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Washington State Capital Gains Tax Held Unconstitutional

by Troy M. Van Dongen | Mar 8, 2022 | Federal Tax, Income Tax, Local Tax, Nationwide Importance, Washington

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.

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

by Stephen P. Kranz and Sarah Hogarth | Jun 24, 2021 | Federal Tax, Income Tax, Local Tax, Nationwide Importance, Tax Base

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.

Connecticut Bill Aims to Address the Impact of Telecommuting during the Pandemic

by McDermott Will & Emery | Mar 8, 2021 | Connecticut, Income Tax, Local Tax, Nationwide Importance

As we continue to face growing concerns because of the nationwide impact of COVID-19, taxpayers should be mindful of the potential impacts that the continued rise in telecommuting may have on their state personal income tax liabilities.

A bill was recently introduced in Connecticut that partially addresses this situation. Connecticut House Bill No. 6513 (HB 6513) clarifies that Connecticut residents will not face double taxation on their 2020 taxes and will instead receive a credit against their Connecticut personal income taxes for taxes paid in other states even if the resident, because of COVID-19, was working remotely from Connecticut rather than from their usual out-of-state office. HB 6513 further states that the Connecticut Department of Revenue Services, in determining whether an employer has nexus with Connecticut for purposes of the imposition of any Connecticut tax, shall not consider the activities of an employee who worked remotely from Connecticut solely because of COVID-19.

HB 6513 passed in the 151-member Connecticut House of Representatives on February 24, 2021, and passed in the 36-member Connecticut State Senate on March 1, 2021. The bill now heads to the state governor’s desk for signature. While it is expected that the Governor will sign the bill, passage of the bill still leaves taxpayers with uncertainty for 2021. Many taxpayers nationwide are likely to continue working remotely (from states other than where their usual offices are located) for the foreseeable future, and absent Congressional legislation or a Supreme Court decision, this state income tax issue does not seem likely to abate any time soon.

Taxpayers May Not Prepay Income Tax to Avoid Cap on SALT Deduction

by Mary Kay McCalla Martire | Dec 22, 2017 | Illinois, Income Tax, Nationwide Importance, Property Tax

The federal tax reform package recently approved by Congress (the Bill) contains a cap on the state and local tax deduction that may be claimed by individuals on their federal income tax returns. The Bill provides that an individual may claim up to $10,000 of state and local property taxes and either income or sales taxes. The cap expires on January 1, 2026.

Individual taxpayers who have been considering prepaying their 2018 (or later) taxes in 2017 should be aware that the final version of the Bill contains a provision that prohibits individuals from prepaying their income tax for future years in 2017. As a result, any guidance issued by state revenue departments (for example, in Illinois) regarding the prepayment of 2018 income tax is no longer applicable. In certain jurisdictions, individuals may still have an opportunity to prepay their property tax assessments. For additional details, please contact your tax preparer.

Tax Highlights of Proposed Illinois “Grand Bargain”

by Mary Kay McCalla Martire | Mar 14, 2017 | False Claims Act, Illinois, Income Tax, Local Tax, Sales Tax

In an effort to resolve Illinois’ 20-month budget impasse, the Illinois Senate leadership (Senate Majority Leader John Cullerton and Senate Minority Leader Christine Rodogno) have jointly proposed a series of bills to increase revenue, reduce spending, and respond to the Illinois Governor’s concerns regarding pension reforms, workers compensation reform and property tax relief. A series of twelve bills have been introduced, all of which are interlinked for passage. The bills are termed the Illinois “Grand Bargain.” Most of the tax-related changes are found in Senate Bill 9. The current version of the Senate Bill 9 (Amendment 3) (“Bill”) was submitted on March 3 and includes the following proposed changes: (more…)

Massachusetts Court Holds Department of Revenue’s Guidance to Be Unreasonable

by Richard C. Call and Scott M. Susko | Apr 22, 2016 | Incentives, Income Tax, Massachusetts, Procedure

Northeastern University, the Trustees of Boston University, Wellesley College and 131 Willow Avenue, LLC prevailed in their appeal of the Massachusetts Department of Revenue’s (the Department) rejection of their Brownfields tax credit applications in Massachusetts Superior Court. 131 Willow Avenue, LLC v. Comm’r of Revenue, 2015 WL 6447310 (2015). The taxpayers argued, and the court agreed, that the Department improperly denied their applications based on the unlawful use of Directive 13-4 issued by the commissioner of revenue (the Commissioner). At issue was the validity of Directive 13-4’s prohibition on nonprofit and transfer Brownfields tax credit applicants from receiving or transferring credits based on documentation submitted in a taxable year that commenced before the effective date of a 2006 amendment expanding the Brownfields tax credit statute to include nonprofit organizations and allow for credit transfers. The court held that the directive was “unreasonable and [the Department’s] denial of the applications based on that directive was unlawful.” (more…)

Massachusetts Department of Revenue Introduces Pilot Voluntary Disclosure Program

by Richard C. Call and Scott M. Susko | Feb 8, 2016 | Audits, Income Tax, Local Tax, Massachusetts, Procedure, Sales Tax

The Massachusetts Department of Revenue (the Department) released a draft administrative procedure introducing a pilot Voluntary Disclosure Program (the Program) for the settlement of uncertain tax issues for business taxpayers on January 19. The Department introduced this Program in response to a suggestion made by Scott Susko, an author of this article, and another practitioner, both of whom serve as taxpayer professional representatives on the Department’s Advisory Council. We commend the Department for reacting to this suggestion in such a proactive manner.

