State and local tax news for March 2025

As many states continued to work on developing substantial tax legislation during March, state courts and administrative agencies released decisions that addressed a variety of key state tax topics such as apportionment, advertising taxes, and property tax valuation affected by the pandemic.

An Arkansas circuit court held that the capital gains a taxpayer received from selling its fast-food franchises constituted non-business income subject to allocation to the taxpayer’s state of domicile. The Maryland Tax Court upheld the Baltimore Outdoor Advertising Tax. In New York, the Tax Appeals Tribunal clarified the sourcing of brokerage commissions for apportionment purposes. The Ohio Board of Tax Appeals held that the property value of a prominent city hotel was properly reduced to reflect the downturn in business resulting from the pandemic.

In a sales tax matter, the Texas Supreme Court held that a corporation that owned and operated correctional facilities was not entitled to receive the sales tax exemption for purchases by agents or instrumentalities of the federal or state government. Finally, the Texas Comptroller considered the franchise tax treatment of a taxpayer’s “printing as a service” offering. All these developments are discussed in the State and Local Thinking newsletter for March.  

Arkansas court holds sale of franchises was nonbusiness income

On March 10, 2025, the circuit court of Pulaski County, Arkansas, held in United States Beef Corp. v. Walther that the capital gains the taxpayer received from selling its fast-food brands and franchises constituted nonbusiness income. In granting the taxpayer’s motion for summary judgment, the court explained that the taxpayer was not in the business of selling fast-food franchises and the income should be allocated to the taxpayer’s commercial domicile in Oklahoma.

The taxpayer, an Oklahoma corporation, owned and operated fast-food franchises in nine states (including Arkansas) for more than 40 years. The taxpayer sold its franchises in 2018 to unrelated third parties and liquidated its business. The taxpayer subsequently filed a refund request with the Arkansas Department of Finance and Administration for a portion of the taxes that it had already paid for the 2018 tax year. On the refund claim, the taxpayer identified as nonbusiness income the income arising for the sale of the franchises. The Department denied the refund request and characterized the income as business income. In response to the taxpayer’s appeal, the Office of Hearings and Appeals affirmed the refund denial. The taxpayer appealed to the circuit court and filed a motion for summary judgment.

The circuit court agreed with the taxpayer that the capital gains constituted nonbusiness income and granted the taxpayer’s motion for summary judgment. As background, the court explained that Arkansas follows the Uniform Division of Income for Tax Purposes Act (UDITPA). “Business income” is defined as “income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.” All income that is not “business income” is considered nonbusiness income. Capital gains that are deemed business income are apportioned, while capital gains that are nonbusiness income generally are allocated to the taxpayer’s state of domicile.   

In determining that the taxpayer’s gains were nonbusiness income, the court considered the transactional and functional tests contained within the definition of business income. The transactional test relates to whether the income arises “from transactions and activity in the regular course of the taxpayer’s trade or business.” Because there was no dispute that the taxpayer’s sales were outside its regular course of business, the Department did not challenge the taxpayer’s assertion that the transactional test was not met.

The taxpayer’s motion for summary judgment turned on the “functional test” which is comprised of the second clause of the “business income” definition as provided above. As explained by the court, the Arkansas Supreme Court has released two decisions narrowing the analysis to the following: “is the taxpayer in the business of acquiring, managing, and disposing of the type of property that generated the income?” (emphasis added by the court). In 1992, the Arkansas Supreme Court held in Pledger v. Getty Oil Exploration Co. that interest accrued on a promissory note failed the functional test because this type of property was outside the taxpayer’s business. The Arkansas Supreme Court similarly held in an opinion released in late 2024, Hudson v. Murphy Oil USA, Inc., that funds used to support a spin-off from one parent company to another failed the functional test. Because the taxpayer used the funds for a one-time event, the activity that generated the income was not considered to be an integral part of the taxpayer’s business.

