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11/24/2018

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What You Need to Know for the Upcoming Year

2017 State Tax Developments

Presented byTim ClancyWindham Brannon P.C.January 24,2018

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Tim Clancy, CPA

Windham Brannon P.C. - Atlanta

[email protected]

678.510.2804

mailto:[email protected]

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Agenda• Federal Tax Reform – State Impact

• U.S. Supreme Court

• Apportionment of Income

• Nexus

• Other

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This Photo by Unknown Author is licensed under CC BY-NC-ND

Federal Tax Reform – State Tax Impact

Conformity is KEY!

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How do states conform to the IRC?

• “Rolling” conformity

• “Fixed date” conformity

• Selective conformity to IRC vs selective decoupling

• Legislative action in 2018 regarding conformity

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Rolling conformity to IRC currently in effect

Conforms to IRC as of a specific date (as noted for each affected state)

Selectively conforms (as noted for each affected state to ‘IRC currently in effect’, or to ‘IRC as of a specific date’)

Not applicable because state does not levy an entity level tax with an IRC reference point

Slide to be used for illustrative purposes only. Not to be used as a substitute for research into application of rules.

Over 35 state legislatures currently in

session

Specific Date ConformityAZ – 1/1/17FL – 1/1/17GA – 1/1/17HI – 12/31/16ID – 1/1/17IN – 1/1/16IA – 1/1/15KY – 12/31/15ME – 12/31/16MI* - Current or 1/1/12MN – 12/16/16NH – 12/31/16NC – 1/1/17SC – 12/31/16TX – 1/1/07VT* - IRC in effect for 2016 TYVA – 12/31/16WV – 12/31/16WI – 12/31/16

Selective ConformityAL – CurrentAR – Varies by IRC sectionCA – 1/1/15MS - Current

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Federal tax rate

• States generally expected to remain constant with current rate

• Blended rate for fiscal year taxpayers – Accelerate deductions

Immediate expensing IRC 168(k) & Increase of IRC 179

• State conformity/non-conformity

• Many states already have non-conformity

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Limitation on interest deductions IRC 163(j) – Federal

• Applies to related party and unrelated party debt

• Businesses interest expense that exceeds 30% of the taxpayer’s “Adjusted Taxable Income” (ATI) plus its business interest income will be disallowed.

• Determine at the tax-filer level

• Partnership – apply at the partnership level

• Corporation – at consolidated filing level

• Unlimited carryforward of disallowed business expense

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Limitation on interest deductions IRC 163(j) (Con’t)

• Increases state AGI/Taxable income -- Expect conformity

• Interest addback conduit exception may be impacted

• Apportionment of carry forward

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Limitation on interest deductions IRC 163(j) (Con’t)

• Limitations under 381 and 382

• Limitation computed at consolidated level

• Most states do not follow federal consolidated return regulations

• States may determine limitation at individual entity level

• Conflict between limitation and state related party interest add back

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NOL modifications• Carryback and carryforward of NOLs

• Federal limitation of NOL carryforwards to 80% of taxable income

• States following federal NOL directly (e.g. MD, VA)

Foreign income • NEW statutes and provisions

• Deemed repatriation of foreign E&P

• Tax on Global Low Taxed Income (GILTI)

• Deduction for Foreign Derived Intangible Income (FDII)

• Federal election – pay over 8 years

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Treatment of dividends received deduction

• Foreign dividends may not be eligible for 100% DRD or exclusion in states of

• AK, CA, ID, LA, ME,MA, MN MT, NH, NM, ND, OR, UT, VT

• AK, LA, NM, MA, MT, ND, OR, UT – appears to conform to IRC Section 965

Elimination of IRC Section 199 (DPAD)

• Most states already decouple

• Conforming states – Increase to income

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Pass-Through Implications

CONFORMITY IS KEY

Questions to ask1. Does the state adopt the IRC “as

currently in effect” or as of a “specific date”

