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Ernst & Young's State and Local Tax Weekly newsletter for May 19 and May 26 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.

TOP STORIES

Tennessee enacts sweeping tax changes, including phase-in of single-sales factor apportionment

On May 11, 2023, Governor Bill Lee signed into law the Tennessee Works Tax Act (HB 323/SB 275), which implements tax relief provisions he proposed as part of his budget. Changes in the law include the phase-in of a single-sales factor apportionment formula, conformity to federal bonus depreciation provisions in the federal Tax Cuts and Jobs Act of 2017 (TCJA), a three-month sales tax holiday for food, and sales and use tax sourcing provisions. The changes discussed below have various effective dates; however, unless otherwise specified, the changes took effect upon becoming law.

Single-sales factor apportionment — applicable to both the excise tax and the franchise tax: A single-sales factor apportionment formula is phased in over three years, with a full phase-in starting in tax years ending on or after Dec. 31, 2025, and applies for purposes of determining net earnings under the excise tax and net worth under the franchise tax.¹

A taxpayer can annually elect to use the triple-weighted receipts factor apportionment formula (i.e., property, payroll, three times receipts with a denominator of five) that applied to tax years ending before Dec. 31, 2023. The election, however, must result in a higher apportionment ratio for the tax year than the standard apportionment formula in effect for the tax year, and the taxpayer must have net earnings (not a net loss).

For taxpayers principally engaged in the sale of telecommunications service, mobile telecommunications service, or internet access service, net earnings for a "qualified member" of a "qualified group" (as these terms are defined in Tenn. Code Ann. § 67-4-2012(j)) are apportioned to Tennessee using a triple-weighted receipts factor apportionment formula for tax years ending on or after Dec. 31, 2023.²

Other excise tax and franchise taxes changes: The law conforms the excise tax to federal bonus depreciation in the TCJA, applicable to assets purchased on or after Jan. 1, 2023. For these assets, net earnings or net loss is computed under IRC § 168 (Accelerated Cost Recovery System) as amended by the TCJA. The law also limits the requirements to add back or subtract certain depreciation³ deducted in computing federal taxable income to assets purchased on or before Dec. 31, 2022. See also, Tenn. Dept. of Rev., Notice #23-07 (May 2023).

For tax years ending on or after Dec. 31, 2024, the law establishes a standard excise tax deduction equal to the lesser of net earnings or $50,000, provided the amount does not create or increase a net loss. See also, Tenn. Dept. of Rev., Notice #23-04 (May 2023).

The law amends the certified distribution sales election, expanding the definition of "certified distribution sales" to include certain sales of alcoholic beverages to affiliates and to allow the taxpayer's affiliates to qualify for the application of these provisions. These changes took effect upon becoming law and apply to tax years ending on or after Dec. 31, 2023. Starting in 2025, the law reduces the receipts-factor threshold a taxpayer must meet from 10% to 7.5%, to qualify for the certified distribution sales election.

The law extends to 25 years from 15 years the carryforward provisions for certain franchise and excise tax credits earned in tax years ending on or after Dec. 31, 2008. The credit carryforward applies to the following credits: (1) industrial machinery credits, (2) brownfield property credits, (3) job tax credits, (4) community investment credits, (5) qualified production credits, and (6) paid family and medical leave credits. See also, Tenn. Dept. of Rev., Notice #23-06 (May 2023).

The law establishes a two-year pilot program during which a taxpayer may claim a state-paid family leave tax credit against excise and franchise taxes. Under this program, taxpayers must add back to net earnings or net losses any amount deducted for the federal employer tax credit under IRC § 45S (i.e., employer credit for paid family and medical leave) and earned as a credit against Tennessee excise tax. Taxpayers may claim a credit against the excise tax and the franchise tax equal to the federal employer tax credit resulting from compensation paid in Tennessee during the tax period. The credit, however, cannot exceed 50% of the combined excise and franchise tax liability shown on the taxpayer's return before the credit is taken. Taxpayers may carry forward unused credits until taken, but not for more than 25 years. The addback is required, and the credit is allowed, for tax years ending on or after Dec. 31, 2023, but before Dec. 31, 2025. See also, Tenn. Dept. of Rev., Notice #23-10 (May 2023).

