January 12, 2023
State and Local Tax Weekly for January 6
Ernst & Young's State and Local Tax Weekly newsletter for January 6 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.
Ohio expands sales tax bad debt deduction to allow for debts written off as uncollectible by credit account lenders
On Dec. 22, 2022, Governor Mike DeWine signed House Bill 223 (HB 223), which allows vendors to deduct sales tax remitted for bad debts on private-label credit accounts when the debt is written off as uncollectible by the credit account lender or by a person succeeding to those accounts. The expansion of the deduction for sales tax remitted on bad debt (bad debt deduction) is effective July 1, 2023.
Background: Ohio Rev. Code 5739.121 allows a vendor to deduct sales tax collected and remitted on a sale on credit, when the purchaser defaulted on payment. To qualify for the deduction, the debt must be uncollected for at least six months and must be deductible for federal income tax purposes. Vendors may only deduct sales tax remitted on debts that have become worthless or uncollectible (i.e., deductible for federal income tax purposes) during the most recent sales tax reporting period. The deduction applies against the sales tax remitted by the vendor for the applicable reporting period, with a refund available if the bad debt exceeds the vendor's taxable sales for the reporting period. If the vendor subsequently collected the debt, it must pay the tax previously deducted.
In 2009, the Ohio Supreme Court held that a vendor using an unrelated finance company to handle its private-label credit card transactions could not deduct the sales tax remitted on the defaulted accounts because it did not charge off the debts as uncollectible on its own books, as Ohio Rev. Code 5739.121 then required.1 Thus, the law in effect until June 30, 2023 only allows vendors that deducted a bad debt for federal tax purposes to claim the deduction; vendors cannot deduct sales tax remitted on bad debts that were deducted on a third party's books.
HB 223 changes to the deduction: HB 223 expands the bad debt deduction by allowing vendors to deduct sales tax remitted on bad debts on private-label credit accounts used to make purchases from the vendor or its affiliates, even when the debt is charged off on the credit account owner's books (referenced in the statute as the "lender") and not the vendor's. A "private-label credit account" is a credit account (1) that carries, refers to, or is branded with the vendor's name, and (2) for which the lender complies with applicable Ohio and federal consumer protection laws when establishing the consumer's credit account.
For the vendor to be eligible for the expanded deduction, the lender must be able to deduct the private-label account debt for federal income tax purposes and charge it off as uncollectible on or after July 1, 2023. The expanded deduction is available for sales tax remitted on the bad debt of the original account issuer; it also applies to sales tax remitted on the bad debt of any other person acquiring the accounts or acquiring receivables from those accounts (i.e., factoring agents and debt collectors, which HB 223 defines as "lenders"), either from a third party or the vendor, provided the vendor remitted the applicable sales tax. If the lender eventually collects the debt, the vendor must pay any deducted tax. HB 223 allows a vendor to claim the deduction based on the lender's bad debt without regard to the vendor's reporting period during which the debt became worthless or uncollectible to the lender.
While vendors are allowed a refund when their own bad debt exceeds their taxable sales for the reporting period, a refund is not available for excess bad debt related to private label credit accounts claimed under the expanded deduction. Instead, vendors may carry forward the remaining deduction to future reporting periods. HB 223 does not limit the carryforward period.
For more on this development, see Tax Alert 2023-0046.
Multistate: Tax Alert 2023-0025 provides a summary of the significant legislative, administrative and judicial actions that affected US state and local income/franchise and other business taxes for the fourth quarter of 2022. These developments are compiled from the EY Indirect/State Tax Weekly and Indirect/State Tax Alerts issued during that period. Highlights include: (1) a summary of legislative developments in Pennsylvania and the City of Philadelphia, PA; (2) a summary of a ballot measure in Colorado; (3) a summary of judicial developments in Colorado and Texas; (4) a summary of administrative developments in Arkansas, Kansas, Louisiana, Maryland, Massachusetts, Michigan, New Jersey, New York, North Carolina, Rhode Island, Utah and the City of Portland, OR; and (5) a discussion of state and local tax items to watch in Colorado and Illinois.