In granting the taxpayer’s motion for summary judgment in this case, the Arkansas Supreme Court determined that the functional test was not satisfied. The court noted that the taxpayer had never sold a franchise prior to the liquidation at issue. Although the taxpayer was in the business of acquiring or operating franchises, it was not in the business of disposing franchises. The taxpayer was no longer involved in the franchising business and none of the proceeds of the sale was used in its franchising business. Because the taxpayer had not previously sold a franchise, the court concluded that the taxpayer was not in the business of disposing of this type of property. Similar to the Arkansas Supreme Court’s recent decision in Murphy Oil, this case may be cited by similarly situated taxpayers in Arkansas and potentially other UDITPA states as support for a nonbusiness income position. 

Maryland Tax Court upholds local advertising tax            

While the constitutionality of Maryland’s digital advertising services tax has garnered significant attention, it is not the only tax related to the advertising industry in Maryland that recently has been challenged by taxpayers. The city of Baltimore imposes a tax on billboards that likewise has been the subject of constitutional scrutiny. On Jan. 31, 2025, the Maryland Tax Court held in Clear Channel Outdoor, LLC v. Director that a major billboard company was subject to the Baltimore Outdoor Advertising Tax. The company qualified as an “advertising host” that was required to remit the tax.

The taxpayer owned and controlled several hundred billboards in the city during a three-year period. The billboards included non-electronic static outdoor displays that were manually changed and electronic digital displays that could automatically change images and serve multiple customers. The taxpayer’s agreements with its customers generally stated that the taxpayer’s provision of advertising services did not transfer any ownership rights of any advertising structure. After the city denied the taxpayer’s refund claims for the outdoor advertising tax, the taxpayer appealed to the Maryland Tax Court.

The Maryland Tax Court affirmed the city’s denial of the refund claim. On appeal, the taxpayer argued: (i) it was not an “advertising host” required to remit the tax because there was no “use” by the advertisers; (ii) the tax was void for vagueness; and (iii) the tax imposes an impermissible non-uniform property tax. Under the city’s code, “advertising host” is defined as “a person who: (1) owns or controls a billboard, posterboard, or other sign; and (2) charges fees for its use as an outdoor advertising display.”

The taxpayer unsuccessfully argued that the tax requires the advertisers to have ownership or control of the billboards, as the court relied on the plain meaning of the city code. First, the taxpayer contended that the “advertising host” definition was not satisfied because the advertisers did not engage in any “use” under the tax. In rejecting the taxpayer’s argument, the court explained that the charging of fees for the use of a “billboard, posterboard, or other sign” matters, rather than the identity of the party actually using the billboard. The court rejected the taxpayer’s argument that the term “use” in the definition requires transfer of control or ownership of the billboards. Further, the court emphasized the fact that the tax is an excise tax required when an advertising host uses billboards as outdoor advertising displays, and that the billboards were necessary for the taxpayer to provide its advertising services to advertisers who controlled the message ultimately displayed on the billboards.

The court also held that the taxpayer was precluded from denying it is an “advertising host” under the doctrine of judicial estoppel because the taxpayer took a contrary position in prior litigation on the subject of the constitutionality of the billboard tax. In the prior litigation, the taxpayer needed to be considered an “advertising host” to have standing to challenge the tax under the constitutional protections of freedom of speech and of the press. All the courts in the previous litigation accepted the taxpayer’s position acknowledging tax liability as an advertising host. The Maryland Court of Appeals denied the taxpayer’s constitutional arguments.  

According to the Maryland Tax Court, the tax is not void for vagueness because it is clear on its face and refers to the use of the billboard as an outdoor advertising display, not for a particular party’s use of the billboard. There was nothing to support the taxpayer’s position that the tax only applies if the end customers (the advertisers) have rights to use or possess the billboards.