Beginning with tax years ending on or after Dec. 31, 2024, the law exempts up to $500,000 of property from the property base of Tennessee's franchise tax. See also, Tenn. Dept. of Rev., Notice #23-05 (May 2023).

Business tax changes: The following changes were made to the business tax and apply to tax years ending on or after Dec: 31, 2023, unless otherwise noted:

• Taxpayers primarily engaged in the fabrication or processing of tangible personal property for resale and consumption off the premises are exempt from the business tax on sales of the property from the manufacturing location or from a storage or warehouse facility that is situated within a 10-mile radius of the manufacturing location (this change took effect upon becoming law).
• The law increases the filing threshold to $100,000 in gross receipts (from $10,000 in gross receipts), for state and local business taxes imposed for the privilege of making sales and engaging in a vocation, occupation, business or business activity.⁴
• The law increases the minimum threshold for filing a business tax return in a county or incorporated municipality (or both) in which the taxpayer is not domiciled or located (i.e., deemed location) to $100,000 (from $50,000) of compensation earned from contracts for work described in Classification 4 of Tenn. Code Ann. § 67-4-708(4) (i.e., a person primarily engaged in the business of contracting or performing a contract or engaged in one of the listed activities for a price, commission, fee or wage).
• The law decreases the business tax rate imposed on an industrial loan and thrift company required by law to obtain a certificate and a license to 0.1% (from 0.3%) of gross income.

Sales and use tax changes: The law establishes a three-month sales tax holiday for food. Sales tax will not apply to retail sales of food and food ingredients sold between 12:01 a.m. on Aug. 1, 2023, and 11:59 p.m. on Oct. 31, 2023. This exemption, however, does not apply to sales from a micro market or vending machine or device. See also, Tenn. Dept. of Rev., Notice #23-09 (May 2023).

Effective July 1, 2024, sales and use tax applies to (1) repairs of tangible personal property (TPP) or computer software, (2) the laundering or dry cleaning of TPP, (3) installing TPP that remains TPP after installation, and (4) installing computer software when the repair, cleaning or installation occurs at a place outside of Tennessee and the serviced TPP or computer software is delivered to a place inside the state's physical limits for use or consumption in Tennessee.

Effective July 1, 2024, the law repeals the sales and use tax exemptions for (1) magazines and books that are distributed and sold to consumers by US mail or common carrier for certain sellers, and (2) direct mail advertising materials by a person solely and exclusively in the business of providing cooperative direct mail advertising.

The law adds new sales and use tax provisions, Tenn. Code Ann. §§ 67-6-901 through 904, which apply when determining whether a transaction is sourced to Tennessee. These provisions discuss a wide variety of transactions, such as advertising, lease or rental of a product. They apply regardless of whether the product is TPP, a digital good, a service or other taxable product and only to determine a seller's or marketplace facilitator's obligation to pay or collect and remit a sales or use tax for the retailer's retail sale of a product. The law also amends sourcing rules under Tenn. Code Ann. § 67-6-905, adding definitions for multiple terms related to telecommunication services. These new provisions and amendments take effect July 1, 2024.

For more on this development, see Tax Alert 2023-0866.

