The Maryland Comptroller appears to have denied all refund claims for the 2022 digital advertising gross revenues (DAGR) tax! The denial notices were seemingly dated on or around October 11, 2023, and were sent via certified mail two weeks ago. The denial notices require immediate action by taxpayers.
On August 9, 2023, the New York State Department of Taxation and Finance (Department) released 417 pages of proposed regulations, an important step toward concluding a now almost decade-long process to implement corporate tax reform.
The journey began in 2014 with the enactment of legislation modernizing the state’s corporate tax law. Thereafter, the Department released several versions of draft regulations while warning taxpayers that the drafts were “not final and should not be relied upon.” Even though the Department announced last spring that it intended to formally propose and adopt such regulations in fall 2022, taxpayers had to wait another year.
Comments on the proposed regulations must be provided to the Department by October 10, and the regulations will be finalized thereafter. In this article, we’re taking a closer look at a few of the items included in the proposed regulations.
ADOPTION OF THE MULTISTATE TAX COMMISSION’S INTERPRETATION OF P.L. 86-272
Consistent with the Department’s final version of the draft regulations, the proposed regulations contain rules based on model regulations adopted by the Multistate Tax Commission, which narrowly interpret P.L. 86-272. Under the proposed regulations, “interacting with customers or potential customers through the corporation’s website or computer application” exceeds P.L. 86-272 protection. By contrast, “a corporation will not be made taxable solely by presenting static text or images on its website.” This sweeping change remains surprising because P.L. 86-272 is a federal law, the scope of which is not addressed by the state’s corporate tax reform.
THE ELIMINATION OF THE “UNUSUAL EVENTS” RULE
The proposed regulations omit the “unusual events” rule contained in the 2016 draft regulations. Generally consistent with Department regulations long predating the state’s corporate tax reform legislation, the 2016 draft stated that “business receipts from sales of real, personal, or intangible property that arose from unusual events” were not included in the business apportionment factor. For example, a consulting firm that sold its office building for a gain would not have included the gain in its apportionment factor because the sale was considered to be from an unusual event. The Department claims to have abandoned the rule “because Tax Reform provided significantly more detailed sourcing rules, including guidelines for those transactions that might have been excluded under pre-reform policy.”
SAFE HARBOR SOURCING FOR DIGITAL PRODUCTS AND SERVICES
Post-reform corporate tax law sources receipts from digital products and digital services to New York if the location the customers derive value from is in New York as determined by a complicated hierarchy of methods. The proposed regulations provide a simplified safe harbor in applying this sourcing rule, where “if the corporation has more than 250 business customers purchasing substantially similar digital products or digital services as purchased by the particular customer . . . and no more than 5% of receipts from such digital products or digital services are from that particular customer, then the primary use location of the digital product or digital service is [...]
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New York Governor Kathy Hochul and the New York State Legislature have reached an agreement on the state’s fiscal year 2024 budget legislation. Most surprisingly, the legislation grants the New York State Department of Taxation and Finance the right to petition for judicial review of New York State Tax Appeals Tribunal decisions that are “premised on interpretation of the state or federal constitution, international law, federal law, the law of other states, or other legal matters that are beyond the purview of the state legislature.” If the Department appeals a Tribunal decision, any interest and penalties that would otherwise accrue on the underlying tax liability would be stayed until 15 days after the issuance of a final judicial decision. This represents a significant change in law as currently, only taxpayers (and not the Department) may appeal Tribunal decisions.
Other notable provisions in the budget legislation include the following:
The budget legislation containing these changes in law passed both houses of the New York State Legislature on May 1, 2023, and is expected to be signed by Governor Hochul.
Like the federal government, many states have adopted False Claims Act (FCA) provisions that exclude tax matters from coverage. The federal model makes clear that matters under the Internal Revenue Service are not covered by the law,[1] and in the vast majority of cases, states also explicitly exclude tax from coverage.[2] However, there is a growing number of states seeking to extend FCA liability to tax cases in which “knowing” causes of action apply to any person that knowingly conceals, avoids or decreases an obligation to pay the state.[3] In such states, FCA liability, including punitive penalties and damages, will be argued to create liability for certified public accountants (CPAs) and other tax professionals who advise clients to take a favorable tax position on a tax return or simply file a return with an “error.” Under a “knowing” standard, an “error” is asserted to exist when the taxpayer’s position differs from someone else’s view of the law—the reasonableness of the position simply does not matter.
This risk is not hyperbole. On March 23, 2022, New York Attorney General Letitia James issued a warning to cryptocurrency investors and their tax advisors: “The consequences of a taxpayer’s failure to properly report income . . . are potentially far-reaching and severe [and could] result in taxpayer liability under the New York False Claims Act,” adding, “False Claims Act liability may also extend to tax professionals advising clients. . .”[4]
New York and Washington, DC, already extend FCA liability to tax cases and apply a “knowing” standard. In other states, FCA expansion bills have started popping up, too. For instance, there is currently a FCA bill before Ohio legislature proposing to extend FCA liability to tax cases and any person that “[k]nowingly present[s], or cause[s] to be presented, to an officer or employee of the state. . .a false or misleading claim for payment or approval.”[5] Recently, a proposal to expand the Connecticut FCA to tax cases failed to advance.[6] While the Connecticut FCA already includes a “knowing” standard, it only applies to false claims made in the Medicaid context. Additionally, New York legislature is considering a bill that would further expand the application of its FCA’s “knowledge” standard to “obligations” under the Tax Law.[7] However, the term is not defined in the Tax Law, making it unclear whether it would apply only to the “obligation” to file a return or to situations where a CPA or tax advisor provides general advice on a specific tax matter.
