March 14, 2022
State and Local Tax Weekly for March 4
Ernst & Young's State and Local Tax Weekly newsletter for March 4 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.
Federal court rules challenge to Maryland's Digital Advertising Services Tax barred by Tax Injunction Act, but pass-through prohibition may be challenged
On March 4, 2022, Judge Lydia Kay Griggsby of the U.S. District Court for the District of Maryland concluded that the federal Tax Injunction Act (28 U.S.C. § 1341) (TIA) bars a challenge to Maryland's new digital advertising services tax (DAT) in the federal courts. The court, however, determined that businesses subject to the DAT could challenge in federal court a provision prohibiting them from directly passing on the cost of the tax to their customers. Chamber of Commerce of the United States of America v. Franchot, Civil Action No. 21-cv-00410-LKG (D. Md. March 4, 2022).
The DAT, which became effective on Jan. 1, 2022, applies to annual gross revenue derived from digital advertising in the state. Persons or entities that have at least $100 million in annual global revenue from all sources and at least $1 million in annual Maryland revenue from providing digital advertising services must pay the DAT. The DAT applies at graduated rates which increase based on the taxpayer's global annual revenues. It does not apply to most broadcast and news media entities. Businesses that are subject to the tax are statutorily prohibited from directly passing on the DAT's cost "to a customer who purchases the digital advertising services by means of a separate fee, surcharge, or line-item."1
The DAT currently is the subject of two legal challenges: one in state court and the present action in federal court. Despite these challenges to the tax, the DAT is currently effective. Persons and entities that provide digital advertising services to Maryland customers should assess whether they satisfy the DAT's revenue thresholds and whether they may qualify for any of the limited exceptions to the tax. The first returns and estimated payments are due on April 15, 2022. At the moment, an approved form for filing a return and reporting and paying the DAT has not been issued, although the regulations implementing the DAT were finalized in December 2021.2
For more information on this development, see Tax Alert 2022-0375.
Iowa governor signs legislation that changes corporate and individual income tax rates and overhauls the research activities credit
On March 1, 2022, Iowa Governor Kim Reynolds signed House File 2317 (HF 2317), which enacts contingent rate reductions for the state's corporate income tax and phased-in rate reductions for its individual income tax. HF 2317 also makes significant changes to the state's research activities credit.
Corporate income tax rates: For tax years 2021 and 2022, the Iowa corporate income tax is based on the following graduated rate schedule: (1) 5.5% on the first $100,000 of taxable income; (2) 9% on taxable income from $100,001 to $250,000; and (3) 9.8% on taxable income greater than $250,000. HF 2317 amends Iowa Code § 422.33 to reduce the corporate income tax beginning in 2023 if certain revenue triggers are satisfied. The new provision (Iowa Code § 422.33(1)(b)) requires both the Iowa Department of Revenue (IA DOR) and the Iowa Department of Management to determine by Nov. 1, 2022 (and by November 1st of each year thereafter) whether net corporate income tax receipts in the prior fiscal year exceeded $700 million. If revenue triggers are satisfied, then the 9% and 9.8% rate brackets would be adjusted to generate $700 million in net corporate income tax receipts. Those rates will apply to tax years beginning on or after the next January 1st following the determination date. The rates cannot decrease below 5.5%.
Overhaul of research activities credit: Under current law, Iowa allows a refundable research activities credit for 6.5% of Iowa's apportioned share of qualifying expenditures for increasing research activities. The Iowa research activities tax credit is generally based on the federal research tax credit, except that the Iowa credit is calculated using the ratio of Iowa research expenditures over total research expenditures.
HF 2317 significantly changes the research activities credit. The law limits the amount of credit in excess of the tax liability that can be refunded. The refundable portion of the credit will be phased down 10% each year for a five-year period starting in 2023, so that 90% of excess credit is refundable in 2023 and 50% of excess credit is refundable in 2027. A taxpayer claiming a refund can elect to have the overpayment otherwise eligible for a refund credited to the following tax year's liability. HF 2317 includes no provision allowing taxpayers to carry forward the unused portion of their refundable credits.
For tax years beginning on or after Jan. 1, 2023, taxpayers are required to compute the research activities credit in a manner consistent with the alternative simplified credit in IRC § 41(c)(4) if they elected, or were required to use, this method for federal income tax purposes for the same tax year. Prior to this change, taxpayers could make an election to alternatively compute the credit in a manner consistent with the alternative simplified credit in IRC § 41(c)(4), regardless of the method used for federal income tax purposes.