Colorado: On Dec. 27, 2022, Colorado Governor Jared Polis, as part of his Constitutional responsibility, issued proclamations "declaring the vote for voter-approved ballot measures passed in the 2022 election." Income tax related ballot measures do the following: (1) Proposition FF, starting in tax year 2023, limits itemized or standard state income tax deductions to $12,000 for single tax return filers and $16,000 for joint tax filers, applicable to individuals with federal adjusted gross income over $300,000; and (2) Proposition 121 reduces the Colorado corporate and individual income tax rate from 4.55% to 4.40% for tax year 2022 and future years. The measures took effect upon the governor's proclamation.
Colorado: The Colorado Department of Revenue issued for public comment draft Proposed Rule 39-22-104(3)(d) on the requirement for individuals, estates and trusts (collectively, "taxpayers") to addback to federal taxable income (FTI) state income taxes deducted under IRC §164(a)(3), including a taxpayer's share of state income taxes deducted by a partnership or S corporation in which the taxpayer is a partner or shareholder. The general rule is that taxpayers who deducted state income tax for federal income tax purpose would have to add back to FTI an amount equal to the deduction claimed. Partners would have to add back to their FTI their share of any state income tax deducted by the partnership for the tax year, regardless of the state to which the tax was paid or accrued. The amount the partner would have to add back is the partner's distributive share of the deduction claimed by the partnership, for federal income purposes, of partnership taxable income or loss. Resident shareholders of an S corporation must add back to their FTI their pro rata share of any state income tax deducted by the S corporation. Nonresident shareholder would add back to FTI their pro rata share of any Colorado income tax deducted by the S corporation. Comments on the draft rule are due by Jan. 31, 2023. Additional information about the proposed rule is available here.
Iowa: Gain the parent entity, an S corporation, would realize from the proposed sale of all its stock in its wholly owned qualified subchapter S corporation subsidiary (Qsub), which operates as a financial institution in Iowa, would not be included in the Qsub's calculation of net income for Iowa franchise tax purposes. In reaching this conclusion, the Iowa Department of Revenue (IA DOR) explained that because Iowa follows federal treatment of S corporations and Qsubs, the Qsub is treated as a disregarded entity and all of its income and activity is reported on its parent's income tax return. Further, when a financial institution is not subject to federal income tax and its shareholders are taxed on income, this tax treatment in disregarded, and the financial institution calculates net income as though it were subject to federal income tax instead of income passing through to its shareholders. Under federal law, a parent S corporation's sale of 100% of its stock in a Qsub terminates the Qsub treatment, the sale is treated as the sale of the assets of the Qsub and the Qsub is treated as a new corporation acquiring all of its asset right before termination. Under this transaction, the gain realized by the transfer of assets would be realized by the parent S corporation. Since the Qsub would not realize gain from the transaction, no gain would be included in the Qsub's calculation of net income for Iowa franchise tax purposes. In the Matter of Peoples Savings Bank, Dck. No. 207171 (Iowa Dept. of Rev. Nov. 18, 2022).
Missouri: The Missouri Department of Revenue adopted emergency rule 12 CSR 10-2.436 "SALT Parity Act Implementation" to provide guidance on how a partnership or S corporation can elect to be an affected business entity subject to the pass-through entity tax, and return filing requirements and estimated tax and withholding obligations of an affected business entity. Starting with tax years ending on or after Dec. 31, 2022, a partnership or S corporation can elect to be an affected business entity for the tax year. The election is made annually on the entity's affected business entity tax return (Form MO-PTE). For the election to be effective, the partnership or S corporation must have designated a person as an affected business entity representative for that tax year by the time the partnership or S corporation attempts to make the election. Form MO-PTE must include the signature of either: (1) each member of the electing entity that is a member at the time the affected business entity tax return is filed; or (2) an officer, manager or member of the electing entity who is authorized to make the election and attests to having such authority. The deadline for making the election is the filing deadline for Form MO-PTE; an election cannot be made after the deadline, including approved extensions. Once the election is made, it cannot be revoked for the tax year. The emergency rule provides guidance on how to designate a person as an affected business entity representative and describes the qualifications necessary to be such representative. Lastly, the rule (1) makes clear that an election to be affected business entity does not relieve a partnership or S corporation of its withholding obligations; (2) sets forth the due date of the affected business entity tax, including when an extension is granted; and (3) describes how to compute the tax credit granted to members of an affected business entity. The emergency rule, which was adopted Dec. 27, 2022, is effective Jan. 11, 2023 to July 9, 2023. The emergency rule along with a proposed rule will be published in the Feb. 1, 2023, Missouri Register.