Finally, the court held the advertising tax is not an impermissible non-uniform property tax. Applying a Maryland Court of Appeals decision, Weaver v. Prince George’s County, from 1977, the court determined that the advertising tax was an excise tax rather than a property tax. The court also held the tax is uniform. The taxpayer argued the tax is not uniform because it only applies to billboards that are at least 10 square feet in size, and that electronic billboards are taxed at a higher rate than static billboards that have to be manually changed. In rejecting this argument, the court explained these are two different subclasses of billboards with different pricing mechanisms.

New York clarifies apportionment sourcing for brokerage commissions         

The New York Tax Appeals Tribunal held on Feb. 20, 2025, in Jefferies Group LLC, that a taxpayer operating as a global investment bank and institutional securities firm must source receipts from brokerage commissions and gross income from principal transactions based on the location of its immediate customers (institutional intermediaries), rather than the location of the underlying investors. While this complex decision also concerned investment tax credits and the taxpayer’s election to treat certain amounts as investment capital, this summary focuses on the Tribunal’s analysis on the apportionment issue raised.  

During the relevant 1997-2007 tax years, the taxpayer, Jefferies Group, Inc. (subsequently changed to Jefferies Group LLC), was the parent of a combined group including Jefferies & Company, Inc. (Jefco) and Jefferies Execution Services, Inc. (Jefex). The taxpayer and its subsidiaries operated as a full-service global investment bank and institutional securities firm. Jefco is a registered securities broker-dealer primarily engaged in the business of providing equity, corporate and municipal debt, securities dealer and brokerage services, and underwriting investment banking services. Since 2001, Jefco has been headquartered in New York City and has sales offices in numerous states throughout the country. Jefex is a registered securities broker-dealer whose business primarily consists of provided securities execution services on stock exchanges, principally for Jefco but also for other financial intermediaries.

Jefco and Jefex derived commissions from executing brokerage transactions in equity securities at the direction of institutional intermediaries such as registered investment advisors (RIAs), pension funds, hedge funds, mutual funds, registered securities brokers or dealers, and similar financial intermediaries. The investors in the institutional intermediaries were referenced collectively as “underlying investors.” Nearly all Jefco’s clients were RIAs or institutional intermediaries, and it did not know the identity or mailing address of the underlying investors. The taxpayer filed amended returns sourcing the brokerage commissions, management fees and gross income based upon an approximation of the locations of the underlying investors rather than the locations of the institutional intermediaries. As a result, the taxpayer requested refunds based on this and other adjustments. The New York State Department of Taxation and Finance denied the refunds and sourced the income based upon the locations of the institutional intermediaries.

Pursuant to the taxpayer’s appeal, an administrative law judge (ALJ) disagreed with the apportionment methodologies used by both the taxpayer and the state. New York law in effect for the relevant tax years sourced brokerage commissions based on the location of the customer responsible for paying the taxpayer. The ALJ found the underlying investors were the customers, but recognized the law did not allow a look through to the underlying investors. Relying on the taxpayer’s expert witness testimony, the ALJ noted the state’s method for apportioning the receipts was distortive and grossly overstated the results reached by using an apportionment method that reasonably approximates the location of the underlying investors. The ALJ directed the state to exercise its discretionary authority and use U.S. Census data to source the receipts.

On appeal, the Tribunal reversed the ALJ’s decision concerning the apportionment issue. The Tribunal determined the taxpayer’s customers were the institutional intermediaries, rather than the underlying investors. In rejecting the ALJ’s decision that the Division should use its discretionary authority to source the receipts, the Tribunal held the taxpayer’s receipts from brokerage commissions and gross income must be sourced to the mailing addresses of the customers (institutional intermediaries) in the taxpayer’s books and records. If the taxpayer does not have these mailing addresses, the receipts should be sourced to the branch or office responsible for the transactions that generated the receipts. The Tribunal affirmed the ALJ’s holding that the Division improperly denied the taxpayer’s election to treat the net income from its securities borrowing and lending transactions, interest rate swap transactions, and cash on deposit with a futures trading business as investment capital. Also, the Tribunal agreed the Division improperly disallowed some of the taxpayer’s investment tax credit claims.

