The states covered in this issue of our monthly tax advisor include:
- Arizona
- California
- Colorado
- Illinois
- Indiana
- Massachusetts
- Michigan
- Minnesota
- Nebraska
- New York
- Ohio
- Washington
Arizona
Corporate, personal income taxes: Rules clarified for elective entity-level taxation for partnerships and S corporations
Arizona’s update to its guidance on elective entity-level taxation for partnerships and S corporations introduces greater flexibility and clarifies key procedures. Entities can now make or revoke the election on amended returns, thanks to a retroactive legislative change. The update confirms that only individuals, estates, and trusts may participate, and those who don’t opt out are automatically included. Estimated payment rules are detailed for entities with income over $150,000, along with penalties for noncompliance.
The publication also clarifies that the PTE credit is nonrefundable but can be carried forward for five years. It must be claimed before other credits, which may limit Arizona residents’ ability to offset taxes paid to other states. Allocation rules are reiterated: partnerships may use special allocations, while S corporations must allocate based on ownership percentages. Final returns may include the election, and single-member LLCs owned by individuals are eligible.
Pub 713, The Arizona Pass-Through Entity Election, Arizona Department of Revenue, September 2025.
California
Corporate, personal income taxes: IRC conformity updated
California has enacted legislation that updates the state’s Internal Revenue Code (IRC) conformity date to Jan. 1, 2025, for taxable years beginning on or after Jan. 1, 2025, with significant exceptions and modifications. California’s previous IRC tie-in date was Jan. 1, 2015, for taxable years beginning on or after Jan. 1, 2015. Thus, the legislation brings California law into conformity with many changes made to the IRC over the last 10 years.
However, the legislation doesn’t conform California law to any changes made by the One, Big, Beautiful Bill Act. Also, the legislation specifically continues California’s nonconformity to many provisions enacted by the Tax Cuts and Jobs Act of 2017 and other acts.
Ch. 231 (S.B. 711), Laws 2025, effective Oct. 1, 2025, and applicable as noted.
Corporate, personal income taxes: Payments under federal environmental credit provisions excluded from gross income
For taxable years beginning on or after Jan. 1, 2026, and before Jan. 1, 2031, certain payments made under federal environmental credit provisions are excluded from gross income for California tax purposes. The exclusion applies to:
- Refund payments received by an eligible entity that elects to treat the amount of a specified credit as a payment against federal income tax.
- Payments received by a transferor as consideration for the transfer of a specified credit.
- The value of a credit received by a transferee pursuant to the transfer of a specified credit.
The federal elective payment and credit transfer provisions apply to the following credits:
- Energy Credit (IRC Section 48).
- Clean Electricity Investment Credit (IRC Section 48E).
- Renewable Electricity Production Credit (IRC Section 45).
- Clean Electricity Production Credit (IRC Section 45Y).
- Commercial Clean Vehicle Credit (IRC Section 45W, applies to elective pay option only).
- Zero-emission Nuclear Power Production Credit (IRC Section 45U).
- Advanced Manufacturing Production Credit (IRC Section 45X).
- Clean Hydrogen Production Credit (IRC Section 45V).
- Clean Fuel Production Credit (IRC Section 45Z).
- Carbon Oxide Sequestration Credit (IRC Section 45Q).
- Credit for Alternative Fuel Vehicle Refueling / Recharging Property (IRC Section 30C).
- Qualifying Advanced Energy Project Credit (IRC Section 48C).
Transferees can’t deduct amounts paid as consideration for credit transfers.
Ch. 215 (S.B. 302), Laws 2025, effective Oct. 1, 2025, and applicable as noted.
Colorado
Corporate, personal income taxes: Rule provides guidance for partnerships and partners relating to federal adjustments
Colorado has adopted a new rule that provides guidance regarding the reporting and payment requirements for partnerships and partners relating to federal adjustments. The rule:
- Defines terms.
- Establishes reasonable qualifications and procedures for designating a person other than the federal partnership representative to be the state partnership representative.
- Identifies the required format for filing the Partnership Federal Adjustments Report.
- Clarifies and details the requirements for reporting partners’ shares of federal adjustments, including the partner notification requirements that a partnership must satisfy, and the amended returns that partners must file.
- Articulates the rules applicable to tiered partners and indirect partners.
- Provides guidance regarding partnership elections to pay an amount in lieu of tax on its partners.
- Prescribes the treatment of estimated tax payments remitted by partners and partnerships for additional tax resulting from federal adjustments.
- Explains the timing, deadlines, and applicability of requests for alternative reporting and payment methods.
Rule 39-22-601.5-1, Colorado Department of Revenue, effective Oct. 15, 2025.
