State and local tax news for June 2024

As the legislative season begins to wind down for many states, Arkansas and Kansas recently held special legislative sessions that resulted in the enactment of income tax relief. Connecticut enacted legislation that extends the net operating (NOL) carryforward period and provides a long-term deduction for taxpayers adversely affected by the state’s combined reporting legislation that was implemented in 2016. The Missouri Court of Appeals decided in favor of remote workers by holding that the City of St. Louis earnings tax does not extend to work performed outside the city. Oregon courts recently released two interesting decisions. The Oregon Supreme Court determined that the activities of the taxpayer’s representatives in the state exceeded Public Law 86-272 protection. Also, the Oregon Tax Court held that industry-specific apportionment methodologies are applied separately to affiliates in a consolidated corporation excise tax return rather than the group as a whole. Finally, the South Carolina Administrative Law Court concluded that a major credit card company had income-producing activity in the state due to its cashless payment network. These developments are discussed in the June issue of State and Local Thinking.  

Arkansas enacts legislation reducing income tax rates

On June 19, 2024, Arkansas Gov. Sarah Huckabee Sanders signed legislation, H.B. 1001, which lowers corporate income tax and individual income tax rates. This legislation was enacted pursuant to a special legislative session that recently was called by Gov. Sanders. For the 2024 and subsequent income tax years, the highest corporate income tax rate imposed on both domestic and foreign corporations is reduced from 4.8% to 4.3%. This rate is imposed on income exceeding $11,000. Also, the top individual income tax rate is reduced from 4.4% to 3.9% for the 2024 and following tax years. The legislation also recalculates the individual income tax bracket adjustments based on the reduced tax rate to maintain a smooth transition between the income tables.  Arkansas previously twice enacted legislation during 2023 that reduced income tax rates. 

Connecticut enacts legislation extending NOL carryforward period   

On June 6, 2024, Connecticut enacted legislation, H.B. 5524, which extends the net operating loss (NOL) carryforward period and provides a long-term deduction to certain combined groups. For operating losses incurred in income years beginning on or after Jan. 1, 2025, the carryover period is increased from 20 income years to 30 income years following the loss.

Beginning with the 2026 income year, a new statute allows certain combined groups meeting specified qualifications to deduct, over a 30-year period, the amount necessary to offset the increase in the valuation allowance against NOLs and tax credits in Connecticut that resulted from the state’s shift to combined reporting (implemented in the 2016 income year). “Valuation allowance” means the portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized, in accordance with Generally Accepted Accounting Principles (GAAP). The increase in valuation allowance must be calculated based on the change in valuation allowance reported in the combined group’s financial statements for the 2016 income year. The valuation allowance deduction: (i) may not be reduced due to events that happen after the calculation, including disposition or abandonment of assets, and (ii) does not alter the tax basis of any asset. If the deduction exceeds the group’s net income, the excess may be carried forward and applied until fully used. Any group that intends to claim this deduction is required to file a statement with the Connecticut Commissioner of Revenue Services by July 1, 2025, specifying the total deduction amount to be claimed by the combined group. 

Kansas enacts legislation providing income tax relief 

On June 20, 2024, Kansas Gov. Laura Kelly signed legislation, S.B. 1, which provides income tax relief. This legislation is the product of a special legislative session called by the governor “to pass sustainable, comprehensive tax relief.” During the main legislative session, Governor Kelly vetoed three bills passed by the legislature that were intended to provide tax reform.

Beginning with the 2024 tax year, the Kansas individual income tax is changed to a two-bracket system. For married individuals filing jointly, taxable income up to $46,000 is taxed at 5.2% and taxable income over $46,000 is taxed at 5.58%. Previously, there was a three-bracket system with income up to $30,000 taxed at 3.1%, income over $30,000 but not over $60,000 taxed at 5.25%, and income over $60,000 taxed at 5.7%. For all other individual filers, taxable income up to $23,000 is taxed at 5.2% and taxable income over $23,000 is taxed at 5.58%. Previously, there was a three-bracket system for other filers with thresholds that were 50% of the corresponding thresholds for married individuals filing jointly. Also, beginning with the 2024 tax year, all Social Security benefits are exempt from Kansas income tax. For prior years, there was an exemption for Social Security benefits for taxpayers with federal adjusted gross income of $75,000 or less. The standard deduction and personal exemption allowance amounts also are slightly increased beginning with the 2024 tax year.