The Program will provide “a process through which uncertain tax issues may be resolved on an expedited basis, generally within four months” (All quotations in this post are from the Department’s draft administrative procedure).

We think this Program will be particularly helpful to public companies in resolving issues related to their financial statement reserves.

The Program defines an “uncertain tax issue” as an issue “for which there is no clear statutory guidance or controlling case law, and which has not been addressed by the Department in a regulation, letter ruling, or other public written statement,” and “for which a taxpayer would be required to maintain a reserve in accordance with ASC 740: Accounting for Uncertainty in Income Taxes (formerly Fin 48).” The issue also “must not have been addressed as part of a prior audit of the taxpayer, a prior application for abatement or amended return filed by the taxpayer, or a prior ruling request made by the taxpayer.”

To qualify for the Program, “any potential tax liability attributable to the uncertain tax issue(s) must be $100,000 or more, exclusive of interest and penalties.” A taxpayer that is under audit or has received notice of an impending audit is not eligible for the Program. The Department has the “discretion to determine that the Program is not appropriate for specific cases.”

The Department “will consider settlement of an uncertain tax issue(s) where: (1) the taxpayer has presented its position on the issue(s) and the Department agrees that the tax treatment of the issue(s) is uncertain; and (2) the taxpayer has fully disclosed and documented the issue(s) and the facts associated with that issue(s).”

A taxpayer may initiate the process by submitting an anonymous letter to the Department, which will respond to the taxpayer within 30 days. If the Department accepts the taxpayer into the Program, the taxpayer may submit an application, including a settlement proposal and identifying the taxpayer, within 45 days of receiving the Department’s acceptance letter.

The Department will waive penalties related to the uncertain tax issue for a taxpayer that reaches an agreement with the Department pursuant to the Program, as well as for a taxpayer that does not reach an agreement with the Department “provided the taxpayer acted in good faith.”

The Department requested practitioner comments on the draft administrative procedure by February 1, and MWE submitted two technical comments.

Our first comment was that following the initial evaluation, the Department should issue to the taxpayer a one-page technical position explaining whether it does or [...]

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D.C. Proposes Law to Allow Indefinite Suspension of Limitation Period for Assessment and Collection

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | May 6, 2015 | Audits, District of Columbia, Income Tax, Procedure, Sales Tax, Transaction Taxes

The Fiscal Year 2016 Budget Support Act of 2015 (BSA), introduced by the Washington, D.C. Council at the request of Mayor Muriel Bowser on April 2, 2015, contains a subtitle (see Title VII, Subtitle G, page 66-67) that would give the Office and Tax and Revenue (OTR) complete discretion to indefinitely suspend the period of limitation on assessment and collection of all D.C. taxes—other than real property taxes, which contain a separate set of rules and procedures. The change to the statute of limitation provision would eliminate a fundamental taxpayer protection that exists today in all states. Those concerned should reach out to members of the D.C. Council to discourage adoption of this subtitle of the BSA.

Current Law

Under current law, the amount of tax imposed must be assessed (in other words, a final assessment must be issued) within three (3) years of the taxpayer’s return being filed. See D.C. Code § 47-4301(a). Practically speaking, this requires the mayor to issue a notice of proposed assessment no later than two (2) years and 11 months after the return is filed—to allow the taxpayer the requisite 30 days to file a protest with the Office of Administrative Hearings (OAH). See D.C. Code § 47-4312(a). As the law reads today, the running of the period of limitation is suspended between the filing of a protest and the issuance of a final order by OAH, plus an additional 60 days thereafter. See D.C. Code § 47-4303. The District has 10 years after the final assessment to levy or begin a court proceeding for collections. See D.C. Code § 47-4302(a).

Proposed Changes

The BSA would extend the limitation period for assessment and collection, as follows:

The BSA would add a new provision to statutorily require the chief financial officer (CFO, the executive branch official overseeing the OTR) to send a notice of proposed audit changes at least 30 days before the notice of proposed assessment is sent; and
The BSA would toll the running of the statute of limitation on assessment and collection during the period after the CFO/OTR issues the aforementioned notice of proposed audit changes until the issuance of a final assessment or order by OAH.

The BSA does not indicate an applicable date for these changes. As a result, the provision likely would be applicable to any open tax period, effectively making the change retroactive to returns already filed.

Effect

By changing the law to toll the statute of limitation for the period after OTR issues a notice of proposed audit changes, the BSA would allow OTR to unilaterally control whether the three-year statute of limitation is running. The current statute requires that OTR issue its notice of proposed assessment before the expiration of the three-year statute—and gives taxpayers the ability to protest such notices before the OAH. By tolling the statute upon issuance of a notice of proposed audit changes, which is not subject to review by OAH, the BSA would strip taxpayers of the [...]

