A Year in Review: SALT Trends and Highlights
Navigating state and local taxes (SALT) has become increasingly more complex. The past year has seen considerable shifts as states search for a balanced formula that enhances revenues while also wooing investments. From modified tax rates to innovative workarounds for federal caps, 2023 witnessed several tax-related updates that businesses must be aware of. This review delves into the significant SALT changes across pivotal states, ensuring stakeholders remain updated, compliant, and poised for the future.
2023 State Tax Rate Updates
The trend towards lower personal and corporate income tax rates has continued in 2023. The following ten states—Arkansas, Connecticut, Indiana, Kentucky, Michigan, Montana, Nebraska, North Dakota, Utah, and West Virginia—have enacted legislation reducing the personal or corporate income tax rates. Since 2021, twenty-six states have reduced their income tax rates between personal and corporate income tax.
Federal SALT Cap Workaround – Elective Pass-Through Entity Taxes
Since the introduction of the Federal SALT Cap with the Tax Cuts and Jobs Act of 2017, states have been looking for viable workarounds to provide their constituents with meaningful relief from the increased tax burden associated with having a limitation on the deductibility of state and local taxes.
As of the date of this publication, there are approximately thirty-six states that generally now provide for an elective pass-through entity tax regime whereby individual pass-through entity owners may shift the state income tax burden on their distributive share of income to the entity itself, given that business entities are generally not subject to the SALT cap.
In 2023, the following states jumped on the bandwagon and followed the rising trend of adopting these elective pass-through entity tax regimes: Hawaii, Kentucky, Indiana, Iowa, Montana, and West Virginia.
Businesses classified as pass-through entities for tax purposes (generally S corporations, Partnerships, and LLCs treated as partnerships) and operating in one or more of these states should assess whether to make a pass-through entity tax election on behalf of their partners or shareholders.
2023 Update on Public Law (“P.L.”) 86-272
One of the more impactful state income tax updates in 2023 has been the consequences stemming from California’s adoption of the Multistate Tax Commission’s (“MTC”) fourth revision to the “Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272” (the Statement). The fourth revision expanded the activities that would break P.L. 86-272 protection to include certain activities conducted via the internet.
Since the Statement is a change of interpretation rather than a change in law, it behooves taxpayers to review how California applies P.L. 86-272. Taxpayers should assess whether this new interpretation puts them in a new tax position, whether favorable or not, by calculating the tax impact the Statement will have on certain tax items, such as California’s throwback rule for sales factor apportionment purposes. In some instances, a business may reduce its tax liability for goods shipped from California by claiming it is taxable in the destination state because of the unprotected activities performed via its website. However, the same could be true of any other state with throwback rules for sales factor apportionment that adopts the Statement in the future.
Importantly, if a taxpayer takes the position that it does not have to throw back sales into its origin-based state (like California, to keep with the above example), then it might have a filing obligation and tax liability in the destination state.
In addition to California, New Jersey is the only other state to have adopted language from the Statement into its laws. On September 5, 2023, the New Jersey Division of Taxation issued TB-108, stating that New Jersey will generally follow the MTC’s guidelines concerning unprotected internet activities under the reinterpretation of P.L. 86-272. However, it is essential to note that there are some nuanced differences between the division’s guidance and that of the MTC.
After amending its draft of the corporate tax regulations, New York released the draft for public comment on August 9, 2023. The proposed rules are subject to a 60-day public comment period, which ends on October 10, 2023. The draft corporate tax regulations include the MTC’s revised interpretation of P.L. 86-272 or the Statement. Assuming there are no setbacks, it is expected that the Statement will be included, in whole or in part, as part of New York law at some point after the comment period.
Oregon has indicated its intentions to amend its regulations to adopt the MTC’s Statement but has not yet released any guidance or legislative drafts. Taxpayers should keep monitoring state reactions to the Statement and expect additional states to incorporate it, in whole or in part, into law.
2023 Sourcing Updates
Continuing with the trend towards a single-sales factor, legislators in both Montana and Tennessee have recently changed the state’s apportionment computation by adopting the single-sales factor apportionment methodology.
Additionally, several recent significant cases have arisen in other states that have been recently decided, which have affected the sourcing of receipts for apportionment purposes.
