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The Path Forward

Posted on Dec. 20, 2021

In this installment of Board Briefs, Tax Notes State advisory board members bid farewell to 2021 and say hello to 2022.

This article is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.

What’s Past Is Prologue

Walter Hellerstein

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Emeritus at the University of Georgia Law School and a visiting professor at the Vienna University of Economics and Business.

I plead guilty to beginning my final 2021 board brief with a cliché, to wit: “What one sees depends on where one stands.” The observation is no less true, however, even if it is “a phrase or opinion that is overused and betrays a lack of original thought.”1 Moreover, at least in my case, it clearly influences the effort to identify the key issues that will populate the state tax landscape in 2022. Increasingly, I find myself standing at the intersection of the international and subnational cross-border tax challenges of the digital economy. For example, in June of this year, I stood (virtually) before a group of students at the Vienna University of Economics and Business teaching a course on “Introduction to U.S. State Taxation of Foreign Taxpayers.” Because hypothetical questions are a law professor’s stock in trade,2 perhaps an appropriate way for me to identify the issues that in my view will inform our collective consciousness in 2022 is to reproduce the examination questions from that course.

Question 1

Your client, Marvelous Mozart Balls AG (MMB), an Austrian corporation, wants to begin selling its Mozart balls and related products in the United States in July 2021. MMB intends to sell its products both to retail stores that will resell the products to consumers and to sell its products directly to consumers. For its direct sales to consumers, MMB is contemplating selling the products through MMB’s own website and through Amazon. MMB has never done business in the United States before and has no property or other assets in the United States. MMB has been advised that it will not have any U.S. federal (national) corporate income tax liability because it will not have a permanent establishment in the United States and will therefore be protected from U.S. corporate income taxation by the U.S.-Austria income tax treaty. You should assume that advice is correct.

MMB seeks your advice as to its potential direct and indirect tax liability in the various states in which it hopes to sell its products. What advice will you give it?

Question 2

MMB has started selling its products in July 2021 to retail stores in various states and directly to consumers through its own website (having decided not to sell through Amazon). Every state in which MMB is selling its products has adopted the “economic” or “virtual” nexus standard for imposing tax collection obligations on remote sellers that was reflected in the South Dakota statute at issue in the U.S. Supreme Court case of South Dakota v. Wayfair Inc. MMB’s sales to individual consumers average $50. It makes 3,000 sales to individual consumers in State A for $150,000; it makes 300 sales to individual consumers in State B for $15,000; and it makes 100 sales to individual consumers in State C for $5,000.

MMB has asked for your advice regarding the following questions:

  • Does it have any obligation in States A, B, or C to collect a sales or use tax?

  • If the answer is “yes,” can MMB safely ignore the obligation because it has no property in the United States, and it was under the impression that the “revenue rule” would prevent a U.S. state tax authority from enforcing a default judgment obtained in the U.S. state courts in Austria courts? Explain your answers to these questions; a simple “yes” or “no” will get little credit.

Question 3

MMB also wants to know about its direct tax liability, if any, in states A, B, and C. Assume that none of these states has adopted any specific threshold for asserting nexus for state corporate income taxes, but their statutes impose corporate income tax upon every business that has “substantial nexus” with the state under the commerce clause of the U.S. Constitution. Assume the following additional facts about MMB’s total income: MMB earns $1 million in total income; $500,000 of that income is earned from operating an Austrian ski resort, which has no connection to its Mozart ball and related products business. With respect to its Mozart ball and related products business, all MMB’s property, all MMB’s employees, and $830,000 of its $1 million in gross sales (that is, $1 million total sales less the $170,000 in the United States, described in question 2) are in Austria. Assume further that State A apportions income to the state by an equally weighted three-factor formula of property, payroll, and sales and that states B and C employ a single-sales-factor formula.

Does MMB have nexus for state corporate income tax purposes in states A, B, or C, and, regardless of how you answered this question, how much of MMB’s income is apportioned to states A, B, and C, on the assumption that MMB does have corporate income tax nexus in those states?

I cannot begin to answer these questions in this Board Brief, as it would take a treatise to do so. In the meantime, I simply wish all readers a Happy 2022!

Are Tax Increases Coming In California in 2022?

Eric J. Coffill

Eric J. Coffill is senior counsel with Eversheds Sutherland (US) LLP in Sacramento, California.

If you Google “reasons to raise taxes,” which I did, you will find several proffered justifications. Some are progressive — that is, they focus on the tax policy for raising taxes on the rich as defined under a variety of metrics. Others are based on competition theories — that is, existing tax rates for a category of taxpayer in a jurisdiction are too low compared to those in comparable jurisdictions. However, as a broad-based question, the answer (justification) is a combination of two themes: either to prevent/minimize unacceptable budget cuts or to fund new initiatives/proposals. Looking to this framework, let’s consider the tax increase outlook in California for 2022.

First, here is some context regarding our tax rates. The top California personal income tax rate is 13.3 percent, which is the highest (personal) state rate in the country. The California corporate income/franchise tax rate is 8.84 percent, which is certainly high, but not the highest in the country. (I believe that honor goes to Pennsylvania, at 9.99 percent.) Sales tax is a difficult one for comparative rate purposes because of so many local components, but the California statewide rate is 7.25 percent, and the combined average local tax rate is around 8.82 percent. Accordingly, under the current regime, California certainly cannot be viewed as a low-tax jurisdiction by any stretch of the imagination.

Here is some context regarding the revenue outlook. On October 22 the California Legislative Analyst’s Office (LAO) posted an interim update to its formal revenue outlook for fiscal 2021-22 (which was published in May). The LAO was expecting from the “big three taxes” (personal income, sales, and corporation taxes) an anticipated revenue between $8 billion and $30 billion. On November 17 the LAO released its fiscal outlook for the 2022-23 budget. It reports that “revenues are growing at historic rates, and we estimate the state will have a $31 billion surplus (resources in excess of current law commitments) to allocate in 2022-2023.” Accordingly, it is a fair statement that California is flush with general fund revenue raised under the current tax rates and regime.

The first justification for raising taxes is to prevent or to minimize unacceptable budget cuts. Barring “black-swan” events, all reasonable minds should agree that with an anticipated revenue surplus of over $30 billion, California does not need to raise taxes to avoid or minimize budget cuts. But note that our second justification has nothing to do with fiscal health — it is all about policy. One can spend an unlimited amount of money on new initiatives cloaked in the guise of good tax or social policy.

Will we see tax increases in fiscal 2022-2023 targeted for new initiatives? In the author’s (at this moment) opinion, the answer is no, if coming from the California State Legislature. At least twice during the fiscal 2021-2022 year, either our governor, or the governor’s office, made public statements to the effect there would be no tax increases. That message from our Democratic governor to our Democratic State Legislature sent a strong signal the governor would not sign tax bills sent to his desk. What about fiscal 2022-2023? The message from the governor’s office should be the same. There is more than ample revenue being raised under the existing tax structure. The governor (and many legislators) also faces reelection in November 2022 and raising taxes in an election year is not a good idea. (Recall that during fiscal 2021-2022 when the governor sent his no-tax message, he was facing a September recall election.)

