February 21, 2023
State and Local Tax Weekly for February 10
Ernst & Young's State and Local Tax Weekly newsletter for February 10 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.
Texas Comptroller summarizes federal internal use software statutes and regulations incorporated-by-reference into Texas law for purposes of the state's R&D credit
The Texas Comptroller of Public Accounts (Comptroller) issued a memo summarizing federal statutes and regulations related to Internal Use Software it recognizes as incorporated-by-reference for purposes of the state's franchise and sales/use tax R&D credits under 34 TAC §§ 3.340 and 3.599, following the amendment of these rules in 2022 (hereafter, "current rules"). Tex. Comp. of Pub. Accts., STAR No. 202302001L (Feb. 6, 2023).
Before the 2022 amendments to the Texas R&D credit rules (prior rules), the Comptroller only recognized federal regulations if taxpayers were required to apply those regulation to the 2011 federal income tax year. Under the current rules, the Comptroller recognize the federal regulations if taxpayers were allowed to apply them to their 2011 federal income tax year. In regard to Internal Use Software, the prior rules did not recognize any federal regulations as incorporated-by-reference into Texas law. The current rules, however, recognize that for the 2011 federal income tax year, federal regulations allow taxpayers to elect between two different versions of Treas. Reg. §1.41-4(c)(6) — the version of the regulation adopted in 2003 (contained in IRB 2001-5) and the version of the regulation proposed in 2002 (contained in IRB 2002-4). The Comptroller noted that the elected version must be applied in-full; taxpayers "do not have the option to elect between different provisions within those versions".
The Comptroller's memo describes the requirements of the two versions of Treas. Reg. §1.41-4(c)(6) and highlights provisions in the two versions that: (1) are identical, (2) cover the same topic but with differences, and (3) are unique to only one of the versions. Identical provisions include the general rule and exemptions from Internal Use Software treatment, computer services, and high threshold of innovation test (2 of 3 parts). Provisions with differences are definition of Internal Use Software, hardware and software developed together as a single product, and high threshold of innovation test (1 of 3 parts and application of test). Provisions of Treas. Reg. §1.41-4(c)(6) unique to the version in IRB 2001-5 include the exception for software used to provide noncomputer services (examples are provided).
The Comptroller's memo also addresses several differences in the final 2016 version of the regulation and the versions incorporated-by-reference into Texas law. The Comptroller said that "[p]rovisions and concepts in the 2016 version of these regulations, not present in the regulations incorporate-by-reference, do not apply." These provisions in the 2016 version are definition of Internal Use Software, interaction with third parties, and dual function software.
The memo includes a side-by-side comparison chart of the two versions in IRB 2001-5 and IRB 2002-4, along with the Comptroller's notes on any differences.
Governor Budget Proposals/State-of-State
Connecticut: On Feb. 8, 2023, Governor Lamont presented his 2023 Legislative Proposals and Budget Priorities. The governor noted that since the state has more than $3 billion in reserves and has experienced four consecutive budget surpluses, the state does "not need to automatically resort to painful service cuts or tax increases." The governor, however, did caution that "[w]hile the economic news has been mostly positive, the state must be prepared for a future economic downturn by ensuring new spending and tax cuts are sustainable." Tax proposals mentioned in the full budget book include: (1) decreasing the individual income tax rate for certain taxpayers and increasing the earned income tax credit; (2) restoring the original pass through entity (PTE) tax rate to 93.01% (from 87.50%) and making the PTE tax elective; (3) doubling the existing corporate human capital investment tax credit from 5% to 10%; and (4) maintaining the 10% corporate tax surcharge, which is set to expire in 2023, through income year 2025.
Michigan: Tax related recommendations in Governor Gretchen Whitmer's FY 2024 budget "Building a Brighter Future" (Feb. 8, 2023) include: (1) temporarily pausing a portion of sales and use tax on the purchase of electronic vehicles (EV) — the exemption would be up to $2,400 off the first $40,000 of the purchase price of the EV; (2) providing $200 million over 10 years for the onshoring clean energy supply chain tax credit; (3) rolling back the retirement tax; and (4) expanding the working families tax credits.
Oklahoma: In his 2023 State of the State address (Feb. 6, 2023), Governor Kevin Stitt said he wants to cut taxes. The governor's proposed cuts would eliminate the state's grocery tax and reduce the personal income tax rate to 3.99%.
