State and local tax advisor: October 2021

The states covered in this issue of our monthly tax advisor include:

• Alabama
• Arkansas
• California
• Colorado
• Illinois
• Indiana
• Massachusetts
• Michigan
• New Jersey
• Ohio
• Oregon
• Tennessee

Alabama

Corporate, personal income taxes: Alabama provides guidance for making pass-through entity tax election

The Alabama Electing Pass-Through Entity Tax Act (Act 2021-1 and Act 2021-423) allows Alabama S corporations and Subchapter K entities (pass-through entities or PTEs) to elect to pay Alabama income tax at the entity level. (Electing PTEs must submit Form PTE-E via My Alabama Taxes (MAT). The Department of Revenue (DOR) expects Form PTE-E to go live in January.)

Electing PTEs must register to use MAT and submit Form PTE-E through MAT prior to the 15th day of the third month following the close of the tax year for which they elect to be taxed at the entity level. They will need the following information to sign up for MAT:

• 10-digit account number, which is on all correspondence sent from the Alabama DOR.
• Sign-on ID, which was assigned and mailed upon registration of the account.
• Access code, which was assigned and mailed upon registration of the account.
• Valid email address, for receiving confirmation emails and authorization code messages.

New entities without an Alabama DOR account must first complete a new taxpayer/account registration application using MAT. They should click on the link to “Register a business/obtain a new tax account number” in the “Businesses” section of MAT. Then, they should select the “Pass Through Entity” account as the type of account.

Anyone who needs assistance setting up an account or who has questions related to the election process can contact the Pass-Through Entity Tax section at 334-242-1170, Option 6. The DOR also provides additional information on electing PTEs on its website at https://revenue.alabama.gov/individual-corporate/electing-pass-through-entities/.

Notice - Alabama Electing Pass-Through Entity Tax Act Guidance, Alabama Department of Revenue, Oct. 19, 2021.

Arkansas

Sales and use tax: Taxpayer not entitled to exemption as machinery not used directly in the manufacturing process

A taxpayer did not qualify for the manufacturing exemption from Arkansas sales and use tax because the machinery was not used directly in the manufacturing process. Arkansas provides an exemption from tax on certain purchases of machinery and equipment purchased by a manufacturer for direct use in manufacturing an article of commerce. However, this does not include machinery and equipment, which handle raw, semifinished, or finished materials or property before the manufacturing process begins.

In this matter, the taxpayer claimed the manufacturing exemption on equipment that transports raw products before the manufacturing process occurs. The Office of Hearings and Appeals asserted that machinery and equipment utilized to transport raw materials prior to the beginning of the manufacturing process was expressly barred from the claimed exemption. The taxpayer failed to satisfy the burden of proof and therefore, the assessment was sustained.

Docket Nos. 22-120, 22-168, Office of Hearings & Appeals, Arkansas Department of Finance and Administration, Oct. 1, 2021.

California

Corporate, personal income taxes: Pass-through entity tax FAQS answered

The Franchise Tax Board answers frequently asked questions (FAQs) about the elective California pass-through entity tax on a new webpage. The topics addressed include:

• Election and qualifications
• Qualified net income
• Tax credit
• Payment and forms

Election and qualifications

A qualified entity must make the election on its original, timely filed return.

A qualified entity can’t have a partnership as a partner, member, or shareholder. It can have a disregarded entity as a partner, member, or shareholder. However, a disregarded entity alone can’t be a qualified entity, because it’s not taxed as a partnership or S corporation.

Qualified net income

An electing entity’s qualified net income is the sum of the pro rata or distributive share of income subject to California personal income tax of each consenting partner, member, or shareholder. It does not include the nonconsenting partners’, members’, or shareholders’ pro rata or distributive shares.

When a qualified entity sells an asset, gain from the sale is included in calculating qualified net income.

If a qualified taxpayer sells an interest in a qualified entity, gain or loss on the sale is owner-level income. It is not included in the entity’s qualified net income.

Tax credit

A disregarded entity and its owners can’t receive the PTE tax credit. Also, the credit can’t reduce the amount of tax due below the tentative minimum tax.

