The states covered in this issue of our monthly tax advisor include:
- Multiple states
- South Carolina
Proposed regs will address state and local tax payments made by partnerships and S corporations
The IRS intends to issue proposed regulations to clarify that state and local income taxes imposed on and paid by a partnership or an S corporation are deductible by the partnership or S corporation in computing nonseparately stated taxable income for the year of the payment. The proposed regulations are intended to provide certainty to individual partners and S corporation shareholders in calculating their state and local tax (SALT) deduction limitations.
The notice describing the proposed regs applies starting today, and also allows taxpayers to apply these rules to specified income tax payments made in tax years ending after Dec. 31, 2017, and before the proposed regulations are published in the Federal Register.
Entity-paid tax and the SALT deduction limit
For tax years beginning after 2017 and before 2026, an individual’s federal SALT deduction is generally limited to $10,000 ($5,000 for married individuals who file separate returns). The SALT deduction includes real property taxes; personal property taxes; income, war profits, and excess profits taxes; and general sales taxes.
However, legislative history indicates that this limit should not apply to taxes imposed at the entity level, such as a business tax imposed on pass-through entities, that are reflected in a partner’s or S corporation shareholder’s distributive or pro rata share of income or loss on a Schedule K-1 (or similar form). Instead, these taxes should continue to reduce the partner’s or shareholder’s distributive or pro rata share of income.
New entity-level taxes and SALT deduction limit
Some state and local jurisdictions have enacted or are considering entity-level income tax on partnerships and S corporations, sometimes with a corresponding credit, deduction, or exclusion for the owners. There is uncertainty as to whether the entity’s payment of such taxes must be taken into account in applying an owner’s SALT deduction limit.
The proposed regs will clarify that Specified Income Tax Payments are deductible by partnerships and S corporations in computing their nonseparately stated income or loss.
Specified Income Tax Payments
A Specified Income Tax Payment is any amount paid by a partnership or an S corporation to satisfy the entity’s liability for income taxes imposed by and paid to a state, a state’s political subdivision, or the District of Columbia.
This definition applies regardless of whether the tax results from an election by the entity, or whether an owner receives any deduction, exclusion, or credit for the payment. However, Specified Income Tax Payments do not include income taxes imposed by U.S. territories or their political subdivisions.
Specified Income Tax Payments, entity income, and owner taxes
The partnership or S corporation can deduct Specified Income Tax Payments in computing taxable income for the year the payment is made. The Specified Income Tax Payments will be reflected in a partner’s or a shareholder’s distributive or pro rata share of nonseparately stated income or loss.
Thus, a Specified Income Tax Payment:
- (1) Is not an item of deduction that a partner or shareholder takes into account separately in determining its own federal income tax liability.
- (2) Is not taken into account in applying the SALT deduction limitation to any individual partner or shareholder.
See Notice 2020-75 and IR-2020-252.
Corporate income tax: California addresses residency and income sourcing during COVID-19 pandemic; LLC subject to tax
The Franchise Tax Board (FTB) updated its COVID-19 Frequently Asked Questions (FAQs) page to address residency and income sourcing during the COVID-19 pandemic.
When determining filing requirements and residency status for 2020 California personal income tax returns, individuals should consider circumstances related to COVID-19. Individuals who are physically present in California for at least nine months of the year are presumed California residents for tax purposes. But, individuals should weigh actions taken related to COVID-19 and Executive Order No. 33-20 when evaluating whether to file a California resident return. Actions taken based on COVID-19 may support a determination of individuals being in or out of California for other than a temporary or transitory purpose.
In Appeal of Stephen Bragg, 2003-SBE-002 (May 28, 2003), 19 factors were identified for determining residency, including physical presence, property interests, and family abode. The factors identified in Bragg were neither exhaustive nor exclusive. In reviewing the weight to be attributed to an individual’s actions related to COVID-19, in addition to the factors identified in Bragg, the following nonexhaustive factors might be relevant:
- When the individual entered California
- Whether the individual remained in California after the COVID-19 period (and if so, how long)
- Whether the individual remained in California throughout the COVID-19 period
- Whether the individual provided COVID-19-related services in California
- Whether the individual cared for an at-risk family member or friend
With respect to income sourcing for nonresidents temporarily relocated to California, the FTB’s FAQs address factual scenarios involving:
- An individual who works for an out-of-state employer and temporarily relocates to California.
