Ernst & Young's State and Local Tax Weekly newsletter for September 20 is now available. Prepared by Ernst & Young's State and Local Taxation group, this weekly update summarizes important news, cases, and other developments in U.S. state and local taxation.

TOP STORIES

Illinois' new 30-day threshold for nonresident taxability also provides relief for residents

On Aug. 26, 2019, Illinois Governor J.B. Pritzker signed SB 1515 into law (Public Act 101-0585) (P.A. 101-0585), which establishes a 30-day threshold for nonresident taxability, changing the "base of operations" approach, effective for tax years ending on or after Dec. 31, 2020.

Nonresidents must pay tax on any compensation sourced to Illinois. If an employee performs his/her services wholly within Illinois, the employee's compensation is sourced to Illinois. If, however, an employee performed his/her services partly within Illinois and partly outside Illinois, prior law required the employee's compensation to be sourced to Illinois only if the employee's base of operations was in Illinois. In other words, under prior law, Illinois employed an "all or nothing" test: Either all of an employee's compensation was sourced to Illinois, or none of the compensation was sourced to Illinois.

Under the new law, the employee's compensation earned while in Illinois is taxable in the state only after a nonresident employee has spent 31 work days in Illinois. Once that threshold has been met, the compensation associated with those days worked in Illinois is taxable by the state. In effect, Illinois is moving from an all-or-nothing to a pro-rata sourcing methodology. Please see Tax Alert 2019-1555 for a more thorough discussion of the impact on nonresidents.

While not obvious on its face, the new law also affects Illinois residents and their ability to claim a credit for taxes paid in other states. Illinois provides such a credit to ensure multiple states don't subject a taxpayer to tax on the same income. Illinois' tax credit, however, does not provide a credit for actual taxes paid in other states. Instead, the credit is calculated based on the tax the resident would have paid in the other state if the other state had applied Illinois' laws.

Before enactment of P.A. 101-0585, when applying the Illinois tax credit standard, resident taxpayers were entitled to a credit for taxes they would have paid in another state if that other state used the "base of operations" approach to source nonresident compensation. Applying that standard, few nonresidents would find their income taxable in those other states, as an Illinois resident's base of operations is most often Illinois. Thus, before enactment of P.A. 101-0585, no credit was usually available to an Illinois resident with a base of operations in Illinois who paid tax in another state based on that state's law. For more on this development, see Tax Alert 2019-1632.

Nebraska revises guidance on state income tax treatment of IRC Section 965 income: amended returns may be required

On Sept. 13, 2019, the Nebraska Department of Revenue (Department) issued a general information letter (GIL 24-19-1), which revises and supersedes guidance issued in December 2018 (see Tax Alert 2019-0062) regarding Nebraska's state income tax treatment of IRC § 965¹ repatriation income for tax year 2017. The Department's guidance is advisory in nature but is binding on the Department until amended.

GIL 24-19-1 reiterates the Department's position, discussed in the 2018 guidance, that the IRC § 965 inclusion is not a dividend or deemed dividend deductible under Neb. Rev. Stat. § 77-2716(5). In addition, the Department gives instructions for reporting the IRC § 965(a) inclusion amount and taking the corresponding IRC § 965(c) deduction. The 2019 guidance drops the requirement that any taxpayer claiming a deduction for the net IRC § 965(a) income must attach a legal analysis supporting the deduction. Instead, GIL 24-19-1 simply says any dividend deduction claimed for the IRC § 965(a) income will be disallowed.

Unlike the 2018 guidance, GIL 24-19-1 addresses apportionment factor representation. The Department clarifies that the realization of deferred earnings and profits of controlled foreign corporations since 1986, and the corresponding recognition of this income in a single year, is a unique and non-recurring factual situation allowing the Department to use special apportionment under Neb. Rev. Stat. § 77-2734.15(2). Accordingly, for the last tax year ending before Jan. 1, 2018, a taxpayer must include the IRC § 965(a) income in its sales factor denominator and exclude it from their sales factor numerator.

