State and local tax advisor: March 2023

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

• Colorado
• Delaware
• Illinois
• Indiana
• Iowa
• Michigan
• Montana
• New York
• North Carolina
• Ohio
• Pennsylvania
• Tennessee
• Texas
• Wisconsin

Colorado 

Corporate income tax: Gross receipts from sales of real estate excluded from apportionment factor

The gross receipts from a real estate rental company’s sales of Colorado real estate must not be included in the company’s receipts for purposes of apportioning income for Colorado income tax purposes. The company received rents in the regular course of its trade or business. Thus, the company produced apportionable income in the form of rents. However, its sales of real property were infrequently occurring transactions, not in the regular course of its trade or business. Thus, the amounts received from the real property sales didn’t meet the definition of “receipts” for apportionment purposes.

PLR 23-002, Colorado Department of Revenue, March 13, 2023.

Delaware

Unclaimed property: U.S. Supreme Court decides that Federal Disposition Act governs escheat of agent/teller checks

The U.S. Supreme Court has held that the escheat of proceeds of unclaimed agent checks and teller checks issued by a financial services company should be governed by the Federal Disposition of Abandoned Money Orders and Traveler’s Checks Act (Federal Disposition Act or FDA) instead of common law.

The financial institution involved in the case followed common law and, since it didn’t keep creditor addresses for this type of financial product, proceeds of the abandoned checks were remitted to Delaware, the state where the financial institution was incorporated. However, multiple states argued that the escheat of the abandoned checks were governed by the FDA.

Under the FDA, money orders or similar written instruments escheat to the state where the instrument was purchased. The Court held that the agent checks and teller checks were similar enough in function and operation to money orders to fall under the FDA. Like money orders, these checks were prepaid written instruments used to transmit money to a named payee.

Also, because of the way the financial institution kept records of these instruments, abandoned proceeds would always escheat to the state of incorporation, which would be inequitable. Delaware would receive a windfall solely because it was the state of incorporation and the FDA was enacted in order to prevent such inequity in escheat.

Delaware v. Pennsylvania, et al., U.S. Supreme Court, No. 145, 598 U. S. ____ (2023), Feb. 28, 2023.

Illinois

Sales and use tax: Taxability of wrapping and packing materials discussed

The Illinois Department of Revenue (department) issued a general information letter discussing the applicability of sales and use tax to the sales of containers, wrapping and packing materials, and related products. Generally, the sale of tangible personal property (TPP) for the purpose of resale isn’t taxable. The department stated that sales of containers to purchasers who sell TPP in these containers to their customers are deemed to be sales for resale. Therefore, the receipts from such sales aren’t subject to the retailers’ occupation tax, provided the purchasers transfer the ownership of the containers to their customers along with the ownership of the TPP contained in the containers.

General Information Letter ST 22-0026-GIL, Illinois Department of Revenue, Nov. 2, 2022, released February 2023.

Indiana

Corporate, personal income taxes: PTE elective tax enacted

Indiana has enacted an elective pass-through entity (PTE) income tax, retroactive to tax year 2022.

Which entities can elect?

The PTE tax allows a partnership or S corporation to elect.

What rate is the tax?

The tax rate is the same as the individual income tax rate.

Is an owner allowed a credit?

Each entity owner is entitled to a refundable credit in an amount equal to the portion of the tax paid by the electing entity that reflects the entity owner's share of the PTE tax. The credit offsets the impact of payment of tax at the entity level on the entity owners.

When does an entity elect?

For tax years beginning after Dec. 31, 2021, and before Jan. 1, 2023, the election must be made after March 31, 2023, and before Aug. 31, 2024. For tax year beginning after Dec. 31, 2022, the election can be made at any time during the tax year or no later than:

• The due date of the electing entity’s return for the tax year, including any extensions.
• The date the electing entity files its return for the tax year.

Once made for a tax year, the election is irrevocable.

Are estimated payments required?

An electing PTE must make estimated tax payments in the same manner as corporations. However, for tax years ending on or before June 30, 2023, an electing entity isn’t required to make estimated tax payments.

For tax years ending after:

• June 30, 2023, and on or before Dec. 31, 2024, a PTE must make an estimated tax payment on or before the end of the tax year, there will be no penalty for underpayment of estimated tax if the payment equals or exceeds 50% of the tax.
• Dec. 31, 2024, there will be no penalty for underpayment of estimated tax if the payments during the tax year equal or exceed the lesser of 80% of the tax imposed or 100% of the tax imposed for the preceding taxable year.

Will the credit for taxes paid another state include PTE taxes?

