court held that the subject-to-tax exception applies only to the extent that the royalty payments were actually taxed by another state. As explained by the commissioner in the recent rulings, the exception applies on a post-apportionment, rather than a pre-apportionment, basis.  

The first decision, Ruling of Commissioner, P.D. 24-18, concerned the subject-to-tax exception and its application to merchandise buyer service fees and systems licensing fees. The taxpayer and several of its affiliates filed combined Virginia corporate income tax returns, claiming a full exception to the addback for intangible expenses paid to three related intangible holding companies on the basis that the income was subject to tax in another state. Under audit, the Department reduced the amount claimed as an exception to the addback to correspond to the amount of the affiliates’ royalty income apportioned to the state in which the intangible holding companies paid tax. The amount of the addback was increased accordingly, and assessments were issued.

In the ruling, the commissioner separately considered the merchandise buyer service fees and the systems licensing fees. The taxpayer and an affiliate paid a fee equal to 3% of their purchases to a related entity for the use of its buyer services. On its Virginia returns, the taxpayer reported this fee as a royalty intangible expense that was not required to be added back based on the subject-to-tax exception. After reviewing the statutory definition of intangible expenses and costs, the commissioner determined that based on the evidence provided, the fees were for specific services that were not the type of expenses included as intangible expenses that are subject to addback. Accordingly, the buyer service fees were excluded from the royalty expense claimed because they were not an intangible expense subject to addback.

The commissioner decided that the amount that the taxpayer and an affiliate paid as a systems license fee for the use of certain trade secrets and other intangible property, including unique computer software application systems, was subject to the addback provisions. The taxpayer unsuccessfully argued that the system license fees were not required to be added back because they were not specifically included in the statutory list of items considered to be “intangible property.” In holding that the system license fees were subject to addback, the commissioner noted that some of the categories of expenses that qualify as intangible expenses are not tied to the “intangible property” definition. However, the intangible expenses would be eligible for the subject-to-tax exception based on the amount of fee income subject to tax in another state.