Finally, GIL 24-19-1 says that any taxpayer that did not report IRC § 965(a) income or improperly computed its sales factor should file an amended return. Taxpayers filing an amended 2017 Nebraska income tax return by Dec. 31, 2019, will receive a waiver or abatement of any penalty or interest. If the taxpayer writes "Amended pursuant to GIL 24-19-1" at the top of the amended return, the Department will automatically waive the interest and penalty. For more on this development, see Tax Alert 2019-1639.

INCOME/FRANCHISE

New Hampshire: New law (SB 190) adopts market-based sourcing for sales of non-tangible property for purposes of the business profits tax and business enterprise tax, applicable to tax periods ending on or after Dec. 31, 2021. For such sales, a business organization's market for the sales will be in New Hampshire: (1) for the sale, rental, lease, or license of real property, or for the rental, lease, or license of tangible personal property, to the extent the property is located in the state; (2) for the sale of a service, to the extent the service is delivered to a New Hampshire location; (3) for the sale, rental, lease, or license of intangible property, to the extent the property is used in New Hampshire; (4) for interest income, to the extent the debtor or encumbered property is located in the state; (5) for dividend income, to the extent the business organization's commercial domicile is in the state; and (6) for other income, to the extent the income is derived from New Hampshire sources. Reasonable approximation will be used if the state(s) of assignment for non-tangible property cannot be determined. If the taxpayer is not taxable in a state to which a sale of non-tangible property is assigned, or if the state of assignment cannot be determined or reasonably approximated, the sale is excluded from the sales factor denominator. Lastly, a committee is established to study the apportionment of gross business profits under the business profits tax and to monitor the market-based sourcing laws of other states, among other issues. N.H. Laws 2019, Ch. 342 (SB 190), signed by the governor on Sept. 6, 2019.

Texas: A telecommunications holding company (company) that sold telecommunications products and signals (e.g., digital light, electrical, and radio frequency signals) is not entitled to deduct the costs of goods sold (COGS) from its taxable margin for franchise tax purposes because it is engaged in the sale of services, and not the sale of tangible personal property. In affirming the lower court, the Texas Court of Appeals (Court) said it is bound by the Third Court of Appeals ruling in NTS Communications,² in which that court held the sale of telecommunications products and signals constitutes the provisions of services. Here, the Court found that the company's delivery of signals through its use of telephone lines, copper wire, and fiber-optic cable, which customers use to make phone calls or access the internet, meets the definition of "telecommunications services." Additionally, the company's deduction of its costs for leasing telephone lines from other telecommunications companies meant that the company improperly deducted the costs of delivering its product, which also is not included in COGS. Lastly, the Court noted that the company had previously marketed itself as a service provider and stated it was providing services in its customer contracts. Metropolitan Telecom. Holding Co. v. Hegar, No. 06-19-00016-CV (Tex. Ct. App., 6th App. Dist., Aug. 21, 2019).

SALES & USE

Arizona: Online travel companies (OTCs) are brokers engaged in the taxable business activity under the Model City Tax Code (MCTC) § 14-444³ and the entire sales price they charge (including service fees and markups on room rental rates) is the gross income for lodging transactions subject to the municipal transaction privilege tax. In so holding, the Arizona Supreme Court (Court) found that the OTCs were engaged in "the business of operating a hotel" under MCTC § 14-444 in that the activities OTCs performed (i.e., advertising rooms, soliciting customers, collecting customers' information, processing payments, confirming reservations, providing customer service, and facilitating reservation modifications and cancellations) are central to keeping a hotel functional and in operation. In contrast to the tax imposed under MCTC § 14-444, which is imposed on the gross income of every person engaged in the business of operating a hotel (and extends beyond the hotel's owners and operators), the tax under MCTC § 14-447 is an additional tax imposed only on the gross income received by a hotel renting lodging to customers and does not extend to hotel brokers such as OTCs. City code defines "hotels" as brick-and-mortar lodging places; the definition does not include "brokers" for hotels or entities such as OTCs. Lastly, in considering whether the cities could impose tax, interest and penalties under MCTC § 14-444 retroactively, the Court remanded the case to the tax court to determine whether the cities' "broker" positions in 2013 assessments represent a change from earlier tax guidance on the issue (i.e., a new interpretation or a new application of the law apart from a change in law), and whether OTCs received "clear notice" from the cities before the 2013 assessments that they were taxable as brokers. City of Phoenix et al. v. Orbitz Worldwide Inc. et al., No. CV-18-0275-PR (Ariz. S.Ct. Sept. 9, 2019).