Oregon: The Oregon Department of Revenue (OR DOR) posted additional FAQs on its elective pass-through entity (PTE) tax. The OR DOR explained that payments cannot be transferred from one taxpayer/account to another and that it cannot transfer payments from an individual account to a PTE. The OR DOR, however, can move a payment that was meant for the PTE tax when an incorrect voucher was used. The OR DOR further explained that the residency status of the owner does not factor into the calculation of the tax at the PTE level; rather, the PTE tax is based on the income of the PTE's Oregon source income. The OR DOR also noted that limited liability entities not set up as a partnership or an S corporation may have trouble registering. Additional information on Oregon's elective PTE tax is available here. Ore. Dept. of Rev., Help with Common Pass-Through Entity Elective Tax (PTE-E) Questions (Dec. 21, 2022).
SALES & USE
Multistate: The EY Sales and Use Tax Quarterly Update provides a summary of the major legislative, administrative and judicial sales and use tax developments. Highlights of this edition, include a review of the most recent developments involving nexus, tax base and exemptions, technology, and compliance and controversy. See Tax Alert 2023-0033 for a copy of the quarterly update.
Alabama: Contracts a company entered-into with several convenience stores (the "proprietors") for placement, servicing and maintaining "bona fide coin-operated amusement machines" in the proprietors' location in exchange for a share of net revenue from the machines constituted joint ventures rather than rental agreements. In so holding, the Alabama Tax Tribunal citing Birmingham Vending,2 found the following contract provisions supportive of this conclusion: (1) the specification that the company is in business of providing, leasing, renting, operating, servicing, maintaining and repairing machines; (2) that it is mutually beneficial for each party entering into the agreement for the placement, servicing and maintaining of the machines at the proprietors' locations; and (3) that the company and proprietors share the responsibilities for and control of the machines as well as the revenue. Because the company was part of a joint venture, it, along with the proprietors, is liable for sales tax. The Tribunal further found that the Alabama Department of Revenue is permitted to assess the company for sales tax on 100% of the gross receipts, but again citing Birmingham Vending, noted that "the better practice would be to include both parties to the joint venture on the assessment." The Tribunal also determined that tax should be calculated on the total wagers placed using the machines. Pinnacle Amusement, LLC v. Ala. Dept. of Rev., Dkt. No. S. 19-1105-LP (Ala. Tax Trib. Dec. 29, 2022).
District of Columbia: Emergency law (B24-1160), the "Tourism Recovery Tax Emergency Amendment Act of 2022" temporarily increases the rate of the additional sales and use tax imposed on gross receipts for transient lodgings or accommodations. Effective for the period beginning April 1, 2023 to March 31, 2027 the rate of tax is increased to 1.3% (from 0.3%). D.C. Laws 2022, A24-0703 (B24-1160), signed by the mayor Dec. 22, 2022; expires March 22, 2023. A temporary act, B24-1161, which would be effective for 225 days, has been sent to the mayor; once approved by the mayor, the temporary act will be sent to Congress for a mandatory 30-day review period.
Kentucky: On Jan. 1, 2023, over 30 services became subject to Kentucky's sales and use tax (see, Ky. Laws 2022, HB 8). The Kentucky Department of Revenue is in the process of posting FAQs on these newly taxable services to its website. Recently added FAQs address the following: (1) employer recruitment services, (2) lobbying services, (3) testing services, (4) photography and photo finishing services, (5) massage services, and (6) cosmetic surgery procedures. For a list of the newly taxable services, see Tax Alert 2022-0564.
Utah: Adopted amendments to rule R865-19S-92 clarify that the sale, rental or lease of custom computer software constitutes the sale of a personal service not subject to the state's sales and use tax. This rule change took effect Dec. 13, 2022. Utah Tax Comm'n, R865-19S-92 (Utah State Bull. Jan. 1, 2023 (adopted); Utah State Bull. Oct. 15, 2022 (proposed)).
