Ernst & Young's State and Local Tax Weekly newsletter for November 27 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

California FTB reverses position on filing requirement and minimum tax for disregarded limited partnerships; affected taxpayers should consider filing refund claims

On Nov. 20, 2019, the California Franchise Tax Board (FTB) issued Legal Ruling 2019-02, in which it concluded that a limited partnership (LP) disregarded for federal income tax purposes (a federal DLP) is not required to pay California's annual $800 minimum tax on LPs, nor is it required to file a California partnership return. Simultaneously, the FTB issued Notice 2019-06, setting forth the process for a taxpayer to substantiate that it is a federal DLP and describing how to file refund claims.

In general, most legal entities that are deemed to be "doing business" under California's tax statute must file an annual return and pay an $800 minimum franchise tax. This includes certain entities, such as limited liability companies (LLCs) that are disregarded for federal income tax purposes and thus, for California franchise or income tax purposes.

California Revenue and Taxation Code (CRTC) §17935 specifically requires an annual tax on LPs doing business in California. Before Legal Ruling 2019-02, the FTB maintained that disregarded LPs were subject to the $800 minimum tax and had a filing obligation. Taxpayers challenged FTB's assessments, asserting that the FTB lacked authority to require a filing and annual tax payment because CRTC §23038 states: "If the separate existence of an eligible business entity is disregarded for federal tax purposes, the separate existence of that business entity shall be disregarded."

The FTB, in reversing its prior position, concluded in Legal Ruling 2019-02 that federal DLPs are not required to pay California's annual tax on LPs under CRTC §17935 and are not required to file a California partnership return under CRTC §18633. In support of its conclusion, the FTB explained that CRTC §23038(b)(2)(B)(iii) generally disregards the separate existence of an eligible business entity for California franchise and income tax purposes, if its separate existence is disregarded for federal income tax purposes. Although limited exceptions to CRTC §23038(b)(2)(B)(iii) apply to LLCs, no exception applies to LPs. Thus, CRTC §23038(b)(2)(B)(iii) applies to LPs and "indicates" that there are no annual LP tax or partnership tax return filing requirements for federal DLPs.

Notice 2019-06 sets forth the process for a taxpayer to substantiate that it is a properly disregarded entity for federal income tax purposes, as discussed in the FTB's Legal Ruling 2019-02. Properly disregarded LPs that receive or have received a Filing Enforcement Notice from the FTB can submit the following documentation to establish that they are not subject to the annual LP tax or tax return filing requirements: (1) certificate of limited partnership, partnership agreement, ownership organizational chart, and partners' federal returns for the tax year(s) in question; or (2) a signed declaration stating that the entity was disregarded for federal income tax purposes during the respective tax years.¹ The FTB will review the submitted documentation and determine whether the LP established that it is a federal DLP, as previously discussed.

LPs that have filed refund claims based on an interpretation of CRTC §23038(b)(2)(B)(iii) that is similar to that set forth in Legal Ruling 2019-02 must submit the documentation for (1) or (2) to the FTB (to the fax numbers or address set forth in Notice 2019-06). New refund claims based on Legal Ruling 2019-02 must be submitted by the LP's local law general partner in the same manner. Refund claims can be filed for open tax years. California has a four-year statute of limitations unless the statute is being held open longer by a California or federal waiver.

For additional information on this development, see Tax Alert 2019-2093.

INCOME/FRANCHISE

Maryland: The Maryland Comptroller improperly disallowed net operating losses (NOLs) a corporation acquired from other corporations that had merged into it (the merged companies) on the basis that the merged companies had not filed Maryland corporate income tax returns for tax years 2001 through 2013. The merged companies incurred the NOLs in tax years 2003 through 2006 and merged with the corporation at the end of 2006. In October 2007, the Comptroller amended its administrative regulations to provide that an acquiring corporation may not use the NOL of a liquidated or acquired corporation if the liquidated or acquired corporation was not subject to Maryland income tax when the NOL was generated. The corporation challenged the denial of the use of the NOLs, arguing that the amended regulation is contrary to Maryland statutory law. In agreeing with the corporation, the Maryland Tax Court explained that the "only permitted modifications to federal taxable income are those expressly set forth by statutes, duly enacted by the General Assembly." Here, the Comptroller's attempt to limit the corporation's federal NOL "is contrary to the Maryland statutory scheme and therefore invalid." Sunbelt Rentals, Inc. v. Comptroller of Maryland, No. 18-IN-00-0241 (Md. Tax Ct. Sept. 9, 2019).

