August 18, 2022
State and Local Tax Weekly for August 5 and August 12
Ernst & Young's State and Local Tax Weekly newsletter for August 5 and August 12 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.
New Mexico Taxation and Revenue Department proposes regulations "clarifying" that state's Gross Receipts Tax applies to digital advertising services
On Aug. 9, 2022, the New Mexico Taxation and Revenue Department (Department) issued proposed regulations "clarifying" how receipts from the sale of advertising services to advertisers within and outside New Mexico are subject to the state's gross receipts tax (GRT). The proposed regulations explain that the tax applies to providers of digital advertising services whose digital platform may be accessed or viewed from within New Mexico, and specifically note that the GRT levied on those advertising receipts "does not impose an unconstitutional burden on interstate commerce." A public hearing will be held on the proposed regulations on Sept. 8, 2022. If approved, the regulations will be effective after publication in the New Mexico Register or later.
The GRT and compensating tax, which function as New Mexico's sales and use tax, are based on gross receipts; accordingly, most service transactions are subject to the GRT. Currently, broadcast and print advertising are expressly subject to the GRT. During the Multistate Tax Commission meeting on August 3, 2022, a representative of the Department said that digital advertising services were already subject to the GRT and that the proposed regulations would ensure that receipts from such activity are treated in the same manner as broadcast and print advertising receipts. The proposed regulations would clarify the Department's position that digital advertising services receipts are taxable.
Under the proposed regulations, "digital advertising services" would be defined as "advertisement services on digital platforms, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services." A "digital platform" would be defined as "any type of website, including part of a website, or application, that a user is able to access or view." The proposed regulations indicate that receipts from digital advertising services would be sourced based on the location of the server "hosting the digital platform from which the advertising is accessed."
The proposed regulations would allow providers of digital advertising services to deduct receipts attributable to the provision of digital advertising services if the receipts (1) are from a national or regional advertiser that does not have its principal place of business in New Mexico or is not incorporated under the laws of New Mexico; or (2) are from an advertising agency that purchases the display of advertisements on the platform on behalf of, or for subsequent sale to, a seller defined in (1). Commissions derived by advertising agencies from performing digital advertising services within the state would not be deductible.
For more on this development, see Tax Alert 2022-1222.
Texas adopts additional amendments to its franchise tax rule for research and development activities credits
On July 15, 2022, the Texas Comptroller of Public Accounts (TX Comptroller) filed with the Secretary of State the final amendments to its franchise tax rule, 34 Tex. Admin. Code § 3.599 (Section 3.599), regarding the tax credit for research and development (R&D) activities (hereafter, the 2022 amendments). The 2022 amendments clarify and modify changes to Section 3.599 that were adopted in October 2021 (see Tax Alert 2021-1860).
Definition of Internal Revenue Code in Section 3.599(b)(5): The 2021 amendments had stated that for Texas R&D credit purposes, taxable entities should apply the IRC in effect as of Dec. 31, 2011, and specified that any federal regulation adopted after this date "is only included in this term to the extent a taxpayer must apply that regulation in the 2011 tax year." The 2022 amendments changed this provision to "could have applied the regulation to the 2011 federal income tax year." In the Preamble of the 2022 amendments, the Comptroller said that it had reconsidered comments received during the 2021 amendments and agreed that the adopted definition was too restrictive.
The 2022 amendments also explain, through the use of examples, which federal Treasury Regulations apply to the 2011 federal income tax year (which can be used as a source for applying the rules for Texas purposes). Specifically, Treas. Reg. §1.174-2 (definition of research and experimental expenditures) and Treas. Reg. §1.41-4 (qualified research for expenditures paid or incurred in tax years ending on or after Dec. 31, 2003) can be applied by taxable entities in 2011 for their Texas returns. For Treas. Reg. §1.41-4(c)(6) (internal use software), however, a taxable entity can elect to follow either: (1) Treas. Reg. §1.41-4(c)(6) in 26 CFR part 1 and IRB 2001-5, or (2) proposed Treas. Reg. §1.41-4(c)(6) described in IRB 2002-4 (as provided under Treas. Reg. §1.41-4(e) (effective/applicability dates)).