Payment and forms

For the 2021 tax year, an electing entity must pay the PTE tax on or before the due date of the entity’s original tax return. For the 2022 through 2025 tax years, an electing entity must make two payments: one by June 15th of the taxable year of the election and the other by the due date of the original return without regard to extensions.

The entity must make the payments using Pass-Through Entity Elective Tax Payment Voucher (FTB 3893).

Help With Pass-Through Entity Elective Tax, California Franchise Tax Board, September 2021.

Colorado

Corporate income tax: Colorado nexus for out-of-state partnership deriving revenue from investment advisory services discussed

For corporate income tax purposes, Colorado issued a General Information Letter (GIL) clarifying how the state nexus is determined for a partnership that derives its revenue from investment advisory services provided to regulated investment companies.

Generally, Colorado applies the same standards for determining if a corporation has substantial nexus to partnerships and other pass-through entities. The GIL clarified that:

• Under the nexus rules, a partnership must determine if it exceeds any of the threshold amounts or percentages for sales, property, or payroll at the entity level in the state.
• When determining nexus for a partnership rendering management, distribution, or administration services to a registered investment company, the sales threshold amounts of $500,000 or 25% of total sales is computed and sourced as per the applicable statute.
• Partnerships that exceed the threshold amounts have substantial nexus with Colorado and must make returns and comply with the requirements for nonresident partners.

GIL 21-004, Colorado Department of Revenue, July 30, 2021, released September 2021.

Corporate, personal income taxes: Enterprise zone rules amended

The Colorado Department of Revenue has amended several income tax regulations with respect to enterprise zone credits.

Credit for enterprise zone contributions

Rule 39-30-103.5, governing the credit for enterprise zone contributions, is amended to correct an error regarding the calculation of the credit limitation for in-kind contributions and to conform the rule to the Department’s current practice.

Enterprise zone investment tax credit

Rule 39-30-104, regarding the enterprise zone investment tax credit, is amended to update the application of the credit. The amendments clarify that:

• A taxpayer can’t claim the credit for property that the taxpayer does not actually claim a depreciation expense for federal income tax purposes.
• The total combined amount of credit a taxpayer can claim to offset tax and receive a refund for a tax year is limited to $750,000, except that any credits carried forward from tax years commencing prior to Jan. 1, 2014, are not subject to this limit.
• A taxpayer can’t claim the credit allowed by Sec. 39-30-104, C.R.S., and the credit set forth in Sec. 39-22-507.5, C.R.S., for the same property, even though the statutes contain no such prohibition.
• No credit is allowed for property acquired or purchased by the taxpayer prior to submitting the required precertification form to the enterprise zone administrator.

Additionally, the amendments address the tax consequence of qualified property not used solely and exclusively in an enterprise zone for at least one year.

Enterprise zone new business facility employee credits

The rule governing enterprise zone new business facility employee credits (Rule 39-30-105) is repealed as result of the repeal of the corresponding statute, effective Dec. 31, 2019.

Credit for rehabilitation of vacant buildings

Rule 39-30-105.6, regarding the credit for rehabilitation of vacant buildings, is amended to:

• Define the term “building” to include the entire physically contiguous structure, regardless of whether it has been legally divided into separate units.
• Clarify that a building is not considered to be unoccupied at any time during which the building is actively utilized in the operation of a trade or business.
• Clarify the conditions under which a building is considered to be rehabilitated for commercial use.
• Clarify the application of the $50,000 credit limit in situations involving multiple tax years or multiple owners or tenants.
• Clarify that no credit is allowed for expenditures paid or incurred by the taxpayer prior to submitting the required precertification form to the enterprise zone administrator.

Aircraft manufacturer new employee income tax credit

The rule regarding the application of the aircraft manufacturer new employee income tax credit is amended to clarify:

• The method of calculating business facility employees for the purpose of calculating the credit.
• The qualifications for employees who work both at and away from the aircraft manufacturer’s facility.
• The calculation of the credit for aircraft manufacturers that acquire an existing facility.

Regulations §§39-30-103.5; 39-30-104; 39-30-105 (repealed); 39-30-105.6; and 39-35-104, Colorado Department of Revenue, effective Oct. 15, 2021.

