Local Tax
Subscribe to Local Tax's Posts

Tax That DC?!?! FCA Suit on Residency Brings Business Intelligence Company into the Crosshairs

For the first time since the enactment of the False Claims Amendment Act of 2020, the DC Attorney General’s (AG’s) Office has used its new tax enforcement powers to pursue an alleged personal income tax deficiency. This development brings to the forefront a long-simmering constitutional problem with DC’s statutory residency law and offers a stern warning to businesses that assist key employees and executives with their personal tax obligations.

The press rapidly and widely reported on DC’s lawsuit against MicroStrategy Co-Founder, Executive Chairman and former CEO Michael Saylor for alleged evasion of D.C. personal income taxes, which was made public this week. The case alleges that Saylor wrongly claimed that he was a resident of Virginia or Florida (rather than DC) since at least 2012.

The case was originally brought under seal by a relator under DC’s False Claims Act in April 2021—less than one month after the False Claims Amendment Act took effect. Using its new tax authority, the DC AG’s Office filed a complaint last week to intervene (taking over the case going forward). Interestingly, when the DC AG’s Office took over the case, it added MicroStrategy as a defendant under the theory that the company conspired to help Saylor evade DC personal income taxes. Under DC’s False Claims Act, both Saylor and MicroStrategy could be liable for treble damages if a court rules in favor of the DC AG’s Office.

ISSUES WITH DC’S “STATUTORY RESIDENCY” TEST

While determining where an individual is a resident for state and local tax purposes generally requires a fact-intensive analysis, the case against Saylor also implicates DC’s unique (and likely unconstitutional) statutory residency standard. DC’s statute is fundamentally different than statutory residency standards in other states. Most states only tax individuals having their domicile in the state as residents, while some states also have a “statutory residency” test to classify individuals as taxable residents. In most states, a person is classified as a statutory resident if they (1) maintain a permanent place of abode in the jurisdiction and (2) spend more than a specific number of days (typically 183 days) in the jurisdiction.

DC truncates this standard and classifies someone as a statutory resident if they merely maintain a personal place of abode in DC for more than 183 days. Thus, no amount of actual presence of the individual in DC is required. The problem created by this one-of-a-kind standard should be obvious: someone can (as many high-net-worth individuals often do) maintain a residence for 183 days in more than one jurisdiction. Thus, the plain language of the statute would violate the Commerce Clause of the US Constitution because it runs afoul of the internal consistency test. Under this test, a statute is unconstitutional if under a hypothetical situation in which every jurisdiction has the same law as the one being challenged, more than 100% of the tax base would be subject to tax. Here, if every state had a statutory residency test applicable to anyone who had a [...]

Continue Reading




Fatally Flawed? Illinois Municipal League’s Model Streaming Subscription Tax

The Illinois Municipal League (IML) represents the interests of 219 home rule municipalities in Illinois.[1] The IML recently released a revised draft model, “Municipal Streaming Tax Ordinance,” (the model) for use by the home rule municipalities in imposing an “amusement tax” on, inter alia, music and video streaming services and online gaming.[2] If the subscriber’s residential street address is within the corporate limits of the municipality, the subscription fee would be subject to the tax.[3] However, the tax proposed by the model has at least two fatal flaws: it is barred by the Internet Tax Freedom Act (ITFA) as a discriminatory tax on electronic commerce and is an unconstitutional extraterritorial tax under the home rule article of the Illinois Constitution.[4]

NATURE OF THE STREAMING TAX

The model proposes a tax on the privilege of viewing an amusement, including electronic amusements that either “take place within the” municipality or are delivered to subscribers “with a primary place of use within the jurisdictional boundaries of” the municipality.[5] The model incorporates the definition of “place of primary use” from the Illinois Mobile Telecommunications Sourcing Conformity Act.[6] That statute requires sourcing to the subscriber’s “residential street address.”[7] The streaming tax operates like a familiar sales tax in that it is imposed on the subscriber but collected by the streaming provider and remitted to the municipality.[8] The model tax would also be imposed on “paid television programming” (sat TV), but not paid radio programming (sat radio), transmitted by satellite.[9] The tax is not imposed on transactions that confer “the rights for permanent use of an electronic amusement” on the customer.[10]

THE NATURE OF MUSIC AND VIDEO STREAMING AND ONLINE GAMING SUBSCRIPTIONS

There are many service providers that allow internet access to the databases of music, videos and games (content). Customers typically enter into an automatically renewing subscription agreement with the provider that allows access to a database such that the subscriber can “stream” the content from any fixed or mobile device with internet connectivity. Subscribers are able to access the content from anywhere at anytime so long as their subscription is current and they have internet access.