Definition of computer software with respect to internal use software in Section 3.599(d)(5): According to the Preamble of the 2022 amendments, the definition of computer software with respect to internal use software in Section 3.599(d)(5) is amended to "remove items that are inconsistent with the changes made to the definition of IRC." As modified, "internal use software" continues to be defined as "computer software developed by, or for the benefit of, the taxable entity primarily for internal use by the taxable entity." The 2022 amendments, however, remove some of the restrictive language that was included in the 2021 amendment by deleting language that had:
Combined reporting and removal of provisions restricting credit carryforwards in Section 3.599(i): The 2022 amendments retain the provision clarifying that the combined group is the taxable entity for purposes of calculating and reporting the R&D credit but reorganizes Section 3.599(i)(1) and (2). Significantly, Section 3.599(i)(3) is amended to remove language that had restricted credit carryforwards. As revised, Section 3.599(i)(3) explains how to determine the credit carryforward when there is a change in the membership of the combined group.
In addition, Section 3.599(m) is amended to make clear that the conveyance, assignment or transfer of an ownership interest in the taxable entity does not convey, assign or transfer the taxable entity's credit.
For additional information on this development, including a discussion on how to carryforward credits when there is a change in membership and the implications of these recently adopted amendments, see Tax Alert 2022-1173.
The TX Comptroller also adopted amendments to the R&D exemption under its sales and use tax rule, 34 Tex. Admin. Code Section 3.340. These changes, however, are not discussed in the alert.
Arkansas: New law (SB 1) accelerates corporate and individual income tax rate reductions, moving forward the rates that would have taken effect in 2025. Effective for tax years beginning on and after Jan. 1, 2023, the corporate income tax rate is reduced to 5.3% (from 5.9%), for corporations with net income exceeding $25,000. Effective for tax years beginning on or after Jan. 1, 2022, the top individual income tax rates, 5% and 5.5%, are reduced to 4.9%, and the adjustment amounts for individuals with net income greater than $84,500 and less than $89,101 are reduced. The law also conforms to IRC §179 as in effect on Jan. 1, 2022 for purposes of computing Arkansas income tax liability for property purchased in tax years beginning on or after Jan. 1, 2022. (Under prior law, Arkansas conformed to IRC §179 in effect on Jan. 1, 2009.) Lastly, the law provides an inflationary relief income-tax credit to resident individuals. Ark. Laws 3rd Extraordinary Sess. 2022, Act 2 (SB 1), signed by the governor on Aug. 11, 2022.
California: An out-of-state limited liability company (LLC), which held an interest in a multimember LLC (classified as a partnership for income tax purposes) that owned property in California, was only subject to the annual $800 LLC tax for the tax years in which it was doing business in the state (2015 and 2016, but not 2013 and 2014). The California Office of Tax Appeals (OTA) explained that a taxpayer will be considered to be doing business in California if one of the bright-line nexus thresholds consisting of property, payroll or sales, is met (see CR&TC §23101(b)). At issue here is the property factor threshold.1 In determining whether the property threshold has been exceeded, the taxpayer must take into account its pro rata or distributive share of California property owned by the pass-through entities in which it held an interest. Ambiguity in CR&TC §23101(d) left unclear how "distributive share" is computed — i.e., is it computed using its capital interest, profits interest or another partnership interest? To resolve this ambiguity, the OTA looked to Cal. Code of Regs., tit. 18, §25137-1(f)(1), which provides guidance in determining the value of partnership property for apportionment purposes. An amendment to Reg. § 25137-1(f)(4) that took effect in 2019, clarified that a taxpayer's interest in a partnership is determined by reference to its profits interest. The OTA found that before this amendment, a partner's interest in the partnership was not expressly defined by Reg. § 25137-1(f)(4) and it was not clear how the interest would be computed. The OTA then looked to the FTB's Explanation of Discussion Draft of the proposed amendments to Reg. § 25137-1, finding that while the amendment is not applicable to the years at issue the FTB's reason for the amendment — "the profit interest percentage is 'more closely tied to the income subject to apportionment than a capital interest approach would provide'" — nevertheless is persuasive in resolving the ambiguity of CR&TC § 23101(d) and Reg. §25137-1(f)(4). The OTA further found that using the same method for finding nexus under CR&TC §23101(d) and apportionment under Reg. § 25137-1, "is consistent with the purpose of facilitating reporting and administration." Hence, the OTA determined that the profit interest should be applied to determine a partner's distributive share under CR&TC § 23101(d). Using the profit interest percentage, the OTA determined that the LLC did not meet the property threshold in 2013 or 2014, but in 2015 and 2016 the threshold was exceeded. Additionally, for 2013 and 2014 the OTA, citing Swart Enterprises, Inc.,2 also determined that the LLC was not doing business in California under CR&TC § 23101(a) as it was not "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit." Matter of MJK Real Estate Fund II, LLC, 2022-OTA-247P (Cal. Off. Tax App. May 26, 2022) (Pending Precedential).