Michigan: A group of related entities that operate movie theaters in Michigan are not entitled to a refund of sales tax paid on prepackaged candy and bottled beverages sold at the theaters' concession stands for the tax periods at issue because the tax was included in the sales price and, as such, the tax was paid by customers. In so holding, the Michigan Tax Tribunal (Tribunal) found that the entirety of the record supported its conclusion that the sales tax was included in the sales prices of the concessions even without signs stating such. The Tribunal also determined that the entities kept records indicating their customers paid sales tax on the transactions, and their lack of signage regarding the tax was not determinative of whether the entities or the customer paid it. Lastly, to the extent the entities paid the sales tax on nontaxable items, refund claims are barred because the entities would be unjustly enriched by receiving a refund for the excess tax paid. Emagine Entertainment, Inc. et al. v. Mich. Dept. of Treas., No. 17-000296 (Mich. Tax Trib. Aug. 5, 2019).

Nebraska: The Nebraska Department of Revenue (Department) issued guidance on collecting and remitting lodging and sales tax imposed on short-term rentals (i.e., less than 30 days) in light of a recent law change (LB 284, Neb. Laws 2019) expanding this obligation to a multivendor marketplace platform (MMP) that facilitates short-term rentals, effective April 1, 2019. The Department explained that the sales tax base for short-term rental accommodations is the total consideration valued in money paid by the consumer to the retailer or seller of property or services (including the hotel or tourist home owner or a MMP), regardless of which party makes the reservation or collects the consumer's consideration. The sales tax base includes any charges imposed by the lodging retailer that are necessary to complete the sale and any local occupation tax imposed by a municipality. The lodging tax base generally covers the same transactions except that it excludes charges for food or beverages, or any personal services rendered to the consumer. Hotel and tourist home owners generally must collect and remit sales and lodging taxes but are not required to do so on MMP-facilitated sales if the MMP has reported and remitted the taxes. Further, since the new law requires MMPs to collect and remit sales and lodging taxes to the state, the Department will no longer enter into separate agreements with MMPs to waive the tax collection responsibility of a hotel or tourist home owner as provided under prior law. Lastly, a travel agent who does not publish room availability and rates on behalf of the hotel or tourist home owner is generally not an MMP. Neb. Dept. of Rev., GIL 1-19-1 (Aug. 22, 2019).

Rhode Island: In a response to a ruling request, the Rhode Island Division of Taxation (Division) advised that the paint stewardship assessment on architectural paint is subject to sales tax because it is included in the total sales price of the paint sold at retail in Rhode Island. The Division explained that the taxable sales price is the "total amount of consideration … for which personal property or services are sold, leased, or rented … without any deduction for the following … (iii) Charges by the seller for any services necessary to complete the sale, other than delivery or installation charges" (emphasis retained). The assessment, which supports downstream transportation and disposal costs of leftover paint, is statutorily required to be added to the purchase price of architectural paint sold in Rhode Island. Therefore, the assessment is a charge for a service necessary to complete the sale of architectural paint and, as such, is part of the taxable sales price. R.I. Div. of Taxn., Ruling Request No. 2019-03 (Aug. 20, 2019).

BUSINESS INCENTIVES

Tennessee: The Tennessee Department of Revenue (Department) issued a response to the question "If a single member limited liability company ('SMLLC') elects to be disregarded for federal tax purposes, can its corporate parent claim the SMLLC's job tax credits on future franchise, excise tax returns?". The Department explained that jobs tax credits are specific to the entity that earned them. Thus, the corporate parent of a SMLLC that elects to be treated as a regarded entity for federal income tax purposes cannot claim the job tax credits earned by the SMLLL on future franchise or excise tax returns because the credits are specific to the SMLLC. Further, if an SMLLC that earned jobs tax credits later elects to become a disregarded entity and be treated as a division of its corporate parent, the corporate parent is not entitled to the job tax credits earned by the SMLLC when it was a regarded entity. Tenn. Dept. of Rev., Franchise & Excise Tax question, SMLLCs and job tax credits (Sept. 11, 2019).