- An individual who works for a California employer and temporarily relocates to California.
- An independent contractor who temporarily relocates to California.
COVID-19 Frequently Asked Questions for Tax Relief and Assistance, California Franchise Tax Board, October 2020
Limited liability company subject to tax
A limited liability company (taxpayer) was doing business in California and, thus, was required to pay LLC tax. Generally, a taxpayer is considered doing business in California if it satisfies certain bright-line nexus thresholds consisting of sales, property, or payroll amounts. In this matter, the taxpayer filed an amended 2016 California LLC return and sought a refund of the LLC tax on the basis that it was a limited partner of another LLC and was not doing business in California. However, the FTB denied the taxpayer’s request, asserting that nonregistered foreign LLCs that are members of an LLC doing business in California were considered to be doing business in California. It was noted that the taxpayer’s employee in the state was under the taxpayer’s direct control, operating under the taxpayer’s direction and selling the taxpayer’s services. Moreover, the taxpayer’s outsourcing of payroll duties did not change the employer-employee legal status it held with its California employee; and the taxpayer had a physical presence in the state. Accordingly, the taxpayer’s protest was denied.
Propharma Sales LLC, California Office of Tax Appeals, OTA Case No. 18010699, Aug. 18, 2020, released October 2020.
Corporate, personal income taxes: Voters approve tax rate decrease measure
According to unofficial results, Colorado voters approved a ballot measure to decrease the tax rate from 4.63 to 4.55% for the following:
- Corporate income tax
- Personal income tax
- Personal income tax withholding
The new rate is effective for tax years beginning on and after Jan. 1, 2020.
Prop 116, Colorado General Election, Colorado Secretary of State, Nov. 4, 2020.
Multiple taxes: Deadline extensions announced for victims of East Troublesome Fire
The Colorado Department of Revenue has announced state tax filing and payment relief for businesses who have been affected by the East Troublesome fires. The primary areas impacted include Estes Park and Grand Lake, but any businesses that believe they have been impacted by the fires may contact the department’s tax hotline for assistance.
November filing and payment deadlines extended
The tax relief postpones various tax filing and payment deadlines that would be due for the month of November. As a result, affected businesses will have until the filing deadlines in December 2020 to file returns and pay any taxes that were originally due during this period, and are still eligible for any vendor fee that applies.
Taxpayers must request relief
The department will not automatically apply the tax deadline waiver. Affected businesses that are located in the covered disaster area must call the tax information hotline at (303) 238-7378 Monday through Friday from 8:00 a.m. to 4:30 p.m. to request penalty and interest relief if they receive a bill.
Relief not applicable to home-rule jurisdictions
Additionally, deadline waivers do not apply to home-rule jurisdictions who collect their own taxes. Taxpayers are advised to contact them directly to find out if they have also waived any tax deadlines.
Press Release, Colorado Gov. Jared Polis, Oct. 29, 2020.
Corporate, personal income taxes: Voters reject constitutional amendment on graduated rates
Illinois voters rejected a ballot measure proposing an amendment to the Illinois Constitution that would allow graduated personal income tax rates.
The amendment would have authorized the Illinois General Assembly to set the income tax rate or rates. The current Illinois Constitution only allows a flat or nongraduated rate.
Impact on rate legislation
The Illinois General Assembly enacted rate legislation in 2019 that was contingent on voter approval of the amendment. The legislation proposed to:
- Replace the state’s flat personal income tax rate with graduated rates ranging from 4.75 up to 7.99%.
- Increase the corporate income tax rate from 7 to 7.99% (9.5% to 10.49% total tax rate including the corporate replacement tax).
