The federal tax reform package recently approved by Congress (the Bill) contains a cap on the state and local tax deduction that may be claimed by individuals on their federal income tax returns. The Bill provides that an individual may claim up to $10,000 of state and local property taxes and either income or sales taxes. The cap expires on January 1, 2026.

Individual taxpayers who have been considering prepaying their 2018 (or later) taxes in 2017 should be aware that the final version of the Bill contains a provision that prohibits individuals from prepaying their income tax for future years in 2017. As a result, any guidance issued by state revenue departments (for example, in Illinois) regarding the prepayment of 2018 income tax is no longer applicable. In certain jurisdictions, individuals may still have an opportunity to prepay their property tax assessments. For additional details, please contact your tax preparer.

The White House and Republican congressional leadership released an outline this week to guide forthcoming legislation on federal tax reform. The states conform to the federal tax laws to varying degrees and the extent to which they will adopt any federal changes is uncertain. This memorandum outlines some of the key areas—individual taxation, general business taxation and international taxation— with which the states will be concerned as details continue to unfold.

Continue reading.

States are competing aggressively to attract data centers with various tax incentives. Data center companies and their business customers are taking them up on their offers. But are these incentives really a good deal for the businesses? Tax incentives that seem attractive at first glance may not be beneficial when they are examined in the context of the entire tax picture, especially in the unique, uncertain, and developing world of state taxation of technology and computer services.

With the rise of global commerce, cloud computing, streaming video and a wide array of other internet-related businesses, data centers have become big businesses.  In 2014, the colocation data center industry reached $25 billion in annual revenue globally, with North American companies accounting for 43 percent of that revenue.[1]

To get in on the action, states have been trying to outdo one another by offering a slew of competing tax breaks to the industry. According to the Associated Press, states have provided about $1.5 billion in data center tax breaks over the past 10 years.[2]   Some states have gone even further, providing tax incentives to the entire data center industry through changes in the tax laws themselves. Such incentives can include reductions or exemptions from sales and use taxes on data center products or services, favorable income tax rates for data center companies and favorable property tax rules for data center assets. According to a recent analysis by the Associated Press, at least 23 states provide such statutory data center tax incentives.[3] Just a few of the most recent examples include a sales tax exemption for data center equipment in Michigan,[4] a broadening of the sales tax exemption for data center electricity and equipment in North Carolina[5] and a favorable apportionment formula for data centers in Virginia.[6]  Importantly, many of these incentives apply not only to the data centers themselves, but also to their customers.

Businesses considering whether to take advantage of these incentives would be well advised to consider not only the potential benefit from any particular tax incentive, but also whether the decision would affect their tax picture as a whole. Because of the current uncertain and changing landscape for state and local taxation of technology and computer services, the analysis of these incentives for data centers and their customers can be particularly complex.

One item that a taxpayer might overlook when considering whether to take advantage of an incentive program is what affect, if any, the choice of location might have on the taxpayer’s property factor for income tax apportionment purposes. Obviously, location of a company’s technology equipment in a data center under a colocation agreement will cause the company’s in-state property factor to increase due to its equipment being located in the state. However, data center customers also should be aware that local tax authorities might also argue that the colocation payments themselves constitute consideration for the use of real or tangible personal property and thus the customer’s in-state property factor should be further increased by the amount of those charges. Our Firm has seen the tax authority in one state argue this precise issue.

Therefore, although a data center customer might pay less in sales tax by choosing a data center in a state that provides certain incentives, the customer should also carefully evaluate any potential increase in tax due to colocation in a state, such as a potential increase of their income tax liability due to higher apportionment from the property factor.

Another consideration that data center customers should keep in mind is the sourcing of receipts. For tax purposes, most states source the sale of technology products based on the location of the user, which usually will be the location of the customer’s employees.[7] However, where a vendor provides a product by way of a server, at least one state tax authority has determined that such receipts should be sourced to the location of the server.[8] These contrasting source rules present the risk that a business will essentially be subject to “double tax” on its purchase of technology services. Where IT-sourcing rules are not codified or their interpretation is uncertain, businesses should be cognizant of the risk of other tax authorities adopting this position, especially in light of the growth in services provided by data centers.