INCOME/FRANCHISE

Indiana: New law (SB 419) updates Indiana's date of conformity to the Internal Revenue Code (IRC) to the IRC as amended and in effect on Jan. 1, 2023 (from March 21, 2021), effective retroactively to Jan. 1, 2023, but decouples from the Tax Cuts and Jobs Act changes to research or experimental (R&E) expenditures under IRC §174. Effective for tax years beginning after Dec. 31, 2021, the law requires a taxpayer, in determining adjusted gross income (AGI), to: (1) deduct the amount of specified R&E expenditure charged to the capital account under IRC § 174(a)(2)(A) for the tax year, and (2) add the amount deducted under IRC §174(a)(2)(B). (There are additional R&E provisions for taxpayers that own an interest in a partnership or an S corporation or if the deduction would be treated as a passive deduction under IRC § 469). These R&E modifications do not apply to taxpayers that are not required to charge specified R&E expenditures to capital account in determining federal AGI, regardless of whether the taxpayer elects to do so. Other income tax changes in the law: (1) create a new rule for the modification of Indiana AGI for taxpayers that are an organization with more than one unrelated trade or business subject to the provisions of IRC §512(a)(6) (this new rule applies to tax years beginning after Dec. 31, 2017); (2) modify the net operating loss (NOL) calculation; (3) create new NOL rules (i) for Indiana NOLs that arise after the application of IRC §512(a)(6), (ii) that apply to an Indiana NOL if the taxpayer had a discharge of indebtedness derived from Indiana sources that is excluded from gross income under IRC §§108(a)(1)(A), (B) or (C), (iii) for taxpayers that have an ownership change for which the limitations of NOLs under IRC §382 apply, and (iv) for two or more corporations that file a consolidated return or a combined return and have an Indiana NOL on a consolidated or combined basis for a tax year (these changes are effective retroactively to Jan. 1, 2023); (4) change the timing of when patent derived income exemption is claimed; and (5) clarify new elective pass-through entity tax, retroactively to Jan. 1, 2022. Ind. Laws 2023, Pub. Law 194 (SB 419), signed by the governor on May 4, 2023.

Indiana: New law (HB 1001) accelerates the individual income tax rate reduction and removes contingencies on further reductions. As originally enacted, the earliest the 2.9% rate could have been reached was 2029. Under HB 1001, the current 3.15% individual income tax rate will be reduced: (1) to 3.05% for tax years beginning after Dec. 31, 2023 and before Jan. 1, 2025; (2) to 3.00% for tax years beginning after Dec. 31, 2024 and before Jan. 1, 2026; (3) to 2.95% for tax years beginning after Dec. 31, 2025 and before Jan. 1, 2025; and (4) to 2.9% for tax years beginning after Dec. 31, 2026. Ind. Laws 2023, Pub. Law 201 (HB 1001), signed by the governor on May 4, 2023.

Maryland: New law (SB 240) requires a resident member of a pass-through entity (PTE), in calculating Maryland adjusted gross income to add back to income the amount of state income tax credit claimed based on tax imposed on any PTE by another state that is deductible in determining the PTE's income under the IRC. This change takes effect July 1, 2023, and applies to tax years beginning after Dec. 31, 2022. Md. Laws 2023, ch. 445 (SB 240), signed by the governor on May 8, 2023.

Maryland: New law (SB 968) modifies the definition of a captive real estate investment trust (REIT) for purposes of the addition modification for the amount of the federal dividends paid deduction claimed by a captive REIT, to expand the list of entities excluded from the definition of a captive REIT. The definition of captive REIT excludes corporations, trusts or associations that otherwise meets the ownership requirements for REIT and is more than 50% owned or controlled, directly or indirectly, by a "qualified foreign entity" or trusts in which a listed Australian Property Trust owns or controls, directly or indirectly, 75% or more of the voting power or value of the beneficial interest or shares of the trust. A "qualified foreign entity" is a corporation, trust, association or partnership that is organized under the laws of a foreign government and (1) at least 75% of the total asset value of the entity at the close of the entity's tax year is represented by real estate assets, cash and cash equivalents, and US government securities; (2) is not subject to tax on amounts distributed to the entity's beneficial owners or is exempt from entity-level tax; (3) annually distributes at least 85% of taxable income of the entity; (4) a single entity or individual does not own or control more than 10% of the voting power or value of the beneficial interests or shares of the entity or the beneficial interests or shares of the entity are regularly traded on an established securities market; and (5) the entity is organized in a foreign country that has a tax treaty with the US. This change takes effect July 1, 2023, and applies to all tax years beginning after Dec. 31, 2022. Md. Laws 2023, ch. 478 (SB 968), signed by the governor on May 8, 2023.

