State and local tax advisor: January 2022

The states covered in this issue of our monthly tax advisor include:

• Colorado
• Connecticut
• Illinois
• Massachusetts
• Michigan
• New York
• Oregon
• Pennsylvania
• Tennessee
• Texas

Colorado

Corporate income tax: Special apportionment rules adopted

The Colorado Department of Revenue has adopted three income tax apportionment rules and repealed 21 apportionment rules.

Apportionment of income for electricity producers

Special Rule 9A is a new rule adopted to prescribe the inclusion of certain receipts of electricity producers in the receipts factor. The rule provides that, except where otherwise provided or allowed, any income, gain, or loss from a transaction properly identified as a hedge under IRC Section 1221(b)(2)(A) or 475(c)(3) will be excluded from a taxpayer’s receipts for the purpose of apportionment. The rule additionally provides special circumstances for including hedging transaction in receipts.

Hedging transactions excluded from receipts

Rule 39-22-303.6-1, providing apportionment and allocation definitions, and Rule 30-22-303.6-7, regarding sales other than sales of tangible personal property, were amended to add language that explains that hedging transactions are excluded from receipts, except as provided in Special Rule 7A and Special Rule 9A.

Repealed rules

Additionally, 21 apportionment rules have been repealed because they applied to tax years prior to Jan. 1, 2009.

Special Rule 9A; Rule 39-22-303.6-1; and Rule 39-22-303.6-7, Colorado Department of Revenue, effective Jan. 30, 2022.

Connecticut

Corporate income tax: 2021 legislative changes affecting the corporation business tax discussed

The Connecticut Department of Revenue Services (Department) issued a special notice discussing the 2021 legislative changes affecting corporate income tax. The notice, among other information, clarified that:

• The 10% surtax, that was scheduled to expire on Jan. 1, 2021, is extended for an additional two years, expiring with income years beginning Jan. 1, 2023.
• The capital base tax will begin to phase out starting in the income year 2024 and relief from interest on estimated taxes underpayment will be available.
• A company may utilize research and experimental (R&E) and research and development (R&D) tax credits up to 60% in 2022 and up to 70% in 2023 and thereafter.
• Unused R&D tax credits earned during income years beginning on or after Jan. 1, 2021, may be carried forward for up to 15 years.
• The film production tax credit may be claimed against sales and use taxes, subject to certain limitations.

Special Notice 2021(5), Connecticut Department of Revenue Services, Nov. 5, 2021.

Illinois

Corporate income tax: Corporate income tax nexus for out-of-state business discussed

The Illinois Department of Revenue issued a general information letter discussing corporate income tax nexus for out-of-state businesses. In this matter, an out-of-state business that had an employee working remotely full-time from her home in Illinois, inquired whether it had income tax nexus within the state. Also, the business inquired if the employee was required to file an annual income tax return even though it had zero sales in the state.

The Department of Revenue clarified that the taxpayer would only be required to file a state tax return if it was registered to conduct business in the state and was required to file a federal tax return. Accordingly, the taxpayer wouldn’t be required to file a state tax return if it had no state tax liability and was not registered to do business in the state.

General Information Letter IT-21-GC-0006, Illinois Department of Revenue, Aug. 31, 2021, released November 2021.

Massachusetts

Sales and use tax: Cookies and apps not considered physical presence

Massachusetts could not retroactively impose a use tax collection requirement on a California auto part company based on the placement of “cookies” and “apps” on its Massachusetts customers’ computers.

Retroactivity

The Massachusetts Commissioner could not retroactively apply Wayfair and expand the ability of states to tax out-of-state vendors who weren’t previously subject to tax.

Physical presence

The company had no actual physical presence in Massachusetts. The existence of “cookies” and “apps” on the company’s Massachusetts customers’ computers didn’t constitute a physical presence for nexus purposes.

U.S. Auto Parts Network, Inc. v. Commissioner of Revenue, Appellate Tax Board (Massachusetts), No. C339523, Promulgated Dec. 7, 2021.

Michigan

Multiple taxes: Overview provided for flow-through entity tax

A Michigan Department of Treasury notice provides an overview of the elective flow-through entity (FTE) tax enacted by Act 135 (H.B. 5376), Laws 2021. The notice also includes special instructions related to the retroactive implementation of the tax. Topics covered in the notice include:

• Who is eligible to pay the FTE tax.
• How to elect to pay the tax.
• The calculation of the tax.
• Filing and payment methods and deadlines.
• Reporting requirements.
• Credits and adjustments for entity members.

