Last year, we noted that the most die-hard state and local tax (SALT) experts wouldn’t remember the top SALT stories of 2020 because of the titanic effects of the pandemic. We began 2021 with the promise of widespread vaccines and optimism that our economy could fully reopen and our society could fully interact again. And perhaps a little healing of our body politic could occur as we tried to “return to normal.”
Many of this year’s top SALT stories revolve around reactions to the pandemic, and to the increased visibility of SALT as issues play out in both the federal legislative and judicial domains. In addition, the return of regularly scheduled live legislative sessions in many state capitals that were forced to shut down in 2020 gave legislators the ability to address short-term concerns as well as long-term tax reforms.
Our Grant Thornton SALT team in the Washington National Tax Office considered what happened this year, and then ranked the 10 most important SALT stories of 2021 in order of perceived importance. Below is an introduction to these topics; the full story of this year in SALT can be read here.
1. SALT cap spurs PTE tax regimes
The biggest story of the 2021 state legislative sessions was the widespread adoption of pass-through entity (PTE) tax regimes as a workaround to the controversial federal $10,000 SALT deduction limitation adopted under the Tax Cuts and Jobs Act (TCJA). Under these regimes, the PTE is permitted to deduct its state and local income taxes as a tax on the business at the federal level, followed by a deduction for the PTE tax on the distributive share of the owners’ income. Depending on the structure of the PTE tax, the owner generally claims a corresponding tax credit against personal tax liability or an exclusion on the portion of the owner’s pass-through income subject to the entity tax.
Seven states had enacted PTE taxes through November 2020, when the Internal Revenue Service (IRS) confirmed that state PTE tax regimes would be respected for federal income tax purposes, therefore providing a more acceptable framework for partnerships and S corporations to deduct the tax at the entity level. Since that time, states moved at a rapid pace to adopt their own elective state PTE regimes, with 14 additional states having done so in 2021 to date. While state PTE taxes have proven to be a popular workaround to the federal SALT deduction limitation that simultaneously do not adversely impact state tax revenues, the differing nature of each state PTE tax regime presents complications and uncertainty. Against this complex backdrop, there remains the possibility that Congress may substantially change or increase the SALT deduction limitation applicable in 2021 as the House and Senate continue to debate the reconciliation bill.
2. States challenge ARPA tax mandate
The American Rescue Plan Act (ARPA) created Coronavirus State and Local Fiscal Recovery Funds for distribution to state and local governments. States must use the funds for either a wide variety of pandemic-related purposes, or to make necessary investments in water, sewer or broadband infrastructure, but are prohibited from using the funds to offset a reduction in state net tax revenue resulting from a change in law, regulation or administrative interpretation. In response to numerous requests by states for information on the scope of this provision, the U.S. Treasury Department adopted interim rules designed to provide further guidance to states regarding when the ARPA tax mandate would be triggered. The tax mandate has led to several constitutional challenges, resulting in three significant U.S. District Court decisions – in Ohio, Kentucky and West Virginia -- during 2021 granting injunctions against enforcement to date.
With three U.S. District Court decisions finding similarly that the tax mandate provision is unconstitutional, and several additional challenges outstanding, the focus may now turn to whether, and if so, when the Treasury Secretary will provide further guidance regarding the mandate and how it will be enforced.
3. SALT implications of COVID-19 telework
Continued remote work brought new state and local tax challenges for employers in 2021 as taxing authorities began rescinding temporary payroll tax withholding and nexus policies, many of which were in effect since the early days of the pandemic. Back in the spring of 2020, many states issued temporary emergency guidance addressing the income tax treatment of employees working from a different state due to the pandemic. However, many states recently announced the end of temporary guidance in conjunction with the lifting of state and local public health restrictions, particularly during the summer and fall months of 2021. A handful of states, including South Carolina and Wisconsin, extended their income tax withholding and nexus relief through Dec. 31, 2021.
Massachusetts adopted a temporary emergency regulation that allowed the state to tax the income of non-resident employees who worked in the state prior to the pandemic, but who were teleworking during the pandemic. This prompted New Hampshire, which does not impose a personal income tax, to challenge whether Massachusetts may constitutionally tax non-residents working in New Hampshire. Ultimately, the U.S. Supreme Court declined to hear the case as a matter of original jurisdiction. Beyond temporary state telework guidance, several states made more permanent legislative changes to their income tax withholding policies in response to widespread remote work.
4. Conformity to CARES Act/PPP loan forgiveness
Major corporate income tax provisions in the CARES Act, enacted in March 2020, included changes to the net operating loss (NOL) rules, modifications to the business interest expense deduction limitation, and the retroactive reclassification of qualified improvement property (QIP) to be eligible for 100% bonus depreciation. Although many states addressed CARES Act conformity during 2020, a significant number of states first considered the CARES Act during their 2021 legislative sessions. Some states that adopt the Internal Revenue Code (IRC) as of a specific date were required to consider the CARES Act as they enacted legislation in 2021 that advanced their IRC conformity dates past the enactment date of the CARES Act.
While most states decided to conform to the federal PPP loan provisions, a few states diverge from the federal treatment. California enacted legislation in April providing greater conformity to federal law regarding the deductibility of expenses paid using forgiven PPP loans. In contrast, Hawaii excludes the loan forgiveness amounts from gross income but decouples from the federal treatment by disallowing the deduction if the expenses paid by a taxpayer entitle it to PPP loan forgiveness and the taxpayer has a reasonable expectation of forgiveness. For tax years beginning on or after Jan. 1, 2020, Rhode Island requires the addition of the amount of any PPP loan forgiven for federal purposes to the extent the amount of loan forgiven exceeds $250,000. Also, Virginia taxpayers seeking to take advantage of the CAA allowance to deduct business expenses which were funded by a PPP loan are limited to a $100,000 deduction.
