TWIST - This Week in State Tax

Welcome to TWIST for the week of February 14th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

Our first couple developments today address recently signed legislation. In California, Senate Bill 113, a comprehensive COVID Relief bill, reinstates the net operating loss deduction for all taxpayers and removes the temporary $5 million limit on allowable business credits for the tax year beginning on or after January 1, 2022.  Senate Bill 113 also adjusts certain provisions of California’s elective Pass-Through Entity Tax.

Effective January 1, 2022, Idaho House Bill 436 reduces the corporate income tax rate from 6.5 percent to 6 percent. The bill also consolidates the individual income tax brackets from five brackets to four and lowers rates such that the maximum marginal rate will be 6 percent on taxable income over $5,000 retroactive to January 1, 2022. 

In Virginia, the Commonwealth’s highest court ruled in a taxpayer’s favor over whether leaf tobacco was included in the property factor for the tax years at issue. The tobacco was stored in Virginia at the taxpayer’s facility for a period of time while it aged.  The court concluded that the tobacco was not “used” in the Commonwealth because the taxpayer did absolutely nothing to it during the storage and aging process.

In Massachusetts, the Department of Revenue issued a technical information release on the Bay State Gas Company court decision addressing the deductibility of the Indiana Utility Receipts Tax, a tax imposed on the gross receipts received from retail sales of utilities in Indiana.  Although the Commissioner argued that the tax was not deductible, the court concluded that the tax was fundamentally similar to a transaction tax on a retail sale and was therefore deductible. In the Tax Information Release, the Department reminds taxpayers that previously issued directives addressing the deductibility of gross receipts taxes continue to apply and consistent with those directives, “taxes imposed on a business as a whole, measured by gross receipts, for the privilege of doing business, are not deductible.”  

Thank you for listening to TWIST and stay well!

California: Tax Attributes Reinstated and Changes Made to Elective Pass-Through Entity Tax 

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In response to the COVID-19 pandemic, legislation was signed into law in California in June 2020 that suspended the use of NOLs for both individuals and corporations with more than $1 million in taxable income for tax years beginning on or after January 1, 2020 and before January 1, 2023. The legislation also generally limited the use of business credits to $5 million a year for the same period. Recently, Governor Newsom signed into law Senate Bill 113, a comprehensive COVID Relief bill.  Importantly, for taxable years beginning on or after January 1, 2022, the bill reinstates the net operating loss deduction for all taxpayers and removes the temporary $5 million limit on allowable credits.

Senate Bill 113 also adjusts certain provisions of California’s elective Pass-Through Entity Tax (PTET). Legislation enacted in July 2021 allows “qualified entities” doing business in California to elect to pay an entity-level tax equal to 9.3 percent of qualified net income. A “qualified entity” means an entity that is taxed as a partnership or an S Corporation and whose partners, shareholders or members are exclusively taxpayers, as defined under the personal income tax law (individuals, fiduciaries, estates, or trusts), or corporations. There was a limitation in the original legislation that having an owner that was a partnership would prevent an entity from electing PTET as a “qualified entity.” Effective for tax year 2021 and forward, Senate Bill 113 provides that a passthrough entity with a partnership owner can be a “qualified entity” that is eligible to elect PTET. Consistent with the original legislation, the partnership owner will not be considered a “qualified taxpayer,” which means that the distributive share of the owner that is a partnership would continue to be excluded from the PTET base.

The definition of “qualified taxpayer” was expanded by Senate Bill 113 to include a consenting owner, of the type that would otherwise be a “qualified taxpayer,” even if this owner holds its interest in the “qualified entity” through a disregarded LLC. Other than this specific exception, there continues to be a general prohibition that a business entity owner that is disregarded for federal tax purposes, or its partners or members, will not be a “qualified taxpayer” that can have its income included in the PTET base. In addition, partners that meet the definition of “qualified taxpayer” will have their guaranteed payments included in the PTET base and, correspondingly, these guaranteed payments will increase the amount of PTET tax credit available for these partners. Prior to Senate Bill 113, guaranteed payments were not includable in the PTET base.

Another change in Senate Bill 113 relates to the amount of PTET tax credit that can be taken by an owner who is a “qualified taxpayer.” Under the original legislation, the PTET tax credit was not permitted to reduce an owner’s net tax below the level computed as the owner’s tentative minimum tax, with any remaining credit subject to a five-year carryforward. Senate Bill 113 provides that the amount of PTET tax credit taken is not limited by an owner’s tentative minimum tax level.

Regarding the ordering of the PTET tax credit among other California tax credits, based on the Senate Bill 113 changes, for tax years beginning before January 1, 2022, the credit ordering rules now provide that the PTET tax credit is taken before the Other State Tax Credit (OSTC), which is a nonrefundable credit. For taxable years beginning on or after January 1, 2022, the credit ordering rules will be further adjusted so that the OSTC will be taken before the PTET tax credit.

For more information on California Senate Bill 113, please contact Gina Rodriquez or Brad Wilhelmson. 