Washington: The Washington Department of Revenue adopted amendments to WAC 458-20-145 regarding the sourcing of sales of tangible personal property (TPP), retail services, extended warranties, digital products, digital codes and leases of TPP for state and local retail sales tax and business and occupation tax, and determining where the use occurred for purposes of sourcing state and local use tax. The rule is divided into the following parts: (1) general information; (2) general sourcing rules for most retail sales of TPP, extended warranties, digital products, digital codes, and other retail services; (3) special sourcing rules for retail sales of certain goods and services; (4) sourcing rules for leases and rentals of TPP; and (5) sourcing rules for use tax purposes (use tax sourcing rules vary depending on the object of use). The rules include illustrative examples and define various terms. In regard to the sourcing of digital products and codes, the rule provides guidance on general application to sales of such and references WAC 458-20-15503, which provides extensive guidance on sourcing sales of digital products and codes and sales that are unique to them. There are special sourcing rules for retail sales of the following: (1) watercraft; (2) modular, mobile and manufactured homes; (3) motor vehicles, trailers, semi-trailers and aircraft that do not qualify as transportation equipment; (4) florist sales; and (5) telecommunications services and ancillary services. The rule changes are effective Jan. 9, 2023. Wash. Dept. of Rev., WAC 458-20-145 (adopted Dec. 9, 2022).
Washington: The Washington Department of Revenue (WA DOR) issued an excise tax advisory (ETA) on rewards programs, specifically (1) the application of "sales price" to select types of rewards program awards, (2) the seller's tax liability when the customer redeems the award for the full price of a good or service, and (3) the tax treatment of reward programs that commingle awards representing taxable consideration and awards representing bona fide discounts. The WA DOR explained that reward programs representing consideration paid by the customer to the seller are not bona fide discounts and must be included in the sales price subject to sales and use tax when redeemed for the seller's goods or service. The WA DOR also considers awards that can be purchased for cash, redeemed for cash or converted to cash to be taxable consideration as cash equivalents. Awards that are bona fide discounts are excluded from the sales price (discount awards) unless the seller receives consideration from a third party as provided under Washington law. Bona fide discount awards include price reductions for a customer's membership in a seller's rewards program. In regard Regarding commingled awards, the WA DOR said sellers have two options: (1) the seller can accurately track the taxable and non-taxable awards until redeemed or (2) if accurate tracking cannot be done, the seller can prepay the tax at the time the award is issued. If one of these options is not followed, the WA DOR will presume these are awards taxable when redeemed. The presumption can be rebutted by a seller that maintains records that identify retail-taxable rewards within the comingled program. When a discount award is redeemed by the customer for taxable items and the seller does not receive additional consideration for the purchase from the customer or a third party, the seller will owe deferred sales/use tax on the item. The ETA includes illustrative examples. The WA DOR noted that this ETA does not address gift cards, gift certificates or discount vouchers redeemed in retail transactions. Wash. Dept. of Rev., ETA 3191.2022 "Rewards Programs" (Dec. 15, 2022).
Illinois: New law (HB 5189) modifies the "Reimagining Electric Vehicles in Illinois Act". The new law revises the definition of "electric vehicle component parts manufacturer" to mean "a new or existing manufacturer that is focused on reequipping, expanding, or establishing a manufacturing facility in Illinois that produces parts or accessories used in electric vehicles, … including advanced battery component parts." As previously defined, such manufacturer had to be primarily focused on reequipping, expanding, or establishing a manufacturing facility in Illinois that produces advanced battery components or components that directly support the electric functions of electric vehicles. The new law also modifies the definition of "retained employee" to change the requirement that the employee's job duties be "directly and substantially" related to the project to just "directly" related to the project. These changes apply to agreements entered-into after this Act's effective date. The new law also permits a taxpayer with a project that (1) is subject to an existing agreement under the Economic Development for a Growing Economy Tax Credit Act (EDGE) and (2) meets the requirements to be designated as a REV Illinois project, to apply to amend the agreement to designate the project as a REV Illinois project. If such project ceases to qualify as a REV Illinois project before the termination or expiration of an agreement because the taxpayer is no longer an electric vehicle manufacturer, an electric vehicle power supply equipment manufacturer, an electric vehicle component manufacturer, or a battery recycling and reuse manufacturer, that project may still receive EDGE tax credits provided the project still qualifies for that credit. In addition, the law increases the amount of credit available instances, including the project is in an underserved area or an energy transition area. The new law includes an option to renew the agreement for an additional term, not to exceed a specified period (e.g., 10 or 15 years). The new law took effect upon becoming law. Ill. Laws 2022, Pub. Act 102-1112 (HB 5189), signed by the governor on Dec. 21, 2022.