Generally, the FTE tax allows a flow-through entity to elect to pay tax on certain income at the individual income tax rate, with members of that entity eligible to receive a refundable income tax credit equal to the tax paid on that income by the flow-through entity. Though the flow-through entity effectively pays tax that would otherwise be paid by its members, it doesn’t eliminate any of the income tax reporting or return filing requirements of those members. Thus, the FTE tax requires the reporting of complementary entity-level and member-level adjustments to fulfill the scope and intended purpose of ensuring that tax is paid only once on income in Michigan.

The FTE tax is effective retroactively for tax years beginning on and after Jan. 1, 2021. However, the tax will continue in effect only for tax years for which the state and local tax deduction limitation under IRC Sec. 164(b)(6)(B) is in effect for individuals.

Who is eligible to pay the FTE tax?

The following types of common flow-through entities may elect to pay the tax:

• Partnerships, including limited partnerships, limited liability partnerships, and general partnerships, but not publicly traded partnerships
• Limited liability companies (LLCs) that file federal income tax returns as partnerships
• S corporations

The following types of entities can’t elect to pay the tax:

• Publicly traded partnerships
• Flow-through entities subject to the financial institutions tax
• Entities that are disregarded for federal income tax purposes, such as single member LLCs
• LLCs that file federal income tax returns as corporations
• Entities that aren’t flow-through entities, such as sole proprietorships and C corporations

How do entities make the election?

Entities must make the election by submitting an electronic payment to the department. Generally, they must submit the payment by the 15th day of the third month of their tax year. However, for the 2021 tax year, and election will be timely if made by April 15, 2022. Entities can make the election for tax year 2021 by specifying a payment for the 2021 tax year that includes the combined amount of any unpaid quarterly estimated payments due for tax year 2021. An entity electing after the due date of the FTE tax annual return should immediately file the return and include payment of the tax due. For entities electing after the due date of the annual return, interest accruing from the initial due date of the return will apply, but no penalty will be levied for the late filing of the return or payment of the tax.

How is the tax calculated?

The FTE tax is levied at the same rate of tax levied on individuals. It’s levied only on the Michigan portion of the positive “business income tax base” attributable to direct members of an electing entity that are:

• Individuals
• Fiduciaries (i.e., estates or trusts)
• Other flow-through entities

The tax is not levied on any portion of the business income tax base attributable to direct members that are:

• Insurance companies
• Financial institutions
• C corporations

Electing entities must calculate the Michigan portion of the business income tax base before adjusting for the portions that are taxable or nontaxable. The starting point for the computation of the business income tax base is the flow-through entity’s business income, which includes federal taxable income and any payments and items of income and expense that are attributable to business activity of the entity and separately reported to its members. Once determined, the federal taxable income of a flow-through entity is subject to certain specific statutory adjustments. These adjustments, which must be performed prior to allocation or apportionment of the business income tax base, generally mirror those adjustments required of individuals. Special additional adjustments may be required when computing the tax base of an entity within a tiered structure.

After making all required adjustments, the FTE tax is levied only on the positive business income tax base of an electing entity. If the business income tax base is less than zero, then no tax is due in that year. A negative business income tax base is includable in the business income tax base of any members that are flow-through entities, but it may not be used to offset the positive business income tax base in any prior or future tax year. That is, the FTE tax doesn’t allow for the carryback or carryforward of losses in a way that’s comparable to the business loss provisions of the corporate income tax or the net operating loss provisions of the individual income tax.

The Michigan portion of the business income tax base of the flow-through entity is determined using the same allocation and apportionment rules that apply to the business income of individuals.

What are the filing and payment methods and deadlines?

An annual FTE tax return is due by the last day of the third month after the end of the entity’s tax year (March 31 for calendar year filers). Upon application, the department may extend the return filing due date (but not the tax payment due date) by up to six months, either for good cause or if the entity has been granted an extension of time to file a federal income tax return for the year.