New York: A corporation and its subsidiaries (collectively, corporation) that provide credit rating services in filing their New York State combined return for tax years 2011 - 2013: (1) are entitled to a discretionary adjustment to source credit rating receipts earned by one of the subsidiaries (MIS) on a destination basis (i.e., sourcing based on the commercial domicile location of debt issuers) for tax years 2011–2013; (2) in calculating its New York entire net income (ENI) could not deduct the 2011 and the 2012 royalty payments from its alien affiliates; and (3) are required to include its New York licensed captive insurance company in its New York State combined filing group for tax years 2012–2014. In making the sourcing determination, an administrative law judge (ALJ) of the New York Division of Tax Appeals found that under N.Y. Tax Law former § 210(3)(a)(2)(B), MIS's credit rating process and results constituted the performance of a service for its customers the receipts from which were allocable based on the location where those services were performed. In so holding, the ALJ rejected various arguments by the corporation including that it should be allowed to allocate the receipts using an audience-based sourcing method and that the N.Y. Division of Taxation discriminated against it in favor of its competitor by providing the competitor with a discretionary adjustment to source its credit rating receipts on a destination basis. The ALJ, however, agreed with the corporation that it should have been afforded a discretionary adjustment for 2011 – 2013, allowing it to source MIS's credit rating receipts for those years in the same manner as the 2014 discretionary adjustment — i.e., source using the commercial domicile of the debt issuers. The ALJ reasoned that the corporation had requested such relief multiple times as required, even beginning in tax years before the audit; thus establishing "a continuum of requests for alternative allocation based on destination sourcing of credit rating receipts." In regard to royalties, the corporation in calculating its New York ENI could not deduct the 2011 and 2012 royalty payments from its alien affiliates because the alien affiliates would not have been required to add back the royalty payments under N.Y. Tax Law former § 208(9)(o)(2) as they were not federal or New York taxpayers. Lastly, the ALJ held that the corporation was required to include its New York licensed wholly owned captive insurance company in its New York State combined filing group for tax years 2012–2014 because the entity was an overcapitalized captive insurance company (OCCIC), the corporation's premiums paid to the OCCIC were not premiums paid for bona fide insurance, and the structure revealed a lack of risk shifting and risk distribution. Matter of Moody's Corp. and Subs., DTA Nos. 828094 and 828203 (N.Y. Div. of Tax App. Oct. 24, 2019).

SALES & USE

New Mexico: An electric company is not entitled to a refund of compensating tax paid on its purchases of natural gas for use in producing electricity at its power plant because the statutory deduction for chemicals and reagents in lots in excess of 18 tons under N.M. Stat. § 7-9-65 does not apply to receipts for natural gas. In reaching this conclusion, the New Mexico Court of Appeals (Court) analyzed whether "natural gas" is a "chemical or reagent" for purposes of N.M. Stat. § 7-9-65. Applying the same rationale as in Peabody Coalsales,² the Court found the statute to be ambiguous regarding its applicability to natural gas, particularly when both the statute and its corresponding regulations do not mention "natural gas" or "fuels." Further, the statute's lack of express natural gas provisions indicated that the legislature did not broadly intend for the deduction to apply to natural gas receipts. Lastly, "as further support [of its] conclusion" the Court noted that recent legislative changes to the statute "highlights that the Legislature does not intend to bestow a tax deduction to the sale of natural gas to power plants for the production of electricity … " Tucson Elec. Power Co. v. N.M. Taxn. and Rev. Dept., No. A-1-CA-35781 (N.M. Ct. App. Nov. 4, 2019).