Illinois
Sales and use tax: Taxation of artificial intelligence services discussed
Illinois issued a general information letter discussing the taxation of artificial intelligence (AI) chatbot services that subscribers access through a company’s website or a free application and related API products that subscribers access using software under open-source licenses. AI and related services are most similar to software as a service or a similar service because a user is paying for access and use of a chatbot that is remotely accessed, can only be used with a separately purchased internet connection, and is owned and maintained by the service provider. Software as a service isn’t subject to the Illinois Retailers’ Occupation Tax or Use Tax. Instead, software as a service and similar services are taxable under the Illinois Service Occupation Tax and Service Use Tax to the extent any computer software or other tangible personal property is transferred to the user.
Software acquired for free under open-source licenses to access API products is de minimis if the annual aggregate cost price of the software transferred incident to the sales of services compared to annual gross receipts from service transaction is less than 35%. No use tax is due on the transaction because the cost price of any software acquired and incorporated is zero.
Additionally, there’s no taxable use of software in Illinois if a customer downloads computer software for free from an out-of-state retailer’s website or from a server that’s also located out of state.
Letter ST 25-0050-GIL, Illinois Department of Revenue, Sept. 16, 2025.
Miscellaneous tax: Chicago budget proposes social media and head taxes, and other tax changes
Chicago Mayor Brandon Johnson unveiled his 2026 budget, including proposals to:
- Increase the personal property lease tax.
- Create an amusement tax fee on social media companies with over 100,000 users in the city of $0.50 per active user.
- Add a community safety surcharge on businesses in the city with 100 or more employees.
- Raise the boat mooring or “yacht” tax from 7% to 23.25%.
- Impose an online sports wagering tax at a rate of 10.25% on adjusted gaming receipts from online sports betting licensees.
- Implement a $2 per-unit tax on cannabinoid hemp products.
- Convert the ground transportation tax on rideshare trips from a flat fee to a 10.25% tax.
- Eliminate the grocery tax.
- Reduce the motor vehicle lessor tax from $2.75 to $0.50 per rental period.
The mayor’s budget didn’t propose any property tax increase.
Budget Address, Budget Overview, and Press Release, Office of Chicago Mayor Brandon Johnson, Oct. 16, 2025.
Indiana
Sales and use tax: Nonreturnable wrapping materials would be subject to tax
The taxpayer, a fulfillment company that handles the logistics of storing, packaging, and shipping its customers’ products, would be liable for Indiana sales and use tax on nonreturnable wrapping materials as well as any machinery and equipment used to provide its assembly and packaging services.
Nonreturnable packaging materials
Indiana provides an exemption for sales of wrapping material and containers for use in the shipping or delivery of tangible personal property. The taxpayer, however, doesn’t transform its customers’ products or create new marketable products. The nonreturnable materials used in the performance of its services (e.g., bags, boxes, bubble wrap, cardboard pads, envelopes, labels, stretch wrap, tape, pallets, and crate) aren’t exempt from sales tax since the taxpayer doesn’t meet the statutory requirements for exemption.
Packaging equipment
The taxpayer’s purchases of packaging equipment used to package or repackage products for customers would not be exempt as manufacturing machinery, tools, or equipment for direct use in direct production. Manufacturing machinery, tools, and equipment are exempt from the state gross retail tax if the person acquiring that property acquires it for direct use in the direct production, manufacture, fabrication, assembly, extraction, mining, processing, refining, or finishing of other tangible personal property.
Machinery, tools, and equipment purchased for direct use in production of goods are subject to sales and use tax unless the property used has an immediate effect on the goods produced and is essential to an integrated process used to produce marketable goods. The taxpayer doesn’t transform their customers’ products into new marketable products, nor are they an industrial processor. As a result, the machinery and equipment used to package its customers’ products would not be exempt from sales tax as manufacturing equipment used directly in direct production.
Revenue Ruling No. 2025-04-RST, Indiana Department of Revenue, Sept. 25, 2025.
Massachusetts
Corporate income tax: Corporate nexus regulation clarifies limits of Public Law 86-272 protections
An amendment to Massachusetts regulation 830 CMR 63.39.1, specifically subsection (4)(e), introduces a significant clarification regarding the application of Public Law 86-272 to out-of-state vendors. The revised language emphasizes that the protection from Massachusetts corporate excise tax under this federal law applies only when a corporation’s in-state activities are strictly limited to the solicitation of orders for tangible personal property, with all orders approved and fulfilled from outside the state. The amendment explicitly states that this protection doesn’t extend to corporations selling services or licensing intangible property within Massachusetts.
Additionally, the regulation now includes examples of activities that disqualify a corporation from the protection of Public Law 86-272. These include digital interactions such as placing cookies on Massachusetts customers’ devices to collect data for business purposes — activities deemed not “entirely ancillary” to solicitation. The amendment also clarifies that post-sale activities typically fall outside the scope of protected solicitation. Importantly, the regulation reiterates that the protection provided by the federal law applies only to the income measure of the corporate excise, not to the non-income or minimum excise components.