Entities that elect to pay the FTE tax must make estimated payments each year that they reasonably expect their tax liability for the year to exceed $800. For calendar year filers, the estimates must generally be made in equal installments on or before April 15, June 15, September 15, and January 15. For fiscal year filers, the estimates must be made in equal installments on dates that correspond to the due dates in the calendar year. Penalties and interest generally apply to underpayments of estimated payments. But, for tax year 2022, penalty and interest won’t be charged if the preceding year’s liability was $20,000 or less and the entity submitted four equal installments in total equal to the preceding year’s liability. Also, because the FTE tax is retroactive for tax year 2021, certain estimated payments otherwise due throughout 2021 may not have been made. But, penalties and interest won’t be levied on any quarterly estimated tax return or payment that was due prior to the enactment of the tax.

All FTE returns and payments must be submitted electronically through Michigan Treasury Online at https://mto.treasury.michigan.gov/.

What are the reporting requirements for electing entities?

Electing entities must report certain information to their members to ensure that member-level return adjustment can be reported accurately. This includes the following information:

• Information regarding the allocation and apportionment of the business income tax base and the allocation and apportionment of income subject to individual or corporate income tax.
• The member’s allocable share of the reporting entity’s taxes on or measured by net income, including the Michigan FTE tax, that was required to be added back in computing the entity’s business income tax base.
• The member’s share of the reporting entity’s refund of Michigan FTE tax received during the tax year, if applicable.
• The Michigan FTE tax allocated to the reporting entity by other flow-through entities with tax years ending on or within the reporting entity’s tax year.

Flow-through entities may provide the required information to members in any reasonable manner, including as separate statements or as notes attached to the Federal Schedule K-1.

What credits and adjustments should members report on their returns?

There are certain credits and adjustments that must be communicated to, and thereafter reported on the respective Michigan income tax returns of, an electing flow-through entity’s members. Together, these components are designed to generally collect the same amount of income tax under the FTE tax as would otherwise have been collected from members of the entity.

Members of an electing entity may claim a refundable credit for their share of any Michigan FTE taxes that are:

• Paid in a tax year that ends with or within the same tax year.
• Imposed in a prior year and paid with or within the member’s same tax year.
• Paid and allocated to the reporting entity by other flow-through entities with tax years ending on or within the reporting entity’s tax year.

The credit is generally available to trusts and estates that are direct or indirect members of an electing flow-through entity. But, additional adjustments are required for resident and nonresident fiduciaries.

The credit is technically available for members subject to the corporate income tax (i.e., corporations, insurance companies, and financial institutions), even though the FTE tax is not levied on shares of income attributed to those members. The credit remains necessary; however, because in certain tiered structures, an electing entity may not know the identity of its indirect members yet is required to pay tax attributed to any direct member that’s another flow-through entity. In these cases, it’s possible that the FTE tax is paid on income attributable to an indirect member that’s a corporation, insurance company, or financial institution. To ensure that tax is not paid at both the entity and member levels, the corporation, insurance company, or financial institution may therefore claim the refundable credit on its respective income tax return. The credit is available only to accommodate these unique circumstances, and flow-through entities may not elect to pay tax for the purpose of generating a credit for direct members subject to the corporate income tax.

Certain members must add back their direct or indirect allocable share of taxes paid by a flow-through entity in the computation of Michigan taxable income. Except for nonresident fiduciaries, financial institutions, and insurance companies, which don’t have a required addition due to the computation of their respective tax bases, this addition is designed to reverse the state tax impact of the federal tax deduction reported by the entity for the payment of the FTE tax. For this reason, the flow-through entity must report to each member their allocable share of taxes paid under the FTE tax that were deducted on the entity’s return for that tax year. Based on this addition, the member is eligible to claim the full refundable credit for the share of FTE tax paid by the entity.

To prevent the state taxation of certain refunds issued under the FTE tax, Michigan allows any direct or indirect allocated share of a refund of the Michigan FTE tax to be deducted from the tax base of those members subject to the individual income tax. However, tax refunds generally aren’t deductible under the corporate income tax law, so there is no similar deduction for corporations, insurance companies, or financial institutions that receive a direct or indirect allocated share of a Michigan flow-through entity tax refund.

Notice Regarding the Implementation of the Michigan Flow-Through Entity Tax, Michigan Department of Treasury, Jan. 14, 2022.

Our state and local tax experts discuss Michigan’s FTE enactment here.

