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INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
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Buehler Doesn’t Get a Day Off from Double Taxation

by and | May 12, 2023 | , , , , ,

The California Office of Tax Appeals (OTA) recently held that a California resident’s income tax paid to Massachusetts from the sale of his membership interest in a limited liability company (LLC) doing business in Massachusetts was not eligible for California’s other state tax credit. The OTA reached this conclusion while acknowledging that it “will result in the income” from the sale of the membership interest “being double taxed.”

The taxpayer in the case, Mr. Buehler, was one of three managing members of an LLC that had an office in Massachusetts and provided portfolio management services for pooled investment vehicles. Buehler “was actively involved in” the LLC’s management and operations. After selling his membership interest in the LLC, Buehler filed a Massachusetts nonresident tax return and reported and paid tax on a share of the net gain from the sale of the membership interest, using the LLC’s Massachusetts apportionment factors.

The OTA’s decision did not question whether Buehler properly determined, under Massachusetts law, the tax owed to Massachusetts from the sale of his LLC membership interest. At that time, the Massachusetts Department of Revenue took the position that such sales of pass-through entity interests were taxable in Massachusetts where the entity conducted business regardless of whether the seller was “unitary” with the entity. (See, e.g., VAS Holdings & Investments LLC v. Comm’r of Revenue, 489 Mass. 669 (2022).) Instead, the OTA focused on the language of California’s other state tax credit, which applies to income taxes paid to another state on “income derived from sources within that state.” As stated by the OTA, “in order for a California taxpayer to be entitled” to a credit, “income taxes paid to the nonresident state (here, Massachusetts) must be based on income sourced to that nonresident state using California’s nonresident sourcing rules.” (Emphasis in original).

The OTA determined that under Cal. Rev. & Tax. Code § 17952, the LLC interest was not sourced to Massachusetts because Buehler’s LLC membership interest had not acquired a “business situs” in Massachusetts. According to the OTA, Buehler’s activities as a managing member of the LLC did not cause the “membership interest itself” to be “integrated into the business activities” of the LLC “in Massachusetts.” (Emphasis in original). In other words, while Buehler’s “services for” the LLC “as one of its three managing partners may connect him with” the LLC’s “Massachusetts business activities, that fact alone does not show that [Buehler’s] membership interest was localized in Massachusetts.”

The OTA also rejected Buehler’s alternative argument that his active involvement in the LLC caused him to “become unitary” with the LLC’s business, allowing for combination and apportionment under California Tax Regulation § 17951-4(d). The OTA explained that Buehler did not establish that he was “operating a sole proprietorship or any kind of business activity” separate and apart from the LLC “that could be considered unitary with” the LLC.

The OTA acknowledged that its decision would lead to double taxation of income from the sale of the LLC membership interest but concluded [...]

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Be Careful What You Wish For: Minnesota May Be on the Precipice of Enacting Worldwide Combined Reporting at the Worst Possible Time

by , and | May 4, 2023 | , , , , , ,

It has been widely reported that the Minnesota Legislature has advanced an omnibus tax bill that would require the inclusion of the “entire worldwide income” of combined corporate income tax filers engaging in a unitary business. Tax press outlets have made the broad claim that mandatory worldwide combined reporting will “add foreign subsidiaries’ profits” to Minnesota corporate tax returns. But these claims disregard how such a change in Minnesota’s tax regime would also bring worldwide losses into a combined filing group’s income (or loss) calculation. If Minnesota passes mandatory worldwide combined reporting legislation this year and economic expert predictions of an impending global recession come true, the state could see a significant decrease in revenue from its corporate income tax.

Claims that worldwide combined reporting will bring additional profits into the corporate tax base presuppose foreign subsidiaries added to a combined group are always profitable. But if the entities added to a combined group are unprofitable, the opposite would be true. Instead, the foreign entities would either decrease income subject to state corporate income taxation or increase losses that generate net operating loss carryforwards that will decrease state corporate income taxation in future years.

This isn’t just a hypothetical concern. Tax specialists who practiced in the wake of the 2008 global recession recall that states with combined reporting regimes often sought to force unitary groups of corporations to “decombine” in order to remove entities generating losses from the state corporate tax base. When attempts to decombine were unsuccessful (as many were), states were often forced to walk away from large assessments or pay large refunds to corporate taxpayers. Such experiences should serve as a reminder that combined reporting often can decrease a state’s revenues from a corporate income tax. In Minnesota’s case, the potential for lost tax revenues may only balloon if its legislature imposes worldwide combined reporting during a recession.

