McDermott Provides Treasury Department with Concrete Suggestions for Guidance on the American Rescue Plan Act’s Claw-Back Provision

The recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision that has brought the world of state and local tax policymaking to a grinding halt. Because ARPA’s adoption occurred during the final weeks of many states’ legislative sessions, rapid issuance of guidance from the US Department of the Treasury is needed before the sessions adjourn to prevent the irreversible damage that will occur if a state foregoes enacting policies aimed at alleviating the economic disruption caused by COVID-19 out of fear of facing claw-back of federal relief.

McDermott recently sent a letter to Treasury Secretary Janet Yellen, urging the issuance of guidance giving a balanced interpretation of the claw-back provision. This guidance is necessary to avoid putting state legislatures, governors and tax administrators across the country in an untenable situation where every tax change or adjustment being considered—no matter how innocuous or routine—will carry the risk of a reduction to their state’s share of federal funding for the next three years.

In the letter, we provided concrete suggestions on areas where the ARPA left room for such balanced interpretation. We suggested that Treasury interpret the claw-back provision as either inapplicable to or provide a safe harbor for:

  • Changes addressing state conformity to the Internal Revenue Code (IRC)
  • Corrections of unconstitutional tax statutes or rules
  • Corrections of tax provisions barred by or that violate federal law
  • Actions in which there is no or only a weak connection between the law change reducing net revenue and the use of federal relief funds
  • Changes in the law announced before the enactment of ARPA
  • Reductions in net revenue related to purposes that further ARPA’s objectives.

The letter pointed out that states need concrete guidance, whether formal or informal, addressing these areas. Such guidance will alleviate the concerns of state governments and allow state policymakers to function and continue the orderly administration of state taxes.




Federal COVID-19 Relief Bill Brings State Tax Policy to a Grinding Halt

On March 11, 2021, US President Joe Biden signed the American Rescue Plan Act of 2021 (ARPA), the COVID-19 relief bill that includes $350 billion in relief to states and localities. To prevent states from using federal relief funds to finance tax cuts, Congress included a clawback provision requiring that any relief funds used to offset tax cuts during the next three years be returned to the federal government. Here is the text of the provision:

  • A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit or otherwise) or delays the imposition of any tax or tax increase.

This language broadly prohibits states from taking legislative or administrative action through the end of 2024 that reduces state tax revenues by any means (deduction, credit, delay, rate change, etc.) if doing so could be characterized as the use of federal relief funds to offset, directly or indirectly, the tax reduction. Practically speaking, this limitation will completely hamstring state and local governments from the normal ebb and flow of tax policy changes, adjustments and interpretations. Taken to its logical conclusion, this language freezes state legislative and administrative tax policy development out of fear anything they may do would require the return of federal relief funds. We expect the US Department of the Treasury will issue guidance clarifying this provision in the coming weeks.

Practice Note: This provision of ARPA is, in our view, the most significant federal pre-emption of state tax policy in history. For the next three years, legislators and tax administrators alike will be scrutinized as their tax policy decisions are evaluated through the lens of this prohibition. This level of congressional control over state tax policy decisions and fiscal autonomy likely violates the Tenth Amendment of the US Constitution and would dismay the framers’ basic notions of federalism.

While Congress has the ability to limit the use of federal funds in ensuring its policy goals are accomplished, the overly broad state tax limitation adopted by Congress goes far beyond its stated purpose and prevents states from furthering ARPA’s goals by using tax policy to craft their own COVID-19 relief measures. Any regulation or administrative interpretation that reduces state tax revenue or delays the implementation of a tax is, effectively, barred by the unprecedented intrusion into state tax policy-making.

The effects of ARPA’s state tax limitation are immediate and far-reaching. It will chill continuing state efforts to couple/decouple state tax codes to or from the Tax Cuts and Jobs Act of 2017. Additionally, ARPA already stalled legislation pending in Maryland that would delay, for one year, implementation of its digital advertising services gross receipts tax, restoring return filing and tax [...]

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False Claims Act Risk for Unclaimed Property Holders

In what has become an unfortunate trend, unclaimed property holders continue to be subject to lawsuits under state false claims acts (FCA – also called a qui tam or whistleblower action) for alleged underreporting and remittance of unclaimed property obligations. More than 30 states have a false claims act with whistleblower provisions and nearly all are applicable to unclaimed property. While an honest mistake should not create liability under an FCA, a holder could be liable if its failure to report not only was done knowingly, but also if such failure to comply was done with deliberate ignorance or with reckless disregard. Actual fraud is not a necessary precursor to being subject to false claims act liability.