Tennessee: In his 2023 State of the State address (Feb. 6, 2023), Governor Bill Lee said the state would be cutting taxes again. The governor is proposing a three-month break from grocery taxes, and he introduced the Tennessee Works Act, which would provide annual tax relief to small businesses and "expand Tennessee's competitive edge". The governor also would add $250 million to the state's rainy-day fund and revitalize the state's 175 brownfields.
In his FY 2023-24 Budget (Feb. 6, 2023), the governor described the "Tennessee Works Tax Reform Act of 2023". This proposal would make modifications to various taxes, including sales and use, excise, franchise and business taxes. Specifically, the proposal would:
Illinois: The Illinois Department of Revenue adopted amendments to 86 Ill. Adm. Code 100.2330 that implement Pub. Act 102-0669's changes to the Illinois net loss deduction that extended the carry forward period to 20 years for losses incurred in tax years ending on or after Dec. 31, 2021. Net losses incurred before Dec. 31, 2021, can be carried forward for 12 years following the tax year of the loss; however, such losses that had not expired as of Nov. 16, 2021 (the effective date of Pub. Act 102-0669) can be carried forward 20 years following the taxable year of loss. The amended rule took effect Jan. 24, 2023. Ill. Dept. of Rev., 86 Ill. Adm. Code 100.2330 (Ill. Register Vol. 47, Issue 6, Feb. 10, 2023).
Tennessee: The Tennessee Department of Revenue (TN DOR) announced that it is updating its Franchise and Excise Tax manual discussion on foreign derived intangible income (FDII). The TN DOR said that manual currently indicates that Tennessee has decoupled from the provision in IRC §250 which allows a deduction for FDII. After reviewing this issue, the TN DOR has determined that while Tennessee has decoupled from the provision of IRC §250 that allows a deduction for global intangible low-taxed income, it has not decoupled for purposes of the FDII deduction. The TN DOR said that taxpayers in computing net earning under Tenn. Code Ann. §67-4-2006, are entitled to the full amount of FDII deducted for federal purposes. Tenn. Dept. of Rev., Tax Manuals webpage: Overview of upcoming tax manual updates "Excise Tax Update — Foreign Derived Intangible Income" (published Jan. 26, 2023).
SALES & USE
North Carolina: In affirming the final decision of the North Carolina Office of Administrative Hearings, a North Carolina Superior Court found a company that regularly purchased raw materials to create hot mix asphalt it used in fulfilling its existing construction contracts and sold the remaining amounts to third parties qualified as a manufacturer for purposes of the Mill Machinery Exemption. Thus, the company's out-of-state purchases of raw materials were subject to the lower 1% privilege tax rather than the higher sales or use tax. At issue in this case is whether the company qualified as a "manufacturing industry or plant." The superior court explained that statutory law "did not expressly define the phrase 'manufacturing industry or plant', or, … any variation of the word 'manufacture,'" but case law describes "manufacturing" as "the producing of a new article or use or ornament by the application of skill and labor to the raw materials of which it is composed."1 The North Carolina Department of Revenue (NC DOR) argued that the company did not qualify as a "manufacturing industry or plant" because it was a contractor and that its creation of hot mix asphalt, by itself, was not enough to transform it into a "manufacturing industry or plant"; rather to qualify for the exemption, the company had to be primarily or principally engaged in the sale of the hot mix asphalt it produced. The company, however, asserted that "as long as it purchased the [tangible personal property] at issue in order to produce [hot mix asphalt] that it then proceeded to use for any business-related purpose, it should be deemed a 'manufacturing industry or plant' for purposes of the exemption." In ruling in favor of the company, the superior court rejected the NC DOR request that this court "infer from the Supreme Court's reasoning in Clayton-Marcus2 a requirement that in order to qualify for the Mill Machinery Exemption a taxpayer must use the purchased tangible personal property to produce a product … for the primary or principal purpose of selling it to third parties." The superior court said it could not find support for the NC DOR's interpretation, further noting that the statutory language for the exemption did not contain such a requirement. The superior court also found that the North Carolina Supreme Court's ruling in Midrex3 suggests a case-by-case approach, rather than an across-the-board approach, of a judicially imposed "primary or principal use" requirement in tax statutes providing special treatment for taxpayers engage in certain activity. Here, the superior court determined that the company manufactured "extremely large" quantities of hot mix asphalt and it did so by utilizing a "manufacturing" process. Accordingly, the company is entitled to the Mill Machinery Exemption. N.C. Dept. of Rev. v. FSC II, LLC, No. 22 CVS 5410; 2023 NCBC 9 (N.C. Super. Ct., Wake Cnty., Jan. 30, 2023).