2. Does the state have separate acts for corporate vs. individual taxpayers

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Federal Provision – Deduction for pass-through entity

• 20% domestic qualified business income

deduction

• Other calculations for federal return are necessary

• Deduction is computed after AGI but before taxable income

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State Impact - Deduction for pass-through entity

• No impact for states starting with AGI

• States starting with “taxable income” may decouple (CO, ID, ND, OR, SC, VT)

• Deduction applied at partner level – No impact to

• Entity level taxes

• Non-resident withholding

• Composite returns

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Federal Provision – Limitation of interest deductions

State Impact-

• Increases AGI – Expect conformity

• Applied at entity level – possible impact to

• Entity level taxes

• Non-resident withholding

• Composite returns

• Carryforward of excess interest will cause issues and opportunities since it is applied at partner level

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Pass-Through Implications - Other Federal Provisions and Potential State Impact

• Immediate federal expensing – Expect non-conformity

• Repeal of technical terminations – Expect conformity

• Business loss limitation rules – Conformity likely• May cause issues for non-resident

• Transition Tax • Individuals may not get DRD or subtraction for

Subpart F income

• State may not spread transition tax over 8 years

• Sales factor apportionment

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Federal Tax Reform – How are the states responding

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Federal Tax Reform – How are the states respondingInitial Response

• Rush to prepay income taxes – Disallowed

• Rush to prepay property taxes – IRS 2017-210

• Discuss replacing/converting income tax deductions into charitable deductions

• Discuss creation/modification of employment taxes to replace income taxes

• Legal action threatened

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Federal Tax Reform – How are the states respondingStates currently assessing impact to state and residents

• Michigan – Increase of over $1 Billion in tax revenue

• North Dakota – Negligible impact

• Others –• Assessing the overall impact

• Depends on tax structures in place

• Income tax

• Gross receipts tax

• Property tax

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Federal Tax Reform – How are the states respondingState legislative sessions have started

• Requests for technical corrections

• Request for delayed enactment

• Determine any decoupling provisions

• Review provisions linked to federal provisions eliminated (personal exemption)

• Submit proposals to remove limitations

• Review tax rate for pass-through entities

• Most rates expected to remain unchanged for individuals and corporations however pressure may occur

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• U.S Supreme Court and Related Cases


• Nexus

• Other

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U.S. Supreme Court

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U.S. Supreme Court

Economic Nexus

• As a result of Quill, retailers without physical presence in a state have historically not been required to collect and remit sales tax.

• Disadvantage to taxpayers located within the state.

• Loss of potential state sales tax revenue

• SCOTUS - Direct Marketing Assoc. v. Brohl (2015) --Justice Kennedy statements for reconsideration of Quill

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U.S. Supreme Court

Economic Nexus

• South Dakota first state to enact legislation that directly challenged Quill.

• Sales tax collection required if out of state seller if

• Sells over $100,000 of tangible personal property or service delivered to South Dakota or

• Completes 200 or more separate transactions for delivery in South Dakota

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U.S. Supreme Court

Economic Nexus – Other states

• Similar provisions to South Dakota (Indiana, Maine, Wyoming)

• Comparable laws but effective dates contingent (North Dakota and Vermont)

• Enacted economic nexus components (Ohio, Rhode Island, Washington)

• Requires out of state sellers to collect sales tax (Alabama and Tennessee)

• Massachusetts issued directive to impose economic nexus

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U.S. Supreme Court

Economic Nexus – Other states

• States impose sales and use obligation on certain marketplaces that facilitate sales for out of state third party retailers

• Minnesota, Pennsylvania, Rhode Island and Washington

• North Carolina also considering options

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U.S. Supreme Court

Economic Nexus – South Dakota

• South Dakota Supreme Court affirmed requiring remote sellers without physical presence to collect sales tax on South Dakota sales is unconstitutional