Does that mean we will not see tax bills introduced in the new legislative session? That is not a reasonable expectation. The “big three” unsuccessful items from last session will likely be reintroduced in some form:

  • A New Wealth Tax. Assembly Bill 310 would have applied to tax years beginning on or after January 1, 2022. The bill would have imposed a 1 percent tax on a California resident’s “worldwide net worth” in excess of $50 million (or $25 million if married filing separately) and a 1.5 percent tax on residents with a worldwide net worth greater than $1 billion (or $500 million if filing separately) “on the activity of sustaining excessive accumulations of wealth as a resident” of California. We also have seen wealth tax bills in other prior years.

  • Higher Personal Income Tax Rates. A.B. 1253 would have increased California’s top personal income tax rate to 16.8 percent. The bill would have imposed an additional personal income tax at the rates of 1 percent, 3 percent, and 3.5 percent on that portion of a taxpayer’s taxable income over specified thresholds, as provided.

  • GILTI Conformity. A.B. 71 would have conformed California law to the federal tax provisions to tax global intangible low-taxed income and required select taxpayers to include a portion of GILTI and/or a portion of repatriated income.

Again, it would be very surprising if any of these legislative proposals gained any traction in the next legislative session, much less were signed into law; the state is flush with cash, and it will be an election year.

However, the State Legislature is not the only source of tax increases. California has a robust, frequently used initiative process, and it is often used for tax measures. For example, Proposition 39, from the November 2012 election, is the reason most multistate businesses are required to use a single sales factor and market sourcing for apportionment purposes. Proposition 19, from the November 2020 election, made major changes to the property tax law and limited or eliminated prior tax benefits for certain transfers of real estate between family members. Assuming a proposed initiative obtained the required number of signatures, it could qualify for a statewide ballot. Here are some tax proposal initiatives (so far) to watch, all of which are early in the process:

  • Property 19 Property Tax Repeal Initiative. Initiative 21-0015A1, known as the “Repeal the Death Tax Act,” would repeal Proposition 19 and largely restate prior property tax law on select family transfers upon death. It would allow parents or grandparents to transfer their homes (and select other real property) to their children and grandchildren upon death without triggering a reassessment and increase in property taxes.

  • Split-Rate Property Tax Initiative. Initiative 21-0023, called the “Housing Affordability and Tax Cut Act of 2022,” would, in general, enact a split-rate property tax system and provide increased property tax exemptions for homeowners and an expanded renter’s tax credit for low-income renters. Specifically, it would increase the portion of a homeowner’s property value that is exempt from property tax from $7,000 to $200,000 (adjusted for inflation) and would provide up to $2,000 supplemental income tax credit for renters (adjusted for inflation). It would reimburse local governments’ lost revenue from these tax changes by enacting a new property tax surcharge of up to 1.4 percent on properties valued over $4 million. This would be a major change to the existing California property tax valuation system under Proposition 13 (passed as an initiative in 1978), which uses acquisition value as the base value, with a restricted rate of increase on assessments of no greater than two percent each year.

  • Another Split-Rate Property Tax Initiative. Initiative 21-0032A, called the “Tax Cut and Housing Affordability Act of 2022,” is another form of a split-rate property tax increase and a property tax exemption for low-income homeowners. This also would be a major change to the existing California property tax valuation system under Proposition 13.

  • Corporate and Personal Income Tax Increase Initiative. Initiative 21-0037, called the “Clean Cars and Clean Air Act,” would create a fund with revenue to be spent on electrical vehicle charging stations, public transit, and wildfire-fighting. The revenue would come from an additional 1.75 percent personal income tax on income above $2 million and from an additional 2.16 percent income tax on every corporation doing business in California with more than $10 million in net income.

  • Corporate Mandatory Worldwide Combined Reporting Initiative. Initiative 21-0038, also called the “Clean Cars and Clean Air Act” (Version 2), and with the same proponent as 21-0037, also creates a fund with the revenue designated for the same programs above, but in different amounts. The revenue under this version would come from a return in California to mandatory worldwide combined reporting (that is, no more water’s-edge election).

Note the focus of the tax five increase initiatives is not to raise general unrestricted revenue. The two split-rate property tax initiatives would divert tax relief to low-income renters and low-income homeowners by raising property taxes on others. The two corporation/personal income tax initiatives would raise revenue dedicated to charging stations, public transit and fighting wildfires. It is far too early to handicap any of these propositions, none of which have yet qualified for the ballot. My only prediction is they could pass, or they could fail. Looking back to the November 2020 general election, Proposition 19 passed, which significantly cut back on property tax benefits of family real property transfers. On the same ballot, Proposition 15 failed, which was a huge taxpayer victory because it was estimated to have raised approximately $10 billion to $12 billion from higher property taxes on commercial buildings. Benjamin Franklin is quoted as saying that nothing is certain except death and taxes. As to taxes, plenty of uncertainty lies behind that certainty.

‘New Normal’ Front and Center

Lynn A. Gandhi

Lynn A. Gandhi is a partner and business lawyer with Foley & Lardner LLP in Detroit.

There is no doubt that everyone is looking ahead to 2022, as we (hopefully) start to return to the “new normal.” Recognizing that we are never going back to what we had before, the best way to prepare for the future is to recognize what changes have now become the new normal in order to anticipate some key issues to look for in 2022.

I’ve identified three new normal(s) that I suspect will be front and center.

One: Remote work is now an option, opportunity, or requirement, and most employers are far from ready to handle the administrative challenges posed by this new work modality. While some cities and states issued COVID-19 pandemic guidance or passed legislative responses addressing remote work, most taxing jurisdictions did not. Remote work on an assignment basis is different than on a convenience basis, and both are different from the scenario in which your home location is your employers’ work location. These scenarios create complexity for employers’ state unemployment insurance reporting, employee withholding, and business licensure requirements. Also, there are imbedded ties to the administration of benefit packages, in- and out-of-network options, prevailing wage requirements, state privacy rules, as well as the critical need to ensure that communications with remote work employees address the employee’s responsibilities to make adequate estimated tax payments, when necessary. Many companies are now addressing, for the first time, the need to capture geolocations for domestic employees and to anticipate when they may have additional registration requirements based on their employees’ wanderlust. Not all payroll reporting companies provide robust options; many simply perform the administrative tasks contracted for with the data stream provided. Employers must be proactive to (1) ensure proper compliance, (2) ensure adequate data is gathered on which decisions can be based, and (3) minimize unintended mishaps.

Two: The increased use of public-private partnerships for significant infrastructure projects will drive the need for sophisticated state and local tax counseling on sales and use tax issues, business license and state qualification requirements, as well as income tax sourcing. There are trillions to be spent on roads, bridges, sewers, and broadband infrastructure. Many of these projects will span multiple tax jurisdictions, both intrastate as well as interstate, and occasionally, international borders!3 Especially pertinent are sales and use taxes and possible exemptions for construction materials. As most state statutes imposing use tax on construction contractors were written before the advent of P3 joint ventures, guidance is scanty. With a deep understanding of construction contracts and AIA forms, there are opportunities to minimize taxes to the benefit of all the parties involved.