PROPERTY TAX

Massachusetts: An energy's company's pipes used to produce, store, and distribute steam are personal property exempt from local tax, because they constitute machinery under Massachusetts law. Specifically, Mass. G.L. c. 59, §5, clause 16(3) exempts from local tax on personal property, property owned by a manufacturing corporation other than real estate, poles and underground conduits, and wires and pipes. The Massachusetts Board of Tax Appeals determined that the pipes at issue (along with appurtenant equipment) "operated in concert as a single, integrated machine" and, as such, the pipes constituted exempt machinery. On appeal, the Massachusetts Supreme Judicial Court (Court) agreed, rejecting the tax assessor's argument that the Board erroneously relied on the "great integral machine doctrine" articulated in Lowell Gas Co.⁴ to find the pipes constituted exempt machinery since the statute explicitly excepts pipes from the exemption. In so holding, the Court found that the exemption was not abrogated by the legislature's addition of "poles, underground conduits, wires and pipes" to the list of exceptions to the local tax manufacturing exemption, because the Court continued to apply the great integral machine doctrine after that statutory change. Veolia Energy Boston, Inc. v. Bd. of Assessors of Boston, No. SJC-12634 (Mass. Sup. Jud. Ct. Sept. 11, 2019).

COMPLIANCE & REPORTING

California: The California Franchise Tax Board (FTB) issued procedural guidance for how to make an election under California's Small Business Method of Accounting provisions⁵ for the 2018 tax year, in light of amendments to federal Small Business Method of Accounting provisions under the Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) that took effect for tax years beginning after Dec. 31, 2017. Through enactment of AB 91 (Cal. Laws 2019 ch. 39) on July 1, 2019, California conforms to the federal amendments related to IRC §§ 263A (Uniform Capitalization, or UNICAP, rules) 447 (accounting method for farming corporations), 448 (limitation on use of the cash method of accounting), 460 (accounting for long-term contracts), 471 (method of accounting for inventories), and the preservation of suspense account rules. Although the California amendments apply for tax years beginning on or after Jan. 1, 2019, taxpayers can elect to apply those sections for tax years beginning on or after Jan. 1, 2018 and before Jan. 1, 2019. To make one or more of the California elections, a taxpayer must: (1) include a statement with the original or amended California tax return that states the taxpayer's intent to make the election(s), specifically naming each election being made; (2) write or print "AB 91 — Small Business Method of Accounting Election" in blue or black ink on the top of the first page of the original or amended tax return; and (3) mail all such returns to the FTB. Taxpayers required to e-file returns may file a paper return to make this election. Such taxpayers must include a statement with the return disclosing that they are filing a paper return in lieu of an electronic return under FTB Notice 2019-03. Cal. Franchise Tax Bd., FTB Notice 2019-03 (Sept. 6, 2019).

PAYROLL & EMPLOYMENT TAX

California: New law (AB 5) codifies the California Supreme Court's decision in Dynamex⁶ — which created a presumption that a worker who performs services is an employee, not an independent contractor, and adopted a new worker classification standard (i.e., the new "ABC test") — and expands and clarifies its application. Specifically, AB 5 codifies the Dynamex (ABC test) standard for purposes of the unemployment insurance code and for the wage orders of the Industrial Welfare Commission. Under this standard, a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all the following conditions are satisfied: (1) the person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; (2) the person performs work that is outside the usual course of the hiring entity's business; and (3) the person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed. AB 5 retains current exceptions for the definition of employee, it reverts to the old standard (i.e., the Borello standard) in some cases, and exempts certain occupations from the Dynamex standard (in this case, the old standard applies). Cal. Laws 2019, ch. 296 (AB 5), signed by the governor on Sept. 18, 2019. For more on this development, see Tax Alert 2019-1625.

Iowa: The Iowa Department of Revenue (Department) is proposing to change the deadline for filing the annual Forms VSP, Verified Summary of Payments Report, W-2 and 1099 with the Department from Jan. 31 to Feb. 15. The new deadline also would apply to when Forms W-2 and 1099 must be furnished to employees and recipients. The change in regulation would affect calendar year 2019, making the deadline for that year Feb. 15, 2020. The proposed regulation changes also would provide that only Forms W-2 and 1099 that reflect Iowa state withholding would need to be submitted to the Department. For more on this development, see Tax Alert 2019-1653.