Idaho: Corporate Tax Rate Reduced

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A number of states are considering legislation to reduce personal and/or corporate income taxes. The first bill to be enacted in 2022 is Idaho House Bill 436. Effective January 1, 2022, the bill reduces the corporate income tax rate from 6.5 percent to 6 percent. The bill also consolidates the individual income tax brackets from five brackets to four and lowers rates such that the maximum marginal rate will be 6 percent on taxable income over $5,000 retroactive to January 1, 2022.  Finally, House Bill 436 provides for individual income tax rebates for the 2021 tax year. Please stay tuned to TWIST for additional rate changes. 

Massachusetts: Department Issues Guidance on Deductibility of Gross Receipts Taxes

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The Massachusetts Department of Revenue recently issued a Technical Information Release addressing the Massachusetts Appeals Court decision in Bay State Gas Company & Affiliates v. Commissioner. The issue in Bay State was the deductibility of the Indiana Utility Receipts Tax, a tax imposed on the gross receipts received from retail sales of utilities in Indiana. Under Massachusetts law, a corporation may deduct taxes imposed by other states. However, deductions are not permitted for “taxes on or measured by income, franchise taxes measured by net income, franchise taxes for the privilege of doing business and capital stock taxes imposed by any state.” The Commissioner has issued guidance addressing the types of taxes deductible in Directive 99-9. There the Commissioner concluded that the core question with respect to the deductibility of a tax is whether the tax is imposed on a business as a whole or on discrete transactions or business activities.  If it’s the former, the tax is not deductible. Directive 08-7 states that gross-receipts-based taxes are generally not deductible because they are “franchise taxes imposed on a taxpayer for the privilege of doing business in a state” that are measured by gross receipts.

The Appellate Tax Board ruled that the URT was not deductible in computing a taxpayer’s corporate excise. Although the URT had some characteristics of a transaction tax, the Board concluded that it more closely resembled the types of taxes that could not be deducted. On appeal, the court disagreed.  In the court’s view, the URT was “in substance fundamentally similar to transaction taxes on retail sales, which are deductible,” influenced in part by the fact that Indiana imposes a complementary use tax to the URT. The TIR notes at the outset that an analysis of individual state tax statutes is necessary to determine whether a particular tax is deductible.  Furthermore, the TIR reminds taxpayers of the previously issued directives and notes that the criteria in those documents continue to apply. Consistent with those directives, “taxes imposed on a business as a whole, measured by gross receipts, for the privilege of doing business are not deductible.”  Please contact Nick Sequeira at 617-988-1787 with questions in TIR 22-4. 

Virginia: Tobacco Aging in Virginia not Included in Property Factor

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Virginia is one of a handful of states that still require most general corporate taxpayers to apportion their income using a formula that consists of property, payroll, and sales. Recently, the Virginia Supreme Court addressed whether a taxpayer was entitled to a refund of corporate income tax as a result of excluding certain property from its Virginia property factor for the tax years at issue. The taxpayer, a tobacco company that had facilities in Virginia, purchased leaf tobacco from third party suppliers. The leaf tobacco was stored at the taxpayer’s Virginia facility for an aging period of 13-23 months. While the tobacco was being stored, it was not treated in any way, and the taxpayer did not perform any acts to facilitate or prompt the aging process. After that time, the tobacco was shipped to the taxpayer’s processing and manufacturing facility in North Carolina. The taxpayer originally included the value of the aging tobacco in its property factor, but later filed amended returns excluding the tobacco. The Department of Taxation denied the taxpayer’s refund claims. After a circuit court ruled in the taxpayer’s favor, the Department appealed to the Virginia Supreme Court.

Before the court the key issue was whether the aging tobacco was “used” in the Commonwealth. Under Virginia law, the property factor includes the corporation’s real and tangible personal property owned and used . . . in the Commonwealth during the taxable year.” The Department asserted that storage of the leaf tobacco constituted “use” because the leaf tobacco was aging, which was important to its subsequent use. In the taxpayer’s view, the term “used” requires a positive act or activity by the user, and merely storing the leaf tobacco in Virginia to prevent theft or damage was merely an exercise of ownership, and not “use” of the leaf tobacco as contemplated under Virginia law.  The leaf tobacco, the taxpayer asserted, was being stored for future use in the manufacture of its cigarettes in North Carolina. The court concluded that the statute was unambiguous, and the plain meaning of the word “used” controlled. Noting that the taxpayer did “absolutely nothing” to the leaf tobacco during the storage process, the court concluded that the tobacco was not being used while it was stored in Virginia. In reaching this conclusion, the court agreed with the lower court that the Department’s regulation, which provided some guidance on the definition of the word “used,” was not relevant. There was no ambiguity in the statute and the regulation did not contemplate aging agricultural raw materials in its guidance on types of property that are “used.” Please contact Diana Smith with questions on Virginia Dept. of Taxation v. R.J. Reynolds Tobacco Co.