Three: The taxation of long-term capital gain at the state level will continue to evolve, particularly when passthrough entities are involved. We have begun to see more controversies in this area, with a focus on the treatment of those intangible attributes which constitute long-term capital gain (at the federal level), such as goodwill, established workforce, and safety history. Gain on the sale of these intangibles is often more properly allocated to commercial domicile than to be treated as “sales” from operational activities. If the standard apportionment formula does not allow for parsing of the gain from the sale of a business, then alternative apportionment may be appropriate if the seller can meet its burden of proof in demonstrating that the standard apportionment formula, as applied to the facts, results in distortion. As many states require a taxpayer to submit a request to use an alternative method of apportionment prior to the filing of the applicable return, consideration of the sourcing of gain, and the appropriateness of making such request, could become a standard checklist item for sellers or a reason to file an amended return. If a seller is a passthrough entity, the analysis becomes more complex, especially for a limited partner. Many states are silent as to the sourcing of gain from the sale of a limited partnership interest, and there is little case law to rely upon.

Welcome to the Future

Helen Hecht

Helen Hecht is uniformity counsel for the Multistate Tax Commission.

I went back and looked at our 2019 year-end Board Briefs, forecasting important developments for 2020. Just as I thought, no one predicted there would be a pandemic.

Even while it was happening, no one knew what to expect. At first, hospitals were inundated with the sick and dying. Schools closed, and families were disrupted. Unemployment claims soared, and some businesses shuttered. And the stock market slipped off a cliff.

Then, in 2021 we rolled out vaccines and other medical treatments. Families, schools, and businesses got greater access to useful tools that enabled remote work and learning. Unemployment abated, even while record numbers of people quit to look for better jobs. And as for the stock market, it broke all records.

Of course, it’s not over yet. But there was a similar arc in how the pandemic impacted state governments. Initially, state unemployment agencies, health departments, public schools, and other government systems were overrun or disabled. Then, within a year, state and local programs recovered, sustained by federal support. As for state revenues, the Federation of Tax Administrators recently estimated that 2021 numbers are up more than 9 percent over 2019.

But something besides federal spending made this turnaround possible — and enabled vaccine development; allowed most hospitals, schools, businesses, and government agencies to function (while often significantly cutting costs); and continued to fuel economic growth — the same thing that has driven similar changes for decades. Technology.

In the tax world, not only did technology make it possible for tax agency employees to work from home during the pandemic — an idea that would have been laughed at in 2019 — but it was already being used for things like AI-assisted identification of fraud and chatbots to answer common taxpayer questions. And, of course, technology has long been an indispensable tool for taxpayers and practitioners to handle our increasingly complex tax systems.

Naturally, technology is also a disrupter of our tax systems. Indeed, it has had fundamental effects on state tax policy. As the U.S. Supreme Court noted in Wayfair, contemplating its physical presence standard: “It is not clear why a single employee or a single warehouse should create a substantial nexus while ‘physical’ aspects of pervasive modern technology should not.”4

And technology has made some aspects of our state tax systems obsolete. In the same way that nexus based on physical presence is hopelessly outmoded, so is having a sales tax that only applies to tangible property. Likewise, the increasing importance of intangible value, which is largely being driven by technology, defies sourcing by traditional rules, and this is forcing the OECD, finally, to move toward using market-based sales-factor apportionment to source multinational income.

Other problems, once thought to have only policy solutions, might be better solved by technology. For example, local transactional levies pose a problem for businesses and intermediaries. Rather than taking away local authority, technology might be used to ease the administrative burden by creating a centralized reporting system. Similarly, compliance issues created by mobile or remote employees could be addressed by technology without disrupting long-standing policies on where wages are taxed.

Don’t get me wrong. I think this technology, which we created, also poses more of a threat than anything we’ve ever encountered — a sentiment I expect our own creator could relate to. Nor is that threat just to teenaged girls on social networks. Recently, the IRS reported that it seized billions in cryptocurrency, presumably used to facilitate tax fraud. I trust the danger to taxation posed by an inherently secret mode of exchange is self-evident. Still, I’d like to be optimistic. (Although the day we start having MTC meetings in the “metaverse” is the day I retire.)

But stepping back, as the last two years have demonstrated, our ability to predict important developments or events, even while they are still happening, was always weak. Now, it’s totally outstripped by complexity and constant change. And, as 2020 proved, a single random event can exact incalculable loss. In short, predictions are generally useless.

What is not useless is preparing ourselves to respond to whatever happens. For tax administrators that means three things:

  • learning about technology — both its promises and its threats;

  • investing in the development of human resources and expertise to effectively manage and employ that technology to make tax systems stronger; and

  • working with fellow tax administrators across the country to identify emerging issues and find the right solutions.

Note that implicit in this list is the recognition that technology will only be as good as we are — as our judgment and our values are.

Here’s how I wrapped up my year-end predictions two years ago: “Assuming you survived 2019, I hope that you can take some comfort from Nietzsche’s famous words: ‘That which does not kill us makes us stronger.’ And I expect that after 2020, you may be stronger still.”

And so, welcome to 2022 and congratulations on your increased strength. I expect you’ll need it.

Not Quite the O.K. Corral

George S. Isaacson

George S. Isaacson is a senior partner at Brann & Isaacson in Maine and represents multichannel marketers and electronic merchants throughout the United States in connection with state sales and use and income tax matters.

The internet has become the Wild West of state and local taxation, and its impact creates challenges and uncertainties for governments, businesses, and individuals.

Taxation of Digital Products

There is a baffling lack of uniformity regarding the types of digital products that are subject to sales and use taxes. Some states have simply applied existing product categories to include new types of digital products, even if those electronic services bear only a remote resemblance to the products to which the tax more clearly applies. The interest of clarity (which should be the objective of all taxes) would be best served by state laws and regulations that describe separately those digital services subject to tax.

Sourcing digital transactions presents the most challenging and perplexing issue. Digital products do not lend themselves to conventional sourcing protocols. For example, if a state requires market state sourcing of digital products, a frequent problem arises in that the seller-provider of an electronically delivered service may not know the location of the customer, especially if there are multiple users. Sourcing “proxies” such as IP addresses or billing addresses are often unsatisfactory because devices are frequently used away from such an assigned base location.

It only gets worse. The interest among state governments to tax revenues derived from digital advertising services is gaining momentum. Maryland, the first state to adopt such a tax, provides a perfect example of the problems presented. To start with, it is unclear what is being taxed. The definitions are vague and difficult to apply to many real-world customer communications. The sourcing requirement is overreaching. The proposed regulation employs a worldwide base to apportion revenue. This arrangement will result in taxing out-of-state activity, and the amount of revenue subject to the tax may not bear any relationship to revenues derived from in-state advertisements. States adopting alternative sourcing regimes would fare little better. Sourcing transactions based upon on a device user’s IP address or presumptions regarding a device’s in-state usage will result in uncertainty, complexity, and conflicting state claims.