Sales and use tax: Guidance on marketplace facilitators and sellers issued

The Michigan Department of Treasury has provided sales and use tax nexus guidance applicable to marketplace facilitators and sellers. Marketplace facilitators are considered the taxpayer for both their direct sales and sales they facilitate for third-party sellers and are responsible for remitting the tax. The Marketplace Acts do not permit a waiver between the marketplace facilitator and seller; therefore, they may not enter into an agreement that allows the seller to remit and report tax on its facilitated sales.

The marketplace facilitator is the only party that may be held liable or audited for facilitated transactions unless it demonstrates that the seller provided incorrect information for the facilitator to collect the tax. As marketplace facilitators are deemed the taxpayer for all sales they facilitate, they are required to register for use tax and file all required returns for facilitated and direct sales. The marketplace seller need not register for sales or use tax or file returns if it only makes facilitated sales. Marketplace sellers must submit all claims of exemption received from customers to their marketplace facilitators.

To determine if they meet the economic nexus threshold (i.e. 200 or more transactions or over $100,000 in sales in the prior calendar year), the marketplace facilitator and marketplace seller must include both direct and facilitated sales.

Revenue Administrative Bulletin 2021-22, Michigan Department of Treasury, Dec. 21, 2021.

New York

Corporate income tax: Deriving receipts nexus thresholds increased for 2022

New York announced an increase in the thresholds at which a corporation is deemed to be deriving receipts from activity in the state and in the Metropolitan Commuter Transportation District (MCTD) for purposes of imposing the corporate franchise tax and MTA surcharge. Specifically, the thresholds have increased to $1,138,000 for tax years beginning on or after Jan. 1, 2022, and before Jan. 1, 2023.

Also, when determining whether the thresholds are met for a unitary group, only receipts from qualifying corporations with at least $11,000 in New York receipts, for the franchise tax, and at least $11,000 in MCTD receipts, for the MTA surcharge, are aggregated.

The thresholds will remain the same until the Commissioner of Taxation and Finance next reviews the cumulative percentage change in the consumer price index and is required to adjust the receipts thresholds.

TSB-M-21(3)C, New York Department of Taxation and Finance, Dec. 28, 2021.

Sales and use tax: eSuite services didn’t constitute taxable sales of prewritten software or information services

A multilevel marketing company (taxpayer) was not subject to New York State sales tax on its subscription-based sales of eSuite services to distributors/independent sales agents (DIAs) because these services didn’t qualify as taxable sales of pre-written computer software or information service. In this matter, the taxpayer claimed that the eSuite services enabled the DIAs to generate customer reports and make informed business decisions only, and that the Division of Taxation’s (division’s) classification of these services for tax purposes was erroneous.

The division contended that the eSuite product and its accompanying mobile app allowed the DIAs to direct the use of the software, download contact information and enroll customers and new distributors, and that granting such access and rights constituted the taxable sale of prewritten computer software. The taxpayer on its part argued that the eSuite sales didn’t entitle the subscribers to any of the rights, benefits or functionalities that would amount to a transfer of prewritten computer software.

To buttress its claim, the taxpayer provided information on the reports that eSuite allowed the DIAs to generate, specifically that the subscription provided them with confidential financial reports for making business decisions. Upon review, it was determined that although the eSuite package had features such as a mobile app, training videos, and accessibility to the replicated website, these were all incidental to the primary function of generating the reports; and therefore, these services were not taxable sales of prewritten computer software.

Further, since the primary function of the subscription was the generation of the reports, these reports constituted the furnishing of information and not the taxable sales of an information service. The information provided to the subscriber was personal in nature and could not be substantially incorporated into the reports of others. Moreover, the taxpayer maintained all the proprietary information used in the reports. Accordingly, the taxpayer’s petition was granted.

IT Works Marketing, Inc., New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 829134, Dec. 30, 2021.

Oregon

Corporate income tax: Recent changes in law affects CAT filing in 2022

Oregon legislature removed the requirement for calendar year filing of returns for the Corporate Activity Tax. Starting 2021 and forward, returns for taxpayers that use a federal tax year other than a calendar year are due on or before the 15th day of the fourth month following the end of the tax year. Taxpayers who use a calendar year for federal income tax purposes will not be impacted by these provisions.