These issues demonstrate that although data centers and their customers stand to reap significant benefits from the wide array of state tax incentives available, any decision should include an analysis of the overall tax picture. Even the most attractive tax break may be outweighed by potential increases in other taxes.

[1] Yevgeniy Sverdlik, Global Data Center Colocation Market Reaches $25B, Data Center Knowledge (December 23, 2014) (accessible at: http://www.datacenterknowledge.com/archives/2014/12/23/multitenant-colocation-data-center-market-reaches-25b/).

[2] Yevgeniy Sverdlik, North Carolina Makes Data Center Tax Breaks Easier to Get, Data Center Knowledge (October 1, 2015) (accessible at: http://www.datacenterknowledge.com/archives/2015/10/01/north-carolina-makes-data-center-tax-breaks-easier-to-get/).

[3] Id.

[4] SB 616, 2015 Leg., 1st Reg. Sess. (MI., 2015).

[5] HB 117, 2015 Leg., 1st Reg. Sess. (N.C., 2015).

[6] SB 1142, 2015 Leg., 1st Reg. Sess. (VA., 2015).

[7] See, e.g., New York Dep’t. of Tax’n and Fin., TSB-A-11(17)S (Jun. 1, 2011).

[8] Tenn. Dep’t of Rev., Ltr. Rul. 11-58 (Oct. 10, 2011).

An Illinois Appellate Court, in Hertz Corp. v. City of Chicago, 2015 IL App (1st) 123210 (Sept. 22, 2015), gave the City of Chicago (City) permission to require rental car companies to collect tax on vehicle rentals from locations within three miles of the City, overturning a lower court ruling that found such taxation was an extraterritorial exercise of the City’s authority.  The appellate court granted summary judgment to the City and lifted the permanent injunction enjoining the City from enforcing the tax.

The tax at issue is the City’s Personal Property Lease Transaction Tax (Lease Tax), which is imposed upon “(1) the lease or rental in the city of personal property, or (2) the privilege of using in the city personal property that is leased or rented outside of the city.”  Mun. Code of Chi. § 3-32-030(A).  While the Lease Tax is imposed upon and must be paid by the lessee, the lessor is obligated to collect it at the time the lessee makes a lease payment and remit it to the City.  Mun. Code of Chi. §§ 3-32-030(A), 3-32-070(A).

The subject of this litigation is the City’s application of the Tax in its Personal Property Lease Transaction Tax Second Amended Ruling No. 11 (eff. May 1, 2011) (Ruling 11).  The plaintiffs argued that Ruling 11 is an extraterritorial exercise of the City’s authority because the City lacks nexus with the rental transactions.  The Ruling “concerns [short-term] vehicle rentals to Chicago residents, on or after July 1, 2011, from suburban locations within 3 miles of Chicago’s border … [excluding locations within O’Hare International Airport] by motor vehicle rental companies doing business in the City.”  Ruling 11 § 1.  The Ruling explains that “‘doing business’ in the City includes, for example, having a location in the City or regularly renting vehicles that are used in the City, such that the company is subject to audit by the [City of Chicago Department of Finance] under state and federal law.”  Ruling 11 § 3.  As for taxability of leased property, the Ruling cites the primary use exemption, exempting from Tax “[t]he use in the city of personal property leased or rented outside the city if the property is primarily used (more than 50 percent) outside the city” and stating the taxpayer or tax collector has the burden of proving where the use occurs.  Ruling 11 § 2(c) (quoting Mun. Code of Chi. § 3-32-050(A)(1)).