5. Remaining states enact remote seller laws
By the end of 2020, nearly all states imposing a sales tax had adopted remote seller and marketplace facilitator nexus legislation in response to Wayfair. As a result of legislation enacted by Florida, Kansas and Missouri during 2021, this trend has become unanimous and all states with a sales tax have adopted remote seller and marketplace facilitator nexus provisions. This development is particularly noteworthy because all states with a sales tax decided to follow Wayfair within just three years of the decision. However, there remain differences in the thresholds and application of the standards among states.
6. Courts decline remote seller sales tax challenges
In 2021, several federal district courts declined to consider sales tax litigation brought by remote sellers, particularly in cases when an alternative remedy could be obtained at the state level. Several states have asserted inventory nexus for remote sellers participating in the Fulfillment by Amazon (FBA) program prior to the enactment of marketplace facilitator laws. Under the FBA program, smaller online sellers may not know where their inventory is stored or where their products are eventually sold, which may result in sales tax assessments from states in which remote sellers have otherwise limited connections.
There were at least three cases in 2021 in which federal courts dismissed claims made by online sellers. A Pennsylvania federal court rejected a challenge from a group of online sellers to the state’s assertion of sales tax nexus on out-of-state businesses having in-state inventory through the FBA program. In a similar case, an Illinois federal district court rejected an Illinois online seller’s motion for a preliminary injunction against the California Department of Tax & Fee Administration (CDTFA) for seizing the seller’s bank account in an effort to collect prior California sales taxes allegedly owed on the basis of inventory stored in Amazon warehouses located in California. And in a case filed by the same group that filed the Pennsylvania litigation discussed above, a California federal court rejected a motion for preliminary injunction against the CDTFA for pursuing back sales taxes from sellers with inventory located in Amazon fulfillment centers in the state.
7. Digital advertising taxes considered
In February 2021, Maryland became the first state to enact a gross receipts tax on proceeds derived from digital advertising services in the state. Enacted by the state legislature over the objections of the Maryland governor, who vetoed the legislation, the tax is imposed on entities with global gross revenues of at least $100 million. Entities having annual gross revenues derived from digital advertising services in Maryland of at least $1 million in a calendar year are required to file a tax return. The tax rate ranges from 2.5% to 10% based on the amount of the entity’s annual global gross revenue. While the tax was enacted with the intent of taxing large technology companies, the tax may also impact other non-technology companies deriving digital advertising revenue from the state.
Maryland’s digital ad tax has been the source of controversy since the day it was enacted. Although the legislation intended for the tax to be effective beginning with the 2021 tax year, subsequent emergency legislation delayed the effective date of the tax to the 2022 tax year due to various difficulties in implementing the tax. The delayed effective date was also the result of lawsuits that were filed in both state and federal court alleging a violation of electronic commerce under the Internet Tax Freedom Act (ITFA) as well as the Commerce and Due Process Clauses of the U.S. Constitution. Although the future of Maryland’s digital advertising tax remains very uncertain, the state’s experience has paved the way for other state legislatures to consider their own digital advertising tax bills, with legislation having been proposed in Connecticut, Massachusetts, Montana, New York, Texas and West Virginia.
8. Recent NOL developments
From a federal perspective, the TCJA and the CARES Act made significant changes to the historic treatment of NOLs for federal income tax purposes. The TCJA provisions specifically limit allowable NOL deductions to 80% of federal taxable income and lift the previously imposed 20-year limitation on carryovers. While the TCJA provisions disallowed NOL carrybacks, the CARES Act temporarily and retroactively allows NOLs incurred in tax years beginning in 2018, 2019, or 2020 to be carried back five years or carried forward indefinitely, at the taxpayer’s election. From a federal standpoint, this change was intended to grant taxpayers a degree of relief from the economic difficulties created by the pandemic.
Over the past 12 months, as states have reckoned with their own financial difficulties and made decisions regarding whether and how to conform to the many significant tax provisions included in the TCJA and the CARES Act, NOL treatment has certainly not escaped notice. In efforts to address their own budgetary woes and maximize revenue, several states have acted to limit taxpayers’ ability to offset taxable income with recognized losses. Significant legislative and judicial developments in Illinois, Pennsylvania and New Jersey highlight imposed limitations on NOL usage.
9. MTC updates statement on Public Law 86-272
After approximately two years of work, the Multistate Tax Commission (MTC) voted in August to adopt revised guidance interpreting longstanding federal protections against state income tax to update for the modern economy and internet business activities. With 19 member states and the District of Columbia voting in favor, the MTC approved an updated statement of information interpreting Public Law 86-272 (P.L. 86-272), the 1959 federal law that limits the state taxation of income from sales of tangible personal property if the taxpayer’s only business activities in the state are the solicitation of orders that are approved and shipped from outside the state. The adoption marks the most significant revisions to the statement since its last revision in 2001.
10. Tax regimes targeting the few
As states and localities have continued to feel the economic pain induced by the pandemic (mitigated to be sure by ARPA funds), some have sought to impose new sources of tax revenue which are designed to intentionally target small groups of taxpayers. Prime examples of this targeted approach include the adoption of billboard taxes by the cities of Cincinnati and Baltimore and a long-term capital gain (LTCG) tax, as well as a business and occupation (B&O) surtax on large financial institutions, by the state of Washington. Although raising funds in this manner may be politically acceptable to many, it also attracts the potential for meaningful legal challenges.
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