Although New York tax law was significantly reformed beginning with the 2015 tax year (following the years at issue in this matter), the current law has similar provisions contained in N.Y. Tax Law Sec. 210-A.5(b), regarding the sourcing of receipts from broker or dealer activities. Thus, this decision may have relevance for current tax years. Note, however, that current law provides that if the taxpayer is unable from its records to determine the customer’s mailing address, 8% of the receipts is included in the numerator of the apportionment factor. 

Ohio BTA rules hotel’s property value lowered by pandemic        

On March 5, 2025, the Ohio Board of Tax Appeals (BTA) agreed with the taxpayer in 127 PS Fee Owner, LLC v. Cuyahoga County Board of Revision that a hotel’s value for property tax purposes was reduced for the 2020 tax year due to the COVID-19 pandemic. The BTA held that the report by the taxpayer’s appraiser was better supported by the evidence than the report issued by the local board of education’s appraiser because it more effectively addressed the impact of the pandemic.

The taxpayer and the Cleveland board of education (BOE) appealed a decision of the Cuyahoga Board of Revisions (BOR) valuing a hotel located in downtown Cleveland for the 2020 tax year. After the fiscal officer initially assessed the hotel’s value at approximately $24.3 million, the taxpayer filed a special COVID complaint seeking a value of $15 million. The BOE supported the fiscal officer’s value. At the BOR hearing, the taxpayer presented an appraisal valuing the hotel at $18.5 million as of Oct. 1, 2020. The BOR found the taxpayer had shown the effect of the pandemic on value, but the BOR criticized the appraiser’s income data and capitalization rate. Accordingly, the BOR made its own adjustments and adopted a value of $19.6 million. The taxpayer and the BOE appealed to the Ohio BTA.

At the hearing, the BTA explained that it was required to independently determine the hotel’s value based on the best evidence available. The taxpayer presented an appraiser who valued the hotel at $18.5 million as of Oct. 1, 2020. The BTA noted that the taxpayer’s appraiser used both the income approach and sales comparison approach to value the hotel. The appraiser explained that the hotel occupancy in the downtown area was low prior to the pandemic and dropped sharply by 64%, resulting in a depressed average daily rate. Full-service hotels with event space were hard hit by the pandemic because of limited demand for conference and event space. The appraiser expected a rebound in 2021, with occupancy rising to 54%. He adjusted the income approach to account for uncertainty in the hospitality industry. Although he conceded full-service hotel sales data was limited, the appraiser selected six comparable properties with sales dates from January 2017 to December 2019. In support of the appraiser, the taxpayer emphasized the impact of the pandemic. 

The BOE presented an appraiser who valued the hotel at $32.7 million as of Oct. 1, 2020, a drastic increase over the value that the BOR had adopted. The appraiser focused on the income approach and emphasized the need to consider stabilized figures, which he attempted to create using four years of market data and forecasts. Rather than treating 2020 as an indicator of the hotel’s future performance, the appraiser developed a “representative year” based on past financial data and industry forecasts. The BOE argued that long-term value and historical performance prior to the pandemic should be considered.

The BTA determined that the taxpayer’s appraiser better addressed the impact of the pandemic. The appraiser considered the effect of the pandemic, but he also addressed historical performance and projected figures for 2021. His report confirmed hotel occupancy and revenue were steadily decreasing in the local area, a trend which had started even prior to the pandemic. The use of the data from 2020 during the pandemic was appropriate and did not constitute the use of unstabilized income and expenses. The BTA agreed with the taxpayer that the BOE’s appraisal failed to fully consider the impact of the pandemic and relied on speculative data. Also, the BTA noted that Ohio expressly enacted a special procedure for challenging property values because the pandemic could have affected values. The BTA concluded that the BOE appraiser’s stabilization method “glosses over” the pandemic and heavily relied on projections for several years in the future without adequate support. As a result, the BTA valued the hotel at $18.5 million for the 2020 tax year. This is a positive decision for taxpayers who are arguing that property valuations should be reduced due to the pandemic, and provides some guidance on the method by which such an argument might be sustained upon challenge.  