South Dakota: New law (SB 30) modifies South Dakota's sales and use tax nexus provisions, eliminating the 200 separate transactions threshold. Under South Dakota's modified provisions, nexus will be created if the seller's gross revenue from sales of tangible personal property, products transferred electronically or services in the state exceeds $100,000. This change takes effect July 1, 2023. S.D. Laws 2023, SB 30, signed by the governor on Feb. 9, 2023.
South Dakota: New law (SB 58) clarifies that the 4.5% special amusement excise tax applies to receipts from the sale of any mechanical or electronic amusement device (this is in addition to receipts from the operation of such devices). This change applies July 1, 2023. S.D. Laws 2023, SB 58, signed by the governor on Feb. 9, 2023.
Federal: In Notice 2023-16, the IRS and Treasury modified earlier guidance on the definition of clean vehicles for purposes of the IRC § 30D credit. With the modifications, the forthcoming proposed regulations previously announced in Notice 2023-1 will provide that the fuel economy labeling regime under 40 CFR 600.315-08 is the basis for determining whether a vehicle is a van, sport utility vehicle, pickup truck or other vehicle eligible for the credit. For additional information on this development, see Tax Alert 2023-0251.
Illinois: New law (SB 2951) creates new, and modifies various existing, credit and incentive programs. The new law creates the Invest Illinois Act to provides incentives and ready access to capital to encourage and promote the retention and expansion of existing businesses and industry within Illinois and attract new business and industry to the State. The law allows the Illinois Department of Commerce and Economic Opportunity (DCEO) to make non-competitive economic incentive awards, such as grants and loans, to taxpayers that operate or plan to operate an eligible business4 in Illinois (i.e., "applicant") and that pledge to make capital investments and create new jobs, or retain jobs, in the State. To qualify for incentives, an applicant must be in good standing with Illinois law and the law in all other states where it was formed or is organized and owe no delinquent taxes to Illinois. The DCEO cannot award incentives under this program to an applicant that closes, or reduced by more than 50%, operations at one location in Illinois and relocates substantially the same operations to another location in the State. This prohibition does not apply if the relocation was done for the purposes of expanding business operations in the State and the expansion could not reasonably be accommodated within the municipality or county where the business was previously located. These incentives also cannot be awarded to professional sports organization moving from one location in the State to another in-state location. The law also describes (1) the information that must be detailed in the application, (2) the factors the DCEO will consider in determining projects eligible to receive the incentives, (3) the provisions that must be included in the agreement between the DCEO and the applicant (e.g., performance conditions), and (4) the penalties that may be imposed if the applicant fails to comply with the performance conditions set forth in the agreement. The DCEO is required to submit an annual report to the General Assembly and Governor that includes information on such things as the number of new jobs created/retained, progress of applicants in meeting the terms of the agreement, and wages paid to full-time employees.
Other credit and incentive changes in the law:
These changes took effect upon becoming law. Ill. Laws 2023, Pub. Act 102-1125 (SB 2951), signed by the governor on Feb. 3, 2023.
Nebraska: The Nebraska Department of Revenue issued guidance on personal property assessment. Under Nebraska law, depreciable tangible personal property used in a trade or business is subject to net book personal property tax if it has a life of more than one year. The guidance lists exempt tangible personal property, such as livestock, business inventory, personal property owned for purposes of leasing or renting if certain conditions are met, among other items. Personal property located in Nebraska is valued as of Jan. 1, 12:01 a.m. of each year; it must be owned as of that date to be subject to tax. Personal property is listed at the location of the business, unless it has acquired a local situs elsewhere, which occurs when the property is kept in a location other than the business location for a greater portion of the calendar year. Information needed to determine Nebraska net book value includes the Nebraska adjusted basis, the year placed in service and the recovery period. Net book value is calculated by multiplying the Nebraska adjusted basis of the tangible personal property by the Nebraska depreciation factor (i.e., the percentage of Nebraska adjusted basis that is taxable), based on the recovery period and year for the item of personal property. Other topics addressed by the guidance include: (1) filing requirements and penalties for failure to file; (2) recovery period for certain farm machinery and equipment; (3) IRC §179 deductions; (4) dissolution or reorganization of a corporation, partnership or trust; (5) involuntary conversion; (6) items with repairs; (7) trade-in personal property, leased personal property, conditional sales, and personal property for both business and personal use; (8) amended federal income tax return or changes to federal return by the IRS; (9) omitted personal property; (10) protest of value or penalties; (11) taxes due; and (12) personal property sold or removed before the current year's taxes have been calculated. Neb. Dept. of Rev., Information Guide "Personal Property Assessment" (Feb. 2023).