Texas: An entity's charges for subscription services that collect and analyze customer data and compare it across the restaurant industry is subject to sales and use tax as taxable data processing and information services. The Texas Comptroller of Public Accounts (Comptroller) found that the entity engaged in data processing services when it compiled its customers' data, manipulated it, and issued reports containing customer-specific information, such as staffing levels, turnover rates, and sales figures. Additionally, the entity provided information services when it retrieved customers' data, researched trends in the data, and provided customers with a comparative analysis of their data in relation to specific restaurant industry segments. The Comptroller, however, rejected the entity's argument that it provided nontaxable proprietary information services, reasoning that the entity's customers did not have an enforceable property right in either the raw data they provided to the entity or in the reports that the entity created and distributed as its work product (i.e., customers could not prevent the entity from selling the information to another party). Tex. Comp. of Pub. Accts., No. 201910009H (Oct. 8, 2019).

Wisconsin: A mandatory professional association's sales of pre-recorded digital on-demand seminars for continuing legal education (CLEs) are exempt from sales and use tax as educational services, because the true object of the transaction is obtaining educational services and not a digital good, which is incidental to the non-taxed service.³ In so holding, the Wisconsin Tax Appeals Commission (Commission) found that the lawyers who purchased the previously recorded seminars over the internet wanted to obtain an educational service with the goals of legal education, competence, and maintaining good standing with the Wisconsin Supreme Court and the state bar, rather than merely obtain a digital good in the form of a streamed service. Moreover, as part of the purchase, lawyers were guaranteed to have the right to contact and ask questions of the CLE presenters, and could obtain CLE certification and compliance-related recordkeeping. Additionally, the Commission differentiated educational services from things of an educational nature, found that the on-demand seminars were not "self-study," and noted that legitimate earned credit as determined by a branch of state government is a strong indicator that there is an educational service and that obtaining the service is the purchaser's true objective. Lastly, the Wisconsin Department of Revenue agreed that its guidance addressing why live-streamed seminars are not taxable was incorrect and would be revised (i.e., a live seminar is not an exempt tangible version of an on-demand seminar). State Bar of Wis. v. Wis. Dept. of Rev., No. 16-S-139 (Wis. Tax App. Comn. Sept. 20, 2019).

BUSINESS INCENTIVES

Connecticut: Governor Ned Lamont announced a new online tool that is "designed to attract investment in Connecticut." The online tool includes a searchable database of available projects, including shovel-ready projects, transit-oriented development, and geographical information. Information will be regularly updated by cities, towns and property owners, and municipalities with opportunity zones can post and promote new projects in the database as they become available. In addition, information in the tool can be searched by municipality, investment size, and real estate and business asset types, as well as proximity of the zone to certain locations such as colleges and universities, airports, historic districts, etc. Additional information is available at: https://portal.ct.gov/ChooseCT/Opportunity-Zones. Conn. Gov., Press Release "Governor Lamont Announces Launch of Online Tool to Attract Investment in Connecticut Opportunity Zones" (Oct. 30, 2019).

PROPERTY TAX

Pennsylvania: New law (HB 407) standardizes the definition of "blighted property" when that phrase is used in any statute enacted on or after Sept. 1, 1937, unless the context clearly provides otherwise. Included within the definition of "blighted property" are premises that are a public nuisance or have an attractive nuisance, dwellings that have been condemned or otherwise deemed unfit for occupancy or use, a fire hazard, certain vacant or unimproved lots that accumulate trash, debris, or vermin through neglect or lack of maintenance, certain vacant property that has not been rehabilitated within one year from receipt of notice for corrective action, certain vacant or unimproved lots subject to municipal liens for demolition costs or unpaid taxes, or certain abandoned property. According to a memo from the bill's sponsor, a standard blight definition will eliminate the need to define the term in each blight remediation bill introduced, but does not prevent the inclusion of an alternative blighted property definition in any future act if such alternative is necessary. HB 407 takes effect 60 days after Nov. 7, 2019. Pa. Laws 2019, Act No. 79 (HB 407), signed by the governor on Nov .7, 2019.