MTC Revised Statement Regarding P.L. 86-272

In the state income tax arena, the MTC’s recently revised “Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272” will impact businesses engaged in any form of electronic commerce, and the statement is likely to be challenged in court once MTC member states begin to adopt these most recent changes. Previous versions of the MTC statement provided useful guidance to taxpayers, but the current version, approved by the MTC in August, goes far beyond interpretation of this federal statute and essentially attempts to read the law’s protections out of existence.

These internet-related additions to the statement are based on the dubious theory that if a business’s website is accessible via the internet to customers located in a taxing state, that company’s interactions with customers via its website constitute business activities occurring “within” the taxing state. Thus, an out-of-state company whose website includes a clickable link by which an in-state customer can email a question to the company will result in that business being treated as engaged in unprotected customer services within the taxing state and thereby subject to the state’s net income tax — based on that fact alone. Equally extreme, if an out-of-state company’s website uses cookies for analytical purposes and the website is accessible by in-state customers, a state adopting the revised statement will consider that company to be engaged in non-solicitation activities within the state and thereby subject to income tax. The MTC’s position relies upon an overly expansive view of the Supreme Court’s Wayfair decision and goes far beyond the context, scope, and holding in the Wayfair case.

Remote Work

The change in work patterns brought on by the pandemic and facilitated by technologies such as videoconferencing and cloud computing are likely to persist and have long-term tax consequences well beyond the COVID emergency. The last two years have proven that for many people, working from home is feasible, preferable, and more productive. While several states have adopted temporary nexus and withholding exceptions for businesses with employees working from home, it is likely that state revenue departments will seize upon the presence of such employees to assert nexus claims in connection with a variety of taxes and related obligations. Issues relating to remote work are likely to increase because of:

  • the continuing geographic dispersion of employees;

  • the temporary presence of workers in multiple states;

  • the borderless nature of technology; and

  • the lack of uniformity among states regarding the tax implications of telecommuting.

All these factors contribute to the compliance challenges confronting both businesses and individuals and increase the potential for double taxation and jurisdictional disputes.

The Future of SALT

Janette M. Lohman

Janette M. Lohman is a partner in the St. Louis office of Thompson Coburn LLP.

I laugh when anyone asks me to predict what the future will bring. In December 2019 not many of us would have predicted that in just a few short months, the entire world would be shut down by the COVID-19 pandemic. In December 2020 I would never have predicted that we would still be in the midst of the pandemic now, with COVID-19 still raging and many companies still working remotely, at least through the end of 2021. But here we are. The pandemic has caused major chaos and disruption in all our lives — everyone has been touched by it in some way, and the practice of SALT is no exception. Accordingly, for what it is worth, here are my observations and predictions for 2022 and moving forward under these circumstances.

State of the States

Most states are absolutely flush with money, so the outlook for tax cuts and other economic development initiatives has never been better. At the beginning of the pandemic, because of lockdowns and stay-at-home orders, almost all the states were predicting horrendous, long-term reductions in general revenues from sales/use and personal income taxes. Although shortfalls did occur for most states during the beginning of the pandemic, several unanticipated situations occurred that saved the day. When the lockdown occurred, many essential employees were allowed to continue to work, and even more businesses found that their employees could work remotely just as well as from their offices. Also, when most of the nonessential retail stores closed, people started shopping online. Finally, over the past two years, each state has received billions of dollars in “extra” relief funds from the Coronavirus Aid, Relief, and Economic Security Act,5 the American Rescue Plan Act,6 and more recently, the Infrastructure Investment and Jobs Act,7 so states now have plenty of money to invest in economic development projects to help them reestablish their economies, improve their infrastructure, and emerge from the pandemic in better shape than ever. This surplus situation will most likely foster many economic development opportunities, potential tax cuts, and greatly enhance public services, at least during the next year.

The State of Business Compliance With State Tax Laws

On the other hand, the future for small and medium-size businesses’ compliance with state tax laws is not so bright. Our tax laws are evolving into a situation in which even the smallest business potentially has (economic) nexus for all tax types wherever the business has customers. My colleagues and I have been spending considerable time helping clients of all sizes and types that have online businesses become compliant with the Wayfair8 rules as (uniquely) applied by each state that imposes a sales/use tax.9 Given that the widely varying sales and transaction thresholds adopted by most states are ridiculously low, compounded by differing effective dates for lookback periods, the costs of complying with the sales tax systems can be far greater than the sales taxes the business owes. This situation is likely to continue for quite some time.

As if that were not bad enough, most of these businesses are shocked to find out that they must also address their income tax compliance in all states, too, particularly if they are coming forward under the states’ voluntary compliance agreement procedures. In the “old days,” businesses that sold tangible personal property and had no physical contacts in a state (other than those related to merely soliciting business) could rely on P.L. 86-27210 for protection against income tax compliance. If, however, the states adopt the MTC’s proposed new standards (as if they wouldn’t) and the courts uphold them, any old interactive customer-focused website will destroy this protection.11 And there are no minimum thresholds for income tax compliance. The result is that compliance with 50 different state sales/use and income taxing systems makes it much more difficult for small and medium-size businesses to conduct tax-compliant national sales. This trend most likely will continue indefinitely until these businesses finally reach the breaking point and demand relief — either through a federal solution or otherwise.

The State of Practicing SALT

As SALT professionals, we have been forced to cope with the depersonalization of the way we practice during COVID-19. Unfortunately, this situation is not likely to change back to the “old normal” when the pandemic is finally under control.

Because in-person contact was all but forbidden during the shutdown phase of the pandemic, almost all professional human interaction immediately went virtual — informal meetings, tax audits, tax appeals, tax hearings, depositions, trials, and other aspects of litigation, client meetings, and seminars, to name a few. Also, tax professionals had to maneuver how to obtain acceptable signature substitutes on powers of attorney, affidavits, contracts, and other documents that traditionally required “wet” signatures. Sometimes, because most SALT professionals and state tax officials were working remotely (generally from home), meetings could be very entertaining, with frequent pet sightings and folks wearing casual clothing while sitting in strange looking, nontraditional offices.

As we emerge from the pandemic, is it even possible for us to return to our pre-pandemic way of practicing? That is probably a pipe dream because it is much cheaper to practice virtually. Many professional and other businesses (including governments) were amazed at how much they saved by not incurring any travel, meal, and lodging-related expenses by holding virtual officewide or client meetings, not sending employees to professional educational seminars; not holding holiday or client parties; not entertaining existing or potential clients; and not holding firm retreats or office parties. All that money dropped to the bottom line.

It is also much cheaper (at least in the long run) for employees to work remotely. Eventually, many firms may decide to drastically reduce their rent expenses by adopting a “hotel-like” system through which employees are hired to work remotely and must make appointments for an office when they absolutely need to be there. Some large law firms are already raiding the associates of other law firms with promises of being able to work remotely from wherever the associates so choose. Many firms will adopt or have already adopted a hybrid system but gone are the days of requiring professionals to be physically in the office to perform their jobs.