The eligibility of payments for supplies to be qualified Iowa research expenses is phased out over five years, starting in 2023. Thus, for tax years beginning on or after Jan. 1, 2027, payments for supplies will not be qualified Iowa research expenses. HF 2317 also appears to limit the eligibility of wages performed by an employee or third parties. Wages are eligible for the credit if the person's services are performed in Iowa and a majority of the total services performed by the person in the tax year directly relate to eligible projects. In addition, HB 2317 limits a taxpayer's ability to claim the credit on an amended return and adds new provisions for calculating the state's apportioned share of qualifying expenditures for increasing research activities (certain rules that apply in calculating the federal credit will not apply for Iowa purposes).
Finally, a taxpayer can only file an amended return increasing the credit that was claimed on a timely filed return if the amended return is filed within six months of the due date, including extensions, of the original return or if the increase resulted from an assessment under a federal or IA DOR examination.
Other tax credits: HF 2317 limits the amount of the redevelopment tax credit, the third-party developer tax credit, the historic preservation tax credit and the assistive device tax credit that can be refunded. The amount of the refundable credit will be reduced by 5% each year for five-years, so that in 2023 a taxpayer will be allowed 95% of the refundable credit and by 2027 the taxpayer will only be allowed 75% of the refundable credit.
Rate reductions for individual income tax and treatment of retirement income: HF 2317 phases down individual income tax rates over the next four years to a flat rate of 3.9% by tax year 2026. Under current law, Iowa does not tax Social Security income or retirement income of $6,000 or less. For tax years beginning in 2023, HF 2317 excludes from income tax the retirement income of someone who is (1) disabled, (2) at least 55 years old, or (3) the surviving spouse of an individual who would have qualified for the exclusion. HF 2317 also grants an employee-owner of a qualified corporation one irrevocable lifetime election to exclude from state individual income tax the net capital gain from the sale of the qualified corporation's capital stock. This exclusion will phase in over three years, beginning in 2023. Retired farmers also will receive a similar capital gain exclusion as well as a lease income exclusion.
For additional information on this development, see Tax Alert 2022-0351.
Idaho: New law (HB 472) updates the state's date of conformity to the Internal Revenue Code (IRC) to Jan. 1, 2022 (from Jan. 1, 2021), except that IRC §§ 85 and 461(l) are applied as in effect on Jan. 1, 2020. These changes are retroactively effective to Jan. 1, 2022. Idaho Laws 2022, Sess. Law ch. 7 (2022 ID HB 472), signed by the governor on Feb. 23, 2022.
Illinois: In a general information letter, the Illinois Department of Revenue (IL DOR) explained that corporate taxpayers are allowed to subtract the amount of wage deduction disallowed for federal income tax purposes under IRC §280C(a) in relation to the Employee Retention Credit (ERC). The subtraction, which is allowed under IITA §203(b)(2)(I)(ii), can be claimed on the Illinois 2021 Schedule M Other Additions and Subtractions, Step 3, Line 16d "expenses related to certain federal credits." Ill. Dept. of Rev., IT-22-0001-GIL (Feb. 23, 2022).
New Jersey: The New Jersey Division of Taxation said the state does not allow an additional deduction for disallowed expenses that were included in federal taxable income related to the employee retention credit (ERC) (e.g., disallowed wages paid for federal income tax purposes as a result of claiming the ERC), even though the taxpayer cannot claim the ERC for Corporation Business Tax (corporations, S corporations) and Gross Income Tax (partnerships) purposes. N.J. Div. of Taxn., Guidance "Employee Retention Credit" (last update March 4, 2022).
Washington: The Douglas County Superior Court Judge ruled that Washington's 7% excise tax on sales of certain long-term capital assets where the profit is in excess of $250,000 annually, imposed by Wash. Laws 2021, ch. 196 (SB 5096), violates the uniformity and limitation requirements of Art. VII, §§ 1 and 2 of the Washington State Constitution. In so holding, the Superior Court Judge Brian C. Huber found that under case law, the tax imposed by SB 5096 is properly characterized as an income tax rather than an excise tax, and, as a tax on the receipt of income, it is also properly characterized as a tax on property. Judge Huber explained that the tax violates the Washington State Constitution's uniformity requirement because a 7% tax is imposed on an individual's long-term capital gains exceeding $250,000, but no tax is imposed on capital gains below that threshold. The limitation requirement is violated because the 7% tax on long-term capital gains exceeds the 1% maximum annual property rate. Quinn/Clayton, et. al. v. State of Washington, et. al., Cons. Cause Nos. 21-2-00075-09 & 21-2-00087-09 (Wash. Super. Ct., Douglas Cnty., March 1, 2022).