Ruling 11 contains a rebuttable presumption that motor vehicles rented to customers who are Chicago residents from the suburban locations of rental companies that are otherwise doing business in Chicago are subject to the Lease Tax.  The Ruling applies to companies with suburban addresses located within three miles of the City.   The presumption may be rebutted by any writing disputing the conclusion that the vehicle is is used more than 50 percent of the time in the City.  The opposite is assumed for non-Chicago residents.  Ruling 11 § 3.  The Ruling provides that such a writing can be as simple as a customer’s initialing a statement that the vehicle will be used more than 50 percent outside the City (Ruling 11 § 3), but it must be part of the lease agreement or otherwise kept in the company’s business records.  Companies that do not wish to comply with the record keeping requirements may opt to pay tax on 25 percent of its rental charges from Chicago customers.

Plaintiffs Hertz Corporation and Enterprise Leasing Company of Chicago LLC, filed separate actions against the City seeking declaratory and injunctive relief.  The cases proceeded in tandem in circuit court and the court granted summary judgment to the companies.  The court declared Ruling 11 facially unconstitutional and permanently enjoined the City from enforcing the ordinance with respect to vehicle rental transactions occurring outside the City.

On appeal, the City argued that the circuit court erred in characterizing the Lease Tax as a transaction tax, arguing instead that it should be considered a use tax on Chicago residents.  The appellate court agreed and found that Ruling 11 is not an extraterritorial exercise of Chicago’s home rule authority because the Lease Tax is imposed upon a use occurring with the City.  Although the plaintiffs conceded that they “do business” in the City, they argued that the City did not have the jurisdiction over their suburban rental locations to require those locations to collect and remit the Lease Tax. The court, however, was not persuaded and found the undisputed nexus between the plaintiffs, the taxable activity and the City to be sufficient to require plaintiffs to collect and remit the Lease Tax.

The court also  rejected the plaintiffs’ argument that Rule 11 exceeds the scope of the ordinance, instead finding the ruling was well within, and even more limited than, the ordinance.  The court found Ruling 11 narrower than the Ordinance since the ordinance imposes tax on any lease personal property that is used in the city, while the Ruling explains that it is the City’s policy to only impose the tax on city residents who use the leased vehicle primarily in the City.  The court also found that the record keeping requirements contained in Ruling 11 impose no greater documentation burden than is already imposed and permitted by the ordinance.  The court noted that Ruling 11 merely provides guidance as to appropriate documentation and an obligation to maintain records is consistent with the ordinances’ ordinary requirements for taxpayers seeking to claim an exemption.  Finally, the court rejected the plaintiffs’ argument that the Ruling’s presumption that Chicago residents will incur taxable use in the City exceeds the ordinance’s scope.  The court found that the multiple ways the Ruling allows the presumption to be rebutted (including deeming customers’ initialing a sentence containing the “magic” language regarding use outside of the City to rebut, as well as any other “written proof to the contrary”) to be a reasonable implementation of the tax.

The court did not address the plaintiffs’ Commerce Clause argument that there is no minimum connection between the City and rental car transaction occurring outside of the state, e.g., Indiana.  Since the ruling does not currently include Indiana, the court found that the plaintiffs’ argument was speculative.  Finally, the court held that the plaintiffs’ did not have standing to bring a Due Process Clause minimum contacts challenge to Ruling 11 because the ordinance taxed the use of the leased personal property in Chicago, not the rental transaction.

With many state legislatures wrapping up session within the past month or so, there has been a flurry of last-minute tax amnesty legislation passed. Nearly a half-dozen states have authorized upcoming tax amnesty periods. These tax amnesties include a waiver of interest and, in some circumstances, allow taxpayers currently under audit or with an appeal pending to participate. This blog entry highlights the various enactments that have occurred since the authors last covered the upcoming Maryland amnesty program.