Nebraska: The Nebraska Department of Revenue (NE DOR) issued guidance on how the Register of Deeds (Register) should treat transfers of real property under IRC §1031's like-kind exchange provisions. While gains and losses from these transfers are not recognized for income tax purposes at the time of transfer, such transfer remains subject to Nebraska's documentary stamp tax. Thus, documentary stamp tax would be collected on (1) the transfer from "A" to "B", and (2) the transfer from "B" to "A". In the case of a reverse 1031 exchange when the owners transfer their property to an accommodation titleholder or exchange accommodation titleholder (collectively, "accommodation titleholder") who then transfers the properties to the respective buyers, the NE DOR said that the transfer from the original owners to the accommodation titleholder generally would be exempt under Neb. Rev. Stat. §66-902(4). The NE DOR noted that certain language must be included in exchange accommodation agreement. Neb. Dept. of Rev., Directive 22-4 (Dec. 8, 2022).
Michigan: The Michigan Department of Treasury (MI DOT) issued an updated bulletin on penalty provisions and the administrative rules on waiver of penalty for reasonable cause. The MI DOT described how discretionary penalties — i.e., fraud, intentional disregard and negligence — and non-discretionary penalties — i.e., failure to file a tax return, failure to pay a tax, failure to pay withholding tax according to the federal schedule (where required) and failure to file an information return — are applied. In terms of discretionary penalties, the MI DOT determines which penalty applies based on specific facts, circumstances and taxpayer's intent. The MI DOT noted that if a discretionary penalty applies to any part of a deficiency, the penalty generally applies to the entire deficiency for the tax year. In regard to non-discretionary penalties, the MI DOT explained that these penalties, except for information returns, are a percentage of tax due. A combined maximum penalty of 25% applies to failure to file and/or pay. The MI DOT defined each discretionary and non-discretionary penalty and provided examples of the penalties. Other topics covered by the guidance include non-negotiable remittance, imposition of simultaneous penalties, objections and defenses to penalties, waiver of penalties for reasonable cause, and frivolous penalties. Lastly, the updated bulletin clarifies the MI DOT's administrative program for taxpayer-initiated disclosures. Mich. Dept. of Treas., RAB 2022-24 (Dec. 9, 2022)(replaces RAB 2005-3).
Minnesota: The Minnesota Department of Revenue issued guidance on the state's substantial understatement penalty, stating that its position is that the terms "substantial authority" and "reasonable basis" in Minn. Stat. § 289A.60, subdivision 4(d) have the same meaning given in the comparable federal understatement penalty under IRC § 6662, as reflected in federal definitions under Treas. Reg. §§ 1.6662-4(d)(2), -4(d)(3)(i) and (ii), and 1.6662-3(b)(3), and cross-referenced language in Minnesota statutory law. Minn. Dept. of Rev., Revenue Notice #22-03: Civil Procedures — Substantial Understatement Penalty (Dec. 12, 2022).
PAYROLL & EMPLOYMENT TAX
Multistate: To assist you in reviewing your state and US territory income tax withholding rates for 2023, the chart provided in Tax Alert 2023-0027 contains hyperlinks to the most recent income tax withholding formulas/tables published by the states and US territories, information concerning their respective highest income tax withholding rates (based on their percentage method of withholding) or flat tax withholding rates, and their supplemental withholding rates, if applicable. Updates to the chart will be available in our 2023 Employment tax rates and limits report, anticipated to be available in late January 2023, and updated throughout the year. You can find the report, once available,here.
Massachusetts: The Massachusetts Department of Revenue announced in TIR 22-15 that beginning in 2023, the law conforms to the federal Internal Revenue Code in determining the tax-free limit that applies to employer-provided parking, transit passes and commuter highway vehicle benefits. Accordingly, effective Jan. 1, 2023, the Massachusetts monthly exclusion for employer-provided parking is $300 and $300 for the combined total of transit pass and commuter highway vehicle benefits. For additional information on this development, see Tax Alert 2022-1942.
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 See Home Depot USA, Inc. v. Levin, 2009 Ohio 1431.
2 Birmingham Vending Co. v. State, 251 Ala. 584, 38 So. 2d 876 (Ala. 1949).