By Terry Barrett, Senior Tax Manager | State & Local Tax Team
In 2016, there was a lot of activity on the state and local tax front as many states and localities struggled to address budgetary concerns and respond to changing business practices. Some states continued to push to try to capture sales tax revenues that escaped taxation because of a long-standing interpretation of the U.S. Commerce Clause. Some adopted comprehensive tax reform initiatives addressing individual, corporate, sales and other business taxes, and others adopted creative taxes, such as “soda” taxes which may have been sold to voters due to health concerns but in reality may just be another revenue generator. We expect 2017 to be just as busy. Below are highlights of the areas of activity in 2016 which may will also be a focus in 2017.
- Change in due dates: With the change in federal due dates for calendar year C corporations (from March 15 to April 15), and partnerships (from April 15 to March 15), most states have also changed their due dates for these returns. Some may still change them. Delaware has announced it will be enacting legislation early this year to adopt the same filing dues dates as the federal dates, effective immediately, for its business tax returns. Virginia has not changed its due dates.
- Economic nexus: The trend continues for state legislation requiring businesses that have an “economic presence” but no real physical presence in the state to be subject to state income/franchise tax laws. Some states have bright-line presence tests for what constitutes “doing business.” Some use minimum thresholds such as $500,000 in sales, $25,000 in payroll, $25,000 in property, or 25% of the company’s sales, payroll, or property in the state. Other states merely say that nexus is created by “doing business.” The term “doing business” may or may not be defined by law but typically the term is interpreted and applied broadly. Currently 34 states use some form of economic nexus. Tennessee adopted economic nexus provisions for its franchise and excise tax (effective for tax years beginning on or after July 1, 2016) as well as its “gross receipts” or business tax (effective beginning January 1, 2016). The bright-line tests noted above are for the franchise/excise and business taxes. The business tax is of particular concern as it may be overlooked in tax compliance initiatives. The tax is much like the business license tax (BPOL) in Virginia as it is based upon gross receipts, business classifications and rates applicable to such classifications.
- “No income tax” states: In 2016, Tennessee enacted legislation that will allow it to eventually become a true “no income tax state.” The state traditionally has been referred to a “no-income tax state” however while it does not tax wage income it has imposed a six percent tax, called the “Hall tax,” on interest and dividend income. The Hall tax will be phased out gradually over the next several years, with the final elimination in 2022. Like Tennessee, New Hampshire currently does not have an income tax on wage income but has a tax on investment income.[i] The other true “no income tax states” for individuals include Alaska, Florida, Nevada, South Dakota, Texas, Washington State, and Wyoming.
- Sourcing of receipts for apportionment of income: The trend continues towards the use of market-based sourcing rules for apportioning income for the sale of services or intangibles. The sourcing methodologies, however, may be different not only between the states but also within a state based upon the industry, thereby complicating tax compliance and contributing to the risk of duplicate taxation. The four sourcing methods generally are: where the services are delivered, where the benefit is received, where the service is received, and where the customer is located. Particular attention should be devoted to determining the proper method. Twenty-two states and the District of Columbia use market-based sourcing.
- Corporate tax rate reductions/increases: North Carolina reduced its corporate income tax rate from 5 to 4 percent for 2016 and anticipates reducing it further in 2017 to 3 percent. The state also is in the process of changing its sourcing methodology for receipts from the sale of services and intangibles from cost of performance to market-based sourcing. Regulations were adopted by the Department of Revenue on January 4, 2017 and are scheduled for review by the Rules Review Commission.[ii]
- Possible Federal Conformity Issues: If federal income tax changes occur in 2017, the states may need to determine how to conform to the changes by the end of the year.
Most of the sales and use tax initiatives have centered on states’ efforts to capture revenue from Internet sales. States traditionally have been limited to taxing only those businesses with a physical presence in the state. The physical presence standard was set by the U.S. Supreme Court in the Quill Corp. v. North Dakota[iii] decision in 1992. While there has been legislation introduced at the federal level to address this, it has stalled. States have come up with different approaches in their attempt to get around or force a challenge to the Quill standard.
