Even though the legislative season is winding down for many states, there were some significant SALT developments this month. On the legislative front, Ohio enacted budget legislation making some major changes, while New Jersey addressed the taxation of remote employees by enacting a convenience of the employer test. There also were some noteworthy tax litigation developments. A federal appellate court affirmed the dismissal of a remote seller’s challenge of Louisiana’s complex state and local sales tax system. Finally, the Minnesota Tax Court issued an opinion providing a detailed analysis of what taxpayer activities are protected under Public Law 86-272. Learn more about these developments in our roundup of SALT news for July 2023.
Federal appellate court affirms dismissal of Louisiana sales tax challenge
On July 7, 2023, the U.S. Court of Appeals, Fifth Circuit, affirmed a federal district court’s dismissal of a challenge to Louisiana’s sales tax system because the matter was barred by the federal Tax Injunction Act (TIA). In Halstead Bead, Inc. v. Richards, an Arizona-based online retailer filed a lawsuit in federal district court alleging that Louisiana’s decentralized sales tax system presents undue compliance burdens for remote sellers under South Dakota v. Wayfair, Inc., due to the lack of uniformity in administration between the state sales tax and the local sales taxes imposed by the state’s 64 parishes. Specifically, Halstead requested declaratory and injunctive relief against the enforcement of Louisiana’s sales and use tax system, as well as nominal damages against various state and local governmental defendants.
In May 2022, the U.S. District Court for the Eastern District of Louisiana held that it did not have jurisdiction to consider the case because the federal TIA precluded it from considering Halstead’s challenge. Under the TIA, federal district courts may not enjoin, suspend or restrain the assessment, levy or collection of any tax under state law where a plain, speedy and efficient remedy is available in state court. Also, the district court held that it did not have jurisdiction on federal comity grounds. The court explained that the comity doctrine provides that federal courts should allow state courts to consider matters such as the constitutionality of state taxation of commercial activity. Halstead appealed the district court’s dismissal of the matter for lack of jurisdiction.
The Fifth Circuit held oral arguments for this case on May 2, 2023. Louisiana subsequently enacted legislation, H.B. 171, in late May that amended the state’s sales tax nexus statute to eliminate the 200- transaction threshold while retaining the $100,000 sales threshold. The elimination of the transaction threshold is effective Aug. 1, 2023. On June 12, 2023, Halstead filed supplemental authority with the court claiming that the enactment of H.B. 171 made its lawsuit moot. To avoid having a Louisiana sales tax obligation, Halstead ensured that it did not meet the 200 transaction or $100,000 sales thresholds in any single year. In 2021, Halstead stopped its Louisiana sales as it neared the 200-transaction threshold and had sales of less than $50,000. Halstead did not present any facts indicating that it would meet the remaining $100,000 sales threshold. As a result, Halstead claimed that in light of H.B. 171, its activity would no longer be subject to Louisiana’s parish-by-parish tax registration and remitting system.
On June 13, 2023, the sales tax collector for Lafourche Parish, one of the defendants in this lawsuit, filed a response contending that the litigation was not moot. The response noted that Halstead claimed in its original complaint that it ensured that it engaged in fewer than 200 transactions or less than $100,000 in taxable sales in Louisiana in any taxable year. According to the response, the lawsuit was not moot because Halstead still was subject to the $100,000 sales threshold.
The Fifth Circuit subsequently affirmed the district court’s dismissal of the lawsuit because it was barred by the TIA, but the court did not address the district court’s comity holding. The court explained that Halstead’s requested relief, if granted, would stop the collection of Louisiana sales and use tax from remote sellers such as Halstead. Also, the court determined that Halstead had a plain, speedy and efficient remedy in the Louisiana courts. First, Louisiana law permits a declaratory judgment action in state court for this type of claim. Second, the Louisiana Board of Tax Appeals can consider Halstead’s challenge to the constitutionality of the state’s tax laws. The Fifth Circuit accordingly affirmed the dismissal of Halstead’s federal litigation.
Despite what likely appears to be the end of the Halstead Bead litigation, taxpayers should note that Louisiana has enacted legislation this year to address the complexities of its sales tax system. On June 14, 2023, the state enacted H.B. 558 to direct the Louisiana Uniform Local Sales Tax Board to design and implement a single remittance system for state and local sales and use taxes. This legislation, effective Jan. 1, 2024, along with the Aug. 1, 2023, removal of the 200-transaction threshold, should serve to simplify Louisiana’s complicated local sales and use tax system.