The sad part is that we are people, and people need to interact, face to face, with each other. It is difficult to measure the intangible cost of quality that we will lose by the revolutionary change caused by forced use of Zoom, Webex, and the like. It is difficult to foster interoffice collegiality during a videoconference. It is also difficult to mentor or be mentored if one cannot learn by observing in person. It has also been strange during COVID to work with new, young associates whom partners have never met, and who have never experienced working in the office. It must be far stranger for the youngsters, and I worry about what value we are losing by not being able to work together, side by side, as we did in the old days.

Finally, what will happen to the wonderful SALT professional educational associations — will many of them survive after the pandemic has ended? Large companies most likely will not pay for travel if a video alternative is available, and employee membership might be limited to one organization. It is impossible to make and foster personal relationships with colleagues and clients while attending videoconferences. Also, how will these professional associations survive in a virtual world, when many of the large legal and accounting firms are competing with them directly and threatening their very existence by offering regular, high-quality continuing legal education/continuing professional education courses for free to anyone who wants to attend?

All in all, SALT professionals are facing an ever-changing tax environment that has become even more challenging and chaotic because of COVID-19. We need to expect the unexpected, and it is time, once again, to turn to Mama Lohman’s sage advice. She would remind us that there is no lemon that cannot be turned into a pitcher of lemonade and order us to get cookin’.

Good luck to all SALT professionals in 2022!

Headaches May Become Migraines

Amy F. Nogid

Amy F. Nogid12 is counsel in Alston & Bird LLP’s New York office.

Many of us will not be unhappy to see 2021 in our rearview mirrors as we turn our sights to a post-pandemic new normal. Will 2022 herald new and exciting SALT issues, or more of the same?

Although prognostication has its challenges, there are certain issues that we will surely see in 2022. Spoiler alert: No surprises here. Nexus (no, Wayfair did not eliminate all nexus issues), apportionment (states will continue to apply their varying methods in varying ways), and local taxes (expect to see localities continue to flex their muscles and be inventive in the breadth and scope of their impositions) are likely to be prominent issues.

But, in addition to these run-of-the-mill issues, 2022 may herald a few new issues. The Build Back Better Act may be (or may have been) enacted and may well raise some additional conformity (more likely, nonconformity) issues as states may choose to decouple from revenue losers. Will the SALT cap be eliminated or raised? If so, will states that enacted passthrough entity taxes eliminate them? The bets are in that those taxes are here to stay and, even if they are not currently revenue raisers, they may easily be tinkered with to allow states to take a cut, e.g., by limiting the amount for which a credit can be claimed.

Remember all those temporary Great Depression-era taxes? Of course you do! Many state and local sales taxes were adopted during the Depression as temporary measures. For example, New York state had a 1 percent sales tax from May 1, 1933, to June 30, 1934, and Pennsylvania had a sales tax that lasted only six months, ending on February 28, 1933; while they were not immediately renewed, they are obviously now alive and kicking. Another example is New York’s former unincorporated business tax, which was enacted in 1935 as a temporary tax and continued until it was repealed and phased out by 1981; New York City’s unincorporated tax continues to this day.

Localities have also been causing more headaches for businesses, and those headaches may become migraines in 2022. Given the breadth of local tax impositions and the inconsistent positions localities often take from one another and the state itself, compliance challenges will continue to mount unless the states start reining in their localities. While a few states have taken baby steps in that direction, it’s unlikely that comprehensive state tax administration will become the norm. Unfortunately.

We will also see more fallout from the pandemic and issues related to remote work. Perhaps we’ll finally see the U.S. Supreme Court consider the convenience of the employer rule, as a growing number of individuals and employers are faced with dueling multistate withholding requirements (one arising from the state where the work is performed and the other from the state where the employer is located and where the employee had worked pre-COVID). Get ready for the prospect of multiple withholding and income taxation becoming commonplace. My prediction: New Jersey sues New York.

Although states fared financially much better than expected during the pandemic, it’s likely that 2022 will see a few additional states expand their False Claims Act (FCA) provisions to cover tax matters. Having ambulance chasers and whistleblowers who see FCAs as dangling dollar signs become involved in tax administration is not a positive development. If states are truly interested in finding fraudulent taxpayers, there is no reason why they can’t enact legislation enabling tax departments to administer fraud-reporting programs, providing modest inducements to whistleblowers. We’re seeing more and more relators bring claims against companies that have taken good-faith positions on issues on which the law is at worst gray and at best clearly supports the taxpayers’ positions.

Finally, this year may also bring additional global tax changes, which may impact how states address taxpayers with multinational business operations. For example, will states retain and continue to enact tax haven provisions if global minimum taxes are adopted and the OECD and EU no longer consider jurisdictions to be tax havens? Will states continue to consider elective or even mandatory worldwide combination? We will need to wait and see. Interesting times undoubtedly lie ahead.

Wishing all in the SALT community a wonderful 2022! And may the Force be with us in 2022 (and always).

State PTE Taxes: Here We Go!

Timothy P. Noonan

Timothy P. Noonan is a partner in the Buffalo and New York offices of Hodgson Russ LLP.

It has been almost four years since Congress put a cap on a taxpayer’s ability to deduct state and local taxes (the so-called SALT deduction). Since that time, many states — especially high-tax blue states — have been scrambling to find workarounds to help its residents lessen the sting of what many see as double taxation. But as we all know, states can move slowly, especially when concocting new taxing schemes like a passthrough entity (PTE) tax. Four years later, and most importantly after the IRS blessed PTE taxing schemes late last year, many states jumped on the bandwagon in 2021, with roughly 20 states putting PTE taxes in place.13 And their timing is impeccable, as it appears the federal government seems poised to possibly bring back the SALT deduction in full or in part! As we look back on these new tax regimes and look forward to the future, here are some things to watch out for in the PTE tax area.

Year 1 Implementation

Again, for most states, 2021 or 2022 will be the first year the implementation of these PTE taxes occurs. We have seen significant confusion and consternation in New York, for example, with new legislation being proposed in April, guidance out in late summer, and all just ahead of a rushed October 15 deadline to elect into the tax.14 Numerous questions remain about implementation in New York and other states, and as of this writing, many states haven’t even rolled out 2021 PTE tax forms. So given that these taxing schemes are entirely new, we can expect the host of these questions to continue a multistate basis, with most of the unfortunate implementation difficulties falling on the poor accountants!

Resident Credit Issues

One of the most troubling aspects of these PTE tax regimes is that not all states have them. This raises a potential conundrum for taxpayers engaged in multistate businesses. For example, if a passthrough entity owned by a Maine resident pays the New York PTE tax, would the state of Maine provide a credit against that taxpayer’s Maine personal income taxes? Before these PTE taxes came into play, the answer was obviously yes, as almost all states would provide their residents with a credit for personal income taxes paid on sourced income in other states. But what if the other state’s tax is paid by an entity and not the in-state resident taxpayer? Some states (like New York) have agreed to allow such a credit, and most states that have enacted PTE regimes have as well. But earlier this year, the Maine Board of Tax Appeals upheld a decision of the Maine Revenue Services that denied a resident tax credit claimed by a Maine resident for his share of a new PTE tax paid to another state.15 So a tax regime designed to “help” taxpayers could end up subjecting them to double state taxation. This problem could significantly undermine the effectiveness and practicality of these PTE tax regimes, so this is another important issue to watch.