- Economic nexus: Economic nexus is a connection with a state whereby there is no physical presence in the state – thus, just by making sales into a state, a vendor may have “economic nexus” and the requirement to collect and report sales/use tax on taxable sales to customers in that state. A few states have enacted provisions that require out-of-state sellers without a physical presence in the state to collect sales/use tax on sales to instate residents. Alabama and South Dakota were the first and Tennessee recently adopted regulations to require out of state vendors with sales of $500,000 or more in the previous calendar year to register with the Department of Revenue and begin collecting the tax July 1, 2017. Litigation has been instituted in both Alabama and South Dakota. Alabama continues to enforce compliance with their tax collection provisions but South Dakota has placed compliance and enforcement of its law on hold pending the outcome of litigation. Other states may follow but it is anticipated that the constitutionality of the economic nexus issue will ultimately be decided by the U.S. Supreme Court. Stay up-to-date with more upcoming changes in sales tax here.
- Notice and Reporting Requirements: Colorado passed legislation several years ago that required non-registered retailers to provide certain notices to in-state purchasers about sales and use tax. These included notification that the purchases were not taxed and the customer was required to self-report the tax; and for purchases in excess of $500 by a purchaser, a notice to that purchaser of the obligation to report use tax and an annual report to the Department of Revenue with information about the purchaser. Penalties were proposed to enforce compliance with the law. Challenges to Colorado’s law went to the U.S. Supreme Court and finally ended when the Court refused to hear the case challenging the constitutionality of the law. Given this, more states may adopt such reporting requirements on non-registered retailers that do not collect sales/use tax on their sales to customers in hopes that more in-state purchasers will self-report use tax or pressure their vendors to voluntarily begin collecting the tax. Currently seven other states, Kentucky, Louisiana, Oklahoma, Kentucky, Tennessee, South Carolina, South Dakota, and Vermont have some type of reporting requirements for unregistered sellers. Colorado is expected to soon begin enforcing compliance with its notification and reporting requirements.
- Online Marketplaces: Arizona adopted a policy in late 2016 that an online marketplace business providing order status and shipping information, customer services, control over the fulfillment process, payment and refund process for third parties has nexus with Arizona and is responsible for collecting Arizona transaction privilege tax (sales tax) for all sales of tangible personal property made by third party sellers on the marketplace.[iv] Other states are considering similar approaches.
- Other Nexus Initiatives: The states continue to pass other legislation in an attempt to have out of state retailers register for and begin collecting the tax. Click-through nexus laws require out-of-state vendors who use in state representatives to sell on their behalf or who refer customers to them (e.g., clicking on a link on a website) to register for and collect sales/use tax in the state. Twenty-four states and the District of Columbia have such laws. In addition, affiliate nexus provisions enforced in 19 states require an out-of-state business with a relationship with an instate affiliate to collect sales and use tax.
- Soda or sweetened beverages taxes were passed by several cities/localities (Philadelphia, Cook County, Illinois, San Francisco, among others) in 2016. These seek to tax the beverages in order to curb consumption; in reality, though, it may just be another way to raise revenues. According to the Tax Foundation, in Philadelphia a 12-pack of sports drinks is now more expense than beer in some instances.[v]
- In 2016, four states passed legislation legalizing (and taxing) recreational marijuana. States with existing marijuana taxes have reaped substantial revenues from such taxes.
[i] “The 5 Best and Worst State Tax Changes of 2016, Plus What’s on the Docket for 2017,” Forbes, Patrick Gleason, Contributor, 12/31/16.
[ii] North Carolina Department of Revenue website.
[iii] Quill Corp. v. North Dakota, 504 US 298 (1992).
[iv] Arizona Transaction Privilege Tax Ruling 16-3, 9/20/2016.
[v] “Sports Drinks Are Now More Expensive than Beer Thanks to the Philadelphia Soda Tax,” Tax Foundation, January 4, 2017.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.