Illinois

Sales and use tax: Changes related to retailers’ occupation tax guidance for remote retailers, marketplace facilitators discussed

Illinois issued an informational bulletin informing sales and use taxpayers that a recent law amended the retailers’ occupation tax and enacted the Leveling the Playing Field for Illinois Retail Act. The amendment implements a series of structural changes to the Illinois sales tax laws that require remote retailers who meet a tax remittance threshold to remit state and local retailers’ occupation taxes beginning Jan. 1, 2021.

Additionally, the bulletin provides sales and use tax information on topics, including:

• Definitions of remote retailer, retailers’ occupation tax, marketplace, marketplace facilitator, marketplace seller, certified service provider, and certified automated system.
• Remittance thresholds for remote retailers or marketplace facilitators subject to the state or local tax.
• Sales that are excluded from the tax remittance threshold determination for remote retailers and marketplace facilitators.
• Information on sourcing the tax rate applicable to sales by marketplace facilitators or remote retailers.
• Links to additional information on the Leveling the Playing Field for Illinois Retail Act.

Informational Bulletin FY 2022-04, Illinois Department of Revenue, October 2021.

Sales and use tax: Taxability of subscription receipts and proceeds of e-commerce company

The Illinois Department of Revenue (department) issued a general letter ruling discussing the application of sales and use tax to a nondomiciliary e-commerce company’s (taxpayer’s) subscription receipts and sales proceeds. The department stated that:

• The taxpayer’s subscription receipts were not subject to state or local sales tax as they were not derived from any transfer of ownership of tangible personal property to a purchaser.
• Transactions in which a customer could try merchandise as part of a subscription program before making a decision whether to purchase or return the merchandise were generally not intended to be covered by the Rental Purchase Agreement Occupation and Use Tax.
• The taxpayer’s merchandise purchases were not considered “a use for demonstration purposes” and were not exempt from Illinois use tax because a month-to-month subscription that allowed customers to receive different items of merchandise was not the same as a lease of an item as stated in the applicable rule.
• If a customer decided to purchase the item, then the sale was subject to both state and local retailers’ occupation tax at the customer’s location, because the company’s inventory was at that location at the time of the sale.

General Information Letter ST 21-0025-GIL, Illinois Department of Revenue, July 27, 2021, released September 2021.

Indiana

Sales and use tax: Guidance on collection of sales tax on drop shipments

Indiana has updated its sales tax guidance on drop shipments to note that a purchaser is required to collect Indiana sales tax, not use tax, on retail transactions in Indiana, unless a specific exemption applies. The bulletin also adds information pertaining to Indiana’s economic nexus thresholds for purchasers not having a physical presence in Indiana (remote sellers). Remote sellers that do not meet either of the economic nexus thresholds do not have an obligation to collect sales tax, the purchaser’s customers would be required to self-remit use tax. Information Bulletin #57, Indiana Department of Revenue, September 2021.

Massachusetts

Corporate, personal income taxes | Correction: Legislature overrides veto of pass-through entity tax, other changes

The Massachusetts legislature voted to override Gov. Charlie Baker’s veto of legislation that:

• Creates an elective pass-through entity tax.
• Repeals the corporate excise and personal income tax credits for federal medical device user fees.
• Ends the corporate excise tax credit for the federal harbor maintenance tax.
• Eliminates an unused deduction for income from energy conservation or alternative energy patents.

A previous story incorrectly stated that the legislature had already overridden the governor’s veto of the tax and other changes. It, in fact, rejected legislative amendments proposed by the governor.

Effective dates

The elective pass-through entity tax is effective for tax years beginning on or after Jan. 1, 2021. The tax applies until:

• The repeal of the federal limitation on the state and local tax deduction under IRC Sec. 164(b)(6).
• The federal limitation expires or is no longer in effect.

The changes to the credits and patent deduction take effect for tax years beginning on or after Jan. 1, 2022.

H.B. 4008 and H.B. 4009, Laws 2021, enacted over Massachusetts Gov. Charlie Baker’s vetoes (H.B. 4049 and H.B. 4050) on Sept. 30, 2021 and effective as noted.