No state currently has a true mandatory worldwide combined reporting regime (Alaska only imposes it on specific industries), and concerns about bringing foreign loss companies into the combined group is one of many reasons why. If Minnesota were to break state ranks by imposing worldwide combined reporting and a US parent corporation determined the regime could cause its Minnesota taxable income to increase, the corporation would have every incentive to either avoid or decrease connections with the state—potentially causing the state to lose out on capital investments that bring jobs with high wages and benefits.

Further, any attempt to impose mandatory worldwide combined reporting is likely to cause an international backlash, along with potential federal action and litigation challenging Minnesota’s regime. In the immediate wake of a 1983 U.S. Supreme Court decision indicating, to a limited degree, that a state mandatory worldwide combined reporting regime could pass constitutional muster, the US Department of the Treasury completed a study outlining state taxing principles supported by “state, [...]

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New York Budget Legislation Contains Significant Tax Provisions

by , and | May 2, 2023 | , , , , ,

New York Governor Kathy Hochul and the New York State Legislature have reached an agreement on the state’s fiscal year 2024 budget legislation. Most surprisingly, the legislation grants the New York State Department of Taxation and Finance the right to petition for judicial review of New York State Tax Appeals Tribunal decisions that are “premised on interpretation of the state or federal constitution, international law, federal law, the law of other states, or other legal matters that are beyond the purview of the state legislature.” If the Department appeals a Tribunal decision, any interest and penalties that would otherwise accrue on the underlying tax liability would be stayed until 15 days after the issuance of a final judicial decision. This represents a significant change in law as currently, only taxpayers (and not the Department) may appeal Tribunal decisions.

Other notable provisions in the budget legislation include the following:

  • The False Claims Act will now apply to a person who is alleged to have knowingly or improperly failed to file a tax return.
  • The top metropolitan commuter transportation mobility tax rate on employers in New York City has been increased from 0.34% to 0.6% of payroll expense.
  • The “temporary” top corporate franchise tax rate for taxpayers with a business income base of more than $5 million will stay at 7.25% through 2026 (rather than expiring in 2024), and the scheduled expiration of the franchise tax business capital base has been delayed from 2024 to 2027.

The budget legislation containing these changes in law passed both houses of the New York State Legislature on May 1, 2023, and is expected to be signed by Governor Hochul.



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Tax That DC?!?! FCA Suit on Residency Brings Business Intelligence Company into the Crosshairs

by , , and | Sep 2, 2022 | , , , , , ,

For the first time since the enactment of the False Claims Amendment Act of 2020, the DC Attorney General’s (AG’s) Office has used its new tax enforcement powers to pursue an alleged personal income tax deficiency. This development brings to the forefront a long-simmering constitutional problem with DC’s statutory residency law and offers a stern warning to businesses that assist key employees and executives with their personal tax obligations.

The press rapidly and widely reported on DC’s lawsuit against MicroStrategy Co-Founder, Executive Chairman and former CEO Michael Saylor for alleged evasion of D.C. personal income taxes, which was made public this week. The case alleges that Saylor wrongly claimed that he was a resident of Virginia or Florida (rather than DC) since at least 2012.

The case was originally brought under seal by a relator under DC’s False Claims Act in April 2021—less than one month after the False Claims Amendment Act took effect. Using its new tax authority, the DC AG’s Office filed a complaint last week to intervene (taking over the case going forward). Interestingly, when the DC AG’s Office took over the case, it added MicroStrategy as a defendant under the theory that the company conspired to help Saylor evade DC personal income taxes. Under DC’s False Claims Act, both Saylor and MicroStrategy could be liable for treble damages if a court rules in favor of the DC AG’s Office.

ISSUES WITH DC’S “STATUTORY RESIDENCY” TEST

While determining where an individual is a resident for state and local tax purposes generally requires a fact-intensive analysis, the case against Saylor also implicates DC’s unique (and likely unconstitutional) statutory residency standard. DC’s statute is fundamentally different than statutory residency standards in other states. Most states only tax individuals having their domicile in the state as residents, while some states also have a “statutory residency” test to classify individuals as taxable residents. In most states, a person is classified as a statutory resident if they (1) maintain a permanent place of abode in the jurisdiction and (2) spend more than a specific number of days (typically 183 days) in the jurisdiction.

