State and local tax news for March 2023


Recent developments in state and local tax news included tax reform enacted in Montana, a Wisconsin court decision concerning the assessment of a vacant big-box site and tax compliance relief for Californians overwhelmed by winter storms. Find out more about these and other stories in our roundup of SALT news for early 2023.




California extends filing and payment deadlines due to winter storms


On March 2, 2023, Gov. Gavin Newsom announced that California is extending its income tax filing and payment deadlines for certain California taxpayers affected by the December and January winter storms to Oct. 16, 2023. The relief provided by the state is consistent with federal extensions previously provided for victims of the severe weather in California.


The California Franchise Tax Board (FTB) has clarified that the emergency tax relief applies to deadlines falling on or after Jan. 8, 2023, and before Oct. 16, 2023, including (but not limited to) the following: 

  • Individual tax returns and payments due on April 18, 2023, and May 15, 2023
  • Business entity tax returns and payments due on March 15, 2023, and May 15, 2023
  • Quarterly estimated tax payments due on Jan. 17, 2023; April 18, 2023; June 15, 2023; and Sept. 15, 2023
  • The pass-through entity (PTE) elective tax payment (the greater of 50% of the tax paid in the prior tax year, or $1,000) due on June 15, 2023, which is required to be eligible for PTE elective tax treatment


Trusts and estates with returns or payments due between Dec. 27, 2022, and Oct. 16, 2023, have until Oct. 16, 2023, to file their returns and make their payments.


California also has provided two additional areas of relief. First, with respect to the income tax, California is allowing certain taxpayers affected by the winter storms that have incurred a loss meeting certain qualification criteria to claim a deduction for a disaster loss. Second, for sales tax purposes, the California Department of Tax and Fee Administration (CDTFA) has announced that taxpayers affected by the winter storms may be able to receive extensions of up to three months to file and pay sales taxes.




Minnesota enacts legislation advancing IRC conformity


On Jan. 12, 2023, Minnesota enacted legislation, Ch. 1 (H.F. 31), which advances the state’s Internal Revenue Code (IRC) conformity date from Dec. 31, 2018, to Dec. 15, 2022. The legislation is effective Jan. 13, 2023, except the changes incorporated by federal changes are effective retroactively at the same time the changes were effective for federal purposes. The Minnesota Department of Revenue has issued guidance on this legislation. The corporate income tax provisions are summarized below.


For tax years beginning in 2019 or 2020, an addition is required for the amount of business interest deducted under special rules in IRC Sec. 163(j)(10)(A) and (B). These federal rules temporarily provided some relief for taxpayers during the pandemic, by increasing the interest deduction limitation from 30% to 50% for the 2019 and 2020 tax years and providing an election to use 2019 adjusted taxable income for the 2020 tax year. A variety of addition and subtraction modifications must be applied in order for a taxpayer to determine how much of the business interest must be added back to taxable income, and how much business interest carryforward is created and carried to the earliest tax year. No subtraction is allowed under this provision for tax years beginning after Dec. 31, 2022. For each of the five tax years beginning after Dec. 31, 2022, a subtraction equal to one-fifth of the sum of all remaining carryforward amounts is allowed.


For expenses incurred before Jan. 1, 2023, a temporary addition is required for the amount of meal expenses in excess of the 50% limitation under IRC Sec. 274(n)(1) allowed by IRC Sec. 274(n)(2)(D). Also, a temporary addition is required for the amount of charitable contributions deducted for the 2020 tax year under Sec. 2205(a) of the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act.


Because Minnesota has adopted federal income tax law changes to which state law previously did not conform, taxpayers may need to file amended returns to correctly determine their federal taxable income. Many of the federal income tax nonconformity modifications reported on 2017 through 2021 Minnesota returns are no longer required. The legislation extends the time to file amended returns to either Dec. 31, 2023, or the general statute of limitations, whichever is later. This extension only is provided for amended returns filed because of a law change in this legislation. The general statute of limitations allows taxpayers to file an amended return claiming a refund or reporting additional tax within 3 1/2 years of the due date or 3 1/2 years filing the return, whichever is later. The guidance includes conformity by form and line as well as conformity by federal act. The Commissioner of Revenue may review and assess the return of a taxpayer covered by this provision for the later of: (i) 3 1/2 years after filing the return; or (ii) one year from the time the amended return is filed as a result of a change in taxability under this provision. Interest on additional liabilities resulting from any provision in this legislation accrues beginning on Jan. 1, 2024. 