Minnesota tax court holds activities exceeded P.L. 86-272 protection
On June 23, 2023, in Uline, Inc. v. Commissioner of Revenue, the Minnesota Tax Court applied Public Law 86-272 (P.L. 86-272) and held that that the taxpayer maintained sufficient minimum contacts with the state to be subject to corporate franchise tax. The taxpayer’s requirement that sales representatives collect and report market data concerning competitors on a twice-monthly basis was not considered to be ancillary to sales in Minnesota, but rather was a function of the representatives’ job duties and a matter of the taxpayer’s corporate policy. Furthermore, the degree and frequency of collecting and reporting market data was not de minimis and established a taxable presence in Minnesota. This decision is noteworthy because the court thoroughly examined the taxpayer’s activities and determined the applicability of P.L. 86-272 protection.
The taxpayer, a business-to-business catalog and web-based distributor of industrial and packaging products, was an S corporation based in Wisconsin. Most of the taxpayer’s inventory items were shipped from its distribution centers via common carrier. During the 2014 and 2015 tax years at issue, the taxpayer did not have a physical office, distribution center, or other place of business in Minnesota. Likewise, the taxpayer did not own, lease, or use any real property in Minnesota, or lease any tangible personal property in the state. The taxpayer historically had owned a distribution center in Minnesota, but replaced this center with a distribution facility in Wisconsin that served as the taxpayer’s main distribution center for Minnesota customers. Orders obtained by the taxpayer’s Minnesota sales representatives were submitted to the Wisconsin distribution facility for acceptance and shipped to Minnesota customers by common carrier.
The taxpayer employed 24 sales representatives whose territories included Minnesota customers. These sales representatives were expected to visit 25 customers per week, and typically visited each Minnesota customer from one to four times per year. During customer visits, the sales representatives solicited orders of the taxpayer’s products, and provided product samples and demonstrations free of charge. Sales representatives prepared Sales Notes and Market News Notes to document their customer visits. The Sales Notes were entered for every customer visit and generally summarized the visit. The Market News Notes contained information that the sales representatives collected from customers concerning special delivery needs, bulk pricing requests, complaints about the products, needs for certain products and what customers were buying from competitors. For the two tax years at issue, 1,610 Market News Notes were prepared. The Wisconsin facility generally processed product returns. On 10 occasions, sales representatives accepted and returned items from Minnesota customers to the Wisconsin facility, but this activity was not a standard practice.
In addition to the activities performed by sales representatives, the taxpayer engaged in other activities in Minnesota. Through its human resources personnel, it participated in 10 one-day job fairs hosted by Minnesota colleges and universities during the tax years at issue. Also, one of the six individual owners of the taxpayer’s business enterprise was a Minnesota resident. Though this person’s primary office was at the Wisconsin facility, he performed job duties such as answering business-related emails and calls while working from his Minnesota residence.
The taxpayer filed a final S corporation return with Minnesota for the 2014 tax year and claimed that it was exempt from Minnesota corporate franchise tax under federal P.L. 86-272 and the Minnesota income tax nexus statute. P.L. 86-272 is a 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. Courts have determined that activities are protected by P.L. 86-272 if they are entirely ancillary to the solicitation of sales. However, activities beyond the solicitation of sales may be protected if they are de minimis. The Minnesota tax commissioner determined the taxpayer’s business activities in Minnesota exceeded the protections of P.L. 86-272. The taxpayer appealed the assessment to the Minnesota Tax Court.
In granting the commissioner’s motion for summary judgment, the court determined that the taxpayer was subject to tax because its Minnesota business activities went beyond the protected solicitation of sales under P.L. 86-272 and were not de minimis. As a result, the taxpayer’s activities formed a non-trivial connection with the state under its nexus statute. The court performed a detailed analysis and applied such controlling cases as the U.S. Supreme Court’s 1992 decision in Wisconsin Department of Revenue v. William Wrigley, Jr., Co.