The legislation reduces the financial institution privilege tax rates for the 2024 and subsequent tax years. For banks, the normal tax rate is reduced from 2.25% to 1.94%. For trust companies and savings and loan associations, the normal tax rate is reduced from 2.25% to 1.93%. The legislation does not change the surtaxes imposed on financial institutions.

A new provision is added to the statute concerning the determination of fair market value for property tax purposes. The sales price or value at which a property sells or transfers ownership in an Internal Revenue Code (IRC) Sec. 1031 exchange is not considered an indicator of fair market value nor as a factor in arriving at fair market value. Federal IRC Sec. 1031 exchange transactions may not be used as comparable sales for valuation purposes, or as valid sales for purposes of sales ratio studies used for measuring tax appraisal accuracy. Under an IRC Sec. 1031 exchange, a taxpayer is allowed to postpone paying income tax on the gain received from selling the property if the taxpayer reinvests the proceeds in similar property as part of a qualifying like-kind exchange.  

Missouri court holds remote workers not subject to city’s earnings tax   

On May 28, 2024, in Boles v. City of St. Louis, the Missouri Court of Appeals held that nonresident employees who worked remotely outside the City of St. Louis were not liable for the city’s earnings tax even though their employers were based in the city. An ordinance imposes a 1% tax on “[s]alaries, wages, commissions and other compensation earned after July 31, 1959, by nonresident individuals of the City for work done or services performed or rendered in the City.” Based on the clear and unambiguous language of the ordinance, the court held that the tax was not imposed on the nonresident employees for work that was not performed in the city. The city subsequently entered into a settlement agreement allowing employees who paid tax on remote work to file refund claims.  

The employees were nonresidents of the city who worked for city-based employers in 2020 and 2021, either on-site at the employers’ premises in the city or remotely outside the city. Regardless of the work model the employees chose, the city assessed earnings tax against them. The employees subsequently submitted refund requests for the number of days they worked remotely outside the city for each calendar year. After the city denied the employees’ refund requests, the employees sued the city seeking refunds of the earnings tax paid for the days that they worked remotely. Following a series of motions filed by both parties, the trial court held that the language of the earnings tax ordinance was clear, and the nonresident employees were entitled to a refund for the days they worked outside the city.

In affirming the trial court, the Missouri Court of Appeals agreed that the earnings tax does not apply to nonresidents for work performed outside the city. The court considered the ordinance’s language and noted that it does not expressly address whether the earnings tax should be assessed on the earnings of nonresidents when they work remotely for their city-based employers. Also, the ordinance does not define the terms “rendered” or “performed.” The city unsuccessfully argued that “performed” applies to earnings derived from services which are carried out or done in the city, while “rendered” applies to earnings derived from services delivered or transmitted into the city. After acknowledging that the earnings tax is intended to tax earnings derived from two different activities, the court rejected the city’s argument that the ordinance intends to tax services which are transmitted into the city. Based on the plain meaning of the terms, the court concluded that “perform” applies to earnings derived from services such as performances and sporting events, while “render” applies to services done for another such as those provided by a law firm or accounting firm for their clients. The court also considered the ordinance’s explicit condition that the earnings tax only applies to work done and services rendered or performed “in the city.”  

On June 12, 2024, the parties entered into a settlement agreement providing that the city will establish a claims process for refunding earnings tax paid on earnings from remote work. The city agreed to publicize the claims procedures through its website, news outlets and social media. For any taxpayers who have already filed a properly documented request, in any form, for a remote work refund for the 2020-2022 tax years, the city will process the request promptly and pay interest on the refund. Regardless of any statute of limitations, the city will honor any properly documented requests for a remote work refund for earnings tax paid in the 2020-2022 tax year, plus interest, provided the refund request is filed between July 1, 2024, and Oct. 1, 2024. The St. Louis Collector of Revenue has stated that information on the refund procedures will be available on its website by July 1, and $26 million has been reserved for these refunds.

Oregon Supreme Court holds activities exceed P.L. 86-272 protection    

On June 20, 2024, the Oregon Supreme Court held in Santa Fe Natural Tobacco Co. v. Department of Revenue that the activities of a tobacco company’s representatives in Oregon exceeded Public Law 86-272 (P.L. 86-272) protection because they went beyond the scope of soliciting orders. The representatives facilitated sales by taking “prebook orders” on behalf of Oregon retailers that contractually obligated wholesalers to accept and process the orders.

P.L. 86-272, codified as 15 U.S.C. Secs. 381-384, 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. In this case, the Oregon Supreme Court needed to consider whether the taxpayer was subject to Oregon corporation excise tax because its activities in the state exceeded the solicitation of orders.