Missouri

On April 27, 2015, Governor Jay Nixon signed a bill (HB 384) that creates the first Missouri tax amnesty since 2002. The bill creates a 90-day tax amnesty period scheduled to run from September 1, 2015, to November 30, 2015. The amnesty is limited in scope and applies only to income, sales and use, and corporation franchise taxes. The amnesty allows taxpayers with liabilities accrued before December 31, 2014, to pay in full between September 1, 2015, and November 30, 2015, and be relieved of all penalties and interest associated with the delinquent obligation. Before electing to participate in the amnesty program, taxpayers should be aware that participation will disqualify them from participating in any future Missouri amnesty for the same type of tax. In addition, if a taxpayer fails to comply with Missouri tax law at any time during the eight years following the agreement, the penalties and interest waived under the amnesty will be revoked and become due immediately. Finally, taxpayers who are the subject of civil or criminal state-tax-related investigations, or are currently involved in litigation over the obligation, are not eligible for the amnesty.

According to the fiscal note provided in conjunction with the bill, the state estimates that 340,000 taxpayers will be eligible for the amnesty and that the program will raise $25 million.

Oklahoma

On May 20, 2015, Governor Mary Fallin signed a bill (HB 2236) creating a two-month amnesty period from September 14, 2015, to November 13, 2015. The bill allows taxpayers that pay delinquent taxes (i.e., taxes due for any tax period ending before January 1, 2015) during the amnesty period to receive a waiver of any associated interest, penalties, fines or collection costs.

Taxes eligible for the amnesty include individual and corporate income taxes, withholding taxes, sales and use taxes, gasoline and diesel taxes, gross production and petroleum excise taxes, banking privilege taxes and mixed beverage taxes. Notably, franchise taxes are not included in this year’s amnesty (they were included in the 2008 Oklahoma amnesty).

Indiana

In May, Governor Mike Pence signed a biennial budget bill (HB 1001) that included a provision authorizing the Department of Revenue (Department) to implement an eight-week tax amnesty program before 2017. While the Department must promulgate emergency regulations that will specify exact dates and procedures, several sources have indicated that the amnesty is expected to occur sometime this fall. The upcoming amnesty will mark the second-ever amnesty offered by Indiana (the first occurred in 2005). Taxpayers that participated in the 2005 program will be disappointed to know that the authorizing legislation specifically prohibits them from participating in the upcoming amnesty.

The amnesty program is applicable to all “listed taxes” collected by the Department, including sales and use taxes, corporate and personal income taxes, financial institutions tax and gas taxes. See Indiana Code § 6-8.1-1-1 for the complete list. Unlike several of the other amnesty programs discussed that apply to more recent liabilities, the Indiana amnesty is only statutorily authorized for liabilities due before January 1, 2013 (i.e., 2012 or earlier). While the Department is not prevented from settling more recent liabilities incurred in 2013 and 2014, such an arrangement would be outside the scope of the statutory amnesty provisions.

The benefits of the upcoming program include abatement of interest, penalties, collection fees and costs that would otherwise be applicable, release of any liens and no civil or criminal prosecution. Indiana taxpayers should be aware that if an eligible liability is not paid during the amnesty period (and is subsequently discovered by the Department) penalties are doubled under the statute.

Arizona

On March 12, 2015, Governor Doug Ducey approved a budget package that included a bill (SB 1471) creating a tax recovery (amnesty) program for taxpayers with outstanding liabilities. The program is scheduled to run from September 1, 2015, through October 31, 2015, and applies to all taxes administered by the Department of Revenue, except withholding and luxury taxes. Taxpayers that come forward with tax liabilities that could have been assessed before 2014 (or before 2015 in the case of non-annual filers) will receive abatement of all civil penalties and interest. Taxpayers that were a party to a closing agreement with the Department during the liability period are not eligible for the program; however, nothing in the statute would appear to prevent a taxpayer that is currently under audit from participating in the program.

As a consequence of applying to the program, the inclusion of the outstanding debt in a taxpayer’s application is considered to be a waiver of the taxpayer’s administrative and judicial appeal rights.

South Carolina

On June 8, 2015, Governor Nikki Haley signed a bill (S. 526) giving the Department of Revenue (Department) authority to schedule and execute a three-month tax amnesty period at their discretion. The bill specifically allows the Department to waive all penalties and interest (or a portion of them at its discretion) for taxpayers that voluntarily file delinquent returns and pay all taxes owed (i.e., the Department cannot waive penalties and interest on a period-by-period basis). Taxpayers with an appeal pending may only participate in the program if they pay all the taxes owed. While payment of the liability is required to participate, it will not constitute an admission of liability or a waiver of the appeal.