The trend to loosen the standard for state FCAs liability is a problematic shift leading to lawsuits that will assert that simply providing advice or a good-faith interpretation of the tax law to a client could result in liability under a state’s FCA. Adding insult to injury, these suits will threaten treble damages, attorneys’ fees and civil penalties per occurrence. Taxpayers and their advisors should know the breadth of each state’s FCA provisions and take them into account as [...]
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In a brief filed on April 29, 2022, the Maryland Attorney General’s Office (Attorney General) agreed that the “pass-through prohibition” of the state’s digital advertising tax “does not purport to impose any restriction on what the taxpayer may say to the customer, or anyone else, about” increased billing charges because of the tax.
Last year, Maryland lawmakers enacted a first-of-its-kind digital advertising tax on the annual gross receipts from the provision of digital advertising services. The tax only applies to companies with annual gross revenues of $100 million or more. Shortly thereafter, Maryland lawmakers added a pass-through prohibition, which provides that “[a] person who derives gross revenues from digital advertising services . . . may not directly pass on the cost of the [tax] to a customer who purchases the digital advertising services by means of a separate fee, surcharge, or line-item.”
In litigation brought by McDermott Will & Emery in Maryland federal court, several leading trade associations have challenged the pass-through prohibition on the basis that it violates the First Amendment of the US Constitution by regulating how sellers may communicate their prices on invoices, billing statements and the like. However, in a brief seeking dismissal of the litigation, the Attorney General claimed that the pass-through prohibition does not regulate speech but instead only prohibits the “conduct of directly passing through to a customer” the tax burden.
Highlighting what it agrees to be the limited scope of the pass-through prohibition, the Attorney General states as an “example” that if a “taxpayer wishes to inform [a] customer that [an] invoiced charge is higher than it might otherwise be due to the imposition of the digital ad tax, the taxpayer is free to communicate that or any other message.” (Emphasis added). Further, the Attorney General agrees that “if the taxpayer wants to use the invoice as an opportunity to engage in political speech, the taxpayer is free to express its displeasure with the tax and identify who bears political responsibility for [the] new tax.”
Consistent with this position, the Attorney General does not dispute that the digital advertising tax may be reflected in the amounts charged to customers. Instead, the Attorney General argues that the pass-through prohibition is a “prohibition against direct, as opposed to indirect, pass-through of the tax cost,” which is intended to ensure that the taxpayer’s “annual gross revenues” subject to the tax “reflect the full amount of revenues received from customers, undiminished by any tax costs that the taxpayer might otherwise have preferred to pass directly to the customer.”
The parties are scheduled to file additional briefs in the case on May 13, 2022. The case is Civil No. 21-cv-410 (D. Md., filed February 18, 2021). Sarah P. Hogarth, Paul W. Hughes, Michael B. Kimberly and Stephen P. Kranz, partners in McDermott’s Washington, DC, office, represent the plaintiffs.
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.
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 [...]
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Yesterday afternoon the Kansas legislature overrode Governor Laura Kelly’s veto of Senate Bill (SB) 50, effectively enacting the provisions of the bill into law. Among those are provisions decoupling from certain Tax Cuts and Jobs Act (TCJA) provisions that taxpayers have been advocating for since 2018.
Under the new law, for tax years beginning after December 31, 2020, taxpayers receive a 100% deduction for global intangible low-taxed income (GILTI) included in federal income. Furthermore, the new law is explicit that foreign earnings deemed repatriated and included in federal income under IRC § 965 are considered dividend income and eligible for the state’s 80% dividend-received deduction. The new law also decouples from the interest expense deduction limitation in IRC § 163(j), enacted as part of the TCJA for tax years beginning after December 31, 2020.
A Kansas decoupling bill was first proposed in 2019. Decoupling efforts faced an uphill battle because of the Kansas legislature’s reluctance to pass laws that could be perceived as tax cuts. The 2019 bill was vetoed by Governor Kelly, but that bill was not overridden by the legislature. The STARR Partnership and its members have worked closely with the Kansas Chamber of Commerce on the Kansas decoupling efforts and finally, in this legislative session, advocates were able to persuade the legislature that the decoupling provisions were not tax cuts but provisions designed to prevent a tax increase. This is a great result in Kansas and serves as a welcomed reminder that states that tax GILTI and 965 income (cough, cough, Nebraska) are outliers.
The Illinois Department of Revenue (Department) announced that it will grant abatement of late filing penalties for taxpayers that file their Illinois business income tax returns on or before November 15 and request penalty waivers for reasonable cause. The Department stated that it will waive late penalties due to the “complexity” of recent federal tax reform and possible taxpayer challenges in meeting the October 15 extended filing deadline for federal and state purposes.
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. (more…)
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