Potential liability under state FCA laws is far in excess of any liability under an unclaimed property audit. FCA laws impose treble damages (3x the value of the underreported property), penalties, interest and attorney’s fees. Successful claims under these laws are not just extremely punitive to the holder but also lucrative for the person bringing the lawsuit who can earn up to 30% of the ultimate recovery to the state. Liability under a FCA can turn a holder’s failure to be appropriately diligent in determining its unclaimed property compliance obligations into a multi-million dollar legal battle with long-term public relations implications. The fact that a holder has already been audited or that the State may have historically agreed with the holder’s position may not prevent a FCA case progressing.

A holder’s FCA unclaimed property horror begins with an investigation, which can be prompted by either claims by private parties (called relators) or the state attorney general’s office. A relator may be a disgruntled employee or any clever person with good research skills. The holder may not even know the claim has been filed and the investigation has been going on for years. These investigations may open closed periods and, once the holder is informed, are very interrogation-like, with the holder often knowing very little about the underlying claims until the case is unsealed. Eventually, these investigations may turn into a public court battle with a sometimes politically motivated state attorney general on the other side. Even if the state AG’s office declines to proceed with the case, the private party initiating the case may nevertheless proceed.

While frequently FCA cases are settled before becoming public, several recent cases provide some background for holders looking for FCA examples. In a series of Delaware qui tam cases, more than 25 retailers and restaurants were sued by a former disgruntled employee of a gift card issuance and management company alleging unclaimed property compliance violations. All but one settled or was dismissed by the court. In New York, a court recently dismissed claims by an audit firm against nearly a dozen life insurers in response to allegations under the false claims act that the companies failed to report life insurance policy funds – alleging more than $14.5 billion in damages. Regardless of industry, these lawsuits are a [...]

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Connecticut Bill Aims to Address the Impact of Telecommuting during the Pandemic

As we continue to face growing concerns because of the nationwide impact of COVID-19, taxpayers should be mindful of the potential impacts that the continued rise in telecommuting may have on their state personal income tax liabilities.

A bill was recently introduced in Connecticut that partially addresses this situation. Connecticut House Bill No. 6513 (HB 6513) clarifies that Connecticut residents will not face double taxation on their 2020 taxes and will instead receive a credit against their Connecticut personal income taxes for taxes paid in other states even if the resident, because of COVID-19, was working remotely from Connecticut rather than from their usual out-of-state office. HB 6513 further states that the Connecticut Department of Revenue Services, in determining whether an employer has nexus with Connecticut for purposes of the imposition of any Connecticut tax, shall not consider the activities of an employee who worked remotely from Connecticut solely because of COVID-19.

HB 6513 passed in the 151-member Connecticut House of Representatives on February 24, 2021, and passed in the 36-member Connecticut State Senate on March 1, 2021. The bill now heads to the state governor’s desk for signature. While it is expected that the Governor will sign the bill, passage of the bill still leaves taxpayers with uncertainty for 2021. Many taxpayers nationwide are likely to continue working remotely (from states other than where their usual offices are located) for the foreseeable future, and absent Congressional legislation or a Supreme Court decision, this state income tax issue does not seem likely to abate any time soon.




Maryland Digital Advertising Services Tax—Implementation Delay Likely

On the morning of Friday, February 26, 2021, the Maryland Senate Budget and Taxation Committee added a new item to its agenda for the hearing later that morning. The new item was proposed amendments to Senate Bill 787, a bill that would amend the Maryland Digital Advertising Tax by excluding broadcasters and news media and preventing service providers from directly passing the tax through to customers. One of the amendments would change the tax years to which the tax applies from tax years beginning after December 31, 2020, to tax years beginning after December 31, 2021. The amendment passed on a voice vote.

The amendment was sponsored by the bill’s author, Senate President Bill Ferguson. Senator Ferguson was also the chief proponent of the Digital Advertising Services Tax. A companion bill, House Bill 1200, sponsored by House Majority Leader Eric Luedtke, came up for a hearing in the House Ways and Means Committee later that day, but only testimony from supporters of the two carve-outs was received. No amendments were offered, and no votes were taken.

Because the amendment delaying the implementation of the Digital Advertising Services Tax is coming from the Senate’s president, we believe its passage a near certainty. This amendment, if passed, would not delay the effective date of the tax, it would only change the tax year to which it first applies from 2021 to 2022.




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