Michigan

Sales and use tax: Distribution of advertising material not subject to tax due to lack of retention of control

A household products and furnishings store (taxpayer) was not liable to pay Michigan use tax on the distribution of advertising material, from an out-of-state source, within Michigan as there was not sufficient retention of control over advertising materials by the taxpayer to constitute “use” because taxpayer deferred all aspects of delivery to a third-party direct mail vendor.

In this matter, the taxpayer promoted its business in Michigan through postcards, circulars, coupons, and newspaper inserts (advertising materials) that were produced outside Michigan and were delivered by a third-party according to its own methodology. The Department of Treasury (department) moved for summary disposition arguing that the taxpayer controlled the aspects of delivery of the advertising materials and also imposed requirements with respect to how and when the materials could be used after delivery to the residents.

The Court of Appeals (court) concluded that the taxpayer’s exercise of a right or power over the catalogs ended when the catalogs were delivered to the postal service. Additionally, the court clarified that the mere fact that a customer might not be able to redeem a coupon or take advantage of a sale after a certain date did not translate to the taxpayer’s “use” of the advertising materials. Therefore, the summary disposition granted in favor of the taxpayer was affirmed.

Bed Bath & Beyond, Inc. v. Department of Treasury, Michigan Court of Appeals, Nos. 352088, 352667, July 8, 2021, released September 2021.

Corporate income tax: Alternate method of apportionment required to avoid constitutional violation

Application of the statutory apportionment formula to exclude the sale of a business from a taxpayer’s sales factor denominator for Michigan business tax purposes was unconstitutional. The case involved the sale of an out-of-state business. The business provided services in many states throughout the Midwest. While engaged in a severe oil spill cleanup project in Michigan, the business sold all of its stock to the taxpayer. According to the Michigan Court of Appeals, the trial court correctly determined that the sale could not be included in the sales factor denominator under the statutory formula. But, applying the statutory formula in this case would result in a violation of the Commerce Clause because it did not fairly represent the taxpayer’s business activity in the state. Thus, the Court of Appeals remanded the case to the trial court with directions to determine an alternate apportionment method if the parties are unable to agree upon one.

Vectren Infrastructure Services Corp. v. Department of Treasury, Michigan Court of Appeals, No. 345462, Sept. 30, 2021.

New Jersey

Corporate income tax: Combined reporting initiative extended

New Jersey’s corporation business tax (CBT) combined reporting initiative period, originally scheduled to expire on Oct. 15, 2021, is now extended to Jan. 3, 2022.

What is the initiative?

New Jersey is in the process of identifying companies that have been included as part of a combined group filing and indicated that they have nexus with New Jersey but have not filed as a separate entity for periods prior to 2019. New Jersey will waive penalties for qualified companies that pay back CBT for certain years that they had nexus with New Jersey but failed to file as a separate entity.

Companies that have had nexus with New Jersey prior to filing as part of combined return will have the opportunity to come forward and voluntarily comply with their CBT filing requirements. These companies are not eligible for a standard Voluntary Disclosure Agreement; however, New Jersey will consider entering into a Closing Agreement with approved companies based upon the following:

• Companies must not have been incorporated in New Jersey, authorized to do business in New Jersey by the Division of Revenue and Enterprise Services, or registered for CBT prior to being included as part of a 2019 or 2020 combined return.
• The taxpayer must provide the New Jersey registration number of the Managerial Member, which begins with NU.
• The look-back period will be limited to the periods ending after June 30, 2016, or the date nexus was established with New Jersey, whichever is later.
• Returns for prior periods will not be required.
• The taxpayer must file all required returns and remit payment of the reported tax liability in full within 45 days of execution of the agreement.
• New Jersey will waive all penalties.
• The taxpayer will remit payment of interest within 30 days of assessment.
• All returns will be subject to routine audits.

Failure to take advantage of the initiative will result in the look-back period going beyond return periods ending after June 30, 2016, and all applicable penalties and interest being assessed.

Corporation Business Tax - Combined Reporting Initiative, New Jersey Divisions of Taxation, Oct. 5, 2021.