The Florida sourcing rules can often cause confusion because the sourcing of services for Florida income tax purposes is ostensibly based upon a Cost-of-Performance method. However, rulings from the state have historically taken more of a Market-Based approach, often concluding that the sourcing of sales other than tangible personal property should be sourced to the location where the customer receives the benefit of the transaction.
The sourcing issue was recently considered by the Circuit Court of Florida’s Second Judicial Circuit in Target Enterprise, Inc. v. Fla. Dept of Rev. on November 28, 2022. Upon judicial review, the Court abated the assessment from the Florida Department of Revenue (“FDOR”), siding with Target Enterprise that the claimed receipts from its sales of services should be attributable to Minnesota, the state where the majority of its payroll costs were incurred during the relevant tax periods, and not the state of Florida.
While the Court’s ruling was primarily concerned with the application of the FDOR’s alternative apportionment method and the documentary support issues raised by the FDOR, the Court’s decision in this case nevertheless provides important guidance for Florida taxpayers required to source receipts from the sale of services within the state.
Recently, the Commissioner of Revenue issued Technical Information Release (“TIR”) 22-14 offering the Commissioner’s interpretation of the decision in VAS Holdings & Investments LLC v. Commissioner of Revenue and seemingly limiting the application of the decision rendered to other taxpayers.
In VAS Holdings & Investments LLC v. Commissioner of Revenue, the Supreme Judicial Court held that Massachusetts law adheres to the unitary business principle in determining how to apportion income. The court further held the Commissioner had violated Massachusetts law when he attempted to apportion and tax gain recognized by a non-resident S corporation that sold an interest in a pass-through entity with operations in Massachusetts based on the apportionment factors of the pass-through entity and with which the S corporation was not engaged in a unitary business.
While the TIR provides some critical insight into the Massachusetts Department of Revenue’s position, the decision rendered in VAS Holdings & Investments LLC v. Commissioner of Revenue should now be the standard for sourcing gains recognized in Massachusetts from similar sales.
New Jersey Sourcing
The “Joyce” rule has been supplanted. All types of combined reporting groups are now required to use the “Finnigan” apportionment method and compute New Jersey-sourced receipts by including all combined group members’ receipts in the sales factor numerator, regardless of whether the member has a nexus with New Jersey.
New York Sourcing
In the Goldman Sachs v. NYC Tax Appeals Tribunal Tax case, the Court addressed how capital gains should be sourced when out-of-state businesses sell interests in pass-through entities. The Court upheld New York City’s application of the investee apportionment or allocation method, which looks to an investee’s activities in a state instead of the investor’s activities when apportioning the tax.
The Appellate Court in the Goldman Sachs v. NYC Tax Appeals Tribunal Tax case dismissed the Taxpayer’s appeal. It held that the New York City Tax Appeals Tribunal’s decision to uphold a tax assessment on the taxpayer corporation’s gain from the sale of an indirect interest in a limited liability company (“LLC”) was rational even where the out-of-state taxpayer corporation had no property or employees in New York City, and was only a limited partner in a partnership that owned an interest in an LLC that conducted business in New York City. Moreover, the taxpayer corporation and the LLC were not engaged in a unitary business. Nonetheless, the Appellate Court upheld the New York City Department of Finance’s position, requiring the taxpayer corporation to apportion the gain from the disposition of its LLC interest using the LLC’s apportionment factor of one hundred percent.
Ultimately, the New York precedent established that it does not matter whether a taxpayer is present or domiciled in New York City for purposes of sourcing capital gains because the business activities resulting in investment income that are conducted in the city from the entity in which the taxpayer is invested provides sufficient nexus between a taxpayer’s capital gains and New York City.
The Pennsylvania Supreme Court recently issued its long-awaited decision in Synthes USA HQ, Inc. v. Commonwealth, wherein the divided Pennsylvania Supreme Court held that service providers were required to apportion receipts based on the location where the customer received the benefit of the service (“Benefit-Received Method”) under Pennsylvania’s “costs of performance” (“COP”) statute in effect before 2014.