PAYROLL & EMPLOYMENT TAX
Multistate: The 2023 edition of our US employment tax rates and limits report, which includes key federal and state payroll tax rates and wage limits, has been released. The report, US employment tax rates and limits for 2023 includes: (1) social Security wage base for 2023; (2) qualified pension plan limits for 2023; (3) health Savings Account limits for 2022 and 2023; (4) fringe-benefit inflation adjustments and Form W-2 penalties for 2023; (5) federal mileage rates and luxury vehicle limit for 2023; (6) per diem rates under high-low substantiation method for 2023; (7) 2021–2022 FUTA credit reduction; (8) state unemployment insurance wage base limits and tax rates for 2023; (9) disability and paid family leave insurance wage base and rates for 2023; (10) federal income tax withholding for 2023; and (11) state income tax withholding tables and supplemental withholding rates for 2023. For more on this development, see Tax Alert 2023-0249.
Massachusetts: Due to legislation enacted as part of the Massachusetts fiscal year (FY) 2023 budget, the Massachusetts Department of Revenue issued a draft Technical Information Release (TIR) explaining the state's tax treatment of certain fringe benefits which, effective Jan. 1, 2022, conform to the Internal Revenue Code (IRC) as amended on Jan. 1, 2022. Prior to the passage of the FY 2023 budget, Massachusetts law (Section 62) generally conformed to the IRC as amended on Jan. 1, 2005. The draft TIR identifies the following fringe benefits as impacted by the law change: (1) employer payments of student loans; (2) employer-provided transportation fringe benefits; (3) qualified moving expense reimbursements; (4) limitation on deduction by employers of expenses for fringe benefits; and (5) employer-provided adoption assistance. For more on this development, see Tax Alert 2023-0236.
Wednesday, March 1, 2023. Domestic tax quarterly webcast series: a focus on state tax matters (1:00-2:30 p.m. EST). For our first quarterly webcast in 2023, we welcome Douglas L. Lindholm, President and Executive Director of the Council On State Taxation, who will join us to discuss important state and local tax policy considerations that are emerging in 2023. Topics to be discussed include an update on the current state of the states, governors' budget initiatives, state and local tax legislative proposals, and the effects of current economic trends on state and local tax policy developments around the country. EY state and local tax professionals from California, Georgia, Illinois, New York, Texas and Washington will join in these discussions and highlight key state and local issues in their states. Register here.
Friday, March 10, 2023. State & local tax developments in the real estate industry: Updates on state pass-through entity taxes and budget legislation (1:00-2:00 p.m. ET). Three months into 2023, the US economy continues to take center stage, with questions about how sectors such as real estate, hospitality, and construction may be affected. Meanwhile, in their ongoing budget sessions, some states are proposing state and local tax (SALT) revenue raisers while others are proposing tax cuts, depending on the jurisdiction. At the federal level, policymakers continue to debate the SALT deduction cap for US federal income tax purposes. At the same time, states continue to rapidly enact new pass-through entity (PTE) taxes to address the SALT cap. State tax measures targeting high-net-worth individuals and corporate profits are also gaining steam with coordinated efforts by some state lawmakers. Join our panel of experienced SALT professionals for a discussion of these topics, including: (1) major state budget legislative tax proposals, (2) elective state PTE tax updates, (3) 2022 ballot initiatives ? what passed and what did not, and (4) other recent SALT legislative activity affecting the real estate sector. 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 Citing Duke Power Co. v. Clayton, 274 N.C. 505, at 513 (N.C. S.Ct. 1968).
2 In re Clayton-Marcus Co., 286 N.C. 215 (N.C. S.Ct 1974) (taxpayer did not manufacture swatch books it gave to potential customers within the meaning of the exemption).
3 Midrex Techs. v. N.C. Dept. of Rev., 369 N.C. 250 (N.C. S.Ct. 2016).
4 An "eligible business" is defined as a "business that is engaged in manufacturing, processing, assembling, warehousing, or distributing products, conducting research and development, providing tourism services, or providing commercial services in office industries or agricultural processing." The term does not include retailers or those providing health or professional services.