TAX ALERT | April 04, 2022 | Authored by RSM US LLP
This information summarizes the listed developments and may not provide additional nuanced considerations that may be relevant for provision purposes. For questions about these quarterly updates, or other recent legislative and regulatory developments, please reach out to your tax adviser for more information.
The Tax Cuts and Jobs Act (P.L. 115-97, TCJA) enacted in Dec. 2017 provides for changes to the treatment of research and development (R&D) expenses under section 174. Without additional legislative action from Congress, these expenses are no longer deductible; taxpayers are required to capitalize and amortize research and experimental expenditures under section 174 for tax years beginning after Dec. 31, 2021. Federal legislation has previously been proposed and may be considered in the future to either delay the onset of, or fully repeal, the new section 174 capitalization rules.
While there has been ample time since the enactment of TCJA for most states to fully conform to the treatment of R&D expenses under section 174 for the 2022 tax year, there are some states that still do not conform to these provisions of the TCJA (e.g., California and Wisconsin). It is also important to note that, even if federal legislation altering the treatment under section 174 is enacted, not all states that currently conform to the TCJA will immediately conform to new legislation. Additionally, some states that generally conform to TCJA may enact legislation to decouple from the new section 174 provisions. For example, On March 24, 2022, Tennessee enacted legislation that conforms to section 174 as it existed before the enactment of the TCJA; the bill is effective for tax years beginning on or after Jan. 1, 2022.
There is also added complexity and potential opportunity associated with states that conform to section 174 but either decouple from section 280C or provide a state-specific modification for expenses disallowed at the federal level due to their association with a federal tax credit. Taxpayers should work closely with their tax advisors to ensure that all opportunities and risks related to state conformity to the updated provisions of section 174 are carefully considered for the 2022 tax year.
The TCJA limited the individual taxpayer deduction for state and local tax (SALT) payments to $10,000 a year ($5,000 for a married person filing a separate return). SALT payments (including income and real property taxes) that exceed these amounts are no longer deductible by individual taxpayers unless the payments are in pursuit of a trade or business.
As a response to the TCJA’s limitation, several states began to adopt a pass-through entity-level tax intended as a workaround. In 2022, at least 24 states will allow a workaround. In the first quarter of 2022, and as of the date of this article, the following states have adopted a new workaround (with the first effective year in parentheses): New Mexico (2022) and Utah (2022). Proposals are before governors in Mississippi (2022) and Virginia (2021).
Other states that have adopted workarounds include Alabama (2021), Arizona (2022), Arkansas (2022), California (2021), Colorado (2022), Connecticut (2018 and mandatory), Georgia (2022), Idaho (2021), Illinois (2021), Louisiana (2019), Massachusetts (2021), Maryland (2020), Michigan (2021), Minnesota (2021), New Jersey (2020), New York (2021), North Carolina (2022), Oklahoma (2019), Oregon (2022), Rhode Island (2019), South Carolina (2021) and Wisconsin (2018). These pass-through entity tax workarounds have complex accounting implications. Please consult with your tax advisor to understand any ASC 740 or other accounting implications associated with these tax regimes.
Arizona updates IRC conformity
On March 23, 2022, Arizona enacted SB 1264, which advances the state’s Internal Revenue Code (IRC) conformity date to Jan. 1, 2022, for tax years beginning on or after Dec. 31, 2021. The legislation also retroactively updates conformity for tax years beginning through Dec. 31, 2021, to conform to the provisions of the federal PPP Extension Act of 2021 and the Infrastructure Investment and Jobs Act.
California: Changes to NOL and credit limitations, guidance on the application of P.L. 86-272, and sourcing of service revenues
On Feb. 9, 2022, California enacted SB 113, which, among other changes, ends the temporary limitations on the utilization of net operating loss (NOL) carryforwards and certain credits. Under previously enacted provisions, NOL carryforward deductions were suspended for tax years 2020-2022 for taxpayers with over $1 million of California taxable income. The newly enacted legislation removes this limitation on NOL utilization for the 2022 tax year and removes the $5 million cap on the usage of corporate income tax credits.
On Feb. 14, 2022, California released Technical Advice Memorandum (TAM) 2022-01, clarifying the state’s interpretation of Public Law (P.L.) 86-272 in light of “the current economy due to technological advancements.” The guidance provides 12 sample fact patterns describing a taxpayer’s activities within the state and then examines whether the facts presented in each example constitute a situation where the protections of P.L. 86-272 would apply. The examples specifically examine internet-based activities similar to those discussed in the Multistate Tax Commission (MTC)’s updated guidance on the subject that was released in the third quarter of 2021. The release of this TAM makes California the first state to provide guidance since the release of the MTC’s updated guidelines last year.