SALES & USE
Arizona: In response to a ruling request, the Arizona Department of Revenue (AZ DOR) advised that a taxpayer's gross income from a long term lease of real property is subject to transaction privilege tax (TPT) under the commercial lease classification. The AZ DOR explained that under Ariz. Admin. Code R15-5-1604, gross income from commercial leases includes all amounts paid to or on behalf of a lessor (e.g., property tax, insurance, common area charges). These amounts, the AZ DOR said, are taxable for TPT purposes. In addition, the AZ DOR determined that the taxpayer is subject to city privilege tax as a speculative builder on 65% of gross income from the lease. Further, since the taxpayer uses the accrual reporting method, it must report the gross income when the right to the rent payment is fixed (i.e., when the payment is due). Ariz. Dept. of Rev., Private Taxpayer Ruling LR 22-003 (Jan. 28, 2022).
Virginia: New law (HB 462) extends through July 1, 2025 (from July 1, 2022) the sales and use tax exemption for parts, engines and supplies used for maintaining, repairing or reconditioning aircraft or any aircraft's avionics system, engine or component parts. For purposes of this exemption, "aircraft: includes both manned and unmanned systems; "manned systems" only include aircraft with a maximum takeoff weight of at least 2,400 pounds. The new law takes effect July 1, 2022. Va. Laws 2022, ch. 8 (2022 VA HB 462), signed by the governor on March 2, 2022. (An identical Senate bill (2022 VA SB 701) has been sent to the governor.)
Virginia: New law (HB 518) modifies Virginia's tax on accommodations intermediaries, changing the process by which retail sales and use tax (RSUT) and transient occupancy taxes are collected. Under the revised provisions, accommodations intermediaries collect and remit RSUT to the Virginia Department of Taxation (VA DOT) or the applicable locality; the requirement to remit tax to the hotel has been eliminated. If the transaction for the accommodations involves two or more accommodations intermediaries the intermediaries can agree to which party will be responsible for collecting and remitting the tax. The responsible party must be a registered dealer with the VA DOT. The party agreeing to collect and remit tax is the sole party liable for the tax. The law expands the definition of "accommodations intermediary" to mean "any person other than an accommodations provider that (i) facilitates the sale of an accommodation, and (ii) either (a) charges a room charge to the customer, and charges an accommodations fee to the customer, which fee it retains as compensation for facilitating the sale; (b) collects a room charge from the customer; or (c) charges a fee, other than an accommodations fee, to the customer, which fee it retains as compensation for facilitating the sale." (New text in italics.) The law also modifies the definition of "room charge" to make clear that it "includes any fee charged to the customer and retained as compensation for facilitating the sale, whether described as an accommodations fee, facilitation fee, or any other name." These changes take effect Oct. 1, 2022. Va. Laws 2022, ch. 7 (2022 VA HB 518), signed by the governor on March 2, 2022.
Virginia: New law (HB 3) extends to June 30, 2025 (from June 30, 2022) the sunset date for the sales and use tax exemption for sales of gold, silver and platinum bullion and legal tender coins if the sales price exceeds $1,000. This change takes effect July 1, 2022. Va. Laws 2022, ch. 12 (2022 VA HB 3), signed by the governor on March 2, 2022.
Virginia: New law (HB 269) extends the sunset date of the major business facility job tax credit to tax years beginning before July 1, 2025 (from July 1, 2022). HB 269 takes effect July 1, 2022. Va. Laws 2022, ch. 11 (HB 269), signed by the governor on March 2, 2022. (An identical Senate bill (2022 VA SB 185) has been sent to the governor.)
Alabama: New law (HB 82) exempts $40,000 of tangible personal property owned by a business from state levied ad valorem tax, effective Oct. 1, 2023. Counties and municipalities can by resolution adopt a similar exemption for county or municipal ad valorem tax purposes. Such resolution must be adopted 90 day before (1) Oct. 1, 2023 or (2) Oct 1 of the electing year. Ala. Laws 2022, Act 2022-53 (2022 AL HB 82), signed by the governor on Feb. 28, 2022.
COMPLIANCE & REPORTING
Alabama: New law (HB 82) extends the due date for filing corporate income tax and financial institution excise tax returns to one month after the corresponding federal income tax return, including applicable extensions. This change is effective for tax years beginning on or after Jan. 1, 2021. This extension of the time to file the return does allow the taxpayer to defer payment of corporate income tax liability beyond the original due date provided in Ala. Code §40-18-39 (corporations) or Ala. Code §40-16-3 (financial institutions) (i.e., the due date of the taxpayer's corresponding federal income tax return). Ala. Laws 2022, Act 2022-53 (2022 AL HB 82), signed by the governor on Feb. 28, 2022.