Because the subscription fees are paid in advance, there is no way for either the provider or the subscriber to know where and when the subscriber might access the content, if at all, during the month. Also, because the streaming tax proposed under the model is on the subscription fee, the tax must be collected before any streaming occurs. It may be that the subscriber doesn’t access the content either from within the corporate limits of the municipality or at all during the subscription period.

FATAL FLAWS

1. Barred Discriminatory Tax on Electronic Commerce

The ITFA generally bars state and local taxes that discriminate against electronic commerce.[11] A tax discriminates against electronic commerce if it is imposed on transactions that occur over the internet but not [...]

Continue Reading




New Mexico Proposes Regulations Addressing Gross Receipts Tax Treatment of Digital Advertising Services

On August 9, 2022, the New Mexico Taxation and Revenue Department published proposed regulations addressing the gross receipts tax (New Mexico’s version of a sales tax) treatment of digital advertising services. The Department states the proposed regulations do not reflect a change in policy but instead ensure the rules are consistent for all advertising platforms.

While the proposed regulations provide some clarity regarding the taxation of digital advertising services under preexisting rules, they introduce several inconsistencies and other gaps, particularly with respect to the finer details of the sourcing provisions. For example, we believe the proposed regulations leave ambiguity regarding whether gross receipts from the provision of digital advertising services should be sourced to:

  1. The purchaser’s address
  2. The server’s location
  3. The viewer’s location

Separately, the proposed regulations would allow a deduction for gross receipts from national or regional advertising. However, the deduction is not allowed if the purchaser is incorporated in or has its principal place of business in New Mexico. While this significantly narrows the base for the tax, it injects complexity by requiring that the seller know the state in which its purchaser is incorporated or has its principal place of business, information not likely available in the context of internet-based advertising platforms.

Collectively, these inconsistencies and lack of clarity could lead to future compliance issues, which we hope will be mitigated as part of the Department’s regulatory approval process.

The Department scheduled a public hearing on the proposed rules for September 8, 2022, at 10:00 am MDT, which also is the due date for submission of written comments. The proposed regulations would be effective upon publication in the New Mexico Register, which could happen as soon as October 11, 2022 (or thereabout).

Please contact the McDermott Will & Emery State & Local Tax team if you have any questions about the potential impact of these proposed regulations on your company. In the meantime, we will be monitoring the regulation approval process and participating in next month’s public hearing.




Pennsylvania Cuts Corporate Tax Rate, Makes Other Changes to Corporate Tax Law

Pennsylvania Governor Tom Wolf has signed into law omnibus tax legislation to implement the Commonwealth’s fiscal year 2022 – 2023 budget. Among other things, the enacted legislation: (1) cuts the corporate net income tax (CNIT) rate from 9.99% to 4.99% on a phased-in basis; (2) adopts market sourcing rules for intangible-related receipts; and (3) codifies the Pennsylvania Department of Revenue’s (DOR’s) CNIT economic nexus rules outlined in Corporation Tax Bulletin 2019‑04. Notably, the enacted legislation does not include Governor Wolf’s prior proposal to strengthen the Commonwealth’s related party interest and intangible expense addback statute.