The taxpayer was a New Mexico corporation selling branded tobacco products to wholesalers, who in turn sold to Oregon retailers. During 2010-2013, the relevant tax years at issue, the taxpayer did not have any offices or inventory in Oregon. The taxpayer sent its employees to Oregon to persuade retailers to order the taxpayer’s products from wholesalers. When a representative visited an Oregon retailer in person and convinced the retailer to agree to order the taxpayer’s products from a wholesaler, the representative could either leave the retailer a “sell sheet order” or a “prebook order.” A sell sheet order was merely a suggestion to buy and was acknowledged to be protected by P.L. 86-272. In contrast, the prebook orders commenced a more structured sales process. When a wholesaler received a prebook order, contractual incentive agreements were triggered requiring it to accept and process the prebook orders. The incentive agreements imposed substantial economic penalties on any wholesalers that did not process the orders. The taxpayer’s representatives placed an average of over 13 prebook orders per month from Oregon retailers.

The taxpayer filed Oregon tax returns but reported no taxable income, instead asserting that its activities in Oregon were protected under P.L. 86-272. The Oregon Department of Revenue audited the taxpayer’s returns and rejected its claimed immunity. As a result, the Department assessed deficiencies for each of the tax years. The taxpayer appealed the assessments to the Oregon Tax Court. In affirming the assessments, the Tax Court held that the prebook orders were more than a protected “solicitation” because they had served an independent business purpose for the taxpayer beyond requesting the orders. The taxpayer appealed to the Oregon Supreme Court.

The Oregon Supreme Court affirmed the Tax Court and held that the representatives’ prebook order activity went beyond soliciting orders on behalf of wholesalers. Because the wholesalers had already been committed by the terms of their incentive agreements to accept a prebook order, the taxpayer’s representatives were doing more than enabling wholesalers to sell the taxpayer’s products to retailers. The prebook orders that the taxpayer’s representatives obtained from Oregon retailers exceeded the scope of the permitted “solicitation of orders” because they were requiring the wholesalers to sell the products and facilitating those sales. 

After finding that the activities exceeded the solicitation of sales, the court determined that the prebook orders were not de minimis activities that were protected by P.L. 86-272. The court noted that the parties stipulated that the taxpayer’s representatives obtained an average of more than 13 prebook orders per month from Oregon retailers. A consideration of the number of prebook orders combined with evidence showing the taxpayer’s strong emphasis on its representatives obtaining prebook orders convinced the court that the taxpayer’s activities were not de minimis. Therefore, the taxpayer was subject to Oregon tax. 

Oregon Tax Court clarifies apportionment for consolidated groups    

On May 14, 2024, in ABC Inc. v Department of Revenue, the Oregon Tax Court held that the determination whether to apply the state’s special apportionment methodology for interstate broadcasters must be made separately for each affiliate in a consolidated Oregon corporation excise tax return rather than all the affiliates as a group. Because each affiliate must determine its own apportionment percentage, an affiliate that is not an interstate broadcaster follows the standard apportionment provisions. 

The taxpayer, a major broadcaster and entertainment conglomerate, had over 600 affiliates in its Oregon corporation excise tax consolidated return. Evidence was presented that at least one of the affiliates did not meet the statutory definition of “interstate broadcaster.” Under Oregon law, a taxpayer that qualifies as an “interstate broadcaster” must use a special apportionment formula that relies heavily on an “audience ratio” to attribute gross receipts from most types of activity (more than just receipts from the activity of "broadcasting”) to Oregon in proportion to the share of overall audience in Oregon. Taxpayers that are not subject to special industry-specific apportionment provisions use the standard, uniform sourcing statutes, which generally consider the destination of the sales of tangible personal property, and the location of income-producing activities for sales of services and intangibles.

Oregon law generally treats affiliates joining in a state consolidated return as one corporation and thus as one taxpayer. The court was required to determine whether a statutory exception to this “one taxpayer” position requires an apportionment formula to be applied separately at the level of each affiliate. The relevant statutory language in Or. Rev. Stat. Sec. 317.715(3)(b) provides that “[t]hose members of an affiliated group making a consolidated federal return or a consolidated state return may not be treated as one taxpayer for purposes of determining whether any member of the group is taxable in this state or any other state with respect to questions of jurisdiction to tax or the composition of the apportionment factors used to attribute income to this state.” The taxpayer argued that this language requires each affiliate to determine its own apportioned percentage of the group’s overall income, while the Department argued that a single percentage must be determined for the group as a whole.