The non-protected activities examined in the guidance include: remote workers performing non-sales activities, providing post-sale assistance via the company’s website through interactive chat or email, soliciting and accepting online credit card applications, advertising and accepting online job applications for non-sales positions, placing internet cookies onto computers or electronic devices in the state, transmitting code or electronic instructions to remotely fix or upgrade products, offering extended warranties for online purchase, contracting with an online marketplace facilitator which stores some of the company’s inventory in the state and providing video and music streaming services to customers within the state. For more information, on the updates to P.L. 86-272 generally, please read our article, MTC adopts new P.L. 86-272 guidance: What you need to know.
On March 25, 2022, California released Legal Ruling 2022-01, which provides guidance on sourcing of receipts from sales of services. The ruling provides a general overview of the application of the “cascading rules” in California Reg. section 25136-2 as well as their application to three specific example situations. The examples analyzed contemplate situations where the benefit of a service is received in a different location than the customer is located, revenue sourcing for pharmacy benefit managers, and proper sourcing in situations where the taxpayer is a subcontractor on an existing service contract.
Colorado adopts new apportionment rules for hedging transactions
On Jan. 10, 2022, Colorado adopted new apportionment rules (Rule 39-22-303.6-1 and Rule 39-22-303.6-7) providing that receipts from hedging transactions should be excluded from the computation of the sales factor, in most cases. Special Rule 9A, adopted on the same date, provides for the inclusion of the impacts of hedging transactions in apportionment for electricity producers, under certain circumstances. All three rules have an effective date of Jan. 30, 2022.
Florida provides guidance on receipts sourcing for service providers
In Jan. 2022, Florida released Technical Assistance Advisement (TAA) 21C1-005, addressing sourcing of receipts for service providers. While prior TAAs have focused on the actual location of the customer as the primary factor in determining the location of the ‘income-producing activity,’ this recent TAA takes a differing approach to the analysis of proper sales sourcing for corporate income tax. Referencing the provisions of Florida Rule 12C-1.0155, the Florida Department of Revenue determined that the taxpayer’s receipts should be sourced to Florida to the extent that deliverables from the services provided were “forwarded, sent, delivered or provided to a location in Florida” on behalf of the customer.
Idaho reduces corporate tax rate, updates IRC conformity, moves to single-sales factor apportionment and market-based sourcing
On Feb. 7, 2022, Idaho enacted HB 436, which reduces the corporate income tax rate from 6.5% to 6%, effective Jan. 1, 2022.
On Feb. 24, 2022, Idaho enacted HB 472 to update its conformity to the IRC. The state conforms to the IRC in effect on Jan. 1, 2022, for tax years beginning on or after the same date.
On March 17, 2022, Idaho enacted HB 563, which provides for several changes to the state’s apportionment rules. The previous three-factor apportionment computation is replaced with a single-sales factor formula, and the cost-of-performance sourcing methodology for sales other than the tangible personal property is replaced by market-based sourcing provisions. The legislation also updates the definitions of business and nonbusiness income, replacing these terms and concepts with ‘apportionable’ and ‘nonapportionable’ income rules. All changes in HB 563 are effective retroactively to Jan. 1, 2022.
Indiana clarifies consolidated filing rules, establishes elective alternative apportionment method
On March 15, 2022, Indiana enacted SB 382, which clarifies certain rules on consolidated filing groups and establishes an alternate apportionment method for certain taxpayers. Indiana allows certain affiliated taxpayer groups to elect to file on a consolidated basis. The provisions of SB 382 clarify the proper treatment of consolidated filing elections in the case of mergers, acquisitions, and other scenarios where there are changes in the composition of the consolidated group. The legislation also provides an elective alternative apportionment method for qualifying taxpayers with greater than $1B of tangible personal property sales sourced to the state. To qualify, taxpayers must have an apportionment factor of greater than 10% under the standard method and makes sales that meet the definition of “qualified distribution sales,” as defined in the statute.
Iowa provides for future rate reductions, places limitations on credit refundability
On March 1, 2022, Iowa enacted HF 2317, which contains provisions to reduce the corporate income tax rate as well as changes to the calculation and refundability of several state credits. While Iowa currently uses a graduated rate to compute corporate income tax, the legislation contains a mechanism to reduce the rate over several years, eventually phasing in a single rate of 5.50%. Note that the rate decreases are contingent on the state meeting future revenue goals; to the extent, these goals are met, rate reductions will begin in the tax year 2023. The legislation also makes changes to the state’s research and development credit computation and reduces the refundability of several tax credits by five percentage points per year, capping refundability at 75% for tax years 2027 and beyond. For additional information on these changes, see our article Iowa enacts major tax reform package with reduced tax rates.