The court first considered the activities in Minnesota that were not performed by sales representatives. Regarding the activities at the Minnesota job fairs, the court agreed with the taxpayer that providing information to prospective employees, without further interviewing or hiring activities, did not establish nexus. Also, the activities of the owner who resided in Minnesota did not establish nexus because he did not maintain an in-home office of the taxpayer.
In considering the activities performed by sales representatives, the court concluded that the instances in which the sales representatives retrieved and transported returns from Minnesota customers were not entirely ancillary to the solicitation of orders. Because product returns were a business activity independent of any sales activity, the returns in Minnesota were not protected by P.L. 86-272. However, the sales representatives’ activities of documenting customer complaints obtained during customer visits were protected as activities ancillary to the solicitation of sales. The court agreed with the commissioner that the market research conducted and documented by the sales representatives in the Market News Notes served a business purpose independent from soliciting sales. The notes also related to product development and pricing determinations.
The court finally considered whether the non-ancillary activities of personally retrieving and transporting returns and preparing Market News Notes, taken together, were de minimis. The sales representatives’ activity of transporting returns was de minimis because this only occurred on 10 occasions and was not the taxpayer’s policy. In contrast, the court determined that the preparation of Market News Notes was not a de minimis activity because these were prepared on a regular basis and over 1,600 individual Market News Notes were produced for the taxpayer. The court concluded that because all non-ancillary activities must be considered together for purposes of the de minimis analysis, and because the preparation of Market News Notes was not a de minimis activity, the taxpayer’s unprotected activities exceeded the protection provided by P.L. 86-272.
New Jersey enacts convenience of the employer rule
On July 21, 2023, New Jersey enacted legislation, A.B. 4694, which provides a convenience of the employer rule for gross income tax purposes if a New Jersey nonresident employee works for a New Jersey employer and is a resident of a state which has a similar convenience of the employer rule. During the pandemic, some states pursued efforts to tax the income of employees working beyond their borders. Several states, including New York, historically have followed a “convenience of the employer” rule that sources employees’ income to their state if the employees work remotely for their own convenience rather than as a requirement of their employer located in the taxing state. New York has interpreted the rule to require nonresidents associated with a primary office in New York to treat days spent teleworking outside New York as days worked in New York, unless the employer established a bona fide employer office at the teleworking location. New York’s policy has received criticism from New Jersey and other bordering states, whose residents historically commuted to New York and paid a significant amount of income tax to the state. During the pandemic, however, these employees were forced to work remotely in their resident state or elsewhere because their New York offices were closed.
Under H.B. 4694, for tax years beginning in 2023 and thereafter, for an individual who is a nonresident of New Jersey and receives compensation from a New Jersey employer for personal services performed outside New Jersey that were not required by the employer to be performed outside the state, and whose resident state has a “convenience of the employer” rule, the individual’s compensation is subject to New Jersey gross income tax. In other words, New Jersey is now taxing the income of a New York resident who works for a New Jersey company even if the work is performed outside New Jersey provided the work location is not required by the employer. Under prior law, this income would not be subject to New Jersey gross income tax because the work was not being performed in New Jersey. As explained in a press release issued on July 21, 2023, by New Jersey Gov. Phil Murphy, this legislation brings the state’s “tax code in line with New York’s and allows New Jersey to tax remote employees who live out of state but work at New Jersey companies – if that state has a similar tax rule.”
For tax years beginning in 2020 through 2023, the legislation provides a new tax credit for New Jersey resident taxpayers who are able to obtain a final judgment from another state’s tax court or tribunal in the taxpayer’s favor, resulting in a refund of taxes paid to that state on the basis that the income was derived from services rendered while the taxpayer was within New Jersey. The credit equals 50% of the amount of additional taxes owed to New Jersey as a result of the readjustment of New Jersey’s existing credit for tax paid to another state (because the existing credit is readjusted to reflect the refund received from the other state).
The legislation also creates a $35 million pilot program to provide grants to encourage businesses with New Jersey resident employees assigned to work locations outside the state to move these employees to New Jersey locations. A business is eligible for a grant under this program if the business has more than 25 full-time employees and is principally located in another state. The amount of the grant is the lesser of: (i) New Jersey gross income tax withholdings of resident employees re-assigned by the business to a New Jersey location; or (ii) $500,000. Businesses seeking a grant must submit an application to the New Jersey Economic Development Authority by July 1, 2028. In awarding the grants, the authority may give priority to businesses that: (i) acquire or lease office space in New Jersey and make a capital investment in the office space; and/or (ii) submit a plan to the authority showing the business will provide bonuses to, or otherwise increase the compensation of, employees relocated to New Jersey.
