Last year, Illinois enacted a mid-year income tax rate increase. Effective July 1, 2017, Illinois increased the income tax rate for individuals, trusts and estates from 3.75 percent to 4.95 percent, and for corporations from 5.25 percent to 7 percent. The Illinois Personal Property Replacement Tax (imposed on corporations, partnerships, trusts, S corporations and public utilities at various rates) was not changed.

As we previously reported, the Illinois Income Tax Act contains a number of provisions intended to resolve questions regarding how income should be allocated between the two income tax rates applicable in 2017. 35 ILCS 5/202.5(a). The default rule is a proration based on the number of days in each period (181/184). For taxpayers choosing this method, the Department of Revenue (Department) has recommended the use of a blended tax rate to calculate tax liability. A schedule of blended rates is included in the Department’s instructions for the 2017 returns. The blended rate is 4.3549 percent for calendar year individual taxpayers and 6.1322 percent for calendar year C corporation taxpayers. Continue Reading Choices for Illinois Taxpayers in Implementing the 2017 Income Tax Rate Increase

Overview

Illinois’ July 2017 Revenue Bill for the 2018 fiscal year included the Invest in Kids Act (Act), which creates a new program, effective January 1, 2018, that provides up to $75 million in income tax credits for Illinois taxpayers making contributions to eligible organizations that grant scholarships to students attending private and parochial schools in Illinois. The Act allows approved Illinois taxpayers to receive state income tax credits of 75 percent of their total qualified contributions to Scholarship Granting Organizations (SGOs), up to $1 million annually per taxpayer. For example, a contribution of $100,000 to an SGO allows an approved taxpayer to claim a $75,000 income tax credit. The program is administered by the Illinois Department of Revenue (Department). The Department will allocate the credits among taxpayers on a first-come, first-served basis.

Who Benefits?

The Act is intended to benefit students who are members of households whose federal adjusted gross income does not exceed 300 percent of the federal poverty level before the scholarship and does not exceed 400 percent of the federal poverty level once the scholarship is received. The Illinois State Board of Education will annually provide the Department with a list of eligible private and parochial schools that may participate in the program and receive scholarship contributions from SGOs. As of December 18, 2017, the list of eligible private and parochial schools for 2018 has not been published. Continue Reading Illinois’ Invest in Kids Tax Credit

The Massachusetts Department of Revenue (Department) has just issued Directive 17-2 revoking Directive 17-1 which adopted an economic nexus standard for sales tax purposes. Directive 17-2 states that the revocation is in anticipation of the Department proposing a regulation that would presumably adopt the standards of Directive 17-1. It appears that the Department took seriously, perhaps among other concerns, internet sellers’ arguments that Directive 17-1 was an improperly promulgated rule. Internet sellers that recently received letters from the Department regarding Directive 17-1 (see our previous blog post) may need to reconsider their approach.

On August 30, 2016, following a one day bench trial, Cook County Circuit Judge Thomas Mulroy ruled in favor of Treasury Wine Estates (“TWE”) in Illinois False Claims Act (“Act”) litigation filed by the law firm of Stephen B. Diamond, PC (“Relator”). Relator alleged that TWE had violated the FCA by knowingly failing to collect and remit Illinois use tax on the shipping and handling charges associated with its internet sales of wine shipped to Illinois customers. State of Ill. ex rel. Stephen B. Diamond, P.C. v. Treasury Wine Estates Americas Company, d/b/a Treasury Wine Estates, No. 14 L 7563 (Cir. Ct. of Cook County, Ill. Aug. 30, 2016) (“Order”). The Court held that Relator failed to prove that TWE knowingly violated the FCA or that it acted in reckless disregard of any Illinois tax collection obligation.

The Court confirmed that an “extreme version of ordinary negligence” standard applies to prove that a defendant “knowingly” violated the FCA by acting in “reckless disregard” of an obligation to pay or transmit money to the State. The Order describes “[t]his standard … [as] meant to reach defendants who intentionally close their eyes, hide their heads in the proverbial sand, and do not make simple inquires which would inform them that false claims are being made.” Order at 14. The Court’s interpretation of the “reckless disregard” standard is consistent with the standard recently established by the Illinois Appellate Court in State of Illinois ex rel. Schad, Diamond & Shedden, P.C. v. National Business Furniture, LLC, 2016 IL App (1st) 150526, ¶ 39 (Aug. 1, 2016) and is very favorable for defendants defending against FCA claims. (“Significantly more than an error, mistake, or ordinary negligence is required … to demonstrate reckless disregard in the context of a False Claims Act violation. Relator … needed to prove that defendant ignored obvious warning signs, buried its head in the sand, and refused to learn information from which its duty to pay money to the State would have been obvious.”), aff’g, No. 12 L 84 (Cir. Ct. of Cook County, Ill. Oct. 23, 2014) (citations omitted).