Kansas plans for future income tax rate reductions
Kansas SB 347, enacted on Feb. 10, 2022, contains a mechanism to reduce the state’s current 7% corporate income tax rate is .5% increments until the tax is fully phased out. Note that all rate reductions are contingent on future capital investments and the construction of “qualified business facilities” by companies within the state.
Kentucky adopts regulations on financial institution apportionment
Effective March 1, 2022, Kentucky has adopted regulations that provide guidance on how financial institutions should compute apportionment for corporate income tax purposes. Kentucky previously eliminated its Bank Franchise Tax, effective Jan. 1, 2021, leaving financial institutions subject to normal corporate income tax and the state’s limited liability entity tax after this date. The law now provides detailed guidance on receipts sourcing and factor inclusion for entities classified as financial institutions.
Massachusetts finds that SaaS company qualifies for manufacturing corporation status
In a recent opinion by the Massachusetts Appellate Tax Board, a Software-as-a-Service (SaaS) provider was found to be properly classified as a manufacturing corporation for both property tax and corporate excise tax purposes. Massachusetts statute allows corporations performing substantial manufacturing operations to use single-factor apportionment for corporate excise tax; the development and sale of standardized software is an eligible manufacturing activity, according to the state’s statute. The taxpayer provided customers with remote access to standardized, pre-written software. Although no actual transfer or licensing of the software took place and the company’s marketing materials described the products offered as a service, the board found that the company was engaged in the sale of software products whose development was an eligible manufacturing activity for Massachusetts corporate excise tax purposes. See Akamai Technologies, Inc. v. Commissioner of Revenue, Appellate Tax Board (Massachusetts), No. C332360, C334907, C336909, Dec. 10, 2021.
Mississippi updates tax treatment of certain federal relief programs
With the enactment of HB 1529 on March 17, 2022, Mississippi’s tax treatment of loans and grants authorized by the federal Consolidated Appropriations Act and the American Rescue Plan Act now aligns with the federal tax treatment of these items. Income associated with these grants is now excluded from Mississippi taxable income; in addition, expenses associated with these grant and loan programs are considered deductible to the extent they are deductible for federal tax purposes.
New Jersey guidance on the treatment of convertible virtual currencies
In Technical Advice Memorandum 2015-1(R) released on March 21, 2022, New Jersey provided guidance on the corporate income tax treatment of Bitcoin and other convertible virtual currencies. The guidance clarifies that the state conforms to the federal tax treatment of convertible virtual currencies and that sellers of these currencies to New Jersey customers are not considered protected under P.L. 86-272.
New York updates bright-line nexus thresholds
New York released TSB-M-21(3)C, providing for an increase of the state’s receipts-based bright-line threshold for economic nexus for tax years beginning on or after Jan. 1, 2022. Taxpayers with more than $1,138,000 of receipts within New York state or within the Metropolitan Commuter Transportation District (MCTD) will be deemed to have nexus for the corporate franchise tax and/or the MTA surcharge, respectively. Additionally, the guidance provides that only group members with over $11,000 in New York receipts or MCTD receipts should be considered when determining whether a unitary group’s activity meets the thresholds. TSB-M-21(3)C was released on Dec. 28, 2021.
Oregon updates IRC conformity
On March 24, 2022, Oregon enacted SB 1525, advancing the state’s IRC conformity date to Dec. 31, 2021, from April 1, 2021. The updated conformity date applies to tax years beginning on or after Jan. 1, 2022.
Pennsylvania provides guidance on split-factor apportionment
On Feb. 17, 2022, Pennsylvania issued Corporation Tax Bulletin 2022-01 addressing the use of ‘split-factor’ apportionment. The concept of split apportionment was previously established in the Buckeye Pipeline Co. v. Commonwealth case and applies to taxpayers who engage in activities subject to both standard apportionment and one or more special industry-specific apportionment formulas required by the state’s statutes. Industries for which Pennsylvania prescribes a special apportionment formula include airlines, publishers, railroads, trucking companies, and pipeline companies, among others. Bulletin 2022-01 details the 12-step approach that the Pennsylvania Department of Revenue has developed to appropriately apply split apportionment to applicable taxpayers.