South Carolina: New law (HB 4017) updates the date of conformity of the South Carolina income tax law to the Internal Revenue Code (IRC) to Dec. 31, 2022 (from Dec. 31, 2021). If IRC sections adopted by South Carolina expired (in full or in part) on Dec. 31, 2022, are extended (but not amended) by federal enactment during 2023, they also will be extended for South Carolina income tax purposes in the same manner as extended for federal income tax purposes. HB 4017 took effect upon approval by the governor, May 16, 2023. S.C. Laws 2023, HB 4017, signed by the governor on May 16, 2023.

SALES & USE

Georgia: New law (HB 408) extends the sunset date for the sales and use tax exemption for competitive projects of regional significance to Dec. 31, 2026 (from June 30, 2023). Ga. Laws 2023, Act 350 (HB 408), signed by the governor on May 5, 2023.

Michigan: New law (HB 4054 and SB 97) expands the sales and use tax industrial processing exemption to include sales of tangible personal property that performs an industrial processing activity upon aggregate product or material (e.g., sand, gravel, crushed stone, slag, recycled concrete, recycled asphalt and geosynthetic aggregates) that will be used as an ingredient or component part for the construction, maintenance, repair or reconstruction of real property in Michigan if that aggregate product or material is subject to the use tax. The definition of "industrial processing" is expanded to include the production, manufacturing or recycling of aggregate by the property for such activity, as long as the aggregate is subject to use tax. The Michigan Department of Treasury (Department) has 90 days from this Act's effective date to cancel all outstanding balances related to such industrial processing activities and property on Notices of Intent to Assess and Final Assessments that were issued before the effective date of these provisions. After the effective date of these provisions, the Department cannot issue any new sales/use tax assessments on such industrial processing activities and property for any tax period before the effective date of this Act. The Department noted that the relief provided by the new law is limited to the cancelation of outstanding balances and prohibition of new assessments, the relief "do[es] not establish a right to a refund for sales tax or use tax on property used for processing aggregate that a taxpayer has already remitted to [the Department] prior to the [Law's] Effective Date." HB 4054 and SB 97 took immediate effect. Mich. Laws 2023, PA 30 (HB 4054) and PA 27 (SB 97), signed by the governor on May 8, 2023. See also, Mich. Dept. of Treas., Notice Regarding Expansion of the Industrial Processing Exemption to Address Property Use To Process Aggregate for Michigan Real Estate Projects (May 11, 2023).

Minnesota: New law (HF 2335) requires the Metropolitan Council to impose a 0.25% metropolitan region sales and use tax on retail sales made in, or to a destination in, metropolitan counties, effective for sales and purchases made after Oct. 1, 2023. A metropolitan county is any of the following counties: Anoka, Carver, Dakota, Hennepin, Ramsey, Scott or Washington. Minn. Laws 2023, ch. 37 (HF 2335), signed by the governor on May 15, 2023.

Mississippi: New law (SB 2862) exempts from Mississippi's sales tax sales of coins, currency and bullion. Coin or currency includes such manufactured in whole or in part of gold, silver, other metal or paper; bullion includes bar, ingot or coin manufactured, in whole or in part, of gold, silver, platinum or palladium. This exemption takes effect and is in force from and after July 1, 2023. Miss. Laws 2023, SB 2862, signed by the governor on April 19, 2023.

Oklahoma: New law (SB 463) extends the sunset date of the sales tax exemption for sales or leases of rolling stock through July 1, 2029 (from July 1, 2024) and eliminates the condition that the rolling stock be sold or leased by the manufacturer. These changes take effect Nov. 1, 2023. Okla. Laws 2023, SB 463, signed by the governor on May 2, 2023.

BUSINESS INCENTIVES

Federal: While the general three-year statute of limitations on assessment will expire on April 15, 2024, for 2020 employee retention credit claims (and April 15, 2025, for 2021 claims), the IRS has an additional two years from issuance of any refund to seek its repayment in court, even if the general three-year statute of limitations has expired. For additional information on this development, see Tax Alert 2023-0887.