Ohio enacts budget legislation providing tax relief
On July 3, 2023, Ohio enacted budget legislation, H.B. 33, for the 2024-2025 fiscal years which amends the Commercial Activity Tax (CAT), individual income tax, and municipal income tax provisions. As part of the budget process, Ohio Gov. Mike DeWine vetoed 44 different line items. The following provisions are the most significant changes included in the final version of the budget that was enacted.
Under existing law, taxpayers with annual gross receipts not exceeding $150,000 are not subject to the CAT and the first $1 million of taxable gross receipts are excluded. Beginning in 2024, H.B. 33 increases the exclusion amount to taxable gross receipts of $3 million. Applicable to 2025 and following years, the exclusion amount is further increased to $6 million in gross receipts. The existing rate of 0.26% applies to taxable gross receipts exceeding these excluded amounts. DeWine vetoed a provision that would have required the tax commissioner to adjust the exclusion amount for inflation beginning in 2026. These changes are predicted to reduce CAT receipts by about $238 million in the 2024 fiscal year and $460 million in the 2025 fiscal year. These changes are designed to reduce or eliminate the CAT obligation of many taxpayers.
In June 2022, Ohio enacted an elective pass-through entity (PTE) tax available for tax years beginning on or after Jan. 1, 2022. H.B. 33 makes amendments concerning the individual income tax treatment of PTE taxes paid to other states. As amended, the resident credit for a taxpayer’s income tax liability to another state or the District of Columbia is expanded to include PTE taxes imposed by the other jurisdiction. Also, a corresponding addition to an individual’s adjusted gross income is required for PTE taxes deducted in computing federal taxable income or Ohio taxable income. These provisions apply to tax years ending on or after Jan. 1, 2023, but taxpayers have the option of applying the provisions to the 2022 tax year, through the filing of an amended or original return.
Ohio law currently provides four rate brackets for individual income tax. The maximum rate is 3.99% for income greater than $115,300. For the 2023 tax year, the number of brackets is reduced to three and income over $115,300 is subject to the highest tax rate of 3.5%. For the 2025 and subsequent tax years, the number of brackets is reduced to two and income over $100,000 is taxed at a rate of 3.5%.
For purposes of municipal income tax, taxpayers generally use an equally weighted three-factor apportionment formula based on property, payroll, and sales. For tax years ending on or after Dec. 31, 2023, H.B. 33 allows businesses with remote employees or owners to elect a modified municipal income tax apportionment formula for the net profits attributable to the activities of those employees and owners. Rather than sourcing the three components of the apportionment factor to the location of a remote employee, the items may be sourced to a “qualifying reporting location.”
Individuals can be designated as remote employees or owners for purposes of this provision if they are individual employees of the taxpayer, or own individual interests in a federally treated partnership. Each remote employee / owner must be assigned by the taxpayer to a qualifying reporting location, at which such remote employee / owner is permitted or required to perform services for the taxpayer.
A “reporting location” is either a permanent place of doing business that is owned or controlled directly or indirectly by the taxpayer, or a location in Ohio owned or controlled by a customer or client of the taxpayer, provided that the taxpayer is required to withhold taxes on qualifying wages paid to an employee for the performance of personal services at that location. In turn, a “qualifying reporting location” means one of the following: (i) the reporting location in Ohio at which an employee or owner performs services for the taxpayer on a regular or periodic basis during the tax year; (ii) if no reporting location exists in Ohio as described in (i), the reporting location in Ohio at which the supervisor of the employee or owner regularly or periodically reports during the tax year; or (iii) if no reporting location exists in Ohio as described in (i) or (ii), the location that the taxpayer otherwise assigns as the employee’s or owner’s qualifying business location, provided the assignment is made in good faith and is recorded and maintained in the taxpayer’s business records.
For taxpayers electing to use the modified apportionment formula, items such as the average original cost of any tangible personal property, wages or other compensation, and gross receipts of the business or profession from services performed generally are sitused to the individual’s qualifying reporting location when such items arise from the individual’s efforts at such location.
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