Proposed Constitutional Amendment, as rejected by the voters (unofficial results) on Nov. 3, 2020.
Sales and use tax: Guidance on remote sellers and market facilitators updated
Indiana updated its sales tax guidance on remote sellers and market facilitators to include information pertaining to physical presence standards for retail merchants. The release explains economic nexus threshold applicable to retail merchants while determining their physical presence in the state.
Sales Tax Information Bulletin #89, Registration, Collection, and Remittance Requirements for Remote Sellers and Marketplace Facilitators, Indiana Department of Revenue, July 1, 2020, released October 2020.
Final Massachusetts sourcing rules for COVID-19 telecommuters adopted
Massachusetts adopted final personal income tax sourcing rules for employees who telecommute during the COVID-19 pandemic. The final rules replace emergency rules.
Employers must source compensation to Massachusetts, and withhold income tax, for personal services performed by a nonresident:
- Who, immediately before the Massachusetts COVID-19 emergency, was an employee engaged in performing those services in the state.
- Who is performing those services from a location outside the state due to pandemic-related circumstances.
Pandemic-related circumstances include:
- A government order issued in response to the COVID-19 pandemic.
- A remote work policy adopted by an employer to comply with federal or state government guidance or public health recommendations on the COVID-19 pandemic.
- Employee compliance with quarantine or isolation directives on a diagnosis or suspected diagnosis of COVID 19 or the advice of a physician on COVID-19 exposure.
- Any other remote COVID-19 work arrangement during the period that the rules are in effect.
Apportionment based on working days in Massachusetts
Nonresident employees who determined Massachusetts source income before the COVID-19 emergency by apportioning based on days spent working in Massachusetts must continue to do so. A nonresident employee must apportion wage income based on:
- The percentage of the employee’s workdays spent in Massachusetts during the period January 1 through Feb. 29, 2020.
- If the employee worked for the same employer in 2019, the percentage used to determine the Massachusetts source income on the employee’s 2019 return.
Credit for taxes paid to other states
Massachusetts will provide a credit for income taxes paid to another state by residents:
- Who, immediately before the Massachusetts COVID-19 emergency, was an employee engaged in performing services from a location outside the state.
- Who began performing those services in Massachusetts due to pandemic-related circumstances.
It also will not require withholding from the employer if the employer must withhold income tax for the employee in the other state.
The sourcing rules apply to wage income from employee services performed beginning March 10, 2020, through the earlier of:
- Dec. 31, 2020.
- 90 days after Massachusetts Gov. Charlie Baker gives notice that the state of emergency declaration is no longer in effect.
830 CMR 62.5A.3, Massachusetts Department of Revenue, adopted Oct. 16, 2020 and effective as noted.
Corporate, personal income taxes: IRC Sec. 179 addback eliminated; retroactive exception created for qualifying depreciable property
Minnesota has eliminated the state addback for the IRC Sec. 179 deduction. The change applies for both corporation franchise tax and individual income tax purposes. It is effective for property placed in service in tax year 2020 and later. Under Minnesota law for property placed in service in tax years beginning before 2020, taxpayers must generally:
- Add back 80% of the difference between the deduction allowed under IRC Sec. 179 and the deduction allowable under IRC Sec. 179 as amended through Dec. 31, 2003.
- Subtract 20% of the addback amount in each of the five following tax years.
Retroactive exception for qualifying depreciable property
Minnesota has created a new exception to this addback for qualifying depreciable property. The exception is effective retroactively. It generally applies to exchanges of property after 2017. “Qualifying depreciable property” is property:
- For which a depreciation deduction under IRC Sec. 167 is allowed.
- Received in a like-kind exchange.
- That did not qualify for gain or loss recognition deferral due to the elimination of the deferral under the Tax Cuts and Jobs Act of 2017.
Taxpayers may not take a subtraction for qualifying depreciable property now retroactively allowed to be fully expensed. Taxpayers who claimed a subtraction for that property must recompute their tax. They must recompute their tax for the tax year in which the property was placed in service and each year a subtraction was claimed.