• Appeal to U.S. Supreme Court

• U.S. Supreme Court granted cert in South Dakota v. Wayfair

• Decision by Court will impact similar laws but may not address all states regulations and methods in effect to require the collection of tax

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Retroactive Legislation

• Options for taxpayer’s who want to challenge a state’s law or position

• Department of Revenue

• State or federal courts

• Successful challenges by taxpayers can be impacted by state legislation

• Change law prospectively

• Reversed entirely by using retroactive legislation

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U.S. Supreme Court ruled

• United States vs. Carlton (1994) – retroactive legislation is permitted if

• “Supported by legitimate legislative purpose”

• Congress “acted promptly and established only a modest period of retroactivity”

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U.S. Supreme Court declined to hear

• Dot Foods Inc. v. Washington Dept. of Revenue

• 27 years of retroactive application

• Washington Supreme Court stated large revenue losses were legitimate purpose

• 6 separate challenges to state of Michigan 2014 retroactive repeal of MTC’s alternative apportionment formula

• 6 years retroactive tax

• IBM, Goodyear, Sonoco, DIRECTV, Skadden, and Arps

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• Nexus

• Other

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Apportionment

Market based sourcing

• Continued migration to market based sales

• Consistency vs. inconsistency

• Know how a state defines “benefit”

• Benefit received

• Service received

• Service delivered

• Service used

• Customer located

• Service performed

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Apportionment

Multistate Tax Commission

• 2014 and 2015 MTC revised Article IV to include market based sourcing (Sections 1, 9 17 and 18 changed)

• 2017 adopted resolution of Model General Allocation and Apportionment Regulations and Amendments

• Regulation IV.17 - Sales sourced to state if and to the extent the taxpayer’s market is in that state

• Very similar to Massachusetts (origally used as working draft)

• Complexity of sourcing

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Apportionment


Reg IV.17 • Provides detailed rules for sales

• Sales of service

• License or lease of intangible property

• Sale of intangible property

• Software transactions and sale or license of digital goods

• General rule: Source to where delivered/used

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Apportionment


Reg IV.17 • Provides hierarchical order to be followed

• Numerous examples showing application of rules

• Distinctions between sales to an individual vs. a business

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Apportionment


Reg IV.17 • Allows for reasonable approximation

• Contains “throw-out” rule

• Can not amend to change “method” but may amend factual error

• Prospective changes must be disclosed

Don’t rely on customer’s billing address as a short cut

Determine how states have adopted MTC provisions

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Sales Factor Sourcing

Market-Based Sourcing

Benefit Received• Arizona (election)• California• Iowa• Michigan• Ohio (CAT)• Rhode Island• Utah• Washington (B&O)• Wisconsin

Service Received• Illinois• Maine• Minnesota


Service Delivered• Alabama• District of

Columbia• Louisiana• Massachusetts• Montana• Oregon• Pennsylvania• Tennessee

Service Used• Connecticut


Customer Located• Georgia• Maryland• Nebraska• New York• Oklahoma

Slide to be used for illustrative purposes only. Not to be used as a substitute for research into application of rules.

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Apportionment

Market based sourcing

• Oregon - beginning on or after 1/1/2018

• Based on MTC provisions

• Does not include throw-out rule

• Expect regulations to be issued

• Montana- beginning on or after 1/1/2018 –

• Adopted MTC provision

• Finnigan approach

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Apportionment

Illinois – Market based sourcing regulations

• Clarified provisions of where benefit is received and sourced to Illinois

• Applies to corporate, partnership, individual, trust and estate taxes

• Provides a variety of examples of when to apply

• Service sourcing rules

• Intangible sourcing rules

• Retroactive to December 31, 2008

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Apportionment

Illinois – Market based sourcing regulations

• Amended regulations on income from • Patent, copyrights or trademark

• Electricity

• Sale or lease of real property

• Interest net gains and other income from intangible property

• Services

• Inclusion of investment management example

• Sale of subsidiary stock is an occasional sale

• Eliminate double throwback rule

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Apportionment

Connecticut – Sales Apportionment

• Changes to single sales factor and market sourcing rules addressed

• Provides more detailed guidance to apply statutes• Sales Factor

• Generally filers will use single sales factors except for specified industries

• Occasional sales removed – Different rules for CBT and IT

Special notice 2017(1) Connecticut department of Revenue Services Apr. 17, 2017

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Apportionment

Connecticut – Sales Apportionment

• Market based sourcing - Source services if market for services are in state• At location directly or indirectly received