Federal: In Notice 2023-38 (Notice), the IRS previewed the proposed regulations it intends to release on how taxpayers can qualify for the domestic content bonus for credits under IRC §§ 45, 45Y, 48 and 48E for qualified facilities, energy projects and energy storage technology. The Notice includes instructions on how to determine if the materials used in the projects meet the requirements, as well as recordkeeping and certification methods. For additional information on this development, see Tax Alert 2023-0908.

Arkansas: New law (HB 1746) expands the list of businesses eligible to apply for economic development incentives under the Arkansas Business and Technology Accelerator Act and the Consolidated Incentive Act of 2003 to include businesses primarily engaged in operating combustors and incinerators for the disposal of nonhazardous solid waste as classified in Code 562213 of the 2022 North American Industry Classification System. The law takes effect 90 days after the General Assembly adjourns sine die. Ark. Laws 2023, Act 834 (HB 1746), signed by the governor on April 13, 2023.

Georgia: New law (HB 482) revises the definition of "taxpayer" for purposes of the income tax credit for establishing or relocating quality jobs, to provide that an exempt organization is a "taxpayer" only to the extent that a trade or business operated by such organization generates unrelated business income (as defined under IRC § 512). Such organization's eligibility for this credit is based only on projects and investments related to the organization's trade or business; qualifying jobs are based solely on such trade or business. The law took effect immediately and applies to tax years beginning on or after Jan. 1, 2023. Ga. Laws 2023, Act 68 (HB 482), signed by the governor on May 1, 2023.

Tennessee: New law (SB 271/HB 319) authorizes a credit against the franchise and excise taxes equal to the remediation costs for brownfield property for a qualified development project in tier 3 or tier 4 enhancement counties. The credit is capped at $500,000 and it, combined with any carryforward taken against these taxes, cannot exceed 100% of the combined franchise tax and excise tax liability shown on the return before the credit is taken. Unused credit can be carried forward. Taxpayers must submit a claim for the credit, including documentation that shows the capital investment was made toward the qualified project during the investment period and the claimed costs are remediation costs. The credit cannot be claimed until the minimum capital investment has been met and the Tax Commissioner has approved the credit amount. These provisions take effect July 1, 2023. Tenn. Laws 2023, ch. 86 (SB 271/HB 319), signed by the governor on March 31, 2023.

PROPERTY TAX

Montana: New law (SB 178) considers digital assets to be personal property for property tax purposes. "Digital assets" are defined as "cryptocurrencies, natively electronic assets, including stable coins and nonfungible tokens, and other digital-only assets that confer economic, proprietary, or access rights or powers." This law took effect upon approval. Mont. Laws 2023, ch. 344 (SB 178), signed by the governor on May 2, 2023.

COMPLIANCE & REPORTING

Montana: New law (SB 24), effective for income tax periods beginning after Dec. 31, 2022, requires a corporation to electronically file its corporate income tax return along with the corresponding federal return filed with the IRS and all other related forms and schedules. For tax periods beginning after Dec. 31, 2023, a late filing penalty will be imposed on a corporation that fails to electronically file its return. For tax periods beginning between Jan. 1, 2023 and Dec. 31, 2024, a corporation will not be required to electronically file its return if it attests that its attempt to electronically file its return was unsuccessful or that hardship would result by filling electronically. For tax periods beginning after 2024, the Montana Department of Revenue may waive the electronic filing requirement if the corporation demonstrates that software is not readily available or that a hardship will result from filing electronically. The electronic filing requirement does not apply to corporations with gross receipts of $750,000 or less in a tax period. Mont. Laws 2023, ch. 225 (SB 24), signed by the governor April 24, 2023.