Massachusetts: New law (H.5050) updates Massachusetts date of conformity to the Internal Revenue Code for personal income tax purposes to Jan. 1, 2022 (from Jan. 1, 2005), but specifically disallows the deduction for 20% of qualified business income earned in a qualified trade or business allowed under IRC §199A. The changes are effective to tax years beginning on or after Jan. 1, 2022. Mass. Laws 2022, ch. 126 (H.5050), signed by the governor on July 28, 2022.
Mississippi: The Mississippi Department of Revenue issued guidance on making the pass-through entity (PTE) tax election starting in 2022. To make the PTE tax election, a partnership, S corporation or other similar PTE must have a vote by or written consent of the members of the entity's governing body, and a vote by or written consent of the owners, members, partners or shareholders (collectively, "member") holding more than 50% of the voting control of the entity. Fiduciaries cannot make a PTE tax election. PTEs can make the election to be taxed as a PTE, or to revoke an election already made, by submitting the PTE Election Form, form 84-381, before the 15th day of the third month following the close of the tax year for which the entity makes or revokes the election. An election, once made, is binding for the tax year and subsequent years, until the election is revoked. To be taxed at the entity level, an electing PTE must file PTE Tax Return, form 84-105, and check the "Electing Pass-Through Entity" box. The PTE Election form must be attached to the return, along with the Mississippi Schedules K-1s for each member of the electing PTE. The K-1s also should have the "Electing Pass-Through Entity" box checked with the amount of tax paid by the electing PTE for each partner provided on the K-1. Electing PTEs with annual income exceeding $200 must make estimated tax payments. (The Notice describes the process for calculating the tax and the due dates for submitting the tax.) PTEs can elect to file the PTE entity tax return as an electing PTE or as a composite PTE; a PTE cannot file as both. The Notice also explains how to calculate the credit for taxes paid on the electing PTE return, with specific instructions for individuals, businesses or fiduciaries. Miss. Dept. of Rev., Pass-Through Entity Election Notice (July 28, 2022).
Oregon: On Aug. 23, 2022, the Oregon Department of Revenue Rules Advisory Committee will hold a public meeting on whether to adopt the Multistate Tax Commission revised Statement of Information concerning practices of the MTC and supporting states under P.L. 86-272, which lists activities conducted over the internet that would and would not be protected by P.L. 86-272. During the meeting potential rule language will be discussed. Additional meetings on this issue are scheduled for Sept. 7 and Sept. 20, 2022, if needed. Information on the Aug. 23rd meeting is available on the DOR's webpage.
SALES & USE
New York: New law (A. 8528-A/ S. 8033-A) exempts from sales and use tax sales of diapers intended for human use including disposable, reusable, adult and children. This exemption applies to sales made on or after the first day of the sales tax quarterly period next commencing at least 90 days after this Act becomes law. N.Y. Laws 2022, ch. 386 (A.8528-A/S. 8033-A), signed by the governor on July 19, 2022.