830 CMR 63.39.1, Massachusetts Department of Revenue, effective Oct. 18, 2025.
Michigan
Corporate, personal income taxes: Calculation of taxable income decoupled from federal provisions; IRC conformity updated
Michigan has enacted legislation that updates the state’s Internal Revenue Code (IRC) conformity date to Jan. 1, 2025. Consequently, for statutory purposes, the “Internal Revenue Code” means the IRC of 1986 in effect on Jan. 1, 2025, or at the option of the taxpayer, is in effect for the tax year. The legislation also decouples from certain changes made by the One, Big, Beautiful Bill Act, relating to the calculation of adjusted gross income or federal taxable income and makes changes to the taxation of tips, overtime compensation, and retirement income.
Calculation of adjusted gross income and federal taxable income
For tax years beginning after Dec. 31, 2024, a taxpayer’s adjusted gross income or federal taxable income is calculated as though Sections 168(n) and 174A of the federal IRC were not in effect, and as though Sections 163(j), 168(k), 174, and 179, as in effect on Dec. 31, 2024, applied. For tax years beginning after Dec. 31, 2021, a taxpayer’s adjusted gross income or federal taxable income are calculated as if the transition rules under Section 70302 of the One, Big, Beautiful Bill Act do not apply, including provisions relating to the application of Section 174A of the IRC. These calculation methods apply to individuals, resident estates or trusts, and taxpayers subject to the corporate income tax, including flow-through entities.
Individual income tax
For tax years beginning after Dec. 31, 2025, and before Jan. 1, 2029, an individual taxpayer may deduct from adjusted gross income an amount equal to the sum of the following deductions allowed to be claimed on the taxpayer’s federal income tax return for the same tax year:
- Qualified tips under Section 224 of the IRC.
- Qualified overtime compensation under Section 225 of the IRC.
For tax years that begin on and after Jan.1, 2026 and before Jan. 1, 2029, a Tier 3 taxpayer (born after 1952) opting to take the $20,000 deduction for single filers ($40,000 for joint returns) against all income, may also deduct Social Security income.
Act 24 (H.B. 4961), Laws 2025, effective Oct. 7, 2025.
Minnesota
Corporate income tax: Receipts from pharmacy benefits management services properly attributed to state
The Minnesota Supreme Court affirmed the tax court’s decision that receipts from pharmacy benefit management services were properly attributed to Minnesota for corporate franchise tax purposes because the services were received both by plan members in Minnesota and by the contracting entity in Wisconsin. The court held that, under Minnesota’s services sourcing statute, “received” didn’t require receipt by direct customers but included receipts by indirect beneficiaries, such as a customer’s customer. Here, the parties stipulated that all of the receipts at issue should be sourced together, either solely to Wisconsin or solely to Minnesota. Because the taxpayer failed to meet its burden to prove that none of the services were received in Minnesota, the tax court did not err by summary judgment to the Commissioner of Revenue.
Humana MarketPoint, Inc. v. Commissioner of Revenue, MNSCt, No. A25-0058, Sept. 24, 2025.
Nebraska
Corporate, personal income taxes: Guidance provided on prohibition on tax benefits received by foreign adversary companies
The Nebraska Department of Revenue has provided guidance on the prohibition on foreign adversary companies (FACs) receiving benefits from any of the state’s tax incentive programs as of Oct. 1, 2025. As of this date, entities applying for credits, investors who attempt to claim the entity’s credits on tax returns, and persons who would claim credits based on employment with or donation to a FAC, are precluded from receiving any tax credits. Credits owned by a FAC on Oct. 1, 2025, will be disallowed, even if they are subsequently transferred to an eligible entity. Any credits transferred to a FAC will be disallowed once transferred (including credits from past years that have been carried forward).
A “foreign adversary” includes:
- The People’s Republic of China (including Hong Kong and Macau special administrative regions).
- Republic of Cuba.
- Islamic Republic of Iran.
- Democratic People’s Republic of Korea (North Korea).
- Russian Federation.
- Venezuelan politician Nicolas Maduro.
A “foreign adversary company” means any corporation, partnership, or other combinations of persons which:
- Are organized under the laws of a foreign adversary.
- Have its principal place of business within a foreign adversary.
- Are owned in whole or in part, operated, or controlled by the government of a foreign adversary.
- Are a subsidiary or parent of any company so described.
Foreign Adversary Company Notice, Nebraska Department of Revenue, Sept. 23, 2025.