The law, for purposes of the credit for taxes paid another state, makes an owner of a PTE considered liable for tax paid another state under similar PTE taxes and the owner is considered to have paid the portion of the tax paid by the PTE. Also, the owner of a PTE will also be considered liable for and to have paid state income taxes to another state paid by the PTE on behalf of an owner through withholding, a composite return, or otherwise.

S.B. 2, Laws 2023, effective retroactive to Jan. 1, 2022 and as noted.

Iowa

Personal income tax: PTE composite return rules updated

Pass-through entity (PTE) income tax composite return rules are amended to reflect changes made to the law in 2021.

What law changes were made?

Iowa repealed the provisions requiring a pass-through entity to withhold and remit income tax on a nonresident individual’s distributive Iowa-source income from the pass-through entity and that allowed a pass-through entity to elect to file an Iowa composite return on behalf of its nonresident individual members. The repealed sections were replaced by a mandatory Iowa composite return filing and tax payment requirement that applies to all nonresident members of the pass-through entity.

A pass-through entity with nonresident members is required to file an annual Iowa composite return and pay Iowa income or franchise tax on behalf of its nonresident members related to their Iowa-source income from the pass-through entity. These changes take effect for tax years beginning on or after Jan. 1, 2022.

What regulation changes are made?

The regulation changes include:

• A new chapter governing the new composite return requirements.
• A rule to address the nonapplication of the current composite rules and other transition rules.
• Other conforming amendments.

Rules 701 — 302.46, 304.44, 307.4, 404, 405, 501.12, 601.24, 700.4, 700.8, and 700.10, Iowa Department of Revenue, effective March 29, 2023.

Michigan

Sales and use tax: Individual personally liable for company’s unpaid taxes

An individual who was the sole corporate officer of a company was properly liable for the company’s outstanding Michigan sales and withholding tax liabilities because the Department of Treasury (department) established that he was personally responsible for those taxes. In this matter, the individual was the sole corporate officer of the company and owner of all of the capital stock. Thus, the department determined that the individual was a responsible person for the company’s tax liabilities for the tax period and issued assessments. The individual protested that his involvement in the company was not “tax specific” and that the general manager was the person responsible for ensuring the filing and payment of tax.

On appeal, the Tax Tribunal found that the individual was the only officer or member who could have been responsible for the company’s tax-specific duties. Additionally, the department established that the individual controlled, supervised, or was responsible for the filing of returns and the payment of taxes before and during the time period of default. Accordingly, the assessments were sustained.

Riaz Ahmad v. Michigan Department of Treasury, Michigan Tax Tribunal, No. 22-002549, Feb. 27, 2023.

Note: Many states have a similar rule holding individuals responsible for taxes personally liable for sales tax and other trust type taxes, such as employee withholding.

Montana

Corporate income tax: Single receipts factor enacted 

Montana has enacted legislation that will change the corporate income tax apportionment formula to a single factor based on receipts, applicable to tax years beginning after 2024. Currently, Montana has a three-factor formula with a double-weighted receipts factor.

S.B. 124, Laws 2023, applicable as noted; News Release, Montana Governor’s Office, March 13, 2023.

New York

Corporate income tax: Corporation could not exclude royalties from foreign affiliates

A New York appellate court affirmed a Tax Appeals Tribunal decision concluding that a corporation could not deduct royalties that it received from certain foreign affiliates. The court noted that the corporation’s arguments about the royalty income exclusion were nearly identical to those addressed in the court's recent Walt Disney decision, and there was no reason to depart from that holding on the issue.

With respect to the dormant Commerce Clause, the corporation argued that the internal consistency test was violated because, if every state applied the addback and exclusion, licensing transactions with non-New York licensees would be subject to greater taxation than licensing transactions with New York licensees. However, that interpretation was rejected because it neglected the fact that there were two taxable events occurring (i.e., the payment and the receipt of that payment). The corporation’s interpretation also ignored other provisions of the law, including former Tax Law Sec. 211(4), which created an offset. When the two actions were properly recognized and balanced based on the whole taxation scheme, non-New York licensees would not be subject to greater taxation than those with New York licensees because non-New York licensees would be able to realize a deduction.

The corporation’s application of the external consistency test was also flawed. The corporation argued that the extraterritorial economic activity was generated by intangible property, such as licenses and patents exploited outside the United States, but this ignored the fact that the corporation was organized under the laws of New York and also located its head offices in New York. The corporation enjoyed significant tax credits under the New York tax scheme; when measured against the challenged royalty income exclusion, it couldn’t be said that those benefits were unreasonable in comparison.