Tennessee: In response to a ruling request, the Tennessee Department of Revenue (TN DOR) described the application of Tennessee's sales and use tax to fees and charges of a company that provides research, development and manufacturing services to clients for use in clinical trials. Based on the facts, the TN DOR determined that products manufactured by the company and sold to clients for use in clinical trials are exempt from sales and use tax as prescription drug. The company's sale of products it manufactures to clients where the client dispenses the products to patients participating in the clinical trials are not exempt from sales and use tax as sales for resale. The TN DOR explained that the resale exemption does not apply because simply transferring the products to these patients or administering the product as part of the patient's participation in the clinical trial "does not constitute a subsequent, bona fide sale." Thus, to the extent products include items that do not fall within the scope of the prescription drug exemption, an actual resale must occur in order for the resale exemption to apply. The taxability of the company's Suite Reservation Fees, which are properly characterized as part of the sales price of the manufactured product or part of the sales price of nontaxable research services (e.g., innovation laboratories), depends on whether the product manufactured by the company is taxable. If the product is taxable, the Suite Reservation Fess are subject to tax; if the product is not taxable, such fees related to the manufacture of the product also are not taxable. Lastly, the TN DOR determined that the company would qualify for the research and development (R&D) sales and use tax exemption for its purchases of machinery, apparatus and equipment when the equipment is primarily used in providing R&D services. Tenn. Dept. of Rev., Letter Ruling #22-04 (June 17, 2022).
Tennessee: Fees a delivery network company charge to sellers and service providers for connecting the seller/service provider to the purchaser, which the company characterizes as lead generation, and for processing payments for purchased items are not subject to Tennessee sales and use tax. The Tennessee Department of Revenue (TN DOR) determined that the true object of the transactions covered by the fees are non-taxable lead generation and payment processing services. The TN DOR found the taxable web-based interface and App (collectively, "software"), which are used to connect sellers, services providers and purchasers via the company's platform, "merely incidental" to the service. The TN DOR explained that without being connected to purchasers who pay for and have items delivered, the "software would be of little to no use to the Sellers and Service Providers." Tenn. Dept. of Rev., Letter Ruling #22-02 (April 11, 2022).
Hawaii: New law (HB 1982) extends Hawaii's motion picture, digital media and film production income tax credit through Dec. 31, 2032 (from Dec. 31, 2025) and modifies its provisions. The law requires every person making payment to a loan-out company3 and claiming the credit to deduct and withhold an amount equal to the highest rate of the general excise tax and any applicable county surcharge for all payments made to the loan-out company for services performed in Hawaii. Persons subject to this withholding requirement, must submit the return by the 20th day of the calendar month immediately following the moth in which the payment was made to the loan-out company. The law increase the amount of the credit as follows: (1) 22% of the qualified production costs incurred by a qualified production in any county with a population of over 700,000 (from 20%); or (2) 27% of the qualified production costs incurred by a qualified production in any county with a population of 700,000 or less (from 25%). To qualify for the credit, a production must have qualified production costs totaling at least $100,000 (down from $200,000). In addition, the law (1) repeals the requirement that a taxpayer claiming the credit submit a verification review by a qualified certified public accountant; (2) imposes a new application processing fee; (3) increase the total amount of credit that can be claimed per qualified production to $17 million (from $15 million); and (4) modifies the definition of "qualified production costs". These changes have various effective dates. Haw. Laws 2022, Act 217 (HB 1982), signed by the governor on June 27, 2022.