South Dakota updates certain conformity
HB 1010 updates the IRC conformity date for South Dakota’s bank franchise tax to Jan. 1, 2022. The change in conformity is effective on July 1, 2022.
Texas addresses FAQs on the computation of COGS, Supreme Court rules on service revenue sourcing
On Feb. 4, 2022, Texas released letter 202202001L, which provides answers to frequently asked questions (FAQs) on the computation of cost of goods sold (COGS) for Texas Franchise tax purposes. Among other topics, the FAQs address the treatment of “mixed” transactions and costs, the proper treatment of federal bonus depreciation and the section 179 deduction, treatment of payments to subcontractors, types of labor, and benefits excluded from Texas COGS, and certain industry-specific guidance.
On March 25, 2022, the Texas Supreme Court ruled in favor of the taxpayer in the Sirius XM Radio, Inc. v. Hegar case. The decision held that revenues for the taxpayer should be sourced based on the location of employees and equipment performing services, rather than the location of the customer. The analysis of the case focuses heavily on the correct interpretation and application of the state’s “receipt-producing, end product act” rules. In January 2021, the state adopted several retroactive amendments to its apportionment rules in an attempt to clarify the state’s position on sourcing service revenues, specifically addressing the “receipt-producing, end product act” test. In the Sirius XM Radio case, the court held that this test, in its original context, was aimed at determining what services are being performed rather than determining the actual location of the service. For more information, see our article, Texas Supreme Court clarifies franchise tax services sourcing.
Utah enacts tax rate reduction
On Feb. 11, 2022, Utah enacted SB 59, providing for a reduction in the corporate income tax rate to 4.85% from 4.95%. The rate reduction is applicable for tax years beginning on or after Jan. 1, 2022.
Virginia: Certain raw materials may be excluded from property factor, updates to conformity, and PPP loan expense treatment
In a decision released on Feb. 10, 2022, the Virginia Supreme Court found that a taxpayer could exclude the value of certain agricultural raw materials stored in the state while undergoing a natural ageing process from the computation of the property apportionment factor. The taxpayer was a cigarette manufacturer with a storage facility in Virginia where tobacco leaves were left to sit and age for a prescribed period. The analysis of the decision examines whether the materials were being “used” during this ageing process under the definitions in the state’s statute; the court concluded that the materials were not being used or processed in any way and were therefore eligible to be excluded from the taxpayer’s Virginia property factor. For further information, see: Department of Taxation v. R.J. Reynolds Tobacco Co., Supreme Court of Virginia, No. 201263, Feb. 10, 2022. On Feb. 23, 2022, Virginia enacted HB 971, advancing the state’s IRC conformity date from Dec. 31, 2020, to Dec. 31, 2021. On the same date, the state released Tax Bulletin 22-1, which provides details on how the provisions of HB 971 affect the computation of Virginia taxable income for 2021. The updated IRC conformity date allows Virginia to generally conform to the provisions of the American Rescue Plan Act of 2021 for the 2021 tax year. Additionally, while Virginia previously decoupled from the federal deductibility rules for Paycheck Protection Program (PPP) loan and Economic Injury Disaster Loan (EIDL) expenses, the state will conform to the federal treatment of these items for the 2021 tax year and forward. The Virginia-specific subtraction of $100,000 for PPP loan expenses for the 2020 tax year has also been retroactively extended to the 2019 tax year.
West Virginia updates conformity
SB 451, enacted on Feb. 21, 2022, updates West Virginia’s conformity to the IRC. The updated provisions provide for conformity to all changes made to the IRC after Dec. 31, 2020, and before Jan. 1, 2022. The legislation is effective for West Virginia tax years beginning on or after Jan. 1, 2022.
Wisconsin provides guidance on new fed/state differences, provides an exemption from tax for certain federal grants
In Jan. of 2022, Wisconsin issued Tax Bulletin Number 216, which clarifies that the state does not conform to the provisions of the Infrastructure Investment and Jobs Act (PL 117-58) that exempt interest from qualified broadband projects exempt facility bonds from federal income tax. Interest associated with these bonds is required to be added back to Wisconsin taxable income.
On March 7, 2022, Wisconsin enacted HB 717, providing an exemption from state taxation for income received as a grant from the restaurant revitalization fund created by federal ARPA legislation. The Wisconsin bill also provides that expenses paid for with grant funds are deductible in the computation of state taxable income. These changes are effective for taxable years after Dec. 31, 2020.
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This article was written by Brian Kirkell, Al Cappelloni, Mo Bell-Jacobs and originally appeared on Apr 04, 2022.
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