Bringing SALT Back?

Finally, and most importantly, will all of this soon be moot? It will indeed be funny (not ha-ha funny, but ironic) if 2022 begins with a fully reinstated SALT deduction, making all these PTE tax schemes useless. More likely, however, is we won’t see a full reinstatement of the SALT deduction, but an increase in the cap is possible.16 If that happens, then these PTE schemes will probably still be highly relevant and useful, since many taxpayers pay multiples of $80,000 a year in state taxes. And even for those right on the line, taxpayers with a large SALT deduction under the cap may still want to participate in these PTE regimes to avoid being kicked into an alternative minimum tax. So as Congress continues to move the goal posts, all of us tax practitioners will need to be on high alert. These PTE tax regimes, and the headaches they cause, will be with us for a while.

SALT Is at the Epicenter of the New Workforce Economy

Mark J. Richards

Mark J. Richards is a partner in the Indianapolis office of Ice Miller LLP.17

The SALT world has been at the center of revolutionary changes in recent years because of the U.S. Supreme Court’s 2018 decision in Wayfair.18 That landmark decision led to myriad state law changes designed to enable states to adapt to the perceived guidelines established by the Court in Wayfair to capture sales tax revenue on remote sales. To make collection (and auditing) easier for states, that exercise led to another set of substantial changes, that being the universal and rapid adoption among states of marketplace facilitator laws. The increasing use of technology by businesses has injected further uncertainty into sales tax collection responsibilities with the introduction of the nebulous concept of “software as a service” — what is it, and do states tax it?

Much of this reformulation of sales tax collection and remittance obligations is still in its formative stages. These new and untested changes and uncertainties present challenges for businesses, particularly given their potential broad reach and the differences in the laws, as well as the interpretation and administration of the laws, from state to state.

The interruptions to the economy caused by the COVID-19 pandemic have not helped clarify things, as businesses and states alike focused on keeping their doors open, in large part by allowing employees to work remotely. That change in business operations, borne out of necessity if not desperation, has led to another revolutionary change — the transition from predominantly working at your employer’s place of business to the now pervasive remote working economy, often referred to as “work from home” or “WFH.” The exact post-pandemic landing spot of the balance between going to work and WFH remains to be determined and will undoubtedly vary from industry to industry if not company to company. There is little doubt that WFH will continue to be a huge part of what will be, if not already is, the new normal.19

The SALT world will be at the epicenter of the transition to this new economic model. A complete list of potential SALT issues presented by remote work is both beyond the scope of this article and not yet fully determinable, but that list includes:

  • tracking where employees are performing work;

  • withholding/remitting the correct state and local taxes;

  • making new registrations and the implications of doing that, such as creating nexus for the employer in states and for various other taxes;

  • handling the risk of double taxation to the employees, because of the convenience of the employer test in a handful of states, for withholding and return filings;

  • considering voluntary disclosure agreements because of prior activity;

  • employees needing to file individual income tax returns in multiple states;

  • residency considerations, including the creation of statutory residency and consequently the risk of residency in more than one state;

  • sourcing income from stock options, bonuses, severance, and certain retirement benefits;

  • compliance staffing, impact on reserves, and employee education;

  • adequate recordkeeping to defend the company in audits;

  • the need to update employee policies, procedures, and handbooks;

  • awareness of state amnesty programs because of the pandemic, what those programs did and did not cover, and when they expired;

  • the impact on service companies determining the location of their costs of performance;

  • impact of worker classifications (and reclassifications); and

  • the impact this will have on future audits.

Companies will get no credit for paying tax to the wrong state, and the statute of limitations on refunds (not to mention a state’s reluctance to give refunds) may prevent correction later and will likely provide no relief in any event for interest and possibly penalties.

The list of non-SALT legal issues is equally daunting and includes the need for secretary of state filings, numerous labor law compliance issues, unemployment insurance registrations, employment contract law differences among the states, review of existing insurance policies, privacy laws, healthcare laws, and professional licensing requirements and restrictions, just to name a few. The list of business issues includes worker attraction and retention, accountability, efficiency, effective communication (including training, mentoring, and collaboration), confidentiality, networking, community engagement, innovation, and team building.

This is a big deal. Rarely do we encounter such a pervasive change in business culture that touches virtually every business and applies globally. Every business needs to do a self-assessment to identify the most significant issues for its business and formulate a game plan to address those issues. Remote work presents significant risks, but for those who are proactive and manage this evolution better than their competitors, it also may present opportunities. And SALT should have a seat at the head table.

What Times We Live In

Mark F. Sommer

Mark F. Sommer is a member of Frost Brown Todd LLC in the Louisville, Kentucky, office, where he leads the firm’s tax and incentives practices.

When the good people at Tax Analysts reached out on the prospect of a year-end piece on the past year and what we might see over the coming year, I enthusiastically gave a “yes” to the editor’s request. Then writer’s block set in. What to cover, what to address?

Bidding 2021 a Genuine Goodbye

What a year, in life and practice, in law, in tax, and yes, in death. 2021 is a year that all generations will remember, topping 2020 in terms of the worldwide COVID-19 pandemic and the associated changes, troubles, and losses therefrom.

Losses of people, friends, colleagues, and relatives. Changes in how everything goes and how the practice of tax law works — internal at taxpayer businesses, internal and external at professional service firms, accounting firms, and law firms. Trouble both internal and external at administrative agencies, commissions, legislatures, and elsewhere. While we didn’t see a once-in-a-generation-type court decision in 2021, we certainly saw a plethora of cases setting the stage for what’s to come: nexus cases, marketplace cases, Streamlined Sales Tax Project/Streamlined Sales and Use Tax Agreement cases, procedural cases, and still more.

We saw significant activity in state legislative action across the country, much of it focused on COVID-19 reactionary legislation, but a growing trend in tax reform, and in particular corporate income and individual income tax reform. And hey, let’s not forget WFH — remote working, telecommuting, and that phrase we’ve all come to love, work from home. Some states even tried to capitalize on WFH through legislation relating to economic development activities associated with remote workers, with some cities and counties offering cash incentives for new residents and relocated workers. Who would have thought!

As has been said, it was the best of times, it was the worst of times.20

Here’s to a Great 2022

Predictions are always judged by history, which as we all know, is written by the victors. In 2022 who will be victorious such that they will write the history of the year?

Look for increased tax reform from state legislative bodies across the country, in particular in the Southeast — corporate income tax reduction and individual income tax reduction being front and center. Couple this with significant, material, and permanent changes on remote working, all which will lead to serious tax policy discussions about nexus, fair apportionment, and of course that long-standing, overriding precept in SALT matters, the due process clause.

I don’t foresee significant state tax cases coming out of the Big Bench, as SCOTUS seems to have its hands full on other but equally significant areas of law. Perhaps this is the year that Chevron deference is substantively reviewed and curtailed.

Will we see a return to “normal” (yet to be defined) activity in state tax policymaking, whether it be in formal activities such as commissions and multistate agencies, or less formally, through professional conferences and seminar presentations? One trend that I have noticed is an increase in academic white paper-type writings throughout COVID-19 — I suspect we will see that continue during 2022 as well.