• Use of ultimate customer

• 4 step hierarchical method used

• Detailed examples how to source receipts

• Look at facts and circumstances

• Use good faith and consistency

Special notice 2017(1) Connecticut department of Revenue Services Apr. 17, 2017

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Apportionment

California – Subcontracted services

• A taxpayer receives income from subcontracting services that its customers would otherwise be required to perform for its ultimate customers

• Benefit is received by the taxpayer’s direct customer• Benefit also received by direct customer is the

released obligation to perform services to the ultimate customer

• Source revenue to location where the subcontracted services would otherwise be performed were it not for the subcontracting with the taxpayer.

Chief Counsel Ruling 2017-01, California Franchise Tax Board April 7, 2017 (released July 2017)

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Apportionment

Virginia – Cost of performance

• Taxpayer located in Virginia

• Taxpayer sold bundled product accessed by customers through internet which included research, executive education and networking tools.

• Virginia is a COP state

• Taxpayer filed original return using standard apportionment.

• An amended return was filed using alternative apportionment formula using single sales factor market based sourcing.

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Apportionment

Virginia – Cost of performance

• On amended return, sales factor changed from 98% to 2.4% for one of the years

• Court held that 3 factor double weighted sales factor as an appropriate measure of activity years

COP is still alive in many states

Corporate Executive Board v. Virginia Dept.. of Taxation, circuit Court Case No CL-13-3104

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Apportionment

South Carolina – COP vs. Market based sourcing

• DIRECTV filed its South Carolina return using market based sourcing.

• Amended return filed using “Cost of Performance”

• “Income producing activity” was limited to the delivery of the signal to the customers.

• Market sourcing disguised by DOR as COP analysis

DIRECTV, Inc v. South Carolina DOR 2017 S.C. Ct App. Lexis 74 (Aug. 30, 2017)

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ApportionmentOregon - Market based sourcing vs. cost of performance

• Taxpayer offers online courses to individuals and is based outside of Oregon

• Taxpayer argued support activities (financial, academic advisors) should be included along with faculty and curriculum development.

• Department held income producing activities are limited to the coursework-related activities by faculty and did not include support activities by advisors.

• Underlying course development and production did not have value unless students could receive course.

• NOTE - Oregon has since enacted market based sourcing

Apollo Education Group, Inc. and Subs v. Dept.. of Rev TC-MD 150352C

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Apportionment

Indiana - Market based sourcing vs. cost of performance

• Taxpayer offers online courses to individuals

• Taxpayer based outside of Indiana

• Taxpayer argued COP sourcing to outside of Indiana.• Costs included course development and production

• Greater of costs were incurred outside of Indiana

Indiana Letter of Findings No. 02-20150399 (7/26/17)

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Apportionment

Indiana - Market based sourcing vs. cost of performance

• Department held receipts were not derived from their underlying out-of-state activities in course development and production

• Revenue from “Ability to deliver and render their services to students in Indiana by means of online courses and for the Indiana students for services performed in Indiana”.

• Underlying course development and production did not have value unless students could receive course.

Indiana Letter of Findings No. 02-20150399 (7/26/17)

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Apportionment

Texas – COP state using “Market based sourcing”

• Taxpayer’s revenue from real-time payment risk and fraud prevention services.

• Customer receives

• Access to services

• Ability to input information

• Response after access to 3rd party databases

Texas PLR No 20703005L

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Apportionment

Texas – COP state using “Market based sourcing”

• State focus

• End product for what customer pays to receive – not the non-receipt producing support activities

• The processing of information is essential however it is a support activity.