Ohio

Sales and use tax: Sales tax assessment cancelled as taxpayer not responsible party

A taxpayer’s Ohio sales and use tax assessment was cancelled as the taxpayer proved that she was not a responsible party for the bar that was subject to the assessment. In this matter, according to the audit remarks, the taxpayer was identified as the manager of the bar being audited.

Upon review the Board of Tax Appeals (board) found that the taxpayer carried her burden and established that she was not a responsible party because she had no meaningful financial responsibilities. Taxpayer was the bartender who sometimes assisted her boss with tasks because of his advanced age and hearing impairment, and she did not have access to the bar’s bank accounts, sales tax returns, financial documents, or the Ohio business gateway account.

Further, the Tax Commissioner claimed that the taxpayer’s actions during the audit were probative in a responsible party determination. The board stated that the taxpayer did not act as the sole contact during the audit, she did not hold herself out as the owner, she did not agree to an audit methodology nor did she provide the auditor with relevant documents. Therefore, the board reversed the commissioner’s final determination and cancelled the assessment issued to the taxpayer.

Amy Crawford v. Tax Commissioner of Ohio, Ohio Board of Tax Appeals, No. 2021-577, Oct. 8, 2021.

Oregon

Corporate income tax: Inclusion of Subpart F income in apportionment formula reconsidered

In reconsidering a previous decision, the Oregon tax court has concluded that a corporate income taxpayer’s dividends and Subpart F income that were excluded from “sales” because they arose from holding controlled foreign corporation (CFC) stock could be reincluded in “sales” if derived from an activity that constitutes the principal business activity of the payor CFC and the principal business activity of taxpayer. The court changed its previous ruling because it was persuaded by the authorities cited in the parties’ briefing on reconsideration, and other authorities, that the conclusion in the Dec. 16, 2020, order was incorrect.

Original decision

In the original decision, the tax court determined that an Oregon corporate income taxpayer filing consolidated returns could not include the unsubtracted amounts of 20% of the Subpart F income or dividends in its apportionment formula. The taxpayer sought to include the unsubtracted 20% of the Subpart F income and the unsubtracted 20% of the dividends in its Oregon sales factor, arguing those amounts were “sales.” The court concluded that “gross receipts,” and therefore “sales” for purposes of Oregon’s sales factor, did not encompass Subpart F income.

Revised conclusion

On reconsideration, the court was persuaded by a contemporaneous statutory definition of “received,” along with other strong contextual evidence, that the legislature intended “gross receipts” to be construed according to the taxpayer’s tax accounting method. The court reasoned that Subpart F functions essentially as a mandatory accounting method, preventing domestic controlling shareholders from using the simple postponement of the payment of dividends to indefinitely defer income earned by foreign-incorporated subsidiaries. Accordingly, the court now agreed that the Subpart F income constitutes gross receipts for apportionment purposes and is treated in the same manner as dividends that some of the CFCs actually paid to the taxpayer.

The remaining task was to determine the taxpayer’s primary business activity and to identify whether that activity was the primary business activity of each CFC whose earnings and profits resulted in a dividend or Subpart F income. The court reasoned that is a factual matter the parties may be able to reach agreement on.

Oracle Corp. v. Department of Revenue, Oregon Tax Court, No. TC 5340, Oct. 6, 2021.

Tennessee

Sales and use tax: Online advertising platform and data processing service not subject to sales tax

An online cloud-based platform operator (taxpayer) was not subject to Tennessee sales and use tax because taxpayer’s offerings did not constitute telecommunication services or use of computer software. The taxpayer’s platform was used by brokers and carriers engaged in the business of commercial freight transportation to arrange for transportation of freight.

The Department of Revenue (department) determined that the taxpayer’s offerings did not constitute telecommunication services as telecommunication services do not include the type of online advertising platform or the data processing and information services that the taxpayer provided. Neither did the taxpayer’s offerings constitute use of computer software since one offering was a nontaxable online advertising platform and the other was a nontaxable data processing and information service.

Therefore, because the taxpayer did not sell or license software to its subscribers nor did it provide a taxable telecommunications service, the monthly subscription fees were not subject to Tennessee sales and use tax.

Letter Ruling No. 21-08, Tennessee Department of Revenue, Aug. 26, 2021, released October 2021.