Montana enacts tax reforms, including single sales factor apportionment


On March 13, 2023, Montana enacted a package of laws providing various tax amendments. Some of the most significant provisions are outlined below.


S.B. 124 adopts a single sales factor apportionment formula for tax years beginning after Dec. 31, 2024. Montana currently uses a three-factor apportionment formula with a double-weighted sales factor. As explained in the fiscal note for the legislation, this change affects multistate C corporations and pass-through entities with nonresident owners who do business in Montana.


For tax years beginning after Dec. 31, 2023, H.B. 212 increases the “class eight” business equipment property tax market value exemption from $300,000 to $1 million. Class eight includes most types of business equipment property and is taxed at 1.5% for the first $6 million in market value over the exemption amount, and 3% for the remaining value.


S.B. 121 lowers the top personal income tax rate from 6.5% to 5.9% for tax years beginning after Dec. 31, 2023. Also, the Montana earned income tax credit is increased from 3% to 10% of the federal credit. H.B. 192 provides an income tax rebate for full-time residents who filed returns for the 2021 tax year. The rebate equals the lesser of $1,250 ($2,500 for joint returns) or the tax liability reported on the taxpayer’s 2021 state return. Finally, H.B. 221 replaces the 30% net long-term capital gains deduction that was scheduled to take effect in the 2024 tax year with separate capital gains tax rate brackets of 3.0% and 4.1%.




New York rules vendor management system fees subject to sales tax


On Feb. 9, 2023, a New York Division of Tax Appeals Administrative Law Judge (ALJ) concluded in, Inc. that the taxpayer’s vendor management system fees were taxable as the sale of prewritten software. The taxpayer was headquartered in Florida and provided services in New York during the relevant period. Specifically, the taxpayer provided services to assist large national and global companies with gathering, organizing, assembling and managing their contingent labor force. The customers were typically large companies that annually spent very significant amounts on contingent labor temporary workers.


Following an audit, the New York State Division of Taxation determined that the taxpayer sold licenses to use prewritten software (referred to as the vendor management system (VMS)), as well as nontaxable professional services (referred to as the managed supplier program (MSP)). After determining that the taxpayer accounted for the VMS receipts separately from the MSP receipts, the Division concluded that the taxpayer owed sales tax on the sale of the VMS but not the MSP. The Division assessed the taxpayer additional sales tax.


The taxpayer argued that it did not receive payments from its customers for a license to use software. According to the taxpayer, the primary purpose of its service was to act as a “matching” agent for suppliers of temporary labor and customers needing this labor. The taxpayer also argued that the Division incorrectly concluded that the taxpayer offered and billed for software separately from its other services. The Division contended that the taxpayer’s licensing prewritten software to its customers was a taxable service. Also, the Division claimed that the taxpayer licensed its software to its customers and that it was billed separately from the other consulting services. The Division acknowledged that some of the related services may be tax exempt, but claimed that they were being performed by taxable software that was licensed to the customer.


In rejecting the taxpayer’s arguments, the ALJ noted that New York imposes sales tax on prewritten computer software. The sample contracts provided that customers paid fees for the VMS service, and the contract included the license of the taxpayer’s software as part of the taxpayer’s service. The ALJ concluded that the sale of the prewritten software was bundled and sold together as one product with other nontaxable services. The software technology and license appeared to be completely intertwined with all the services the taxpayer offered in the contract. The ALJ rejected the taxpayer’s argument that the businesses that supplied the labor, rather than the taxpayer’s customers, actually paid the taxpayer’s fees. According to the ALJ, the taxpayer’s argument did not affect the conclusion that the VMS fees were subject to sales tax.




Pennsylvania denies nonprofit property tax exemption for hospitals


On Feb. 10, 2023, the Pennsylvania Commonwealth Court issued a series of decisions that denied local property tax exemptions for hospitals that were unable to prove that they had a nonprofit or purely public charity status under Pennsylvania law due in part to high executive compensation (Pottstown School District v. Montgomery County Board of Assessment Appeals; Phoenixville Hospital, LLC v. Chester County Board of Assessment Appeals (unpublished); Brandywine Hospital, LLC v. Chester County Board of Assessment Appeals; Jennersville Hospital, LLC v. Chester County Board of Assessment Appeals (unpublished)).


