20 May 2016 Law firm clients: Connecticut budget package would affect law firms with business in the state If budget implementation bill S502 becomes law in Connecticut, law firms operating in partnership form and law firm partners with partnership/income tax filing requirements in the state would be subject to market-based sourcing and single sales factor apportionment for tax years beginning on or after January 1, 2017. As a result of these changes, law firms that have Connecticut-based clients and provide their services from offices located in another state will likely have increased Connecticut-source income. This is such a dramatic change in law that, in certain cases, some law firms may have Connecticut-source income for the first time beginning in 2017 and should consider filing returns in Connecticut. These new Connecticut provisions are similar to the market-based sourcing rules already enacted in other states (e.g., Illinois). Connecticut Governor Dannel Malloy is expected to sign S502, which would significantly change the state's corporate and personal income tax laws by enacting: (1) market-based sourcing for sales of non-tangible property and services for both corporate and personal income tax purposes; and (2) single sales factor apportionment for determining Connecticut-source income for nonresident taxpayers for personal income tax purposes. If these changes are enacted, law firms serving Connecticut clients from offices in another state will likely have increased Connecticut-source income and some law firms may have Connecticut-source income for the first time beginning in 2017. The personal income tax changes — generally applicable to partnerships with individual partners — would be effective January 1, 2017, and apply to personal income tax for years commencing on or after January 1, 2017. Under S502, market-based sourcing for sales factor apportionment purposes would apply such that gross receipts from sales of services will be sourced to Connecticut if the market for the services is in the state. A taxpayer's market for services will be in Connecticut to the extent the service is used at a location in the state. Moreover, only the sales factor will be considered for apportioning income within and outside Connecticut. For corporate income tax purposes, the move to market-based sourcing for non-tangible property and services will be effective for tax years beginning on or after January 1, 2016. As a result, market-based sourcing will apply to law firms that have entities taxed as corporations in their structure in the year prior to the year in which it will apply to those entities that are treated as pass-through entities. These are significant changes from current law. Under current law, Connecticut generally sources sales of services for personal income tax purposes based on whether the services were provided by or through a Connecticut office. Further, the state applies a three-factor apportionment formula equally weighting the property, payroll and sales factors. The new law likely means that law firms located outside of the state but with Connecticut-based clients will have higher apportionment to the state and thus, a greater share of their income would be sourced to the state resulting in additional Connecticut personal income tax for their nonresident partners. Therefore, law firms should review and/or revisit the revenues derived from their Connecticut-based clients to consider whether the new law will materially affect their partners' Connecticut tax liabilities. If a law firm concludes that it cannot reasonably determine where its gross receipts are earned in accordance with these market-based sourcing rules, it may petition the Commissioner of the Department of Revenue Services to use an alternative apportionment methodology. Any such petition would have to be submitted at least 60 days prior to the due date of the return for the first tax year for which relief is requested, determined with regard to any extension of time for filing the return.
Document ID: 2016-0897 | |||||||||||