After finding that the disputed statutory language was ambiguous, the Oregon Tax Court performed a thorough analysis that considered the context of the statute, including application of the special apportionment treatment for public utilities and financial organizations. Based on the text and context of the statutory definitions of “public utility” and “financial organization,” the court found it highly likely that the 1984 Oregon legislature which enacted the statutory language at issue would have understood those terms to apply to each legal entity separately, rather than to an entire group of related entities. The court concluded that the taxpayer’s interpretation of the statutory language was “more persuasive by far” than the Department’s suggested interpretation. The Department’s interpretation would have implied a substantial change to prior law that was not supported by the legislative history. In contrast, the taxpayer’s interpretation would not require a change in existing law and was supported by the Department’s administrative rule.

This decision has applicability beyond the context of the special apportionment methodology for interstate broadcasters. Consolidated groups that have only some affiliates subject to industry-specific apportionment could use this decision to limit the use of the special apportionment method to the members within the industry rather than the entire consolidated group. 

South Carolina holds credit card company must apportion income to state   

On June 3, 2024, the South Carolina Administrative Law Court held in Mastercard International Inc. v. South Carolina Department of Revenue that a major credit card company had income-producing activity in the state by providing access to its network that facilitated cashless transactions between cardholders and merchants. As a result, transactions were sourced to South Carolina when a cardholder initiated cashless purchases of goods and services in the state.

Mastercard, a wholly owned subsidiary of a technology company based in New York, operates a worldwide credit card network, including accepting cards at merchant locations in South Carolina. During the 2007-2016 tax years at issue, Mastercard’s activities such as authorizing credit card transactions occurred at data centers located outside South Carolina. Prior to an audit that the South Carolina Department of Revenue initiated in 2017, Mastercard never had filed a corporate income tax return in South Carolina.

The Department determined that Mastercard generated income by charging fees to banks that issued the credit cards (“issuer banks”) and the merchants’ banks (“acquirer banks”) for merchant/cardholder transaction processing and ancillary value-added services provided by the Mastercard network. These fees were based primarily on the number of transactions in which the credit cards were used for payment and the gross dollar volume (“GDV”) of the transactions. The Department calculated the gross receipts that should have been sourced to South Carolina based on its view that Mastercard’s income-producing activity occurred in South Carolina when the transaction was initiated in the state. Mastercard appealed the proposed assessment of $6 million to the South Carolina Administrative Law Court (ALC).    

South Carolina law provides that service receipts are sourced to the state based on income-producing activity. If the income-producing activity is performed partly within and partly outside South Carolina, sales are attributed to the state to the extent the income-producing activity is performed in the state. The Department implements this statute by examining a taxpayer’s industry to determine what revenue should be sourced to South Carolina.

The ALC determined that Mastercard was doing business in the state because its network was providing services to South Carolina cardholders and merchants and generating revenue from fees paid to it for various transaction-related purposes. During the audit period, Mastercard processed over 1.2 billion credit card transactions in South Carolina with a total value over $73.5 billion. The ALC concluded that Mastercard’s income-producing activity was the provision of its network that facilitated cashless payments for goods and services. Each time a cardholder used a Mastercard credit or debit card, Mastercard was entitled to fees under its agreements. These fees were Mastercard’s revenue, which was generated, in part, through the cardholder/merchant credit and debit transactions in South Carolina. Mastercard unsuccessfully argued that it did not have income-producing activity in the state because its income was generated solely by the services it performed for issuer and acquirer banks outside the state. The ALC rejected Mastercard’s contention that the cardholders and merchants were not also Mastercard’s customers. In determining that Mastercard also had a relationship with the merchants and cardholders, the court noted that no fees would be earned unless there were merchant and cardholder transactions using Mastercard branded cards.  

According to the ALC, the Department’s method for allocating and sourcing Mastercard’s income to South Carolina was proper. Mastercard did not produce any data concerning the actual income generated by the transactions initiated in South Carolina. However, it provided the exact number of credit card transactions initiated in the state for every year of the audit period and the annual GDV of those transactions. Also, Mastercard provided comparable information for total transactions in the U.S. For each year of the audit, the Department determined the ratio of South Carolina GDV to GDV for the entire U.S. and of South Carolina transactions to all U.S. transactions. The Department then applied the appropriate ratio to the U.S. revenue for each of the relevant income streams to obtain the South Carolina apportioned revenue from each income stream. Mastercard did not offer any alternative approximation for calculating its South Carolina revenue. The ALC abated most of Mastercard’s penalties for not filing in South Carolina but did not abate the interest.