Texas court holds sales tax exemption for government not applicable 

The Texas Supreme Court held in GEO Group, Inc. v. Hegar, released on March 14, 2025, that a corporation that owned and operated correctional facilities for the federal and state governments was not entitled to a sales and use tax exemption for its purchases because it failed to prove that it was a government agent or instrumentality exempt from tax.

The taxpayer, GEO Group, Inc., was a Florida corporation that owned and operated correctional facilities throughout the U.S. for the detention of federal and state inmates. While operating its detention facilities in Texas under government contracts, GEO purchased various supplies to operate the facilities, such as electricity, natural gas, food and furniture. GEO did not pay tax on these purchases because it believed they were tax-exempt. Following an audit, the Texas Comptroller assessed a deficiency against GEO, which GEO challenged via request for an administrative hearing. The Comptroller rejected GEO’s argument at the administrative hearing and subsequently denied its motion for a rehearing. In response, GEO paid the stipulated tax due and filed a suit in district court.

The district court denied GEO’s refund claim because GEO failed to show it was entitled to the governmental exemption by clear and convincing evidence. In response to GEO’s appeal, the court of appeals affirmed the district court’s judgment. The court of appeals explained that GEO was engaged in for-profit activities and failed to establish that it was an agency or instrumentality of the federal or state government immune from sales tax. Also, the court of appeals rejected GEO’s argument that the district court erroneously applied the clear and convincing standard of proof. GEO appealed to the Texas Supreme Court.

The Texas Supreme Court affirmed the decisions and held that GEO was not entitled to the exemption from sales tax. First, the court considered GEO’s argument that the lower courts mistakenly concluded that it was required to meet the heightened clear and convincing standard of proof. The court agreed with GEO that it was required to prove its entitlement to an exemption by the lower preponderance of the evidence standard.

After clarifying the applicable standard of proof, the court considered GEO’s argument that it was entitled to an exemption as an unincorporated instrumentality of the federal and state governments. Texas tax law provides a sales and use tax exemption for “government entities,” which are defined in pertinent part as the federal government, an unincorporated instrumentality of the federal government, a corporation that is an agency or instrumentality owned by the federal government, or the state of Texas. GEO unsuccessfully argued that the purchases it made under its governmental contracts were exempt from tax because it qualified as an “unincorporated instrumentality” of the federal government or Texas. The court first noted that GEO failed to explain how a private, for-profit corporation may be characterized as “unincorporated.” Because the parties did not address this issue before the lower courts, the court decided not to base its decision on this factor. 

The court considered the Comptroller’s administrative rule concerning exempt entities. As noted by the court, the rule expressly exempts the federal government, its unincorporated agencies and instrumentalities. The rule describes the type of federal entities exempt from tax. Also, the rule provides an exemption for the state of Texas, its unincorporated agencies and instrumentalities. According to the court, the rule intends to cover entities that: (i) have been explicitly declared to be a qualifying agency or instrumentality by the government; or (ii) those that could reasonably be viewed as an arm of the government as opposed to merely performing a governmental function. The court concluded that there was ample evidence to support the trial court’s finding that GEO was not a government instrumentality. Many of GEO’s contracts with its government clients included provisions that GEO was an independent contractor, there was no principal-agent relationship between the government and GEO, and GEO was responsible for any taxes. The decision reflects how a private entity stepping into the shoes of what would at first blush be considered a government function – the operation of a correctional facility – may not be able to obtain tax-free treatment on purchases of items deployed at the facility that it likely expected to be tax-free when entering into this type of government contract.  