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Maryland Offers Attractive Amnesty Program – Even for Taxpayers Under Audit!

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Apr 23, 2015 | Income Tax, Interest and Penalties, Local Tax, Maryland, Sales Tax, Transaction Taxes

Starting September 1, 2015, the Comptroller of Maryland (Comptroller) will offer qualifying taxpayers that failed to file or pay certain taxes an opportunity to remit tax under very attractive penalty and interest terms. The 2015 Tax Amnesty Program (Program) is the first offered in Maryland since 2009, when the state raised nearly $30 million, not including approximately $20 million collected the following year under approved payment plans. The amnesty program offered before that (in 2001) brought in $39.4 million. Consistent with the Maryland amnesty programs offered in the past, the Program will apply to the state and local individual income tax, corporate income tax, withholding taxes, sales and use taxes, and admissions and amusement taxes.

The Program was made law by Governor Larry Hogan when he signed Senate Bill 763, available here, after two months of deliberation in the legislature. While the Program is scheduled to run through October 30, 2015, the Comptroller has a history of informally extending these programs beyond their codified period. For companies that are nervous about potential assessments following the Gore and ConAgra decisions, the amnesty offers an opportunity that should be evaluated.

Perks

The Program’s main benefits include:

Waiver of 50 percent of the interest;
Waiver of all civil penalties (except previously assessed fraud penalties); and
A bar on all criminal prosecutions arising from filing the delinquent return unless the charge is already pending or under investigation by a state prosecutor.

Qualification

The Program is open to almost all businesses, even if under audit or in litigation. The statute provides for only two classifications of taxpayers that do not qualify:

Taxpayers granted amnesty under a Maryland Amnesty Program held between 1999-2014; and
Taxpayers eligible for the 2004 post-SYL settlement period relating to Delaware Holding Companies.

Because the Program’s enacting statute does not prohibit participants from being under audit, or even those engaged in litigation with the Comptroller, even taxpayers with known issues and controversy may find the amnesty an attractive vehicle to reach resolution of a controversy with the state.

Practice Note

Because the range of taxpayers eligible for the Program is so broad, we encourage all businesses to evaluate whether participation will benefit them. Given that past Maryland amnesty programs excluded taxpayers over a certain size (based on employee count), large companies who were not able to resolve uncertain exposure in the state should evaluate this new offering. If your business is currently under audit (or concerned about any tax obligations from previous years), please contact the authors to evaluate whether the Program is right for you.

State Revenue Departments Misapplying Federal Tax Law

by McDermott Will & Emery | Sep 9, 2014 | Audits, Federal Tax, Idaho, Income Tax, Maryland, Nationwide Importance, Procedure

State income tax laws generally build on federal tax law. The typical pattern is to begin the calculation of state taxable income with federal taxable income and then to modify it by adding or subtracting items where state tax policies differ from federal tax policies. As a result, a corporation’s state taxable income can be affected by the application of the federal Internal Revenue Code. State revenue departments generally do not consider themselves bound by Internal Revenue Service determinations respecting the application of federal tax law and believe that they are free to interpret the Internal Revenue Code as they see fit. Unfortunately, this has led to problems because state tax auditors often are not well trained in federal tax principles. We had an instance earlier this year in which an auditor claimed that the merger of a wholly-owned subsidiary into its corporate parent was taxable because there was an increase in the parent’s retained earnings. The merger was a plain vanilla tax-free liquidation under Sections 332 and 337 of the Internal Revenue Code (there was no intercompany debt and the subsidiary was clearly solvent), but sending copies of these provisions to the auditor left him unmoved. We finally got him to back down by showing that the parent’s increase in retained earnings was matched by a decrease in the subsidiary’s retained earnings so that there was no overall increase. As we explained to the client, a win is a win, even if for the wrong reasons. Nevertheless, if the auditor had been properly versed in the most basic federal corporate tax principles, this exercise would not have been necessary.

Two recent decisions illustrate misapplications of federal tax law by state revenue departments.

The Idaho Tax Commission recently held that a subsidiary’s net operating loss (NOL) carryovers did not pass to its parent in a merger of the subsidiary into the parent. The parent did not continue to operate the business of the merged subsidiary and the Commission held that “based on IRC §382, the Petitioner cannot carry the loss forward after the merger.” Idaho State Tax Commission Ruling No. 25749 (Apr. 17, 2014). The Commission’s statement of federal tax law is incorrect. Section 382 of the Internal Revenue Code does not apply to a merger of a wholly-owned subsidiary into its parent. Because of constructive ownership rules, no change in ownership is deemed to occur. Moreover, Section 382 does not prevent an NOL from passing to the surviving company in a merger; it simply limits the extent to which the NOL can be used. Although it is true that the limitation is zero for years in which the merged company’s business is discontinued, the NOL is not destroyed. If the parent later sells assets received from the subsidiary that had built-in gain at the time of the merger, the loss can be used to offset the gain.

Discussions that we have had with the Commission after the decision came out indicate that the Commission had [...]

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