Analyzing the evidence produced at trial, the Court held that it was reasonable for TWE to rely on third party tax consultants to prepare and file its Illinois tax returns, even though TWE did not review the returns before they were filed. The Order states:

Defendant relied on its consultants to do the job for which they were hired, to do the right thing and to be acquainted with Illinois sales tax law.Defendant relied on its preparers’ expertise, experience in the field and representations to ensure its ST-1 forms were accurate. Defendant was faced with the task of filing hundreds of tax returns in many states which have different and conflicting laws. Defendant did what a prudent business would do: it asked for help with navigating the murky waters of Illinois tax law and the challenging task of correctly preparing an Illinois sales tax return. Defendant did not intend to defraud Illinois; it intended to do what Illinois law required and sought expert help to do it. Defendant was not required to check the work of its consultants by seeking advice from other professionals. Defendant was prudent when it sought and paid for advice from companies experienced in its industry and experienced in state tax preparation work.

Order at 15.

The Court also held that the fact that TWE’s tax returns specifically disclosed that TWE was not collecting tax on its shipping charges further supported the conclusion that TWE did not knowingly violate the tax laws.

The Court rejected Relator’s argument that TWE and its advisors acted recklessly based on TWE’s participation in a voluntary disclosure application with respect to time periods prior to time periods at issue in this lawsuit, in which it paid tax on shipping charges. Evidence presented at trial established that the VDA payment was made for administrative convenience; no professional ever told Defendant that tax was due on shipping charges. Evidence was also presented that after the lawsuit was filed, the Department of Revenue advised both TWE and its third party consultant, in separate consultations, that tax was not owed on separately stated shipping charges.

Taxpayers who rely on qualified third party consultants for the preparation of their tax returns, particularly those who expressly disclose their filing practice on their returns, can take comfort from the Court’s conclusion that TWE did not violate the FCA.

The Diamond firm will have 30 days from the date of entry of the Circuit Court’s Order to either seek reconsideration or appeal from the trial court’s ruling.

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.

In this article, McDermott partner Arthur R. Rosen interviews Art Rosen, whom he claims to “know quite well,” about vexing state tax litigation.  One instance that he found troubling came after he and two other taxpayer representatives presented their explanation of a case during a settlement hearing, only to have a Department of Revenue representative respond that they weren’t there to discuss the issues!

Read the full article.

Settlements of tax audits are typically memorialized in closing agreements between the department of revenue and the taxpayer.  Negotiating these agreements can be an important part of any settlement.

The department of revenue may have standard printed form closing agreements, and the taxpayer should determine the extent, if any, to which the standard form can and should be changed.  If department representatives are reluctant to change the printed form, one possibility would be to add an appendix that elaborates on—and even contradicts—the provisions of the form.

The agreement should indicate whether it is effective with respect to similar issues in future years.  Part of the settlement may be an agreement as to how certain items will be treated in future years; if so, this should be explicitly stated.  On the other hand, if the intent is that the agreement will not govern the treatment of settled items in future years, this too should be explicitly stated.  We have had cases in which this was not made clear, and, when the taxpayer in future years departed from the agreed treatment of certain items, the auditors said that the taxpayer was reneging on a deal.  When the taxpayer pointed out that the agreement specifically said that the settlement was not to apply to future years and did not necessarily reflect the opinions of the parties as to the proper tax treatment of any item, the auditors backed down, but they were still somewhat resentful.  The best approach is to pin down precisely the effect, if any, of the agreement on future years.

The department of revenue may want to provide that it can reopen the audit years if it discovers tax avoidance transactions.  While the auditors are thinking about abusive tax shelters, their suggested language is often broad and can apply to routine business transactions where tax considerations have been taken into account.  One government draft closing agreement that recently crossed our desks would have allowed the department to reopen the audit in the case of any “scheme, product, or transaction structured with the intent of evading or avoiding federal or state taxes.”  This language could apply to the most routine business transactions where taxes were taken into account, such as a decision to sell a business in a tax-free reorganization as permitted by section 368 of the Internal Revenue Code (the Code) rather than in a taxable sale. Taxpayers should try to limit any such provisions to objectively determinable tax shelters such as “listed transactions” within the meaning of the Code or comparable state law.  While the desire of state tax officials to be able to challenge abusive transactions is understandable, the typical closing agreement occurs only after an audit has gone on for some time and the taxpayer’s books have been carefully checked, so there is no reason why any significant transaction should not have come to light.  The department should not be allowed to reopen an audit or address routine business transactions just because they were structured with tax considerations in mind.

Closing agreements will often contain confidentiality provisions.  In the past, it was principally taxpayers who wanted the department to be prohibited from disclosing the terms of the settlement to the media or otherwise.  More recently, our experience has been that revenue departments do not want taxpayers to be allowed to discuss settlements with their colleagues in other companies.

The taxpayer’s objectives will be achieved if the department of revenue is prohibited from disclosing the existence or terms of the settlement except pursuant to tax information sharing agreements with other jurisdictions or as compelled by legal process.

Taxpayers should retain the right to disclose the existence and terms of the settlement if compelled to do so by legal process. If a taxpayer is required to disclose the agreement in a lawsuit, that disclosure should not be a violation of the agreement.  In addition, a taxpayer should be allowed to disclose the existence of the agreement and its contents to its professional advisors, auditors and government regulators.  One draft closing agreement routinely proposed by a department of revenue would not allow the taxpayer to disclose the agreement to its lawyers for the purpose of seeking their advice as to its meaning and enforceability.  Taxpayers should insist that the confidentiality language not be too narrow, and revenue departments have generally been reasonable in adjusting their form language in this respect.

For a more detailed discussion of recommended strategies for state and local tax audits, please click here.