Finally, the corporation’s foreign Commerce Clause argument was rejected, in part because the contentions were speculative and conclusory. The corporation pointed to no foreign policy issues or federal directives that the New York tax scheme would violate.

International Business Machines Corp. v. Tax Appeals Tribunal, Appellate Division of the Supreme Court of New York, Third Department, No. 533572, March 16, 2023.

Sales and use tax: Individual personally liable for LLCs’ unpaid taxes as bulk sale purchaser

An individual was properly liable for an outstanding New York State sales tax liability with respect to bulk sale purchases made by two limited liability companies (LLCs) because the Division of Taxation (division) established that he was a responsible person of both LLCs. In this matter, the individual who was the managing member of the LLCs first argued that the notices of determination (notices) issued to him were invalid because he didn’t consent to receive the notices through electronic means of communication. However, it was noted that the individual had opted for electronic service of the notices, and therefore, the said notices were valid.

Further, the individual argued that the division wasn’t authorized to issue an assessment against a bulk sale purchaser’s responsible person because the bulk sale liability was neither a collected tax nor a sales tax liability. The Appellate Division rejected this argument because the law requires a purchaser in a bulk sale transaction to give notice of such sale to the division at least 10 days before taking possession of the subject of said sale. Further, if the purchaser fails to comply with the applicable provisions, then such a purchaser becomes personally liable for the taxes determined to be due from the seller. Therefore, the individual, as a responsible person, was under a duty to comply with the statute and, as a result, he became personally liable for the outstanding liabilities. Accordingly, the determination of the Tax Appeals Tribunal was sustained.

Carlson v. Tax Appeals Tribunal, Appellate Division of the Supreme Court of New York, Third Department, No. 533916, March 16, 2023.

Note: In many states purchasers of a business’s assets are required to notify the state tax authority of the purchase, which is often known as a bulk sale notification. Purchasers that do not comply with bulk sale notifications are often held liable for any underpaid taxes, interest, and penalties that exist prior to the acquisition.

North Carolina

Sales and use tax: Taxpayer didn’t meet the definition of “marketplace facilitator”

The taxpayer, an affiliate of original equipment manufacturers (OEMs), didn’t meet the statutory definition of a “marketplace facilitator.”

Two-part definition of “marketplace facilitator”

North Carolina law provides a two-part definition of “marketplace facilitator:”

• First, the person lists or otherwise makes available for sale a marketplace seller’s items through a marketplace owned or operated by the marketplace facilitator.
• Second, the person collects the sales or purchase price, processes payments, or makes payment processing available.

A person may satisfy either part of the definition directly or indirectly.

Taxpayer didn’t meet both parts of statutory definition

Although the taxpayer owns and administers a marketplace in North Carolina that lists a marketplace seller’s items for sale, neither the taxpayer nor the taxpayer’s affiliate, directly or indirectly, collect the sales price or purchase price of the marketplace seller’s items, process the payments for such items, or make payment processing services available. Independent entities that aren’t affiliates of the taxpayer process the qualified customer’s payment and make payment processing services available. As such, the taxpayer didn’t meet both parts of the definition of a “marketplace facilitator.”

SUPLR 2022-0008, North Carolina Department of Revenue, Dec. 9, 2022.

Ohio

Corporate, personal income taxes: IRC conformity updated

Ohio has updated its income tax Internal Revenue Code (IRC) conformity to incorporate changes to the IRC taking effect after Feb. 17, 2022.

What is the IRC conformity date?

The updated conformity date is March 15, 2023. The incorporated changes include those made by the:

• Inflation Reduction Act of 2022
• Consolidated Appropriations Act

Further, taxpayers with tax years ending after Feb. 17, 2022, and before March 15, 2023, can irrevocably elect to apply the IRC in effect to their taxable year.

S.B. 10, Laws 2023, effective March 15, 2023.

Pennsylvania

Corporate income tax: Department’s use of benefits-received apportionment method affirmed

The Pennsylvania Supreme Court has determined that a corporate income taxpayer could receive a refund after applying the correct method to determine its percentage of out-of-state sales of services.

What is the history of the case?

The taxpayer originally calculated and paid its 2011 corporate net income taxes using the costs-of-performance method to determine the sales factor. After the taxpayer determined that filing using the benefits-received method would result in lower taxes, it requested a refund. The Department of Revenue denied the refund request because the taxpayer failed to present sufficient evidence demonstrating where its sales occurred. The taxpayer then appealed to the Board of Finance and Revenue, which upheld the decision of the Department. The taxpayer eventually did provide the evidence needed to support its refund claim.