CONTROVERSY

Washington: The Washington Department of Revenue (WA DOR) adopted new rule WAC 458-20-10005, which lists the criteria it uses to decide whether a determination is precedential. Under the rule, the WA DOR may publish a determination and designate it as precedential when all of the following criteria are met, the determination: (1) is a well-reasoned application of the law to a specific set of facts; (2) addresses only the law and facts necessary to resolve the case; (3) is needed to (i) provide guidance on a previously unaddressed area of the law and articulate the WA DOR's current policy, (ii) apply the law to a significantly different set of facts, (iii) overrule a published determination, or (iv) provide a better or more current articulation on how the law should be interpreted; and (4) can be effectively sanitized (or the taxpayer waived the secrecy clause). WAC 458-20-10005 was adopted May 4, 2023, and takes effect June 4, 2023.

PAYROLL & EMPLOYMENT TAX

Multistate: Now that most employees have filed their 2022 personal income tax returns, employers can expect an increase in withholding tax questions and a rise in adjustments to federal and state withholding allowance certificates (e.g., federal Form W-4). Our special report provides information employers need to know about federal and state Form W-4 compliance. For more on this development, see Tax Alert 2023-0898.

MISCELLANEOUS TAX

District of Columbia: The District of Columbia Office of Tax and Revenue issued guidance on the tax treatment of refinances and modifications of security interest instruments (i.e., documents that evidence a security interest in real property). D.C. Off. Tax Rev., OTR Tax Notice 2023-04 (April 26, 2023) (supersedes OTR Tax Notice 2014-05).

Indiana: New law (SB 3) establishes a state and local tax review task force. The task force will review: (1) the state's near term and long term financial outlook and overall fiscal position; (2) the state's appropriation backed debt obligations; (3) funded status of state managed pension funds; (4) the individual income tax (including methods to reduce or eliminate the individual income tax); (5) the corporate income tax; (6) the state gross retail and use tax (including a review of the state gross retail tax base); (7) the property tax (including methods to reduce or eliminate the business personal property tax); and (8) local option taxes (including the local income tax, food and beverage taxes and innkeeper's taxes). The task force will meet at least four times in 2023 and in 2024, with its report to the legislative council due by Dec. 1, 2024. Ind. Laws 2023, P.L. 163 (SB 3), signed by the governor on May 4, 2023.

UPCOMING WEBCASTS

Wednesday, June 7, 2023. Domestic tax quarterly webcast series: a focus on state tax matters (1:00-2:30 p.m. EDT). For our second quarterly webcast in 2023, please join our panel to discuss important state tax policy developments, as well as international tax policy developments that could affect state and local taxes. Topics will include: (1) potential US state and local tax implications of the OECD's Model Rules for new global minimum taxes under Pillar Two of the BEPS 2.0 project; (2) state income tax considerations of credits enacted under the federal Inflation Reduction Act; (3) an update on state fiscal conditions; (4) highlights from the 2023 state legislative sessions; and (5) other state tax policy considerations, including non-legislative developments. To register for this event, go to State tax matters.

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.

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ENDNOTES

¹ Current law allows qualified manufacturers and financial asset management companies to elect single-sales factor apportionment. See Tenn. Code Ann. §§ 67-4-2012(l)-(m) and 67-4-2111(l)-(m). These provisions though are repealed for tax years ending on or after Dec. 31, 2025.

² See also, Tenn. Dept. of Rev., Notice #23-11 (May 2023).

³ Tenn. Code Ann. §§ 67-4-2006(b)(1)(H) or (b)(2)(I), addback and subtraction, respectively. The depreciation relates to excess depreciation the taxpayer could have deducted had the taxpayer computed its depreciation under IRC § 168 as it existed before federal changes made by the Job Creation and Worker Assistance Act of 2002.

⁴ Specifically, a person with sales of less than $100,000 within a county/incorporated municipality is exempt from tax and licensing provisions that otherwise apply to sales sourced to that county/municipality. A person with substantial nexus in Tennessee and less than $100,000 within a county is exempt from tax on sales occurring in that county. See also, Tenn. Dept. of Rev., Notice #23-08 (May 2023).