North Carolina: The North Carolina Department of Revenue announced that it will again automatically waive the penalty for failing to file Form NC-3, Annual Withholding Reconciliation, and Forms W-2/1099 electronically for calendar year 2019. However, the deadline for filing, whether electronically or on paper, remains Jan. 31, 2020. For additional information on this alert, see Tax Alert 2019-1654.

Oregon: New law (HB 2660, 2019 Ore. Laws ch. 407), effective Jan. 1, 2020, allows eligible janitorial and maintenance workers employed by public and nonprofit educational institutions to collect unemployment insurance (UI) benefits during school breaks, such as summer vacations and holiday recesses. Other educational employees, such as teachers/professors, those performing research or principal administrative work, bus drivers and school nurses, etc. continue to be ineligible for UI benefits during school breaks. For more information on this development, see Tax Alert 2019-1661.

Texas: A court challenge to the Dallas paid sick leave ordinance was filed by the Texas Public Policy Foundation (TPPF) on behalf of two Dallas businesses. Texas Attorney General Ken Paxton announced that he had joined the lawsuit. The Dallas ordinance took effect Aug. 1, 2019. It's reported that TPPF previously sent a letter to the city stating that, to avoid a lawsuit, the city should delay its effective date to Dec. 1, 2019. However, the effective date remained Aug. 1, 2019, as of the date of Sept. 19, 2019. For more information on this development, see Tax Alert 2019-1662.

UPCOMING WEBCASTS

Multistate: On Oct. 3, 2019, from 1:00-2:00 p.m. EDT New York; 10:00-11:00 a.m. PDT Los Angeles, Ernst & Young LLP (EY) will host a webcast providing an update on state activity post-issuance of the U.S. Supreme Court in Wayfair. In the year since the U.S. Supreme Court's ruling in Wayfair (by which the Court eliminated the physical presence requirement under the Commerce Clause for nexus purposes), legislation has been proposed or enacted in nearly every states addressing remote sellers and extending the sales tax collection responsibilities to marketplace facilitators. Due to this activity, several significant challenges and unforeseen consequences have arisen that affect multistate taxpayers and state tax administrators alike. During this webcast, EY panelists will discuss the practical implications of the Wayfair decision. The panelists will: (1) provide a high-level overview of state and local responses to date, with a special focus on the evolution of the marketplace facilitator provisions; (2) highlight challenges and associated unforeseen consequences of the various state responses to Wayfair; and (3) discuss some of the issues businesses will need to address while navigating the new sales and use tax landscape. Register for this webcast here.

Because the matters covered herein are complicated, State and Local Tax Weekly should not be regarded as offering a complete explanation and should not be used for making decisions. Any decision concerning matters covered herein should be reviewed with a qualified tax advisor.

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ENDNOTES

¹ The Tax Cuts and Jobs Act (P.L. 115-97), enacted in 2017, amended IRC § 965 to require taxpayers to include in income an amount (the IRC § 965(a) inclusion) based on the accumulated post-1986 deferred foreign income of certain foreign corporations that they own either directly or indirectly through other entities. IRC § 965(c) allows a deduction intended to reduce the applicable tax rate on the IRC § 965(a) inclusion amount to 15.5% on a portion of the inclusion amount that represented cash or cash equivalents and 8% on the remainder.

² NTS Commc'ns, Inc. v. Hegar, No. 03-16-00771-CV (Tex. App. — Austin June 7, 2018, pet. denied) (mem. op).

³ The Model City Tax Code does not substantively differ from the tax ordinances in Arizona cities that are parties in the case.

⁴ Commonwealth v. Lowell Gas Light Co., 12 Allen 75 (1866). See also Boston Gas Co. v. Assessors of Boston, 334 Mass. 549 (1956).

⁵ Cal. Rev. and Tax. Code §§ 17563.51, 17564, 24422.3, 24652, 24652.6, 24654, 24673.2, and/or 24701.

⁶ Dynamex Operations West, Inc. v. Superior Court of Los Angeles, S222732 (Cal. S.Ct. April 30, 2018) (available on the internet at here (last accessed Sept. 24, 2019).