The case then went to the lower court. The Pennsylvania Attorney General intervened at that time, arguing that the Department’s interpretation of the tax code was in error. The Attorney General argued that the costs-of-performance method was the correct method to use when apportioning sales of services and that the taxpayer wasn’t entitled to a refund. The Department had long interpreted the law to mean that the place where the income-producing activity occurred was the place where the customer received the benefit of the service. The court upheld the Department’s application of the benefits-received method of calculating the sales factor and remanded the matter for issuance of a tax refund.

Was the attorney general allowed to intervene?

The Court had to determine if the attorney general could represent Pennsylvania, separately from the Department, and forward a statutory interpretation that conflicted with the Department’s long-standing interpretation. The Court concluded that the attorney general, as an independently elected, constitutional officer, was authorized by the Commonwealth Attorneys Act to represent Pennsylvania separately from the Department on appeals from the Commonwealth Court generally.

Which sourcing method was correct?

The attorney general argued that the taxpayer should use the cost of performance method to source receipts instead of the benefits received method. The Department argued in support of its long-standing interpretation requiring the sourcing of a corporation’s sales of services to the location where the customer received the benefit of the transaction.

The attorney general relied on interpretations of Uniform Division of Income for Tax Purposes Act (UDITPA) from other states to support its argument. While Pennsylvania code was based on UDITPA, which was meant to bring uniformity, the relevance of other states’ interpretation of their sales of services provisions was diminished given the variations in the regulations adopted and the amendments enacted. The court determined that it had to interpret the tax code in the context of other Pennsylvania provisions. The Department’s interpretation locates the sale of services to where the service is fulfilled and the income finally produced, which is at the customer’s location. By reading the provisions regarding sales of services in conjunction with the rest of the statute, the court found the Department’s interpretation most compelling.

The court remanded the case for issuance of a refund to the taxpayer.

Synthes USA HQ, Inc. v. Commonwealth of Pennsylvania, Supreme Court of Pennsylvania, Middle District, No. 11 MAP 2021, Feb. 22, 2022.

Tennessee

Corporate income tax: Treatment of FDII deduction discussed

Although Tennessee decoupled from IRC Section 250 for purposes of global intangible low-taxed income (GILTI), the Department of Revenue announced that the state hasn’t decoupled for purposes of the foreign-derived intangible income (FDII) deduction. Therefore, in computing net earnings under the excise tax, a taxpayer is entitled to the full amount of the IRC Sec. 250(a) deduction to which it is entitled under federal law as it relates to FDII.

Excise Tax Update, Tennessee Department of Revenue, Jan. 26, 2023.

Texas 

Corporate income tax: Service apportionment rule amended

The Texas Comptroller has amended the rule regarding the sourcing of revenue from services for Texas franchise tax apportionment purposes. The amended rule sources services to the location where the service is performed and defines the place where the service is performed as “the place where the taxpayer’s personnel or equipment is physically doing useful work for the customer.” The amended rule defines useful work for the customer as “work that the customer hired the taxable entity to perform.”

This change comes in response to the Texas Supreme Court’s decision in Sirius XM Radio, Inc. v. Hegar. There, the Texas Supreme Court declined to apply the Texas Comptroller’s prior service sourcing rule, which defined the location where the service is performed as the location of the receipts-producing, end-product act(s).

34 TAC 3.591, Texas Comptroller of Public Accounts, March 10, 2023.

Wisconsin

Corporate income tax: Royalty deductions disallowed due to lack of economic substance and valid business purpose

In a Wisconsin corporate franchise tax case involving a corporation that claimed deductions for royalties paid to an affiliate for the use of certain intellectual property, it was proper for the Department of Revenue to disallow the deductions because the underlying transactions lacked economic substance and a valid business purpose. Documents and testimony highlighted no identified business problem or need, or benefit to be obtained, other than tax avoidance, before the creation of the affiliate or the transactions at issue. The corporation’s expert witness opined about several valid, nontax, intellectual property-related benefits, but none of those reasons were considered by the corporation before the formation of the affiliate. 

The corporation had the burden of proving that it had a valid nontax business purpose for entering into the licensing transaction that generated the royalty deductions claimed on its Wisconsin tax returns and that the licensing transaction had economic substance. However, the corporation didn’t present persuasive evidence or testimony of either requirement being met.

Skechers USA, Inc. v. Wisconsin Department of Revenue, Wisconsin Tax Appeals Commission, Nos. 10-I-171 and 10-I-172, Feb. 24, 2023.