COMPLIANCE & REPORTING

Kentucky: Amended regulation (amended 103 Ky. Admin. Regs. 25:131) modifies the requirements for sales and use tax accelerated payments by larger taxpayers so that they apply to any taxpayer whose average monthly sales and use tax liability exceeds $50,000. (Under prior regulations, that amount was $10,000.) A taxpayer meeting this threshold must remit by the 25th of each month taxes applicable to the period beginning on the 16th of the previous month through the 15th of the current month. The Kentucky Department of Revenue (Department) will annually identify taxpayers that meet the $50,000 threshold based on the average monthly tax liability for that period and must give affected taxpayers at least 40 days of notice before the first payment is due. The accelerated filing requirement is effective for the July tax return after the Department's calendar year review and notification. Affected taxpayers must file their July return no later than Aug. 25 and remit tax for both the full month of July and for the first 15 calendar days of August. The amendments took effect Nov. 1, 2019. Ky. Dept. of Rev., 103 Ky. Admin. Regs. 25:131 (Ky. Reg., Vol. 46, No. 4, Oct. 1, 2019).

PAYROLL & EMPLOYMENT TAX

Multistate/Federal: From tax filing to taxability, there is much to consider when closing the year and starting anew, and with federal, state and local employment tax reporting rules constantly changing, preparing a year-end payroll checklist is no simple task. To get you started, Ernst & Young LLP's Employment Tax Advisory Services' team has compiled a sample payroll checklist of items to consider for 2019 and 2020 and other information to guide you through the many employment tax requirements that apply. For a copy of the year-end checklist, see Tax Alert 2019-2079.

Massachusetts: The Massachusetts Department of Revenue announced that fourth quarter 2019 (Oct. 1-Dec. 31, 2019) employee contributions to the state's Paid Family and Medical Leave (PFML) fund should be reported on the 2019 Form W-2 in box 14 (Other). Contributions by independent contractors should be reported on the 2019 Form 1099-MISC in box 16 (State tax withheld). The contribution line for both should read "MA PFML." (Massachusetts DOR news, Nov. 2019.) For additional information on this development, see Tax Alert 2019-2085.

Nebraska: The Nebraska Department of Revenue released new Form W-4N, Employee's Nebraska Withholding Allowance Certificate, for use beginning Jan. 1, 2020, by a new employee to indicate the number of personal exemptions an employer should use in determining the amount of Nebraska personal income tax to withhold from the employee's wages. Prior to this release, the federal Form W-4 was used for this purpose. For additional information on this development, see Tax Alert 2019-2070.

Nevada: As we previously reported, legislation (SB 312) (bill) enacted earlier this year requires Nevada employers of 50 or more employees to provide paid leave to their employees. The bill provides that the law is effective Jan. 1, 2020, or upon the state's performing any other preparatory administrative tasks necessary to carry out the provisions of the bill. The Nevada Labor Commission originally stated a July 1, 2020 effective date but has now accelerated the effective date to Jan. 1, 2020. (Advisory opinion, Nevada Labor Commission, 10-4-2019; EY Payroll NewsflashVol. 20, 128, 8-28-2019.) Employers in their first two years of operation are not required to comply with the paid leave law. For more information on this development, see Tax Alert 2019-2073.

New Jersey: The New Jersey Department of Labor and Workforce Development released the calendar year 2020 taxable wage bases used for state unemployment insurance (SUI), temporary disability insurance (TDI) and family leave insurance (FLI). The 2020 employer/employee SUI taxable wage base increases to $35,300, up from $34,400 for calendar year 2019. For more information on this development, see Tax Alert 2019-2031.

Ohio: The Ohio 2020 state unemployment insurance (SUI) tax rates will range from 0.3% to 9.4%, up from the 2019 range of 0.3% to 9.2%. The 2020 SUI taxable wage base reverts to $9,000, down from $9,500 for 2018 and 2019. New employers, except for those in the construction industry, will continue to pay at 2.7%. New construction employers will pay at 5.8% for 2020, down from 5.9% for 2019. Employers can potentially reduce their 2020 SUI rate if they take advantage of statutory elections by Dec. 31, 2019. For additional information on this development, see Tax Alert 2019-2091.