Ch. 3 (H.F. 1), Laws 2020, 5th Special Session, effective as noted.
Multiple taxes: Minnesota answers frequently asked questions related to COVID-19
Minnesota has answered frequently asked questions (FAQs) related to COVID-19. The FAQs address income and property tax issues related to:
- Paycheck Protection Program loan amounts
- Federal pandemic unemployment compensation payments
- Economic impact payments
- Substitute forms and electronic filing
Paycheck Protection Program loan amounts
Taxpayers must make an adjustment on Minnesota Schedule M1NC, Federal Adjustments, to report:
- Paycheck Protection Program loan forgiveness amounts excluded from gross income for federal purposes
- Related business expenses that were not deductible for federal purposes
Minnesota will treat repaid Paycheck Protection Program loan amounts the same way they are treated on the federal return.
Federal pandemic unemployment compensation payments
Taxpayers must include the $600-a-week federal pandemic unemployment compensation payments in Minnesota adjusted gross income. All unemployment insurance payments are taxable income in Minnesota.
Economic impact payments
The federal economic impact payments are not household income for the Minnesota property tax refund. Minnesota considers these payments federal tax credits.
Substitute forms and electronic filing
COVID-19 has not affected the turnaround on substitute forms and electronic filing certification testing. The expected turnaround is still 10 business days from submission.
Law Change FAQs for Tax Year 2020, Minnesota Department of Revenue, October 2020.
Multiple taxes: COVID-19 telework guidance issued
Pennsylvania has issued temporary guidance relating to telework and related income and sales and use tax implications. The guidance will be in effect until the earlier of June 30, 2021, or 90 days after the Proclamation of Disaster Emergency in Pennsylvania is lifted.
If an employee is working from home temporarily due to the COVID-19 pandemic, Pennsylvania does not consider that a change to the sourcing of the employee’s compensation. For nonresidents who were working in Pennsylvania before the pandemic, their compensation remains Pennsylvania-sourced income for all tax purposes. This includes for purposes of PA-40 reporting, employer withholding, and three-factor business income apportionment for S corporations, partnerships, and individuals.
Conversely, for Pennsylvania residents who were working out-of-state before the pandemic, their compensation remains sourced to the other state and they can still claim a resident credit for tax paid to the other state on the compensation.
For Pennsylvania employers with nonresident employees temporarily working from home due to the COVID-19 pandemic in a state that doesn’t have a reciprocity agreement with Pennsylvania, Pennsylvania advises that the employee’s compensation remains Pennsylvania-sourced, and the employer must withhold on the compensation.
Nexus for corporate net income tax/sales and use tax
As a result of the COVID-19 pandemic causing people to temporarily work from home, Pennsylvania will not seek to impose corporate net income tax (CNIT) nexus or sales and use tax (SUT) nexus solely on the basis of this temporary activity.
Telework During the COVID-19 Pandemic, Pennsylvania Department of Revenue, Nov. 9, 2020.
Corporate, personal income taxes: Treatment of PPP loans discussed
Under recently enacted South Carolina legislation, for tax year 2020, to the extent that loans under the Paycheck Protection Program (PPP) are forgiven and excluded from gross income for federal income tax purposes, the loans are also excluded for South Carolina income tax purposes. In addition, to the extent that the federal government allows the deduction of expenses associated with the forgiven PPP loans, those expenses will be allowed as a deduction for South Carolina income tax purposes.
Accordingly, the Department of Revenue has advised that for South Carolina income tax purposes, the PPP loan is not taxable and the forgiveness of the PPP loan is not taxable for tax year 2020. The department will follow the IRS position in Notice 2020-32 and will disallow related payroll and occupancy costs to the forgiven portion of the PPP loan. A business is not permitted to deduct expenses that are normally deductible, to the extent that the expenses were reimbursed by a PPP loan that was then forgiven. However, if Congress or the IRS changes this treatment to allow for the deduction of these costs, then South Carolina will also allow the deduction of these costs for tax year 2020.