• State ruled that the sales should be sourced to the location of the customer.

Texas PLR No 20703005L

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Apportionment

Texas – Sourcing of Capital Asset Sales

• A net loss from the sale of all Texas investments and Texas capital assets is not included in Texas receipts

• Statute only references “net gain” so net losses should not be included in sales everywhere calculation.

• Combine all gains and losses together – CAN NOT BE less than zero

• Similar application for the numerator• 4 examples provided by Comptroller for reference• Statute has yet to be changed

Texas Letter No. 201707002L, Texas Comptroller of Public Accounts July 7,2017

Response to Hallmark Marketing Co v Hegar

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Apportionment

California – Occasional Sales

• Taxpayer divested of businesses in 3 separate transactions

• California rule provides for when to exclude substantial receipts and arise from occasional sales• > 5% decrease in sales factor denominator

• Occasional – outside normal business and infrequent

• FTB determined sales were occasional and substantial

Consider impact of having impact of apportioned gains with no factor relief

California Chief Counsel Ruling No. 2017-3, 10/18/17

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Apportionment

Tennessee – Single Sales Factor

• Manufacturing companies whose principal business in Tennessee is manufacturing can elect to use single sales factor to apportion BOTH net earnings and net worth

• Principal business - if more than 50% of revenue derived from activities in TN is from fabricating or processing tangible personal property in TN.

• Excludes passive income

• Election made on return

• 5 year election

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Apportionment

Arkansas – Partnership income

• Partnerships with income within and outside Arkansas will apportion income similar to corporations (UDITPA).

• Each individual partner must continue to ALLOCATE its share of partnership income to Arkansas as under current law

• Allows for alternative apportionment requests

• Applies to tax years beginning on or after 1/1/18

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• Nexus

• Other

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Nexus

Oregon – Warranty Services

• A Georgia based wholesale tire distributor sold to Oregon retail tire seller, repairer and installer

• No employees in Oregon

• No property in Oregon

• Warranty services provided through independent contractor

• Activities exceeded the protections afforded by P.L. 86-272 and the Oregon statutes

Cheng Shin Rubber v. Dept.. of Revenue TC-MD 150268D Mar. 31,2017

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NexusMaryland – Activities exceeding solicitation

• Blue Buffalo Company employed several individuals located in Maryland• Distributor Sales Manager

• Account Manager

• 2 Regional Demo Managers

• Several dozen in-store sales representatives (Pet detectives)

• Activities included • Meet with local retailers

• Provide education and training at industry related events

• Maintain relationships with customers

• Maintain retail displays

• Recruitment and trained Pet Detectives

• Reported incidents of defective goods

Blue Buffalo Co. v. Comptroller of the Treasury, Maryland Tax Court No 16-IN-00-0364 (Aug 30, 2017)

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NexusMaryland – Activities exceeding solicitation

• Tax Court ruled the employees suggested a business purpose other than requesting orders

• Education, training, attendance at pet-related events were factors cited

• Quality control

• Gathering competitive intelligence also stated

• Getting customer’s to make in-store purchases of product

• Tax Court ruled Activities exceeded the protected activities under Public Law 86-272 when considered as a whole

Blue Buffalo Co. v. Comptroller of the Treasury, Maryland Tax Court No 16-IN-00-0364 (Aug 30, 2017)

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Nexus

California – Doing Business

• Corporate member of LLC had a .2% non-managing ownership interest with no right of control over business affairs

• LLC member interest was in a “manager managed” LLC

• Member conducted no other California business• Court ruled

• Passive membership in LLC was not “doing business”• Non-managing member of LLC is not doing business in

California• Not subject to the $800 minimum tax

SWART ENTERPRISES, INC., Plaintiff and Respondent, v. FRANCHISE TAX BOARD

Be careful of applying this case to your clients!