Montana: Reminder - Montana's corporate income tax law requires members of a unitary business to file returns on a worldwide combined basis, unless a water's-edge election is made to exclude foreign affiliates from the combined group. A Montana water's-edge group pays tax at an elevated tax rate of 7% instead of the regular rate of 6.75%. While many states require a water's-edge election to be made by the due date or extended due date of the return for the year for which it is intended to be effective, Montana is unique in that a water's-edge election must be made within 90 days of the beginning of the first year in which it is first intended to become effective. Accordingly, a corporation wishing to make a new water's-edge election, or renew an existing election, for the 2022 tax year must file a Form WE-ELECT with the Montana Department of Revenue by March 31, 2022. For additional information on this development, see Tax Alert 2022-0017.
PAYROLL & EMPLOYMENT TAX
Nevada: The 2022 state unemployment insurance (SUI) tax rates continue to range from 0.25% to 5.4%. The tax brackets changed slightly, but the average SUI tax rate remains 1.65% for 2022. According to Governor Steve Sisolak's news release, the Nevada Employment Security Council recommended an increase to the SUI tax rates for 2022, increasing the average rate from 1.65% for 2021 to an average rate of 2% for 2022. Instead, after discussion with the business community, the Employment Security Division (ESD) decided to hold the average rate at 1.65%, the same as was in effect for 2020 and 2021. For additional information on this development, see Tax Alert 2022-0337.
Oregon: The Oregon Department of Revenue has published updated guidance reflecting the 2022 district tax rates (i.e., Oregon Transit Payroll Taxes for Employers). The following are the 2022 district transit tax rates that apply: (1) Tri-County Metropolitan Transportation District (TriMet) employers pay 0.7937% (up from 0.7837% in 2021) of the wages paid by an employer and the net earnings from self-employment for services performed within the TriMet District boundary; and (2) Lane Transit District (LTD) employers pay 0.77% (up from 0.76% in 2021) of the wages paid by an employer and the net earnings from self-employment for services performed within the LTD boundary. Employers are also required to withhold the Oregon statewide transit tax of 0.1% from the wages of (1) Oregon residents (regardless of where the work is performed) and (2) nonresidents who perform services in Oregon. For additional information on this development, see Tax Alert 2022-0349.
Philadelphia, PA: In a Feb. 10, 2022 update to its frequently asked questions on the Philadelphia's temporary nexus waiver due to the COVID-19 emergency (FAQs), the Philadelphia Department of Revenue clarified the expiration of its temporary nexus waiver for the business income and receipts tax and net profits tax. For additional information on this development, see Tax Alert 2022-0343.
Virginia: The Virginia Department of Taxation (VA DOT) announced that the Virginia Disposable Plastic Bag Tax has been adopted by the City of Falls Church effective April 1, 2022. The cities of Alexandria, Fredericksburg and Roanoke and the counties of Arlington and Fairfax began collecting the bag tax on Jan. 1, 2022. The tax applies to disposable plastic bags provided to customers in grocery stores, convenience stores and drugstores within the locality. The VA DOT administers the bag tax. Additional information on Virginia's bag tax is available here. Va. Dept. of Taxn., Bulletin No. 22-2 (March 3, 2022).
VALUE ADDED TAX
International — Kenya: The Kenya High Court, in a case (ruling delivered on Jan. 31, 2022) between the Commissioner of Domestic Taxes (the Commissioner or the Appellant) vs. W. E. C. Lines (K) Limited (WEC (K) Ltd or the Respondent), declared Kenya's Value Added Tax (VAT) Regulations, 2017 null and void and held that maritime agency services provided to nonresident shippers should qualify as exported services for VAT purposes. For additional information on this development, see Tax Alert 2022-0338.
Wednesday, April 6, 2022. US corporate income tax compliance: Tax year 2021 readiness and preparing your tax function for what's next (3:30-4:45 p.m. EDT New York; 12:30-1:45 p.m. PDT Los Angeles). The corporate tax landscape is more dynamic than ever as we prepare for the 2021 tax filing season. Join our Ernst & Young LLP professionals for insights on preparing for 2021 US federal and state tax filings as well as key considerations for international filers. Topics will include: (1) key federal and state tax compliance updates and developments, including interdependencies among federal, state and international compliance and filings; (2) an IRS update and discussion of current activities, including notifications and plans for compliance enforcement; and (3) trends and insights from the recent EY Tax and Finance Operate and Chief Executive Officer surveys, including preparing your tax function for tax year 2022 and beyond. Register.
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 For more on the Maryland DTA, see Tax Alerts 2021-0788 and 2021-0343.
2 See COMAR § 03.12.01.00 to .06. See also Tax Alert 2021-2253.)