DC truncates this standard and classifies someone as a statutory resident if they merely maintain a personal place of abode in DC for more than 183 days. Thus, no amount of actual presence of the individual in DC is required. The problem created by this one-of-a-kind standard should be obvious: someone can (as many high-net-worth individuals often do) maintain a residence for 183 days in more than one jurisdiction. Thus, the plain language of the statute would violate the Commerce Clause of the US Constitution because it runs afoul of the internal consistency test. Under this test, a statute is unconstitutional if under a hypothetical situation in which every jurisdiction has the same law as the one being challenged, more than 100% of the tax base would be subject to tax. Here, if every state had a statutory residency test applicable to anyone who had a [...]

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Pennsylvania Cuts Corporate Tax Rate, Makes Other Changes to Corporate Tax Law

by and | Jul 14, 2022 | , , , , ,

Pennsylvania Governor Tom Wolf has signed into law omnibus tax legislation to implement the Commonwealth’s fiscal year 2022 – 2023 budget. Among other things, the enacted legislation: (1) cuts the corporate net income tax (CNIT) rate from 9.99% to 4.99% on a phased-in basis; (2) adopts market sourcing rules for intangible-related receipts; and (3) codifies the Pennsylvania Department of Revenue’s (DOR’s) CNIT economic nexus rules outlined in Corporation Tax Bulletin 2019‑04. Notably, the enacted legislation does not include Governor Wolf’s prior proposal to strengthen the Commonwealth’s related party interest and intangible expense addback statute.

CNIT RATE CUT

Pennsylvania’s CNIT rate is currently 9.99%—one of the highest corporate tax rates in the nation. The enacted legislation phases in a decrease of Pennsylvania’s CNIT rate as follows:

  • January 1, 1995, through December 31, 2022; 9.99%
  • January 1, 2023, through December 31, 2023; 8.99%
  • January 1, 2024, through December 31, 2024; 8.49%
  • January 1, 2025, through December 31, 2025; 7.99%
  • January 1, 2026, through December 31, 2026; 7.49%
  • January 1, 2027, through December 31, 2027; 6.99%
  • January 1, 2028, through December 31, 2028; 6.49%
  • January 1, 2029, through December 31, 2029; 5.99%
  • January 1, 2030, through December 31, 2030; 5.49%
  • January 1, 2031, and each year thereafter; 4.99%

MODIFICATION OF INTANGIBLES SOURCING RULE

The enacted legislation shifts Pennsylvania’s sourcing regime for receipts from intangibles from a cost-of-performance regime to a market-based regime. The legislation generally sources gross receipts from the sale, lease, or license of intangible property to the location the property is used. Further, the legislation generally sources receipts from a broker’s sales of securities to the location of its customer and receipts from credit card interest, fees, and penalties to the billing address of the cardholder.

The legislation also contains detailed sourcing rules for interest, fees, and penalties earned by a lender, generally sourcing those receipts:

  1. From loans secured by real property to the location of such real property;
  2. From loans related to the sale of tangible personal property to the location the property is delivered or shipped; and
  3. To the location of the borrower (if not otherwise addressed by the legislation).

These sourcing rule changes apply to tax years beginning after December 31, 2022. According to the Senate Appropriations Committee’s Fiscal Note to the legislation, the purpose of the sourcing rule change is to “[a]lign[] the apportionment rules governing sales of intangible property with the sales of tangible personal property, real property and services to be consistent with market sourcing (i.e., where the purchaser paying for the sale or using the property is located).” As discussed in a prior blog post, the Pennsylvania legislature changed the sourcing regime for services from cost-of-performance to a market-based regime.

Nevertheless, the Pennsylvania DOR has insisted that current law requires the use of a market-based approach to source receipts from certain intangibles, despite the cost-of-performance statutory regime currently in effect. For tax years before 2014, the Pennsylvania DOR also employed a market-based approach [...]

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“Voluntary” in Name Only? New Jersey Introduces Transfer Pricing Initiative

by , and | Jun 16, 2022 | , , , ,

The New Jersey Division of Taxation (Division) has announced a “voluntary” transfer pricing initiative beginning June 15, 2022, and continuing through March 2, 2023. According to the Division, the initiative is targeted toward companies that have intercompany transactions that would be subject to transfer pricing adjustment.