With federal legislation pending, it’s but a certainty that significant changes will be coming at the state and local levels relating to environmental- and sustainability-related endeavors, green energy, tax policy associated therewith, and of course incentives to encourage such actions.

Having gone back and looked at my last few years of year-end wrap-ups and future year predictions, I think I am batting around .650. And we all know, or at least those that still follow the game of baseball, that if you hit .400 over a season, you’re all but guaranteed a slot in the Hall of Fame. I wonder what the batting average is to get into the state and local tax Hall of Fame as it relates to predictions? Let’s hope all members of the Tax Notes State advisory board hits 1.000 on their predictions as we move forward into 2022. Stay healthy, and happy holidays to all in our SALT community!

2022: The New Normal

Marilyn A. Wethekam

Marilyn A. Wethekam is a partner with Horwood Marcus & Berk Chtd. and co-chairs the firm’s multistate SALT practice.

2020 could be characterized as the year one learned to manage the shock of COVID. 2021 could be characterized as the year of learning to adjust lifestyles, work environments, and business models to deal with what seems to be a never-ending pandemic. Hopefully, there is light at the end of the tunnel, so as we bid farewell to 2021, we should examine recent history and determine what can be learned from it and the impact those lessons may have on 2022.

At the onset of COVID, the fear was the economy would tank and state revenues would plummet. Those fears, at least in the short term, seem to have been unfounded. One reason is that the federal government has provided billions of dollars of relief to cover the costs incurred by the state and local governments’ response to the pandemic. An outstanding question to be addressed in 2022 is how the state and local governments may use the additional $350 billion that was allocated in ARPA. Even absent the infusion of federal funds, the dire predictions for state revenues have thankfully not come true. States have seen increases in both corporate and individual income tax collections. Similarly, in what should be a shock to no one, sales tax revenues have also increased. There is a saying that timing is everything. Clearly, the timing of the Wayfair decision and the legislation it spawned is a key factor in the increased sales tax collections. These increased state revenues have led some states to cut tax rates, phase out taxes, and issue refunds. How long will this prosperity last is a question for 2022. One thing history has taught us is that states’ economic outlooks change quickly, and it is difficult to raise tax rates and/or to reenact taxes if or when the bubble bursts.

In 2017 Congress enacted the Tax Cuts and Jobs Act, and four years later, tax administrators and taxpayers alike are still grappling with the effects of federal tax reform. Is more federal tax reform on the horizon in 2022? Will any portion of the Made in America Tax Plan be enacted? If so, how will the states respond to changes in the GILTI calculation or the enactment of the stopping harmful inversions and ending low-tax developments proposal? If any or all the proposed tax plan is enacted, once again, states will be required to evaluate the impact of the federal changes on both revenue and tax policy to determine if they should adopt or decouple from certain provisions of the Internal Revenue Code. Taxpayers again will be faced with uncertainty and possibly increased compliance burdens.

It is unlikely that 2022 will see a decrease in SALT litigation, and history is likely to repeat itself with respect to the issues that are raised. Nexus has been and will continue to be at the forefront of litigation issues. The new twist to nexus litigation may involve P.L. 86-272. The MTC took an ambitious step revising its statement addressing the application of P.L. 86-272 to update the application of the concepts to new business models, including the business activity conducted by an online seller. The updated statement raises several questions. How will the revised statement be applied? How will taxpayers test the updated concepts? More importantly, will it result in increased nexus litigation? There has been an uptick in merger and acquisition activity in the last couple of years. As a result, there is a potential for an increase in cases dealing with the characterization of the income — for example, business versus nonbusiness income — as well as the methods used to apportion that income. The apportionment of the income recognized on the divestiture of a passthrough entity or the assets of a passthrough entity could be the apportionment issue for 2022. New issues percolating in 2022 revolve around the taxation of passthrough entities, the treatment of related party transactions, the taxation of digital goods and services, and the increased enforcement of local taxes, just to name a few.

2022 will bring challenges both old and new to practitioners and administrators alike. Recent history has shown the SALT world is resilient and up to the challenge of dealing with the “new normal.”

California’s Revenue Surplus Versus the Gann Limit

Kathleen K. Wright

Kathleen K. Wright is the director of the state and local tax program in the School of Taxation at Golden Gate University, San Francisco. She frequently presents seminars on SALT issues for the California CPA Education Foundation.

Looking forward to 2022, the economic outlook in California looks like it is off to a spectacular start. For the last two years, the state has run significant surpluses, and the legislative analyst’s most recent report projects a $31 billion surplus available in the upcoming year.21 For the last two fiscal years, California has been accumulating increasingly larger surpluses, and the healthy revenue stream looks like it will continue. But it is not necessarily the case that budget surpluses (for two years running) are all good news. This is a summary of what happens in California when the state runs “perpetual” budget surpluses, and the Gann limit kicks in.

The 2021-2022 Budget

Cash Collections: The California Department of Finance monthly Economic Bulletin for October 2021 reports that general fund cash receipts for the first three months of the fiscal year are running approximately $14 billion above the 2021-2022 budget forecast. The surplus is made up of two pieces. General fund cash receipts for the first three months of the 2021-22 fiscal year were $9.145 billion above the 2021-22 budget forecast of $33.235 billion.

California started the fiscal year with a windfall. In the last fiscal year (2020-2021), general fund cash receipts for the entire 2020-21 fiscal year were $4.783 billion above the 2021-22 budget forecast. When this prior fiscal year-end amount is combined with the current fiscal year-to-date total, general fund cash receipts are $13.928 billion above the 2021-22 budget forecast. Not bad for a year that might best be characterized as the tail end of the pandemic.

This surplus is spread across all three major taxpaying groups (personal income tax, corporate tax, and sales/use tax). For the first three months of the year, the personal income tax is running $6.5 billion above the forecast of $22 billion, the corporate tax is running $1.4 billion above the forecast of $2.7 billion, and the sales tax is approximately $1 billion above the forecast of $2.2 billion.

With a very progressive State Legislature (like California), there is no shortage of ideas put forth regarding how to spend the funds. Although it may be hard to believe, there is also a risk associated with spending too much money — and it is called the Gann limit.

The Gann Limit (California’s State Appropriations Limit)

Proposition 4 (1979), also known as the Gann limit,22 added Article XIIIB to the California State Constitution. The stated goal of Proposition 4 was to establish an appropriations limit on the state and most types of local governments. Essentially, the limit forbids the state from exceeding the 1978 per-person spending levels, adjusted for economic growth, population growth, and inflation. The population adjustment for 2022 could be lower than expected because California’s population, for the first time, declined year over year in 2020 (compared to 2019), most likely because of COVID-19, a low birth rate, and people moving out of the state due to shelter-in-place orders.

In 2021 the state did authorize a refund to taxpayers to comply with the appropriations limit and approved another round of Golden State Stimulus rebate payments to be made to qualified taxpayers who have adjusted gross incomes of $75,000 or less.23 The amount of the payment depended on a range of factors but could not exceed $1,100. Obviously, not every taxpayer in California is going to get a check under this program, but the director of the Department of Finance, Keely Bosler, has stated that the administration believes that this program does satisfy the constitutional rebate requirements.24 Rebates have only been required once before (in 1986-1987), when the state had excess revenues of $1.1 billion, which did result in a 15 percent reduction in all taxpayer’s tax bills.

