August 31, 2021
State and Local Tax Weekly for August 20
Ernst & Young's State and Local Tax Weekly newsletter for August 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.
California superior court rules Proposition 22 which changes employment classification rules for app-based transportation and delivery drivers is unconstitutional
On Aug. 20, 2021, Alameda County Superior Court Judge Frank Roesch ruled Proposition 22, which changed the employment classification statutes for app-based transportation and delivery drivers by classifying them as independent contractors rather than employees, violates the state's constitution.1 Judge Roesch found the Proposition unconstitutional because it " … limits the power of a future legislature to define app-based drivers as workers subject to workers' compensation law."
Proposition 22 was approved by voters in 2020 in response to a law enacted by the Legislature in 2019 (Cal. Stats. 2019, ch. 296 (AB 5)). AB 5 codified the "ABC test" standard established by the California Supreme Court in the Dynamex2 case for purposes of the unemployment insurance code and for the wage orders of the Industrial Welfare Commission. Under the ABC test, a person providing labor or services for remuneration will be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all the following conditions are satisfied: (A) 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; (B) the person performs work that is outside the usual course of the hiring entity's business; and (C) the person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed. (For more on AB 5, see Tax Alert 2019-1625.)
While AB 5 significantly impacted all industries that customarily engage independent contractors; however, it is widely believed that it would have had the greatest impact on the gig economy as it would reclassify app-based drivers (e.g., rideshare and delivery drivers) as employees. A key provision of Proposition 22 exempted app-based drivers from the ABC test by treating them as independent contractors and not as employees or agents. (Cal. Bus. & Prof. Code § 7451.)
In addition to its reclassification provisions, Proposition 22 contained a restriction requiring a seven-eighths, rollcall vote of the Legislature to amend any of its provisions. Judge Roesch found that this provision conflicted with the express provisions in the California Constitution addressing the means by which ballot measures could be subject to subsequent amendment. In finding Proposition 22 violates the state's constitution, Judge Roesch held "Proposition 22's Section 7451 is … an unconstitutional continuing limitation on the Legislature's power to exercise its plenary power to determine what workers must be covered or not covered by the worker's compensation system." Judge Roesch further found that since this provision is not severable from the remainder of the statute, "the entirety of Proposition 22 is unenforceable."
It is anticipated that this ruling will be appealed.
Arizona: The Arizona Supreme Court (Court) ruled Proposition 208 (Prop. 208), a ballot initiative approved by Arizona voters in 2020 and that imposed a 3.5% income tax surcharge on high wage earners to provide direct funding to schools, is unconstitutional. Prop. 208's Local Revenues Provision characterized the direct funding as "grants" exempt from educational expenditure limitations under Ariz. Const., Art. 9, §21. The Court, however, determined that the direct funding provision did not fall within the constitutional definition of grant and that the grant exception language "received directly or indirectly from any private agency or organization, or any individual … limits the word 'grant' to private, non-governmental voluntary contributions." Thus, Prop. 208 is facially unconstitutional to the extent it mandates expending tax revenue in violation of the Education Expenditure Clause of the state's constitution. The Court also found the non-revenue provisions of Prop. 208 (i.e., the taxing provision), when considered separately, are not workable (i.e., they cannot operate independently) and, therefore, they are not severable from the invalid provision. Severance on the unconstitutional provisions, the Court reasoned, would "leave Prop. 208 with no statutory authority to spend approximately 85% of the funds raised by the tax" and would "materially impact the initiative's operation … " The Court remanded the case to the trial court for determination of whether Prop. 208 revenue will exceed the expenditure limitation on local revenue. Fann v. Arizona, No. CV 21-0058-T/AP (Ariz. S.Ct. Aug. 19, 2021).
New York City: An architectural, urban planning and engineering firm may not claim a deduction for payments to partners under NYC Admin. Code §11-507(3) for deemed commission payments made to a federally recognized domestic international sales corporation (DISC) with no employees and whose shareholders are all partners in the firm. Under NYC Admin. Code §11-507(3), a deduction is not allowed for amounts paid or incurred to a proprietor or partner for services or for use of capital. In rejecting the firm's argument that the commissions do not trigger the unincorporated business tax (UBT) bar on payments to partners because the DISC is not a partner in the firm, an administrative law judge (ALJ) of the New York City Tax Appeals Tribunal found that since the DISC had no employees, the only way its services could be rendered is through its shareholders. All the shareholders, in turn, are active partners in the firm. Thus, the payments are to the partners and, as such, are not deductible. In the Matter of Skidmore, Owings & Merrill, LLP, No. TAT(H) 17-21(UB) (N.Y. City Tax App. Trib. July 30, 2021).
SALES & USE
Alabama: A foreign company is not liable for sales tax on invoices for additional information technology services remotely provided to an in-state company if the nontaxable services are separately stated on the invoice and do not involve the transfer of computer software. The additional information technology services include hot line support, suggestions/handouts for additional training, error analysis, weak point analysis, hosting test facilities regarding the information technology system, among other services. The Alabama Department of Revenue (AL DOR) determined that the object of these transactions is not the provision of additional computer software but rather is the provision of optional nontaxable services in relation to the information technology system. The AL DOR said these additional information technology services are "akin to an optional software maintenance agreement because the activities entail support services, error corrections, and training services." Ala. Dept. of Rev., Revenue Ruling 2021-001 (Feb. 23, 2021).