The initiative is broadly available to taxpayers with related party intercompany pricing, even if those taxpayers are currently under audit or have a case pending before the Division’s Conference and Appeals Branch. However, the initiative does not apply to matters in litigation.

Taxpayers must agree in writing to participate in the initiative by September 15, 2022, and comply with Division deadlines thereafter (including by providing “all required transfer pricing, tax, and financial information and documentation” to the Division by October 31, 2022). As part of any agreement reached with a taxpayer, the Division will agree to waive all applicable penalties and all rights to assess any additional tax, interest or penalties except for adjustments relating to federal corrections.

Notably, the Division is warning taxpayers that do not reach an agreement through the initiative that in the future it will: (1) “assess all applicable penalties;” (2) “not waive any penalties;” and (3) audit according to the Division’s “regular audit schedule” without agreeing “to a methodology or settlement for any unaudited open tax years.”

Evidently, the Division has hired Dr. Ednaldo Silva, Founder & Director of RoyaltyStat, to assist with the initiative. Sources familiar with the initiative report that the Division will consider prospective-only settlement agreements under the initiative, under the right circumstances.



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Washington State Capital Gains Tax Held Unconstitutional

by | Mar 8, 2022 | , , , ,

The Washington State capital gains tax, which went into effect on January 1, 2022, has been held unconstitutional by the Douglas County Superior Court. Created in 2021, the tax was ostensibly labeled an “excise” tax in an effort by the Washington State Legislature (Legislature) to avoid difficulties associated with implementing an income tax in the state of Washington. The judge, however, was not persuaded.

Citing to authority from the Washington State Supreme Court, the trial judge held that courts must look through any labels the state has used to describe the statute and analyze the incidents of the tax to determine its true character. Here, the judge reviewed the most significant incidents of the new tax, including:

  • It relies on federal income tax returns that Washington residents must file and is thus derived from a taxpayer’s annual federal income tax reporting;
  • It levies a tax on the same long-term capital gains that the Internal Revenue Service (IRS) characterizes as “income” under federal law;
  • It is levied annually (like an income tax), not at the time of each transaction (like an excise tax);
  • It is levied on an individual’s net capital gain (like an income tax), not on the gross value of the property sold in a transaction (like an excise tax);
  • Like an income tax, it is based on an aggregate calculation of an individual’s capital gains over the course of a year from all sources, taking into consideration various deductions and exclusions, to arrive at a single annual taxable dollar figure;
  • Like an income tax, it is levied on all long-term capital gains of an individual, regardless of whether those gains were earned within Washington and thus without concern of whether the state conferred any right or privilege to facilitate the underlying transfer that would entitle the state to charge an excise;
  • Like an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year; and
  • Unlike most excise taxes, if the legal owner of the asset who transfers title or ownership is not an individual, then the legal owner is not liable for the tax generated in connection with the transaction.

The court found that these incidents show the hallmarks of an income tax rather than an excise tax, and because the new capital gains tax did not meet the uniformity and limitation requirements of the Washington State Constitution, it was unconstitutional.

The Washington State Attorney General has already indicated that the ruling will be appealed; in all likelihood, this issue will ultimately be decided by the Washington State Supreme Court. In the meantime, if you have questions about the Washington State capital gains tax, please contact Troy Van Dongen.



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Massachusetts Department of Revenue Stops Applying COVID-19 Telecommuting Policy, Returns to Location of Work Performed

by and | Sep 24, 2021 | , , ,

In a recently issued guidance, the Massachusetts Department of Revenue indicated that the emergency telecommuting rules it put in place during the Massachusetts COVID-19 state of emergency would cease to be in effect as of September 13, 2021. Under the telecommuting rules, which were effective beginning March 10, 2020, wages paid to a non-resident employee who worked remotely (i.e., working from home or a location other than their usual work location) because of the COVID-19 pandemic were sourced based on where the employee worked prior to the state of emergency. Effective September 13, 2021, wages will generally be sourced based on where the employee’s work is actually performed.



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Illinois Enacts Pass-Through Entity Tax to Help Partners and S Corporation Shareholders Avoid the $10,000 SALT Cap

by | Sep 3, 2021 | , , ,

Illinois enacted a pass-through entity tax (PTE Tax) that may be elected by partnerships and S corporations to permit a federal deduction of state income taxes that otherwise are limited to $10,000 per year from 2018 to 2025 by the Tax Cuts and Jobs Act of 2017 (TCJA). State income taxes paid by individuals, whether attributable to pass-through entity income or other income, are subject to the TCJA’s $10,000 “SALT Cap.”