South Carolina: South Carolina has implemented a state disbursement unit for the remittance of child support withheld from employee wages. In addition, South Carolina now participates in the federal electronic income withholding order (e-IWO) process, allowing South Carolina employers the option to receive child support withholding orders electronically. For additional information on this development, see Tax Alert 2019-2032.

Texas: The business association, Alliance for Securing and Strengthening the Economy in Texas (ASSET), announced that Bexar County District Court Judge Peter Sakai blocked the San Antonio paid sick leave ordinance from taking effect on Dec. 1, 2019. As we reported previously, the ordinance was originally effective Aug. 1, 2019, but a lawsuit filed by a San Antonio business coalition delayed the effective date to Dec. 1, 2019. For additional information on this development, see Tax Alert 2019-2102.

Virgin Islands: According to the US Department of Labor (USDOL), the Virgin Islands continues to have a federal unemployment tax (FUTA) credit reduction for calendar year 2019. Virgin Islands employers will pay FUTA taxes for calendar year 2019 at a net rate of 3.3%, composed of a FUTA credit reduction rate of 2.7% and the 0.6% minimum FUTA rate. For more on this development, see Tax Alert 2019-2049.

MISCELLANEOUS TAX

Washington: The Washington Department of Revenue issued guidance on how to calculate the new 36-month (previously 12-month) lookback period for determining whether a controlling interest transfer has occurred for real estate excise tax (REET) purposes. The 12-month lookback period applies through Dec. 31, 2019. Beginning Jan. 1, 2020, transfers of controlling interests in entities that hold real estate are subject to REET by taking account of all transactions within a 36-month period, except that the 36-month lookback period applies to transactions occurring on or after Jan. 1, 2019. The guidance defines what constitutes a controlling interest and when REET applies to such transfers, clarifies how tax applies to aggregated non-controlling interest transfers once they reach the applicable threshold, gives examples of how to apply the lookback period and calculate REET, provides business reporting requirements related to controlling interest transfers, and clarifies enforcement provisions related to REET liability and liens. Wash. Dept. of Rev., Excise Tax Advisory 3216.2019 (Nov. 5, 2019).

WEBCASTS

Multistate: A replay of the Ernst & Young LLP webcast in a series on the ongoing impacts of the Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) on state taxation held on Nov. 14, 2019 is now available. On the second webcast of the series, the panelists discussed the various state tax policy approaches to the TCJA and how these varied approaches can help shape discussions with state policymakers about key TCJA implementation, compliance and conformity challenges. Topics discussed included: (1) the state policy timeline: where we've been and where we're going; (2) notable state approaches to the TCJA; (3) the impact of other federal, state and local tax developments that are influencing state tax policy decisions with respect to state conformity to the various provisions of the TCJA; and (4) state tax policy considerations for 2020. The replay is available through this link.

Multistate: On Thursday, Dec. 12, 2019, from 1:00-2:30 p.m. EST New York (10:00-11.30 a.m. PST Los Angeles), Ernst & Young LLP (EY) will host its quarterly webcast focusing on state tax matters. For our final webcast in 2019, panelists from our Indirect, State and Local Tax practice will look back on 2019 and the decade that was the 2010s and look forward to 2020 and what that decade could bring. Looking back, the panelists will highlight the most important developments affecting state income, sales and use, property and payroll taxes as well as federal and state business credits and incentives. As panelists look forward to the upcoming year and the forthcoming decade, they will highlight trends likely to carry over from 2019 and into the new year and decade to come. They will also identify emerging developments that deserve every tax practitioner's attention along with the potential disruptions on the horizon. To register for this event, go to State tax matters.

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.

———————————————
ENDNOTES

¹ The declaration must be signed under penalty of perjury by the LP's general partner under local law. If the general partner is an LLC, the manager (or, if no manager, the LLC's authorized member) must sign the declaration.

² Peabody Coalsales Co. v. N.M. Taxn. and Rev. Dept., No. A-1-CA-36632, mem. op. 8 (N.M. Ct. App. May 31, 2019) (non-precedential).

³ The parties did not dispute that the mandatory professional association's live seminars and live webcast seminars were non-taxable.