Taxpayers should note that any debts not fully paid within an agreed-upon post-amnesty period will be subject to a 10 percent collection and assistance fee, in addition to the penalties and interest otherwise owed. The bill grants authority for imposition of this fee for up to one year after the close of the extended amnesty period.

Practice Note

Now is the time for taxpayers with outstanding tax obligations in any of the state’s offering amnesty (including Maryland) to consider whether the issues can and should be resolved through the amnesty program. In deciding whether to avail oneself of the amnesty offerings, taxpayers should be aware that failure to participate in many states (including Indiana and South Carolina) can lead to increased penalties and fees (the infamous “amnesty hammer”) if the delinquent obligation subsequently surfaces.

The United States Tax Court recently determined that certain refundable tax credits issued by New York in connection with economic development activities (EZ Credits) constituted taxable income to the recipients for federal tax purposes. Maines v. Comm’r, 144 T.C. No. 8 (Mar. 11, 2015). In reaching this determination, the Court noted that the characterization of certain of the EZ Credits as refundable taxes for New York purposes “is not necessarily controlling for federal tax purposes;” instead, the Court looked at the substance of the EZ Credits and determined that the credits were not actually a refund of previously paid state taxes, and, instead, the credits were a taxable accession to wealth since they were “just transfers from New York to the taxpayer—subsidies essentially.” The Court also considered one other refundable tax credit (the QEZE Credit), which was a credit against income tax liability for the amount of real property taxes paid, and determined that, while the amount of QEZE Credits refunded did not constitute a “taxable accession to wealth” as did the EZ Credits, the application of the tax benefit rule mandated that the refundable portion was subject to federal taxable income.

The taxpayers received the EZ Credits from New York for engaging in specific economic development activities in the state through their pass-through business entities. As the Court noted, New York labels the EZ Credits “credits” and treats them as refunds for “overpayments” of state income tax; the taxpayers in Maines received refunds of their state income tax based on their claim for the EZ Credits. Despite New York’s characterization of the EZ Credits, the Commissioner asserted that they were nothing more than cash subsidies, and thus should be treated as taxable income to the taxpayers. On the other hand, the taxpayers argued that New York’s label of the EZ Credits as overpayments was binding for purposes of federal law. The Court, noting President Lincoln’s famous quip that “if New York called a tail a leg, we’d have to conclude that a dog has five legs in New York as a matter of federal law. . . . Calling the tail a leg would not make it a leg,” agreed with the Commissioner, observing that federal law looks to the substance of legal interests created by state law, not to the labels the state affixes to those interests.

As for the QEZE Credit, the Tax Court agreed that it did not result in a taxable accession to wealth since it was really a refund of real property taxes that the taxpayer had paid to the state. However, the Court still determined that the refunded amounts would be taxable due to the tax benefit rule to the extent that a deduction had been claimed for the real property taxes paid. Under the tax benefit rule, to the extent a taxpayer obtains a refund of payments for which it received a tax benefit (such as a deduction), such refund should be taxable.

The Maines decision is one of the first Tax Court decisions to address the taxability of refundable state tax credits. After the issuance of this decision, taxpayers should analyze the effect that a refundable state tax credit will have on their federal taxable income. In making such an analysis, a taxpayer must pay careful attention to how the credit operates and not to the labels that a state uses. In addition, in determining the benefit of any potential state tax credit, taxpayers should consider the result of this decision and determine whether they lose some of the anticipated benefit they were expecting.

