TWIST - This Week in State Tax

Welcome to TWIST for the week of March 7th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

In Unclaimed Property news, Assembly Bill 2280, which would authorize the California Controller to establish a Voluntary Compliance Program, has been introduced in the legislature.  Under the bill, the Controller would be required to waive interest on past due unclaimed property for businesses that participate in and complete the requirements of the program. This would be the first time in recent history that California has offered a voluntary compliance program for unclaimed property.

In Iowa, a comprehensive tax relief bill was enacted that includes a methodology for future corporate rate reductions. Specifically, Iowa’s top two corporate income tax rates will be reduced if the amount of corporate income taxes collected by the state exceeds a base amount of $700 million. If that occurs, the Department of Revenue is instructed to determine what top tax rate would have generated $700 million in the fiscal year that just concluded. The top rate will then be adjusted to that rate for the next tax year until it is equal to the next highest rate; subsequently, both rates will be adjusted equally. If the tax rate is adjusted, the Director of Revenue is required to publish the new rate by December 31 following the determination date.

In Washington State, a superior court judge ruled that the state’s new capital gains excise tax was actually a tax on income and also a tax on property that violated certain provisions of the state Constitution. Effective January 1, 2022, the tax is imposed at a rate of 7 percent on an individual’s Washington capital gains after a standard deduction of $250,000 for both individuals and joint filers. The tax, in the court’s view, violated the uniformity clause because it was imposed at a 7 percent rate on an individual’s capital gains over $250,000, but not imposed on any individual with capital gains of $250,000 or less. The limitation clause of the constitution limits the rate of tax imposed on property to one percent and because the excise tax was imposed on capital gains at a 7 percent rate, the court concluded it also violated the limitation clause. The case will likely be appealed to the Washington State Supreme Court.

Finally, a Texas appeals court concluded that a law firm was purchasing taxable data processing services when it purchased loan packages from vendors. Although the process of setting up the unique loan package for the taxpayer’s clients involved the application of legal knowledge by the vendor’s employees, the taxpayer carefully constructed the terms of its contracts so that it was not purchasing legal services. As such, the court determined that the essence of the transaction was the purchase of taxable data processing services.  

Thank you for listening to TWIST and stay well!

California: Proposed Legislation Would Adopt Unclaimed Property Voluntary Compliance Program

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Assembly Bill 2280, which was introduced in the California legislature on February 16, 2022, would authorize the California Controller to establish the California Voluntary Compliance Program (VCP), contingent upon the legislature appropriating funds for the program. The VCP would permit voluntary compliance by businesses holding past due unclaimed property. 

Per the legislation, the Controller would be required to waive interest on past due unclaimed property for businesses that participate in and complete the requirements of the VCP. (Currently, California law allows the Controller to assess interest on past due property at a rate of 12 percent per annum.) Further, the bill would allow the Controller to reinstate interest assessments if the property identified in the voluntary compliance review is not timely paid or delivered to the Controller. This would be the first time in recent history that California has offered a voluntary compliance program.

The legislation sets forth criteria participation in the program. A business would be ineligible to participate in the program if the business:

—   Is currently undergoing a California unclaimed property examination or has been notified that such an examination will occur;

—   Is the subject of a civil or criminal prosecution involving unclaimed property compliance;

—   Has been notified by the Controller of an interest assessment within the past five years and the assessment is unpaid; or

—   Has had an interest assessment waived by the Controller in the past five years. 

The major timeframes and tasks associated with the VCP are outlined in the legislation, including that the business would be required to participate in a training program provided by the Controller within three months after the date the Controller notifies the business of its enrollment in the program.  Further, the bill provides that a VCP-enrolled business would be required to review its books and records for at least the previous ten years and then make reasonable efforts to notify owners of reportable property no less than thirty days prior to submitting the required unclaimed property report to the Controller.  The business would then be given six months from the date of enrollment to provide the initial unclaimed property report to the Controller.  Thereafter, the business would be required to submit an updated report and remit the property to the Controller within seven months and fifteen days after the initial report was filed.    

If the legislation is enacted and the Controller initiates the VCP, businesses that have not been in compliance with the California unclaimed property law may benefit from the waiver of interest on past due property. 

KPMG’s National Unclaimed Property practice is monitoring the progress of this significant legislation. For more information, contact a KPMG professional in our Unclaimed Property Practice:

Nina Renda | +1 (973) 912-6528 | akrenda@kpmg.com

Marion Acord | +1 (404) 222-3053 | marionacord@kpmg.com

Will King | +1 (214) 840-6107 | williamking@kpmg.com

Jenna Fenelli | +1 (973) 912-4546 | jfenelli@kpmg.com. 