CNIT RATE CUT

Pennsylvania’s CNIT rate is currently 9.99%—one of the highest corporate tax rates in the nation. The enacted legislation phases in a decrease of Pennsylvania’s CNIT rate as follows:

  • January 1, 1995, through December 31, 2022; 9.99%
  • January 1, 2023, through December 31, 2023; 8.99%
  • January 1, 2024, through December 31, 2024; 8.49%
  • January 1, 2025, through December 31, 2025; 7.99%
  • January 1, 2026, through December 31, 2026; 7.49%
  • January 1, 2027, through December 31, 2027; 6.99%
  • January 1, 2028, through December 31, 2028; 6.49%
  • January 1, 2029, through December 31, 2029; 5.99%
  • January 1, 2030, through December 31, 2030; 5.49%
  • January 1, 2031, and each year thereafter; 4.99%

MODIFICATION OF INTANGIBLES SOURCING RULE

The enacted legislation shifts Pennsylvania’s sourcing regime for receipts from intangibles from a cost-of-performance regime to a market-based regime. The legislation generally sources gross receipts from the sale, lease, or license of intangible property to the location the property is used. Further, the legislation generally sources receipts from a broker’s sales of securities to the location of its customer and receipts from credit card interest, fees, and penalties to the billing address of the cardholder.

The legislation also contains detailed sourcing rules for interest, fees, and penalties earned by a lender, generally sourcing those receipts:

  1. From loans secured by real property to the location of such real property;
  2. From loans related to the sale of tangible personal property to the location the property is delivered or shipped; and
  3. To the location of the borrower (if not otherwise addressed by the legislation).

These sourcing rule changes apply to tax years beginning after December 31, 2022. According to the Senate Appropriations Committee’s Fiscal Note to the legislation, the purpose of the sourcing rule change is to “[a]lign[] the apportionment rules governing sales of intangible property with the sales of tangible personal property, real property and services to be consistent with market sourcing (i.e., where the purchaser paying for the sale or using the property is located).” As discussed in a prior blog post, the Pennsylvania legislature changed the sourcing regime for services from cost-of-performance to a market-based regime.

Nevertheless, the Pennsylvania DOR has insisted that current law requires the use of a market-based approach to source receipts from certain intangibles, despite the cost-of-performance statutory regime currently in effect. For tax years before 2014, the Pennsylvania DOR also employed a market-based approach [...]

Continue Reading




Seattle Payroll Expense Tax Upheld by State Appellate Court

This week, the Washington Court of Appeals affirmed a lower court’s decision to dismiss a challenge to the recently enacted payroll expense tax in Seattle, WA. Seattle Metro. Chamber of Commerce v. City of Seattle, No. 82830-4-I, 2022 WL 2206828 (Wash. Ct. App. June 21, 2022).

The tax, which went into effect on January 1, 2021, applies to entities “engaging in business within Seattle” and is measured using the business’s “payroll expense” (defined as “compensation paid in Seattle to employees,” including wages, commissions, salaries, stock, grants, gifts, bonuses and stipends). The tax only applies to businesses with a payroll expense of more than $7 million in the prior calendar year, and compensation is considered “paid in Seattle” if the employee works more than 50% of the time in the city. Additionally, if the employee does not work in any city more than 50% of the time, the employee’s compensation is treated as though it was “paid in Seattle” only “if the employee resides in Seattle.”

Although the tax is based on employee compensation, the Washington Court of Appeals held that incidence of the tax is on the employer, not the employee. This was a critical distinction because, under Washington law, municipalities generally are prohibited from levying taxes directly on wages (e.g., an income tax). By finding that the tax incidence fell on the employers, the Court was able to define the tax as an excise tax on the employer’s privilege of doing business in the city.

As expected, the tax is already bringing in significant revenue for Seattle. In its first year on the books, the tax brought in more than $230 million. Yet, despite this new revenue (as well as revenue from several other recently enacted taxes), Seattle is still projecting a financing gap of more than $100 million for 2022. Taxpayers are concerned that the city will explore even more revenue options to help close the gap.

The McDermott tax team is constantly monitoring tax developments on a state-by-state basis and will provide updates on the PNW specifically as they are made known.




New York State Department Intends to Finalize Corporate Tax Regulations This Fall

Almost seven years after it started releasing draft regulations concerning sweeping corporate tax reforms that went into effect back in 2015, the New York State Department of Taxation and Finance (Department) has issued guidance, stating that “the Department intends to begin the State Administrative Procedure Act (SAPA) process to formally propose and adopt” its draft corporate tax regulations this fall.

