Katie Quinn of McDermott Will & Emery LLP discusses the state tax implications of the COVID-19 pandemic with Tax Notes senior reporter Lauren Loricchio.
The interview has been edited for length and clarity.
Lauren Loricchio: Hi Katie, thanks for being on the podcast.
Katie Quinn: Hi Lauren, thanks so much for having me.
Lauren Loricchio: In your view, what are the major issues facing taxpayers at the state level as a result of the COVID-19 pandemic?
Katie Quinn: There are three primary issues. The first is obviously preserving liquidity and keeping cash out of the pockets of the states and in the taxpayers' pocket. The second is the implications of the Coronavirus Aid, Relief, and Economic Security Act and how those provisions flow to the states. The third is making sure that there aren't potential tax increases at the state level as a result of the COVID-19 crisis.
Lauren Loricchio: How would you like to see states address those issues?
Katie Quinn: The best way for states to address these issues is to provide guidance to taxpayers in real time, so now.
With respect to liquidity, the states have already helped taxpayers in that respect. The states have extended filing and payment deadlines, which give taxpayers temporary liquidity.
With respect to the implications of the CARES Act, there are some quirky issues at the state level, which could result in a state tax increase. I'd like the states to provide guidance to taxpayers letting them know that this federal relief package will not result in a state tax increase.
Finally, there are some nexus and withholding issues that states can address by just giving taxpayers guidance. Essentially, employees working remotely can create income tax nexus and withholding obligations for employers in those states. I think it would be a good and fair response for state tax departments to come in and say, "We are not going to hold this COVID-19 crisis against you. We're going to ignore employees that are forced to work from home, based on COVID-19 and shelter-in-place orders and everything else that's going on."
Lauren Loricchio: In terms of the teleworking issue, could you explain a little bit why that would cause those withholding obligations?
Katie Quinn: Of course. There are really two issues: the income tax nexus issues and the withholding issues.
Across the country employees are required to work from their homes. For many employers, their employees do not work in the same state as they live. For example, if you have an employer that's in New York City, but their employees are working from home in New Jersey, that could potentially create sufficient presence for that taxpayer in New Jersey, such that they are now required to file income tax returns.
Now I caution you: that was just an example. They may be required to file income tax returns in New Jersey anyway. But if the nexus is created just because the employees are working remotely from home, to me that seems unfair. I think that states should issue guidance saying, "We're not going to consider employees that are forced to work remotely from home to be nexus-creating activity." New Jersey actually has been one state that has issued such guidance.
Now with respect to withholding, it's a little different. Employers are required to withhold state income tax on wages earned in the state. An employer based in state A may have an employee, who usually works in the office in state A, is now required to work from home in state B. Arguably, the employer would have to withhold state B income tax.
While that's not really a liquidity issue, that creates a real administrative burden for employers. Again, I think the right answer would be for states to say, "We are not going to consider employees working from home to have earned those wages in the state for withholding purposes."
Lauren Loricchio: Are there any states you're looking at specifically for this guidance?
Katie Quinn: No. We're asking all states for this guidance. McDermott Will & Emery LLP sent a letter to state tax commissioners asking them to issue this guidance or to think about these concerns. We've heard from Mississippi, New Jersey, and a couple others. Largely, we have not received that guidance yet. This is really an issue across the vast majority of states.
Lauren Loricchio: You had mentioned the deadline extension. Do you think states are providing enough relief on this? What do you think of the response so far?
Katie Quinn: I do think that states have been providing favorable extensions and that they have been doing a pretty good job in this respect. Again, these extensions only provide temporary liquidity to taxpayers. Most of the income tax deadlines have been extended to July 15. We don't know how long this is going to go on, so we don't know if additional extensions are going to be necessary.
One thing, though, I will caution taxpayers about is with respect to extensions to pay sales taxes. Sales taxes are trust fund taxes. Usually taxpayers aren't supposed to spend the money that they collect on sales tax. I think that the departments of revenue and the legislatures extending payment deadlines sort of implies that they are going to allow businesses to use that money to fund payroll or anything else that they need right now.