Texas Comptroller considers franchise tax treatment of printing services  

In March 2025, the Texas Comptroller of Public Accounts released Decision No. 119,652, dated Dec. 4, 2024, holding that a taxpayer could not include costs associated with its revenue from providing a printing as a service (PaaS) offering in its cost of goods sold (COGS) calculation for franchise tax purposes. Also, due to the disallowance of PaaS revenue from transferring equipment, the taxpayer was not eligible to use the lower tax rate for entities primarily engaged in a retail or wholesale trade.   

During the 2017-2020 report years at issue, the taxpayer sold printers, scanners, copiers, supplies and related printing services. Approximately 20-30% of its revenue was from third-party leases of equipment and cash sales. There was no dispute that these sales constituted sales of merchandise and the cost of acquiring the equipment was includible in the taxpayer’s COGS. In addition, approximately one-third of the taxpayer’s revenue was from the sale of bundles that included labor to care for the customer’s equipment as well as parts and supplies. Because the bundles did not include the sale of equipment, the parties agreed that these costs were not included in COGS.

The dispute centered on the treatment of the taxpayer’s revenue from PaaS, which constituted approximately one-third of its total revenue. PaaS consisted of selling bundles that included printing-related services, the transfer of equipment, parts sourced by manufacturers, and supplies such as toner. In calculating its taxable margin, the taxpayer included equipment, supplies, and parts related to the PaaS in its COGS. The Comptroller’s auditor disallowed these costs because they were not adequately supported by documentation. Based on this treatment, the auditor applied the 30% deduction from total revenue rather than the COGS deduction as recalculated by the auditor, as the 30% deduction yielded a lower taxable margin.

With respect to the applicable tax rate to use for calculating the franchise tax, the taxpayer originally had determined it was eligible to receive the lower franchise tax rate for retailers and wholesalers by combining its revenue from transfers of equipment and supplies under the PaaS agreements and revenue from its traditional sales of equipment. The auditor disallowed the revenue classification from sales under the PaaS agreements as retail sales after deeming these to be the sale of a service. Based on the adjustment, the auditor found the taxpayer was not primarily engaged in retail or wholesale trade. The auditor applied the standard tax rate to the taxpayer’s taxable margin with application of the 30% deduction from total revenue, and determined that additional franchise tax was due. The taxpayer appealed the auditor’s adjustments to an administrative law judge (ALJ).

Under Texas law, taxable margin generally is determined by deducting either 30% from total revenue, or by subtracting from total revenue, at the election of the taxpayer, either COGS, compensation, or $1 million. The ALJ determined the taxpayer failed to prove that the auditor’s disallowance of the COGS deductions related to PaaS was in error. The taxpayer’s PaaS sales were a bundle of printing services and tangible personal property. Assuming the equipment transferred constituted a sale, the ALJ explained the taxpayer did not provide documentation showing what pieces were transferred to its customers, when they were transferred, and the costs of purchasing the equipment. Because the taxpayer’s estimates were insufficient to meet its burden of proof, the ALJ recommended the auditor’s revised COGS calculations be upheld and the 30% deduction from total revenue be applied.  

The general franchise tax rate is 0.75% of taxable margin, but entities that are primarily engaged in retail or wholesale trade are taxed at 0.375%. A taxpayer qualifies for the lower tax rate only if the total revenue from its activities in retail or wholesale trade is greater than its total revenue from other activities. The taxpayer argued that the portion of its PaaS sales attributable to the transfer of equipment, when added to its revenue from traditional sales, was sufficient to establish that its wholesale or retail sales were greater than the revenue from its services. To support its argument, the taxpayer provided percentage-based estimates of its PaaS revenue from the transfer of equipment. After determining the taxpayer’s estimates were insufficient, the ALJ held the higher tax rate applied because the taxpayer failed to prove that it was primarily engaged in wholesale or retail trade. The Comptroller adopted the ALJ’s decision. This matter reflects the importance of providing sufficient substantiation at audit, which may have supported treatment of at least some portion of the bundle of costs from the PaaS transactions as COGS, or may have buttressed the taxpayer’s argument that it should have been allowed to utilize the retail / wholesale trade franchise tax rate.