In Internal Revenue Service (IRS) Notice 2020-75, the IRS announced its approval of the federal deduction of state PTE Taxes paid by the entity in circumstances where the partner or shareholder receives a state tax credit, and the PTE Tax essentially is paid in lieu of the state income tax otherwise imposed upon the partner or S corporation shareholder.

The new Illinois PTE Tax was signed into law by Governor JB Pritzker on August 27, 2021 (Public Act 102-658) and applies to taxable years ending on or after December 31, 2021, and prior to January 1, 2026. Eighteen other states have also enacted PTE Taxes and 14 of those (including Illinois) are effective for 2021.

TAX AT ENTITY LEVEL

The Illinois PTE Tax is imposed on electing partnerships and S corporations at a rate of 4.95%, the flat income tax rate applicable to individuals. The tax is imposed upon the Illinois net income of the partnership or S corporation, which is equal to Illinois base income after apportionment or allocation. As discussed below, partners and S corporation shareholders may claim a refundable Illinois credit equal to their distributive share of the Illinois PTE Tax paid by the partnership or S corporation. Illinois base income of a partnership or S corporation for purposes of the PTE Tax is computed without deduction of Illinois net loss carryovers or the standard exemption. It’s also computed after addback of the partnership subtraction modification for reasonable compensation of partners (including guaranteed payments to partners) and the subtraction modification for income allocable to partners or shareholders subject to the Illinois “replacement tax.” The PTE Tax does not affect the replacement tax computation.

The Illinois PTE Tax is paid by the partnership or S corporation on all of its Illinois net income after apportionment or allocation. As a result, any tax exempt owner of a partnership or S corporation may be required to file Illinois refund claims in order to recoup PTE Taxes paid at the entity level (including as estimated payments). In some cases, this may be avoided by forming an upper-tier partnership for partners that are not tax exempt. Other states have avoided this problem by permitting the PTE Tax to be elected on a partner-by-partner basis rather than for the entity as a whole (e.g., California) or by imposing the PTE Tax only upon income that is allocable to partners subject to the state’s personal income tax (e.g., New York State).

TIERED PARTNERSHIPS

In the case of tiered partnerships, if a lower-tier partnership makes the PTE Tax election, the upper-tier [...]

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Nebraska District Court Holds That GIL 24-19-1 is Not Afforded Deference

by and | Jun 24, 2021 | , , , ,

Last week, the Lancaster County District Court granted the state’s motion to dismiss in COST v. Nebraska Department of Revenue. COST brought this declaratory judgment action to invalidate GIL 24-19-1, in which the department determined that earnings deemed repatriated under IRC § 965 are not eligible for the state’s dividends-received deduction and are thus subject to Nebraska corporate income tax. COST has until July 19, 2021, to appeal the judge’s decision.

The state’s motion was brought on procedural grounds, one of which was that the GIL is a guidance document and not a “rule” such that a declaratory judgment was not permitted under Nebraska law. COST argued that although the GIL is labeled a guidance document, it is in substance a rule because it establishes a legal standard and explicitly penalizes taxpayers that do not comply. The district court determined that the GIL is not a rule and granted the state’s motion. The district court did not address the substantive issue of whether 965 income is eligible for the dividends received deduction.

While on its face this decision may seem to be a taxpayer loss, the language of the judge’s order suggests otherwise. In finding that the GIL is not a “rule,” the judge determined that the GIL was a mere interpretation of the law that was not binding on the taxpayer and not entitled to any deference by the Nebraska courts. This strengthens an already strong taxpayer case on the merits.

The department’s position that 965 income is not eligible for the dividends-received deduction is inconsistent with the legislative history of the deduction and the nature of 965 income. The fact that a judge stated that this position is now afforded no deference only makes the taxpayer case stronger.

As a practical matter, taxpayers that have appealed assessments on 965 income should consider including the deference argument in their appeals, and taxpayers that have followed the GIL and paid tax on 965 income may consider filing refund claims. The substance of this issue will be litigated one way or another, and the district court’s finding that the GIL is not afforded deference can only help the taxpayer case.



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