But you have to be very careful in making sure that you pay by the extended deadline. Otherwise there could be responsible personal liability for officers, managers, and employees, as well as criminal penalties.
Lauren Loricchio: In terms of the CARES Act, do you see any areas where it would have a major impact at the state level?
Katie Quinn: I think one of the biggest areas where it will have an impact at the state level is on GILTI. This is not a multistate issue, but this is an issue in states that passed GILTI and allow the deduction in the Internal Revenue Code section 250.
The way that the CARES Act works at the federal level is it allows the carryback of net operating losses. There are mechanics under IRC section 250 that essentially say if your taxable income is reduced, your section 250 deduction could potentially be reduced.
That's a complicated mechanic that I won't get into. I'll pick on New Jersey again. New Jersey does not allow federal NOLs, so the federal NOL carryback provisions have no impact on the amount of the NOLs that can be taken in New Jersey. But New Jersey does tax GILTI and does allow the section 250 deduction.
In New Jersey, if the 250 deduction is reduced federally, that means that there's going to be more GILTI tax in New Jersey. GILTI typically says we tax 50 percent of GILTI. But now that you have these NOL carrybacks, taxpayers could see a tax increase in New Jersey. That will be retroactive, so they'll have to file amended returns.
It just seems like the wrong answer to the federal relief bill. It could result in taxpayers filing amended returns and paying additional tax to the state.
Lauren Loricchio: You're picking on New Jersey because it is one of the only states that actually taxes GILTI, right?
Katie Quinn: Right. It's one of the very few states that taxes a material portion of GILTI. Some states will tax 5 percent or 15 percent, but very few states tax 50 percent of GILTI. New Jersey may be taxing even more than 50 percent now. But New Jersey is not the only one. This issue can arise in New York City, Nebraska, Iowa, but it's not a issue across all states.
Lauren Loricchio: In terms of conformity to the CARES Act, are you watching any states in particular?
Katie Quinn: We're really watching all states. New York just did something interesting with respect to 163(j).
The CARES Act increased the amount of the interest expense that can be deducted at the federal level by 20 percent. You used to be able to deduct interest up to 30 percent of your adjusted taxable income. The CARES Act increased that federally to 50 percent. If most states conform to the Internal Revenue Code as amended by the CARES Act and conform to the Tax Cuts and Jobs Act's section 163(j) limitations, they still allow that additional 20 percent deduction.
It wasn't publicized widely until after it was enacted, because I think taxpayers would have been very upset about it. But New York came in and said, "We're not going to allow that additional 20 percent deduction for state tax purposes." That applies in both New York state and New York City.
I think we have to watch out for that type of stuff because the CARES Act was supposed to provide liquidity and tax savings to businesses under these unprecedented circumstances. It would be an odd and potentially unfair result for the CARES Act to create additional state tax or for the states to not allow the federal benefit.
Lauren Loricchio: Would you like to see states conforming to provisions of the CARES Act?
Katie Quinn: I would like to see states conform to provisions of the CARES Act to the extent that they provide benefits to taxpayers. Again, if conforming because of the mechanics of the federal code and the state code results in a state tax increase, then I think states should be careful to ensure that's not the result. Tax increases shouldn't be anyone's intention right now. It certainly wasn't the intention of the CARES Act.
Lauren Loricchio: Which provisions of the CARES Act are most beneficial in terms of conformity?
Katie Quinn: Section 163(j) is definitely beneficial. States that conform to the CARES Act and conform to section 163(j) get an additional interest expense deduction. I think that is helpful.
The only other provision that really has an impact at the state level is the new NOL provisions. That will only impact the states that conform to the IRC as amended by the CARES Act and follow the federal NOLs.
A lot of states have their own NOL regime, so the NOL provision really wouldn't provide a benefit. But if the states do follow the federal NOL provision, then it is certainly a benefit.
Lauren Loricchio: Thanks for joining us on the podcast.
Katie Quinn: Thanks so much for having me, Lauren. Stay safe everyone.