Information Letter 20-28, South Carolina Department of Revenue, Nov. 2, 2020.
Corporate income tax: Foreign entity storing inventory in state not subject to franchise tax
Tennessee discusses franchise tax treatment of a foreign corporation that did not have income effectively connected to a U.S. trade or business. In this matter, the taxpayer was a foreign entity registered with the Tennessee Secretary of State to do business in Tennessee. The Taxpayer’s business activities in Tennessee involved storing inventory at a toll manufacturer’s facility in the state. The taxpayer’s Tennessee inventory included the raw materials used by the toll manufacturer, as well as finished goods. The finished goods were stored at the Tennessee manufacturer’s facility until the taxpayer shipped the goods to its customers, some of which were in Tennessee.
Generally, foreign corporations are permitted to transact business in Tennessee after obtaining a certificate of authority from the Tennessee Secretary of State. This certificate of authority, however, is not equivalent to a corporate franchise. Whereas a corporate franchise grants the rights and privileges to exercise corporate powers, a certificate of authority merely authorizes a foreign corporation to transact such business in the state. Additionally, a certificate of authority does not permit Tennessee to regulate the foreign corporation’s organization or internal affairs as the state or country of incorporation can. Thus, a certificate of authority is not a corporate franchise.
It was noted that:
- Tennessee imposes the franchise tax on corporations exercising the corporate franchise in Tennessee, and, thus, an entity must hold a Tennessee charter or Tennessee Articles of Organization to be exercising the corporate franchise in Tennessee.
- In this matter, that taxpayer was not a Tennessee-chartered corporation and was not exercising the corporate franchise in Tennessee by storing inventory in the state.
Accordingly, the taxpayer would not be subject to the state franchise tax.
Letter Ruling No. 20-08, Tennessee Department of Revenue, Oct. 9, 2020.
Corporate income tax: Taxpayer’s payment was not flow-through sales commissions; refund properly denied
A taxpayer’s Texas franchise tax refund claim was properly denied as the taxpayer’s payment at issue did not qualify as “sales commissions.”
Generally, a taxable entity must exclude from its total revenue calculation only the following flow through funds that are mandated by contract or subcontract to be distributed to other entities:
- Sales commissions to nonemployees.
- The tax basis of securities underwritten.
- Subcontracting payments made under a contract or subcontract entered into by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, remediation, or repair of improvements on real property or the location of the boundaries of real property.
In this matter, the taxpayer paid hotels commissions to be the exclusive provider of audiovisual equipment and services. Subsequently, the taxpayer contended that payments constituted sales commission flow-through funds that should be excluded from the total revenue. The Tax Division (staff) asserted that the taxpayer’s payments could not be excluded from total revenue because they were not “sales commissions” under the applicable statute. Upon review, it was noted that:
- The payments were not “sales commissions” in part because they were not for engaging in an act that required a license.
- The taxpayer was not required to report the payments on Form 1099-MISC.
Accordingly, the taxpayer’s refund claim was properly denied.
Decision, Hearing No. 116,694, Texas Comptroller of Public Accounts, July 23, 2020, released October 2020.
Corporate, personal income taxes: Rate reductions, withholding, and COVID-19 telecommuting discussed
For 2020, Wisconsin has reduced the personal income tax rates for the first and second brackets to 3.54% and 4.65%. However, there are currently no plans to change the withholding tax rates.
For the duration of the national COVID-19 emergency, Wisconsin will not consider an out-of-state business to have nexus if its only Wisconsin activity is having an employee working temporarily from the employee’s home during the pandemic.
Telecommuting employees continue to report their income based on the guidance in Wisconsin Tax Bulletin 171.
For employers, Wisconsin’s withholding tax requirements for wages paid to an employee have not changed. However, the Department of Revenue has provided examples in its withholding tax update illustrating how employers and employees may be subject to different tax requirements when an employee telecommutes from home instead of working at the employer’s business location.
Withholding Tax Update 2020-1 and Wisconsin Tax Bulletin 211, Wisconsin Department of Revenue, November 2020.
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