New York: New law (A. 10507/ S.9467) expands the Excelsior tax credit program to provide eligibility for Green CHIPs projects. A "Green CHIPs project" is defined as a project that meets all of the following: (1) is within the semiconductor manufacturing and related equipment and material supplier sector; (2) includes sustainability measures to mitigate the project's greenhouse gas emissions; (3) pays not less than the federal prevailing wage rates for project construction; (4) commits to worker and community investment such as training and education benefits and programs to expand employment opportunities for economically disadvantaged individuals; (5) creates at least 500 net new jobs; (6) makes at least $3 billion in qualified investment; and (7) maintains a Green CHIPS benefit-cost ratio of at least fifteen to one (the law explains how to calculate the "Green CHIPS benefit-cost ratio"). Projects meeting these requirements are eligible to enter into phase one of the Green CHIPS 10-year benefit term; projects in good standing with these requirements also are eligible to enter phase two of the Green CHIPS project. Phase two is a new and separate 10-year term. Phase two requires the creation of an additional 500 net new jobs and $3 billion in qualified investments, beyond that created/made in phase one. Green CHIPS projects phase one and phase two may overlap, depending on when the projects were initiated. The Excelsior jobs tax credit for each net new job created by a Green CHIPS project equals the product of gross wages paid and up to 7.5%; however, for Green CHIPS projects only the first $200,000 of gross wages per job is eligible for the credit (this cap may be adjusted annually for inflation). The Excelsior investment tax credit is an amount up to 5% of the cost or other basis for federal income tax purposes of the qualified investment in the Green CHIPS project. The Excelsior research and development (R&D) tax credit for Green CHIPS projects shall not exceed 8% of the R&D expenditures attributable to activities conducted in New York. In addition, the special Excelsior jobs program rates are available to Green CHIPS projects that enter into phase two. The amount of total Green CHIPS project credit that can be issued in tax years 2022 to 2041 is capped at $500 million per year. Green CHIPS project credit cannot be awarded, and credits cannot be claimed, after 2050. N.Y. Laws 2022, ch. 494 (A. 10507/ S.9467), signed by the governor on Aug. 11, 2022.
Rhode Island: New law (HB 7123 Sub. A (Art. 9)) extends the sunset date of various tax credits. The sunset date of the historic preservation tax credit is extended to June 30, 2023 (June 30, 2022); no credits will be authorized after the sunset date or the maximum aggregate amount of credits is exhausted, whichever occurs first. The sunset dates for the Rhode Island New Qualified Jobs Incentives Act 2015 and the Rebuild Rhode Island Tax credit are extended through Dec. 31, 2023 (from Dec. 31, 2022). The sunset provisions for the Rhode Island Tax Increment Financing and the Tax Stabilization Incentive are amended to prohibit the commerce corporation from entering into an agreement after Dec. 31, 2023 (from Dec. 31, 2022). The law also extends the sunset date of the following to Dec. 31, 2023 (from Dec. 31, 2022): the Small Business Assistance Program, the Innovation Initiative, the Air Service Development Fund, among other programs. Lastly, for tax year 2023 and tax year 2024, the amount of total motion picture tax credit and/or theatrical production tax credit is capped at $40 million (for 2022 it is capped at $30 million). R.I. Laws 2022, ch. 231 (HB 7123 Sub-A as amended), signed by the governor on June 27, 2022.
Puerto Rico: In Administrative Order 2022-05, the Puerto Rico Municipal Income Collection Center (CRIM) has extended from Aug. 15, 2022 to Aug. 31, 2022, the due date for the first estimated property tax payment for tax year 2022. The other estimated property tax payments are due on their normal dates: Nov. 15, 2022 (2nd payment); Feb. 15, 2023 (3rd payment); May 15, 2023 (4th payment). For additional information on this development, see Tax Alert 2022-1234.
COMPLIANCE & REPORTING
New York: New law (A.9461-B/ S.8398-B) aligns the extension of time to file a state tax return with the federal filing extension granted to taxpayers who are (1) determined to be affected by a presidentially declared disaster for federal tax purposes, or (2) determined to be affected by a presidentially declared disaster or by a disaster emergency declared by the governor. Under prior law, the tax department had the authority to provide an extension for a period of up to 90 days. As revised, the tax department can provide a longer extension period when necessary to align with relief being provided by the IRS under the authority to postpone certain deadlines under IRC §7508A. This change took effect immediately. N.Y. Laws 2022, ch. 451(A.9461-B/S. 8398-B), signed by the governor on July 21, 2022.