Under Pennsylvania law, in order to qualify for a tax exemption as a charity, an entity must show that it is an institution of “purely public charity” by satisfying the five criteria of the Pennsylvania Supreme Court’s Hospital Utilization Project v. Commonwealth decision (known as the HUP test):

  • Advances a charitable purpose
  • Donates or renders gratuitously a substantial portion of its services
  • Benefits a substantial and indefinite class of persons who are legitimate subjects of charity
  • Relieves the government of some of its burden
  • Operates entirely free from private profit motive

The Montgomery County trial court granted the charitable exemption for Pottstown Hospital, but the trial court in Chester County denied the charitable exemptions for the other hospitals. In Pottstown, the trial court concluded that the hospitals met all five criteria of the HUP test. The trial court determined the fifth criteria was satisfied even though the executives received high compensation that the trial court described as “eye popping.” Relying on the Commonwealth Court’s decision in Phoebe Services, Inc. v. City of Allentown from 2021, the trial court concluded that the executive compensation met the HUP test because the salaries did not exceed the 90th percentile of all salaries paid by the hospitals. The trial court reached this conclusion even though 40% of incentive pay was based on financial performance.


On appeal, the Commonwealth Court in Pottstown focused on the fifth criteria and determined that Phoebe Services was not applicable or persuasive in this case. The Commonwealth Court applied its analysis in a 2012 decision (In re Dunwoody Village), in which it denied the exemption because a “substantial percentage” of executive compensation was based on the institution’s financial or marketplace performance. The court rejected the suggestion that the executive salaries must be deemed reasonable merely because they did not exceed the 90th percentile for such salaries. Also, the court concluded that tying 40% of the bonus incentives to the hospital’s financial performance was sufficiently substantial to indicate a private profit motive that violated the HUP test. Furthermore, the trial court did not consider any evidence regarding the reasonableness of the charges imposed by the parent company for the management and administrative services it provided to the hospital. Thus, the hospital could not meet its burden of showing that it operated entirely free from a profit motive under the HUP test.  




South Dakota remote seller nexus law removes transaction threshold


On Feb. 9, 2023, South Dakota enacted legislation, S.B. 30, which changes the remote seller nexus standards for sales tax purposes. Under existing law, South Dakota required remote sellers without a physical presence to collect sales tax if the seller satisfied either of the following criteria in the previous or current calendar year: (i) the seller’s gross revenue from the sale of tangible personal property, any product transferred electronically, or services delivered into South Dakota exceed $100,000; or (ii) the seller sold tangible personal property, any product transferred electronically, or services for delivery into South Dakota in 200 or more separate transactions. This is the remote seller nexus statute that was approved by the U.S. Supreme Court in South Dakota v. Wayfair, Inc. in 2018 and subsequently adopted by many other states.


As recently amended, South Dakota has eliminated the 200 or more separate transactions threshold effective July 1, 2023. This should provide relief to remote sellers that engage in sales transactions in the state at a relatively low selling price. For example, under the original statute, a remote seller that sells 200 items in South Dakota at an average price of $20 would have a filing and remittance obligation even though it had sales of only $4,000 in the state. The amended statute will prevent remote sellers from having a filing and remittance requirement if their sales in the state do not exceed $100,000.




Wisconsin Supreme Court: Vacant sites should not be part of property tax valuation


On Feb. 16, 2023, in Lowe’s Home Centers, LLC v. City of Delavan, the Wisconsin Supreme Court held that the city properly excluded unoccupied big-box retail locations as comparable properties from its valuation analysis. The taxpayer asserted that the city assessor’s revaluation of its occupied big box retail store for the 2016 and 2017 tax years was excessive. The city revalued the property using the cost approach and applied market adjustments for depreciation and additional obsolescence. The assessor also compared the assessments to recent valuations in other communities. The taxpayer argued that the property should have been valued at a much lower amount using a sales comparison approach that considered recent sales including vacant big-box property.


The trial court upheld the city’s assessment and concluded that two of the comparable properties offered by the taxpayer should not be considered because they were vacant beyond the two-to-three-year window that was identified as normal exposure time in the community. As a result, these were “dark” properties that should not be considered unless the subject property also is “dark.” Also, the trial court disagreed with the taxpayer’s suggested valuation because half of the properties submitted by the taxpayer were distressed properties that were in receivership. The Wisconsin Court of Appeals affirmed the trial court’s decision, and the taxpayer subsequently filed an appeal with the Wisconsin Supreme Court.