To address the gap between the end of the 2020 calendar year and the start of the taxpayer’s fiscal year that began in 2021, taxpayers that use a federal tax year other than a calendar year must:

• Prorate the annual registration, filing, and payment thresholds based on the number of days in the short-year return.
• File a short-period return, if the taxpayer reaches the prorated filing threshold.
• Prorate the $500,000 cap on compensation to a single employee when calculating labor costs included in the short-year return.
• If required, file the short-year return by April 15, 2022.

Release, Oregon Department of Revenue, Jan. 19, 2022.

Pennsylvania

Corporate income tax: NLC deduction severed for 2001 tax year

The Pennsylvania Supreme court reversed a lower court decision severing the corporate income tax net loss carryover (NLC) deduction cap for 2001. Instead, the court severed the NLC deduction entirely for the 2001 tax year.

Further, the taxpayer’s income tax will be recalculated without capping the NLC deduction and a refund was ordered. The court ordered the refund to remedy the violation of the taxpayer’s due process rights.

Commonwealth court decision

The taxpayer challenged the application of the NLC provision, for the 2001 tax year. At that time, the NLC imposed a $2,000,000 cap on the amount of loss a corporation could carry over from prior years as a deduction against its 2001 taxable income. This statutory cap created a nonuniform classification based solely on whether the taxpayer’s income exceeded $2,000,000; taxpayers whose income exceeded $2,000,000 paid the tax, while taxpayers whose income did not exceed $2,000,000 did not. The Pennsylvania Supreme Court found the cap violated the Uniformity Clause of the Pennsylvania Constitution in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, 171 A.3d 682 (Pa. 2017). In order to cure the constitutional infirmity, either the $2,000,000 flat-dollar deduction or the entire NLC provision had to be severed. The lower court determined that only the flat-dollar deduction had to be severed from the law, and the case was remanded to the board for recalculation and the issuance of a refund.

Severability

The court determined that the only available options to it were severing the $2 million cap, resulting in unlimited NLC deductions, or eliminating the entire NLC deduction, resulting in no NLC deductions. Severing the NLC provision in its entirety was more consistent with the General Assembly’s intent, based on the history of NLC deduction provision. Specifically, as the court noted in Nextel, the legislature initially enacted the NLC deduction without a cap in 1980, eliminated the NLC deduction in its entirety from 1991–1994 to address budgetary concerns, and then reinstated it in 1994 but only in capped format.

Due process

Further, the court concluded that the underlying due process concerns regarding the denial of post deprivation remedies applied equally to Uniformity Clause violations as to Commerce Clause violations. While the statutory flaw was remedied by severing the NLC deduction provision, severance did not remedy the discriminatory impact of the Uniformity Clause violation on the taxpayer. Instead, the due process clause required Pennsylvania to equalize the taxpayer’s position with the favored taxpayers who weren’t subject to the $2 million NLC deduction cap. The remedy was refunding the tax the taxpayer paid as a result of the imposition of the NLC deduction cap.

General Motors Corp. v. Commonwealth of Pennsylvania, Supreme Court of Pennsylvania, Middle District, No. 12 MAP 2020, Dec. 22, 2021.

Tennessee

Sales and use tax: Repeal of drop shipment rule discussed

Effective Jan. 10, 2022, a Tennessee sales and use tax rule regarding drop shipments is repealed. If a Tennessee supplier sells to an out-of-state dealer personal property or taxable services for resale and drop ships the goods to the out-of-state dealer’s Tennessee customer, the Tennessee supplier may accept a resale certificate issued by another state or a fully completed Streamlined Sales and Use Tax Exemption Certificate that includes the sales tax ID number issued by the other state to make drop shipped sales for resale without tax.

Important Notice No. 22-01, Tennessee Department of Revenue, Jan. 1, 2022.

Texas

Corporate income, sales and use taxes: Remote sellers guidance updated

For corporate income tax and sales and use tax purposes, the Texas Comptroller of Public Accounts updated its guidance on remote sellers clarifying that:

• Remote sellers with total revenue of less than $500,000 in the preceding 12 calendar months are not required to obtain a tax permit or collect, report, and remit state and local use tax.
• Local use tax is due at the location where the order is shipped or delivered when the order is not received or fulfilled from a Texas place of business.
• The current single local use tax rate is 1.75%.
• Each taxable entity with nexus must file a franchise tax report and an information report, and pay any franchise tax due.

Position Letter, Hearing No. 202201003L, Texas Comptroller of Public Accounts, Jan. 5, 2022.