New York: The New York Department of Taxation and Finance (Department) issued a reminder that partnerships and S corporations in New York have until Sept. 15, 2022 to opt in to the New York State (NYS) pass-through entity tax (PTET) for 2022. To make the election, a pass-through entity must use the state's PTET Annual Election application and make an estimated payment. The Department recommends against waiting until the deadline to make the election, to provide enough time to complete the process before the deadline. The Department noted that "only an authorized person can make the election on behalf of an eligible entity. Tax professionals cannot make the election on behalf of their clients." Pending legislation (A.10506 / S.9454) would New York City's PTE tax election to be made starting in 2022 (under current law, the election can be made starting in 2023). N.Y. Dept. of Taxn. and Fin., "Extended deadline to opt in to the New York State pass-through entity tax (PTET) for 2022" (Aug. 12, 2022).
PAYROLL & EMPLOYMENT TAX
Multistate: Most employers will encounter the need at some time to recover wage advances and/or wage overpayments from employees. For instance, an employment contract may require the repayment of a sign-on bonus or relocation reimbursements if the employee resigns before a set date; wages may be cover estimated when a disaster prevents the normal automated processing of wages; or a payroll error may result in an overpayment. In this special report, we explain the special payroll tax rules that apply when the repayment of wages occurs in years subsequent to a wage advance or overpayment and state/local wage-hour laws that can place restrictions on the manner and amount of future wage deductions. For more on this development, see Tax Alert 2022-1215.
Louisiana: New law (HB 192/Act 116) freezes the 2023 Louisiana SUI taxable wage base at $7,700, which has been the case for calendar years 2021 — 2022. The 2022 SUI tax rates did not include an additional solvency tax due to legislative resolution. The Louisiana 2022 SUI tax rates continue to range from 0.09% to 6.20%, with most rates listed on the state's tax table increasing by 0.01% to 0.4%, depending on the rate bracket. However, due to the adoption of a resolution in 2021 (Resolution SCR 5), employer 2022 SUI tax rates do not include an additional solvency tax of up to 30% be added to employer tax rates when the UI trust fund balance falls below $100 million. For more on this development, see Tax Alert 2022-1159.
Vermont: The Vermont Department of Taxes (VT DOT) has issued on its website income tax withholding guidance for remote employees. Of significant note, the VT DOT states that employers are not required to begin withholding Vermont income tax from a nonresident employee's wages until that employee has worked in Vermont for 30 or more days in the tax year. For more on this development, see Tax Alert 2022-1137.
Massachusetts: New law (H.5164) authorizes, regulates and taxes sports wagering. The law imposes on sports wagering operators in the commonwealth an excise at the rate of: (1) 15% of the operator's adjusted gross sports wagering receipts from the operation of in-person sports wagering; (2) 20% of the operator's adjusted gross sports wagering receipts from the operation of sports wagering through mobile applications and other digital platforms; and (3) 15% of the adjusted gross fantasy wagering receipts of a person or entity that offers fantasy contests. The accrual method of accounting is used for purposes of calculating the amount of tax owed by the licensee. The excise is due and payable to the commission in monthly installments on or before the 15th day of the following month; amounts due must be submitted via electronic funds transfer at the same time the return is filed. The excise on adjusted gross sports wagering receipts is in lieu of all other state and local taxes and fees imposed on the operation of (or proceeds from the operation of) sports wagering. Mass. Laws 2022, ch. 173 (H.5164), signed by the governor on Aug. 10, 2022.
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 the years at issue, the property factor threshold, which is adjusted annually for inflation, was as follows: (1) $51,816 in 2013; (2) $52,956 in 2014; (3) $53,644 in 2015; (4) $54,771 in 2016; and (5) $56,195 in 2017.
2 Swart Enterprises, Inc. v. Franchise Tax Bd., 7 Cal. App. 5th 497 (2017).
3 The law defines "loan-out company" as "a wholly-owned entity formed on behalf of a person that serves as a separate entity that constitutes the person's means of entering a contract with a third party for the purpose of providing services to the third party."