In affirming the city’s valuation of the taxpayer’s big-box property, the Wisconsin Supreme Court noted that a city’s assessment receives a presumption of correctness. A taxpayer challenging an assessment must present significant contrary evidence sufficient to overcome the presumption and demonstrate that the city’s assessment is excessive. The taxpayer conceded that all the proposed comparable stores were vacant at the time they were sold, but argued that the assessor deviated from the Wisconsin Property Assessment Manual by categorically excluding vacant and dark stores from the comparison analysis.


The court explained that the case revolved around the question of what constitutes a “comparable” property in the context of a sales comparison analysis. The manual provides that “[t]he assessor should avoid using sales of improved properties that are vacant (‘dark’) or distressed as comparable sales unless the subject property is similarly dark or distressed.” Furthermore, the manual states that a “vacant store is considered dark when it is vacant beyond the normal time period for that commercial real estate marketplace and can vary from one municipality to another.” The court concluded that the manual does not strictly prohibit the use of vacant properties as comparable to occupied properties because the “should avoid” language is not mandatory. However, the manual urges assessors to use caution in using vacant property as a comparable. After giving deference to the trial court’s factual findings, including its credibility determinations, the court concluded that the taxpayer did not provide significant contrary evidence sufficient to overcome the presumption of correctness.




Wisconsin disallows royalty deductions due to lack of business purpose, economic substance


On Feb. 24, 2023, in Skechers USA, Inc. v. Wisconsin Department of Revenue, the Wisconsin Tax Appeals Commission held that a taxpayer that created a wholly-owned subsidiary to hold its domestic intellectual property (IP) could not take deductions for royalties paid for use of the property because the transactions lacked a valid business purpose and economic substance.


The taxpayer is headquartered in California and sells footwear throughout the U.S., including Wisconsin. In 1999, the taxpayer followed the advice of a third-party provider offering state tax minimization services and created a subsidiary to hold its domestic IP such as trademarks, service marks, copyrights, and patents. The taxpayer contributed all its domestic IP and $18 million in cash in exchange for 100% of the subsidiary’s stock. Under a licensing agreement, the IP was conveyed back to the taxpayer in exchange for a royalty payment. The taxpayer claimed a Wisconsin corporate income tax deduction for the royalties paid to the subsidiary. Neither the taxpayer nor the third-party provider provided the Wisconsin Department of Revenue with any evidence that anyone conducted a cost-benefit analysis of any business benefit, aside from state tax minimization, for creating the subsidiary and transferring ownership of the domestic IP.


The Department denied the entire royalty expense paid by the taxpayer to the subsidiary, denied the entire balance of interest paid on the net unpaid balance of royalty fees, adjusted the amount of the deduction taken by the taxpayer for management fees charged to and paid by the subsidiary, and denied the research and development expense deduction taken by the taxpayer. The auditor identified the transfer and leaseback of the IP as a sham transaction or otherwise lacking a valid business purpose.


On appeal, the Wisconsin Tax Appeals Commission explained that the taxpayer had the burden of demonstrating that the transactions had a valid business purpose other than tax avoidance and had economic substance. The Commission determined that there was no valid business purpose for creating the subsidiary. The reasons presented by the taxpayer before the creation of the subsidiary only addressed tax savings. The taxpayer’s expert witness provided several valid, non-tax, intellectual property-related benefits related to the formation of the subsidiary, but none of the reasons was considered by the taxpayer before the subsidiary was created. Furthermore, the Commission concluded there was no valid business purpose in the transfer of the domestic IP to the subsidiary and the licensing of the IP back to the taxpayer. The taxpayer failed to prove by clear and satisfactory evidence that it subjectively had nontax business reasons for the transfer of the IP to the subsidiary and the license back to the taxpayer.


The Commission also determined that the transfer of the domestic IP to the subsidiary and the licensing of the IP back to the taxpayer did not have economic substance. The Department argued that the licensing transactions created no meaningful economic change on a pretax basis and produced $495 million of deductions from moving money from one of the taxpayer’s entities to another, without the potential for profit or risk of loss. Also, the Department contended that these transactions were all undertaken as part of the tax minimization project. The taxpayer unsuccessfully argued that the subsidiary was a valid business entity because it experienced substantial growth. The fact that the subsidiary grew substantially did not address the crucial issue of whether the transfer of the IP to the subsidiary and the licensing of the IP back to the taxpayer had economic substance.





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