Iowa: Adopted amendments to Iowa Admin. Code 230.13(7)d modify the sales and use tax refund process for data centers. Effective Sept. 15, 2021, data centers seeking a refund can now file the affidavit certifying that qualifications for the refund have been met at the same time as the filing of the refund claim. The Iowa Department of Revenue (IA DOR) must approve the affidavit before it can review the refund claim. Prior to this change, data centers had to file the affidavit with the IA DOR, which had to approve the affidavit before the data center could file a refund claim. The IA DOR said "[t]his change makes it easier for data center businesses to provide the information required to request a refund." Iowa Dept. of Rev., Iowa Admin. Code 230.13(7)d (ARC 5840C published Aug. 11, 2021).
North Carolina: In reversing an administrative law judge's ruling, a North Carolina Superior Court held that an out-of-state company is not liable for sales tax on sales of printed materials delivered to North Carolina customers, finding that under the U.S. Supreme Court ruling in Dilworth3 the sales at issue lacked a sufficient transactional nexus to North Carolina under the Commerce Clause since title and possession of the printed materials took place outside the state. Quad Graphics, Inc. v. N.C. Dept. of Rev., 2021 NCBC 37 (N.C. Superior Ct., Wake County, June 23, 2021).
Virginia: The Virginia Department of Taxation (VA DOT) issued guidelines for the application of retail sales and use tax (SUT) on sale accommodations facilitated by accommodations intermediaries to address law changes made by 2021 Va. Acts, Special Sess. I, ch. 383. Starting Sept. 1, 2021, an accommodations intermediary facilitating sales of accommodations is the deemed dealer making a retail sale of accommodations and must collect SUT computed on the room charge. If the accommodations are at a hotel, the accommodations intermediary must remit the SUT on the accommodations fee; any remaining SUT will be remitted by the hotel. For accommodations that are not hotels, the accommodations intermediary must remit SUT on the price of the entire transaction. Accommodations providers also must collect and remit tax on additional charges levied in connection with the rental of accommodations that are not part of the room charge. The VA DOT said accommodations intermediaries must separately state the amount of tax on the bill, invoice, or similar documentation and add the tax to the room charge. The VA DOT further explained that under the law, accommodations intermediaries that are deemed dealers for purposes of a retail sale of accommodations, may not assign or otherwise transfer their duty to collect and remit taxes to accommodations providers or any other entity. The VA DOT noted that the guidelines represent its interpretation of the laws and "do not constitute formal rulemaking" and as such do not have the force and effect of law or regulation. The guidelines take effect Sept. 1, 2021. Va. Dept. of Taxn., "Guidelines for the Application of the Retail Sales and Use Tax to Sales of Accommodations Facilitated by Accommodations Intermediaries" (July 2021).
Federal: A new IRS safe harbor (Revenue Procedure 2021-33) will allow taxpayers to exclude certain items from gross receipts under IRC §§ 448(c) and 6033, solely for determining eligibility for the employee retention credit (ERC). The excludable items are: (1) the forgiven portion of a Paycheck Protection Program (PPP) loan; (2) a shuttered venue operators grant; and (3) a restaurant revitalization grant. The safe harbor applies for determining an employer's eligibility to claim the ERC for wages paid after March 12, 2020, and before Jan. 1, 2022, the full period for which the ERC is available. For additional information on this development, see Tax Alert 2021-1529.
California: New law (SB 151) authorizes the California GO-Biz agency (CA GO Biz) to establish through Jan. 1, 2030 a California Competes Grant Program for applicants that meet certain job and investment criteria. Grants will only be provided to applicants that meet at least one of the following criteria: (1) creates at least 500 new, full-time jobs in California; (2) makes a significant infrastructure investment — in this case construction or renovation expenditures of at least $10 million over no more than five years in California; or (3) creates jobs or makes the investment in a high-poverty area or high-unemployment area. The amount of the grant will be set forth in a written agreement between CA GO-BIZ and the qualified grantee. In determining whether to enter into such an agreement, CA GO-BIZ will "consider the extent to which the grant will influence the qualified grantee's ability, willingness, or both, to create jobs in this state that might not otherwise be created in the state by the qualified grantee or any other California business." Other factors that CA GO-BIZ may consider include the qualified grantee's financial solvency and its ability to finance the proposed expansion, the qualified grantee's compliance with federal and state laws and the qualified grantee's litigation history. The law limits the amount of grant that can be allocated to any one grantee to no more than 30% of the aggregate amount of grants appropriated for any fiscal year. Grants will not be available to qualified grantees that have received a California Competes tax credit for the same jobs or investments for which the grant is sought. The law includes credit recapture provisions for applicants that fail to satisfy the terms of the grant agreement. The law also establishes the California Microbusiness COVID-19 Relief Grant Program, the California Nonprofit Performing Arts Grant Program and the California Venues Grant Program and revises the California Small Business Development Technical Assistance Expansion Program. SB 151 took immediate effect. Cal. Laws 2021, ch. 74 (SB 151), signed by the governor on July 12, 2021.