The Department has released many versions of “draft” regulations addressing corporate tax reform since September 2015. However, these draft regulations have been introduced outside of the SAPA process because the Department intended to formally propose and adopt all draft regulations at the same time. In the meantime, the Department warned taxpayers that so long as the regulations remain in draft form, they are not “final and should not be relied upon.”

Now, the Department has given its first public signal that it is prepared to formally adopt the draft regulations later this year. On April 29, 2022, the Department released “final drafts” of regulations that address a variety of topics, including nexus and net operating losses, and indicated that it will release final draft regulations addressing “apportionment, including rules for digital products/services and services and other business receipts” this summer.

Notably, the draft regulations released on April 29 include new provisions, “largely modeled after the [Multistate Tax Commission (MTC)] model statute . . . to address PL 86-272 and activities conducted via the internet.” Like the MTC model statute, the new draft regulations take a broad view of internet activities that would cause a company to lose PL 86-272 protection. In one example, the draft regulations state that providing customer assistance “either by email or electronic ‘chat’ that customers initiate by clicking on an icon on the corporation’s website” would exceed the scope of protections provided under PL 86-272.

As it intends to formally propose the draft regulations this fall, the Department is “strongly” encouraging “timely feedback” on all final draft regulations. With respect to the final draft regulations released on April 29, the Department is asking for comments by June 30, 2022.




Washington State Capital Gains Tax Held Unconstitutional

The Washington State capital gains tax, which went into effect on January 1, 2022, has been held unconstitutional by the Douglas County Superior Court. Created in 2021, the tax was ostensibly labeled an “excise” tax in an effort by the Washington State Legislature (Legislature) to avoid difficulties associated with implementing an income tax in the state of Washington. The judge, however, was not persuaded.

Citing to authority from the Washington State Supreme Court, the trial judge held that courts must look through any labels the state has used to describe the statute and analyze the incidents of the tax to determine its true character. Here, the judge reviewed the most significant incidents of the new tax, including:

  • It relies on federal income tax returns that Washington residents must file and is thus derived from a taxpayer’s annual federal income tax reporting;
  • It levies a tax on the same long-term capital gains that the Internal Revenue Service (IRS) characterizes as “income” under federal law;
  • It is levied annually (like an income tax), not at the time of each transaction (like an excise tax);
  • It is levied on an individual’s net capital gain (like an income tax), not on the gross value of the property sold in a transaction (like an excise tax);
  • Like an income tax, it is based on an aggregate calculation of an individual’s capital gains over the course of a year from all sources, taking into consideration various deductions and exclusions, to arrive at a single annual taxable dollar figure;
  • Like an income tax, it is levied on all long-term capital gains of an individual, regardless of whether those gains were earned within Washington and thus without concern of whether the state conferred any right or privilege to facilitate the underlying transfer that would entitle the state to charge an excise;
  • Like an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year; and
  • Unlike most excise taxes, if the legal owner of the asset who transfers title or ownership is not an individual, then the legal owner is not liable for the tax generated in connection with the transaction.

The court found that these incidents show the hallmarks of an income tax rather than an excise tax, and because the new capital gains tax did not meet the uniformity and limitation requirements of the Washington State Constitution, it was unconstitutional.

The Washington State Attorney General has already indicated that the ruling will be appealed; in all likelihood, this issue will ultimately be decided by the Washington State Supreme Court. In the meantime, if you have questions about the Washington State capital gains tax, please contact Troy Van Dongen.




CDTFA Proposes Significant Revisions to Chapters 4 and 13 of the Sales Tax Audit Manual

On February 2, 2022, the California Department of Tax and Fee Administration (CDTFA) held an interested parties meeting (IPM) to discuss proposed amendments to sales tax audit manual (AM) Chapter 13, “Statistical Sampling,” and Chapter 4, “General Audit.”

Prior to the IPM, the CDTFA released a lengthy discussion paper outlining the extensive proposed changes to the AM, which includes:

1. Removing the three error rule. The current text of AM 1308.05 explains that when a sample produces only one or two errors, the auditor must evaluate whether these errors are representative or whether it is possible they indicate problems in certain areas that could be examined separately. Under the proposed amendment, the same evaluation standards would still be in place without the minimum error requirement. According to the CDTFA, the proposed removal of the three error rule is because of the fact that “the number of errors identified in a sample does not give any indication whether the sample is representative or not…If the combined evaluation evaluates within Department [CDTFA] standards, it is justified to project the results even if one or two errors are found.”