The City of Chicago’s (City’s) 2015 budget includes a number of changes to taxing ordinances found in titles 3 and 4 of the Chicago Municipal Code.  The City of Chicago Department of Finance has notified taxpayers and tax collectors of the amendments, effective January 1, 2015, via a notice posted on its website.  The text of the amendments can be found on the Office of the City Clerk’s website.  The amendments, designed to bolster the City’s coffers, affect multiple City taxes by enlarging tax bases, increasing tax rates and tightening credit mechanisms.  The amendments include:

  • Hotel Accommodations Tax(Section 3-24-020(A))
    • The definition of “operator” (the tax collector) was amended to include: (1) any person that receives or collects consideration for the rental or lease of hotel accommodations; and (2) persons that facilitate the rental or lease of hotel accommodations for consideration, whether on-line, in person or otherwise.
    • A definition of “gross rental or leasing charge” (the tax base) was added that excludes “separately stated optional charges” unrelated to the use of hotel accommodations.
  • Use Tax for Non-titled Personal Property(Section 3-27-030(D))
    • A credit is available for sales and use “tax properly due” and “actually paid” to another municipality against the City’s 1 percent use tax imposed on the use in the City of non-titled tangible personal property that was purchased outside of the City.  The added definitions of “tax properly due” and “tax actually paid” exclude other municipal taxes that are rebated, refunded, or otherwise returned to the taxpayer or its affiliate.
  • Personal Property Lease Transaction Tax
    • The exemption from the tax for a “car sharing organization” (i.e., Zipcar) was eliminated.  (Sections 3-32-020(A) (definition) and 3-32-050(A)(13) (exemption))
    • The definition of “lease price” or “rental price” (the tax base) was amended to exclude nontaxable, separately-stated charges only if they are optional.  (Section 3-32-020(K))
    • The tax rate was increased from 8 percent to 9 percent.  (Section 3-32-030(B))
  • Amusement Tax
    • The amusement tax was amended to be imposed on the full charge paid for the privilege of using a “special seating area” such as a luxury suite or skybox (Section 4-156-020(F)).  Credit against this tax is available in the amount of any other taxes the City imposes on the same charges (for example, food and beverage charges) if the taxes are separately-stated and paid.  Previously, tax was imposed on 60 percent of the charge for a special seating area and did not include a credit mechanism.
    • Credit against the amusement tax was eliminated for franchise fees paid to the City for the right to use the public way or to do business in the City.  (Section 4-156-020(J))
    • The amendments eliminated the additional tax imposed on ticket sellers (Section 4-156-033).  The tax was imposed on sellers selling tickets from a location other than where the taxable amusement occurs on the amount of the service fee (as distinguished from the taxable admission charge).  Now, all ticket sellers must collect amusement tax from the buyer on the full amount of charges paid to view the amusement.  (Section 4-156-020(F))
  • Parking Lot and Garage Operations Tax
    • The tax rate was increased by 2 percent for daily, weekly and monthly parking for “the use and privilege of parking a motor vehicle in or upon any parking lot or garage in the City of Chicago [“Parking Tax”].”  (Section 4-236-020(a), (d))
    • The definition of “charge or fee paid for parking” (the tax base) was amended to exclude nontaxable, separately-stated charges only if they are optional.  (Section 4-236-010)
    • An additional tax was added and is imposed on a person engaged in a valet parking business in the City.  Section 4-236-025 imposes tax on the full amount charged by the valet parking business at a rate of 20 percent.  A credit against the additional tax is available in the amount of Parking Tax paid.  These rules replace the former rule for valet parking operators providing that they were to collect Parking Tax only if the operators of the parking lot or garage did not collect the tax.

The New Jersey Division of Taxation (Division) is trying to help taxpayers resolve unpaid tax liabilities for tax periods 2005 through 2013.  Through November 17, 2014, the Division is offering taxpayers that pay all tax and interest for the applicable periods a waiver of most penalties (but not penalties related to the 2009 amnesty) and any costs of collection or recovery fees.  Notably, this is not an amnesty like those conducted in 2002 and 2009.  It is not statutorily mandated and no penalties may be imposed for non‑participation.  Because the initiative is not statutorily mandated, the Division is not offering something it could not offer at any other time.  However, the Division’s offer to waive most penalties may be a good chance for many taxpayers to resolve issue and move on and is worth considering.