Alabama: The Alabama Department of Revenue (AL DOR) suggested that financial institutions review their Financial Institution Excise Tax payments, to check for potential underpayments of excise tax that may result from tax reform enacted in 2019. One of the changes brought about by tax reform requires financial institutions to make quarterly estimated payments of the annual excise tax for tax years beginning after Dec. 31, 2019. During the transition from the prior post-payment system to the new quarterly payments system, the AL DOR is authorized to waive penalties and interest associated with the underpayments of estimated tax payments in the first two tax years, provided the underpayment is not attributable to an intentional disregard of the law. Financial institutions that have been (or may be) billed for underpaying the 2020 estimated tax payments, should consider filing a Request for Waiver of Penalty form. The AL DOR noted that the form may be included with the 2020 Financial Institution Excise Tax returns that have not yet been filed as well as the 2021 return. Ala. Dept. of Rev., "ALDOR Reminds Financial Institutions to Avoid Underpaying Excise Tax" (Aug. 5, 2021).
Iowa: Amended subrule 3.1(3) regarding voluntary disclosure agreements makes clear that state and local hotel and motel taxes, automobile rental excise tax, equipment excise tax, water service excise tax and the prepaid wireless 911 surcharge are eligible for settlement under the state's voluntary disclosure program. This change takes effect Sept. 15, 2021. Iowa Dept. of Rev., Iowa Admin. Code subrule 3.1(3) (ARC 5841C published Aug. 11, 2021).
PAYROLL & EMPLOYMENT TAX
Hawaii: New law (HB 1278/Act 1) freezes Hawaii's employer state unemployment insurance (SUI) tax rates for 2021 — 2022 at Rate Schedule D, with rates ranging from 0.2% to 5.8%, rather than issuing SUI tax rates at Rate Schedule H, the highest schedule provided for under state law. The result of HB 1278 is a lower new employer rate for 2021 — 2022 of 3.0%, rather than 5.2% under Rate Schedule H. Hawaii employers continue to pay an Employment & Training Assessment for 2021 of 0.01%. For additional information on this development, see Tax Alert 2021-1531.
Rhode Island: The Rhode Island Division of Taxation announced that it has extended through Sept. 15, 2021 (previously extended through July 17, 2021) emergency regulations that temporarily waive the requirement that employers withhold Rhode Island state income tax from the wages of employees working within the state solely due to COVID-19. The emergency regulations took effect on March 9, 2020. For additional information on this development, see Tax Alert 2021-1536.
Vermont: The Vermont Department of Taxes announced that Governor Phil Scott removed all COVID-19 restrictions and ended the state of emergency effective June 15, 2021. Accordingly, the temporary income tax withholding guidance for teleworkers during COVID-19 applies only through June 14, 2021, unless the emergency order is reinstated. For additional information on this development, see Tax Alert 2021-1527.
Nevada: New law (SB 389) provides for the taxation and regulation of peer-to-peer car sharing programs. Starting Oct. 1, 2021, peer-to-peer car sharing programs are required to collect from each shared vehicle driver a governmental service fee equal to 10% of the total amount for which a passenger car was shared through the program (with some exemptions), plus any local fees imposed on passenger car sharing. In addition, peer-to-peer car sharing programs are required to collect and remit, on behalf of shared vehicle owners, sales and use taxes if the owner of the vehicle has not paid the tax due or has elected to collect sales and use taxes measured by gross charges for which the vehicle is shared. In this instance, the sales and use tax is measured by the gross charges for the sharing of a vehicle that is placed on a digital network or software application of the peer-to-peer car sharing program on or after Oct. 1, 2021 for sharing through the program. The law also provides for tax liability relief and record retention requirements. The Nevada Department of Taxation is required to adopt regulations to implement these provisions. Nev. Laws 2021, ch. 313 (SB 389), signed by the governor on June 3, 2021.
Thursday, September 9, 2021.Domestic tax quarterly webcast series: A focus on state tax matters (1:00 p.m. EDT (New York); 10:00 a.m. PDT (Los Angeles)). For our third quarterly webcast in 2021, Helen Hecht, Uniformity Counsel for the Multistate Tax Commission (MTC), will join us to discuss the MTC's recently launched partnership tax project, as well as other ongoing uniformity projects. Other featured topics include: (1) state tax considerations for employers and employees if employees continue to work from home on an interim or permanent basis after temporary state nexus relief and other similar measures end; (2) state proposals to impose new income taxes or expand existing sales and use taxes to digital advertising and digital services; and (3) other important state tax policy developments from the past quarter. 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.
1 Castellanos v. California, Case No. RG21088725 (Cal. Superior Ct., Alameda Cnty., Aug. 20, 2021).
2 Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (2018).
3 McLeod v. J.E. Dilworth Co., 322 U.S. 327 (1944).