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Nexus

Iowa - Economic Nexus

• Court held out of state parent company could not be included in an Iowa Consolidated return

• Parent’s activities included

• Ownership and control

• Owned intangible property (shares of stock and money) with Iowa situs

• Use of trademark in Iowa

• Contradicts many other states rulings on economic nexus

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NexusOregon – Economic Nexus

• Capital One Auto Finance is a subsidiary of Capital One Financial Corporation. Asserted banks did not have nexus with Oregon

• No Employees in Oregon

• No property in Oregon

• Tax Court held

• Physical presence was not required in establishing nexus for purpose of corporate excise and income tax

• Similar rulings for banks in Illinois, Indiana, Massachusetts, and West Virginia

Capital One Auto Fin. V. Dep’t of Rev (Oregon) Dec 23, 2016

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• Nexus

• Other

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Tax Base

Texas – Cost of Goods Sold

• Texas calculates franchise tax based on one of 3 methods• Gross receipts x 70%

• Compensation

• Cost of goods sold

• Cost of goods sold definition of production no longer includes “installation”

• A clarification or a prospective change?

• Current litigation Hegar v. Autohaus

• Taxpayer is an auto repair shop

• Installation labor costs were disallowed by state and did not constitute production

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Tax Rate Changes

• Annual fee increase to $200

State 2016 2017 2018

Arizona 5.5% 4.9% 4.9%

D.C. 9.2% 9.0% 8.25%

Illinois 5.25 7% (7/1/2017) 7%

Indiana 6.5% 6.25% (6% after 6/30/17)

6% (5.5% after 6/30/18)

North Carolina 4% 3% 3% (2.5% in 2019)

New Hampshire 8.5% 8.2% 8.2%

New Mexico(highestrate)

6.6% 6.2% 5.9%

New York MTA 28.3% of NY 28.3% of NY 28.6% of NY

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Business Income

New Mexico – Business income vs. Nonbusiness Income

• Taxpayer realized gain from the sale of a subsidiary's stock in which it owned less than 50% interest

• New Mexico has three prong test

• Transactional test - Sale from regular course of taxpayer’s business

• Disposition test - met since the income arose from sale of business

• Functional test – income was an operational benefit integral to the business

• State ruled the income was apportionable income

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Business Income

New Jersey – Sale of S corporation

• Gain from deemed asset sale under IRC Section 338(h)(10) was non-operational income and not subject to apportionment.

• New Jersey based S corporation with non-resident shareholders

• Gain allocated to New Jersey• Based on previous case McKesson Water Products Co. V

Division of Taxation • Laws have since been changed to either functional or

transactional tests are satisfied

States have ruled both ways across country

Xylem Dewatering Solutions, Inc v. Director of Taxation, New Jersey Tax Court Docket nos. 011704-2015, 000056-2016, April 7, 2017

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Voluntary Disclosure/Amnesty Programs

• What is the benefit to the state to have programs?

• How does the Taxpayer benefit?

• Statute of limitations closed on prior years

• Reduced or elimination of penalties and/or interest

• ASC 740

• Statutory vs. negotiated voluntary disclosure

• Beware of post program penalties

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Voluntary Disclosure/Amnesty Programs

• Current or upcoming programs

• Connecticut

• Ohio

• Rhode Island

• Texas

• Recently expired programs

• MTC, Oklahoma, Pennsylvania, Virginia

• Other specific programs for click through nexus and other sales tax issues are available in some states

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What’s ahead for 2018

• More states will decouple from bonus depreciation

• Some states will evaluate and propose gross receipts tax

• Significant confusion over the repatriation laws

• Continued expansion of sales tax base to E-commerce and services

• More guidance on market based sourcing rules will be issued from states

• Challenges to federal tax reform act by members of Congress and state officials

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Tim Clancy, CPA

Windham Brannon P.C. - Atlanta

[email protected]

678.510.2804

mailto:[email protected]

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