2. Requiring 300 minimum sample items per stratum unless the auditor obtained approval from CAS to select fewer than 300. Currently, the “minimum sample size of at least 300 items of interest is to be used in all tests, except where the auditor can support a smaller sample size and it evaluates well.” (AM 1303.05) Under the new subsection titled “Materiality,” a minimum of 300 sample items per test stratum is recommended. Computer Audit Specialist (CAS) approval is required for selecting less than 300 sample items per test stratum.

3. Refunding Populations: A minimum of 100 sample items per stratum is required. In the section addressing sampling refund populations (AM 1305.10), the proposed amendment would permit auditors to select as few as 100 sample items per test stratum without CAS approval, provided the expected error rate is sufficiently high (greater than 20%). No such rule exists under the current text of Chapter 13.

4. Contacting CAS when the prior audit had 300 hours charged to it is now mandatory. In contrast, under the current rule, it is mandatory that CAS be contacted when the prior audit expended 400 or more hours or if CAS was involved in the prior audit.

5. Replacing Credit Methods 1, 2 and 3 with one recommended approach to handling credits in a statistical sample. The subsection (AM 1303.25) currently lists three types of credit methods that can be used for a statistical sample. The CDTFA now only recommends one credit method for use in a stratified statistical sample, which is referred to as “Method 1” in the current AM text. When auditors review electronic data, attempts should be made to match credit invoices to original invoices (including partially) if it is certain that the credit invoices are related to the original invoice. For all credit memos that are not matched to original invoices, those credits will be removed from [...]

Continue Reading




Washington State’s Mandatory Withholding for Long-Term Care Put on Hold

In 2019, the Washington State Legislature (Legislature) established the Long-Term Services and Supports Trust Program (LTSS Trust Program) to provide funding for eligible beneficiaries that they can apply to the cost of their long-term care. The LTSS Trust Program is funded through a 0.58% payroll tax on employee wages, which went into effect on January 1, 2022.

Though the LTSS Trust Program was intended to provide a baseline of benefits to Washingtonians lacking private long-term care insurance, the program drew public criticism in recent months because, among other things, employees had no easy way to opt out of it. The legislation provided that individuals could opt out by purchasing private long-term care insurance before November 1, 2021, and applying for an exemption by the end of 2021. However, shortly after the program went into law, most (if not all) private long-term care insurance providers pulled out of the state.

When the Legislature convened earlier this month, it fast-tracked new legislation to put the LTSS Trust Program on hold. Though many lawmakers were calling for an outright repeal of the program, the majority ultimately passed a bill to delay its implementation until July 2023. Washington Governor Jay Inslee is expected to sign the measure by Friday, January 28.

Since this delay comes after employers have already started withholding the tax from their employees’ wages and, in some cases, after the tax has been remitted to the Employment Security Department (ESD), refunds will be necessary. Under the new law, employers are required to provide refunds to their employees within 120 days of the collection. If the employer already remitted the tax to the ESD, the ESD is required to refund that money to the employer who is then required to pass it on to the employee.

If you have questions about the LTSS Trust Program or its delayed implementation, please contact the author of this article.




Massachusetts Department of Revenue Stops Applying COVID-19 Telecommuting Policy, Returns to Location of Work Performed

In a recently issued guidance, the Massachusetts Department of Revenue indicated that the emergency telecommuting rules it put in place during the Massachusetts COVID-19 state of emergency would cease to be in effect as of September 13, 2021. Under the telecommuting rules, which were effective beginning March 10, 2020, wages paid to a non-resident employee who worked remotely (i.e., working from home or a location other than their usual work location) because of the COVID-19 pandemic were sourced based on where the employee worked prior to the state of emergency. Effective September 13, 2021, wages will generally be sourced based on where the employee’s work is actually performed.




STAY CONNECTED

TOPICS

ARCHIVES