New York
Sales and use tax: Petition dismissed for lack of jurisdiction
A taxpayer’s New York sales and use tax petition was dismissed for lack of jurisdiction because the taxpayer failed to include a required statutory notice. While the petition included a copy of a notice and demand, this notice was insufficient to confer jurisdiction upon the Division of Tax Appeals to consider the merits of the taxpayer’s petition.
Yougie Iron Works, Inc., New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 851124, Oct. 9, 2025.
Ohio
Corporate income tax: Chargebacks could reduce gross receipts
The Ohio Board of Tax Appeals concluded that a taxpayer’s wholesale adjustment cost (WAC) should be reduced by chargebacks when calculating its taxable gross receipts for commercial activity tax (CAT) purposes.
Following an audit, Ohio assessed additional CAT after the auditor used the WAC to calculate liability, without consideration of sale price adjustments, including chargebacks, rebates, shortages, and other discounts. The taxpayer petitioned for reassessment, claiming that the cash discounts, returns, and allowances which reduced the list price were not deductible expenses, but rather price adjustments that reduced the original invoice amount.
The board agreed with the taxpayer that the contested amounts did not constitute gross receipts. The taxpayer received only the adjusted sales price, not the full WAC. The board reasoned that CAT is a tax on receipts realized by the taxpayer, not the WAC, not on theoretical invoice amounts, and not on amounts that are contractually offset before payment is ever made. Because the taxpayer never received the WAC, they were not gross receipts. The chargeback reduction wasn’t an expense, but rather the accounting mechanism used to establish the actual purchase price, the gross amount realized.
Perrigo Sales Corp. v. Patricia Harris, Ohio Board of Tax Appeals, No. 2024-485, Oct. 9, 2025.
Washington
Sales and use tax: High grossing business surcharge explained
Beginning Jan. 1, 2026 through Dec. 31, 2029, businesses with Washington taxable income of $250 million or more in a calendar year must pay a surcharge in addition to the business and occupation (B&O) tax. The 0.5% surcharge rate applies to certain taxable income over $250 million. The following amounts are exempt from the surcharge:
- Income subject to the financial institution surcharge.
- Income subject to any manufacturing B&O tax classification, including wholesale and retail sales of these products.
- Retail sales of exempt food and food ingredients.
- Retail sales of prescription drugs.
- Income subject to the preferential tax rates for timber or wood products.
- Income from the wholesale or retail sale of petroleum products owned by a person not located in Washington and processed for hire in Washington by an affiliated entity.
- Income for which the multiple activities credit (MATC) is allowed.
- Income earned by persons engaged in business primarily as a farmer or eligible apiarist.
- Income subject to the workforce education surcharge.
- Income from the wholesale or retail sale of a motor vehicle or special fuel.
Special Notice, Washington Department of Revenue, Sept. 29, 2025.
Sales and use tax: Interim guidance provided on taxability of custom software
The Washington Department of Revenue has issued interim guidance on the imposition of retail sales tax and retailing business and occupation (B&O) tax to custom software and customization of prewritten software effective Oct. 1, 2025.
Sourcing
If the location of service is known and the purchaser receives the services at multiple known locations, the department will accept proportional allocation to each known located based on the amount of the service received at each location, or equal proportional allocation. The seller and purchaser may allocate the sale to multiple locations based on a reasonable and consistent method. The agreed-upon allocation must be provided by the purchaser at the time of the invoice. If the location of receipt is unknown, the service is received at the business address of the purchaser based on their business records. If such information is unavailable, the service is considered received at the purchaser’s billing address.
Reselling of custom software
The seller of custom software or customized prewritten software may provide a reseller permit to a third-party subcontractor to document the purchase for resale purposes, if the following factors are met:
- The seller of custom software or customized prewritten software is contractually responsible for providing the services for a third-party buyer.
- The seller has no intervening use of the services provided by the third-party contractor.
At this time, the department believes it’s unlikely that custom software or the customization of prewritten software may be provided without intervening use; therefore, most transactions won’t qualify for resale.
Multiple Points of Use (MPU) exemption
If custom software or customization of prewritten software meets the requirements of RCW 82.04.050(6)(b) and are concurrently used inside and outside the state, purchasers may use the MPU exemption and pay use tax on the amount apportioned to Washington. However, if the MPU-eligible product is sold as part of a bundled transaction, the exemption is unavailable.
Nonprofit organizations
Nonprofits are taxed like other businesses in Washington. Therefore, nonprofit organizations must collect sales tax when making retail sales of custom software or customization of prewritten software, and they must pay sales tax when purchasing such services.
Sales between members of an affiliated group
The sale of custom software or customization of prewritten software between members of an affiliated group is excluded from the definition of “retail sale.” Such services would be subject to the service and other activities of B&O tax classification.
Interim Guidance Statement Regarding Changes Made by ESSB 5814 For Custom Software, Washington Department of Revenue, Sept. 26, 2025.
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