Iowa: Tax Cut Legislation Enacted

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Iowa House File 2317 was signed into law by Governor Reynolds on March 1, 2022. The bill reduces Iowa individual income tax rates and consolidates brackets, provides that certain types of income are not subject to personal income tax, makes various changes to Iowa tax credits, and adopts contingent reductions to the state’s corporate income tax rates. Currently, Iowa has a graduated corporate income tax rate regime; the highest rate of 9.8 percent is imposed on taxable income over $250,000, and the second highest rate is 9.0 percent on taxable income between $100,000 and $250,000.  With respect to the corporate income tax rate, the bill creates a methodology whereby Iowa’s top two corporate income tax rates will be reduced if the amount of corporate income taxes collected by the state exceeds a base amount of $700 million. If that occurs, the Department of Revenue is instructed to determine what top tax rate would have generated $700 million in the fiscal year that just concluded. The top rate will then be adjusted to that rate for the next tax year. The 9.8 percent rate will be reduced until it is equal to the 9.0 percent rate; subsequently, both rates will be adjusted equally. The calculation on the new will take place at the conclusion of each fiscal year until the Iowa corporate income tax rate is lowered to a single rate of 5.5 percent. If the tax rate is adjusted, the Director of Revenue is required to publish the new rate by December 31 following the determination date.  Please stay tuned to TWIST for additional rate changes. 

Texas: Purchases of Loan Packages Taxable as Data Processing 

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The Texas Court of Appeals recently addressed whether a law firm was entitled to a refund of sales tax paid on purchases of loan packages.   Lending institutions engaged the law firm to prepare loan packages, typically including a promissory note, deed of trust, and disclosures required by state and federal law, among other documents. The taxpayer either generated the packages itself using software that interfaced with the clients' loan origination systems, or purchased loan packages generated by vendors, which were then reviewed by the law firm. Upon audit, the Comptroller assessed sales tax on the purchased loan packages. The taxpayer subsequently paid the assessment under protest and filed a suit in district court for a refund. After the district court awarded the taxpayer a refund, the Comptroller appealed. The appeals court first established it had jurisdiction in the case by clarifying the procedural requirements of a refund suit – which would have required the taxpayer to exhaust administrative remedies before the court could have jurisdiction – and a protest suit – the type pursued by the taxpayer in this case.  A protest suit, the court concluded, required a taxpayer to pay an assessed amount, submit a payment with a protest letter, and timely file suit.

Under Texas law, data processing services are subject to sales and use tax, but professional services are not. The district court had concluded that the essence of the vendor transactions was the conveyance of a compliant loan package through “the services of paralegals and legal compliance and mortgage experts.” On appeal, the Comptroller argued that the taxpayer intended to purchase data-processing services because, by the terms of the taxpayer’s own contracts, the taxpayer was the party responsible for ensuring that the loan packages were legally compliant. The appeals court found it compelling that although the process of setting up the unique loan package for the taxpayer’s clients involved the application of legal knowledge by the vendor’s employees, the taxpayer carefully constructed the terms of its contracts so that it was not purchasing legal services. Reasoning that the contractual language reflected the parties’ intent, the court concluded that the essence of the transactions was the purchase of taxable data processing services. For questions on Hegar v. Black, Mann, & Graham LLP contact Sarah B Vergel de Dios.

Washington State: Superior Court Strikes Down Capital Excise Tax

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In 2021, legislation was enacted in Washington State imposing a new excise tax on the sale or exchange of long-term capital assets. The tax became effective on January 1, 2022. Only individuals are subject to the tax, which is imposed at a rate of 7 percent of an individual’s Washington capital gains after a standard deduction of $250,000 for both individuals and joint filers. The new tax was controversial, and opponents of the measure quickly filed lawsuits challenging the tax.  

A superior court judge recently ruled on two consolidated motions for summary judgment. It was stated at the outset that a wealth of material had been filed in connection with the pending motions, much of it related to the policy behind the enactment of the tax and whether schools in Washington State are appropriately funded. However, as noted by the judge, courts are not permitted to include policy considerations in determining constitutional questions. In addressing whether the capital gains tax violated certain provisions of the Washington State Constitution, the superior court first concluded that although it is labeled an “excise” tax, the capital gains tax is actually a tax on income. The court noted that the regime demonstrated many hallmarks of an income tax, including that it was tied to federal income tax returns, levied on the same long-term capital gains that the IRS characterizes as income, and allows for charitable contribution deductions. After concluding that the tax was properly characterized as an income tax and also a tax on property (income is considered property under prior Washington State caselaw), the court addressed the plaintiffs’ constitutional challenges. The uniformity clause requires that taxpayers be treated uniformly across all classes of taxpayers.  The tax, in the court’s view, violated the uniformity clause because it was imposed at a 7 percent rate on an individual’s capital gains over $250,000, but not imposed on any individual with capital gains of $250,000 or less. The limitation clause of the state constitution limits the rate of tax imposed on property to one percent. Because the excise tax was imposed on capital gains, which are considered property, at a 7 percent rate, the court concluded the tax also violated the limitation clause. The case will likely be appealed to the Washington State Supreme Court, so stay tuned to TWIST for future updates.  Please contact Michele Baisler with questions on Quinn/Clayton, et. al. v. State of Washington, et. al.