The computation of the state appropriation limit is defined here in three steps:

  • Spending Limit: The spending limit is last year’s limit increased by the “growth factors.” Proposition 4 established 1978-1979 as the base year, which is increased every year by several growth factors. The two most significant are the increase in economic growth and the increase in population growth.

  • Appropriations Limit: The appropriations limit is based on appropriations from tax revenue collected for all sources. This means that the limit applies not only to taxes collected and deposited in the general fund but also all tax revenue that goes into special funds. User fees are not included, and there are a handful of exclusions. Federal funds do not go into this computation. All the tax revenues are deemed to be appropriated, with certain exceptions — such as the amount needed to service debt, federal/court mandates, capital projects, and certain emergency spending.

  • Calculation of the Limit: The state then compares the limit (step 1) to the appropriations that come under the limit (step 2) to determine if appropriations exceed the limit.

If appropriations subject to the limit (step 2) exceed the limit (step 1) over a two-year period, then the state constitution requires that the excess revenues either be:

  • appropriated for purposes not under the appropriations limit (such as capital projects); or

  • split the excess between community colleges, additional school funding, and taxpayer rebates.

Taxpayer rebates also raise an additional issue with respect to federal funds that the state has received to rebuild the economy.

The State Appropriation Limit and Federal Funding

Regarding federal funding, the question is whether a rebate of tax revenues might trigger the provision in ARPA that claws back federal funding used to offset a reduction in state tax revenue caused by a change in a law, regulation, or administrative interpretation. ARPA includes $350 billion in aid to states and localities — of which approximately $195 billion is for states. California received approximately $27 billion. The bill was modified as it moved through Congress, and when it reached the Senate, Majority Leader Charles E. Schumer, D-N.Y., added an amendment to impose an important limit on the sovereign power of states that accept funding:

A state or territory shall not use the funds provided under this section or transferred under section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.

If a state violates this provision, now known as the tax mandate, the Treasury secretary is empowered to recoup the lesser of:

  • the amount of the applicable reduction to net tax revenue; or

  • the amount of funds the state received from the federal government (adding section 602(e) to the Social Security Act).

The statute does not entitle the states to any process before the money is reclaimed. Since money is fungible and cannot be traced, any reduction in tax revenues is arguably a violation of the tax mandate. This clawback requirement sets up a conflict between two components of the U.S. Constitution: the spending clause and the 10th Amendment. It also sets up a conflict for California — if in 2021-2022 the state collects excess tax revenues and is required to issue tax rebates, then would the state also be required to return a portion of its federal relief funds? Or in the alternative, if the state takes steps to reduce tax revenues (so it would not be subject to the Gann limit), would that also trigger a return of federal relief funds?

This is a very controversial issue that is in the courts. Treasury did issue guidance attempting to define what a state could do with the monies received under ARPA. That was not enough to satisfy the U.S. District Court for the Northern District of Alabama in West Virginia v. Yellen,25 in which the judge held that the provision “falls short of the clarity required when Congress exercises its powers under the spending clause” and that Treasury’s interim final rule “cannot cure that ambiguity.” He granted final judgment in favor of the states, permanently enjoining Treasury Secretary Janet Yellen from enforcing the provision against the 13 states that brought this lawsuit and denying the federal government’s motion to dismiss the suit.26

Fiscal 2022-2023 looks to be another challenging year for the state, with balancing demands for social services, continuing to provide aid to businesses and workers affected by the pandemic, and managing a budget that is under almost unimaginable constraints/restrictions.

FOOTNOTES

1 Oxford Languages, Oxford Languages and Google (defining cliché).

2 To repeat a point I recently made on these pages, see Walter Hellerstein and Andrew Appleby, “Does the Supreme Court’s Decision in Wayfair Apply Retroactively?Tax Notes State, Nov. 15, 2021, p. 715.

3 Currently under construction is the Gordie Howe International Bridge, a modern cable-stayed bridge across the Detroit River, connecting southwest Detroit and Sandwich, Ontario. When completed in 2024, the bridge will be the largest port of entry along the Canada-U.S. border.

4 South Dakota v. Wayfair Inc., 138 S. Ct. 2080, 2095 (2018).

5 Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136 (Mar. 27, 2020).

6 American Rescue Plan Act, P.L. No. 117-2 (Mar. 11, 2021).

7 Infrastructure Investment and Jobs Act, P.L. 117-58 (Nov. 15, 2021).

8 Supra note 4.

9 Except, of course, the author’s home state, Missouri, where the Wayfair law won’t become effective until Jan. 1, 2023 — see S.B. 153 (L. 2021).

10 P.L. 86-272, 15 U.S.C. sections 381-384 (1959).

11 Multistate Tax Commission, “Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272” (Aug. 4, 2021).

12 The views expressed here are mine and mine alone and should not be attributed to Alston & Bird LLP or any of its clients.

13 See Steven N.J. Wlodychak, “They’re All Different and That’s the Problem: State PTEs,” Tax Notes State, Aug. 2, 2021, p. 455.

14 Timothy P. Noonan, Elizabeth Pascal, and Christopher L. Doyle, “The Nuts and Bolts of New York’s New Passthrough Entity Tax,” Tax Notes State, June 7, 2021, p. 997.

15 [Individual Taxpayer] v. Maine Revenue Services, No. BTA-2020-1 (Maine Bd. of Tax App. Mar. 20, 2021) (Maine BTA Opinion).

16 As of this writing, the House-passed $1.75 trillion reconciliation bill would raise the SALT cap from $10,000 to $80,000.

17 This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.

18 Supra note 4.

19 Lydia Saad and Ben Wigert, “Remote Work Persisting and Trending Permanent,” Gallup (Oct. 13, 2021).

20 Charles Dickens, A Tale of Two Cities (1859).

21 Gabriel Petek, “The 2022-2023 Budget: California’s Fiscal Outlook,” Legislative Analyst’s Office (Nov. 2021).

22 See Petek, “The State Appropriations Limit,” Legislative Analyst’s Office (Apr. 2021).

23 S.B. 139 (Ch. 21-71).

24 Note that the last time the state triggered the Gann limit in 1986, every taxpayer got a 15 percent cut in their tax bill. The California Constitution, in Article XIIIB, section 2(a)(2) states: “Fifty percent of all revenues received by the State in a fiscal year and in the fiscal year immediately following it in excess of the amount which may be appropriated by the State in compliance with this article during that fiscal year and the fiscal year immediately following it shall be returned by a revision of tax rates or fee schedules within the next two subsequent fiscal years.” It does not say anything about partial tax rebates to some, but not all, fulfilling the requirement.

25 W. Virginia v. United States Department of Treasury; Case 7:21-cv-00465-LSC (Nov. 15, 2021).

26 The 13 states that brought this lawsuit include Alabama, Alaska, Arkansas, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah, and West Virginia.

END FOOTNOTES

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