Substantively, the Synthes USA HQ Inc. v. Commonwealth case involved the proper application of Pennsylvania’s corporate net income tax apportionment sourcing rules to sales of services for years prior to 2014, during which time Pennsylvania had a Cost-of-Performance sourcing statute for apportioning sales from services. In the holding, the court reasoned that since the Pennsylvania Department of Revenue’s (“PDOR”) interpretation of the Cost-of-Performance sourcing statute had for many years before 2014 been enforced using the benefit-received method, the legislature had acquiesced in the PDOR’s interpretation when it amended the law in 2013 to a Market-Based sourcing statute to clarify the application of the benefit-received method. Ultimately, the court concluded that the PDOR’s interpretation was consistent with the statute’s legislative intent and ruled in the taxpayer’s favor, resulting in the taxpayer being entitled to a refund.
In light of the Synthes USA HQ Inc. v. Commonwealth case, taxpayers filing a Pennsylvania return should pay particular attention to the statutory language used in the state’s legislation and the PDOR’s historical treatment for sourcing income.
Texas recently promulgated a new rule in direct response to the Texas Supreme Court’s ruling in the Sirius XM Radio, Inc. V. Hegar case, which was decided on March 25, 2022. Effective March 10, 2023, Texas sourcing rule 3.591(e)(26) removes references to its previous guidance indicating Taxpayers must look to the location of the “receipts-producing, end-product act” when determining the location of where a service is performed for purposes of sourcing receipts.
The amendment to the law is said to interpret the Texas Supreme Court’s use of the phrase “useful work for the customer” to mean “work that the customer hired the taxable entity to perform” and does not include “activities that enable the taxable entity to do business in general or are not directly used in the provision of a service to the customer.” Additionally, the new law uses the term “property” rather than “equipment” to account for circumstances where property may be used to perform services and the property may not be considered equipment.
Specifically, the amended rule adds the following language: “A service is performed at the location or locations where the taxable entity’s personnel or property are doing the work that the customer hired the taxable entity to perform. Activities that are not directly used to provide a service are not relevant when determining the location where a taxable entity performs a service.”
Taxpayers whose fact patterns resemble those mentioned in Sirius XM Radio, Inc. V. Hegar should take note of this update in the future, as their sourcing of receipts will need to be updated.
Notable New Jersey Updates
New Economic Nexus Threshold
For NJ Corporate Business Tax (“CBT”) purposes, the state has adopted economic nexus provisions like those applicable to the state’s sales and use tax regime. A corporation is subject to the CBT if it derives receipts in excess of $100,000 or has more than 200 separate transactions delivered to New Jersey customers.
New CBT Return Filing Deadline
Establishes the due date of the New Jersey return as the 15th day of the month immediately following the month of the original or extended federal corporate tax return filing due date. For example, the federal corporation tax return (Form 1120) is generally due on the 15th day of the fourth month following the end of the tax year, which for calendar year taxpayers is April 15th of the succeeding year. Under the new rules, the New Jersey CBT return will be due by May 15th.
New Partnership Sales Factor Sourcing Rules
Partnerships must now use single sales factor sourcing, consistent with the apportionment rules under the CBT applicable to corporations. The Division of Taxation is working on and will soon release updated tax forms and instructions to reflect this change in apportionment methodology. Furthermore, sales of services must now be sourced to New Jersey using market-based sourcing, which sources receipts to the location where the benefit of the service was received. Note that given the retroactive application of this new provision to January 1, 2023, taxpayers will be relieved from the estimated tax penalty and interest relief. No penalties or interest will accrue for an underpayment of tax due for any provision that creates additional tax liability, provided that for tax periods “ending on and after July 31, 2023, the additional estimated payments shall be made no later than the second next estimated payment due following the enactment…or the second estimated payment due after January 1, 2024, whichever due date is later.”
Key Takeaways and Recommendations
2023 has set the tone for the next year. States have showcased their adaptability by revising tax regulations, understanding the business ecosystem, and crafting policies to foster economic growth. The year has been transformative for SALT, from revamped sourcing rules to emerging economic nexus thresholds. Businesses, investors, and stakeholders must incorporate these changes, strategize accordingly, and anticipate forthcoming shifts. As the curtain falls on this year’s SALT developments, one thing is evident: Staying informed and agile will be the cornerstone of tax compliance and business success in the year to come.