2023: In the Crosshairs

The Confluence of International and Subnational:
Cross-Border Tax Issues in the Digital Economy

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Law Emeritus at the University of Georgia Law School, and is a visiting professor at the Vienna University of Economics and Business and chair of the Tax Notes State advisory board.

In attempting to identify questions that state tax professionals are likely to encounter during 2023, I would point to those raised by the increasing confluence of international and subnational cross-border tax issues in the digital economy. I realize that my views simply may reflect the truism that what one sees depends on where one stands, and I have been devoting a growing proportion of my waking hours to these issues.¹ Nevertheless, I suspect that, like me, most readers of this Board Brief cannot check their daily tax reports from Tax Notes and other sources (that shall remain nameless) without seeing references to ongoing developments regarding the OECD/G-20’s inclusive framework on base erosion and profit shifting and its two-pillar global corporate tax reform plan.² I would subdivide the confluence of international and subnational digitalization-related cross-border tax challenges into three broad categories: (1) nexus, (2) digital platforms, and (3) corporate income attribution.

Nexus. The concept of nexus in the cross-border tax context has long been associated with physical presence in both the international and U.S. subnational tax contexts. If there is an overarching theme that informs both the international and U.S. subnational efforts to address the cross-border tax challenges of the digital economy, however, it is that the concept of physical presence has lost its stature as the controlling nexus standard. As anyone reading these words is no doubt aware, in Wayfair the U.S. Supreme Court unequivocally repudiated the physical-presence test of nexus it previously endorsed under its constitutional jurisprudence and in its stead embraced a test of nexus based on “economic and virtual contacts.”³ In the global context, the international tax community has likewise repudiated a nexus concept inextricably linked to physical presence and embraced a “new nexus rule based on indicators of significant and sustained engagement with market jurisdictions, which could in some circumstances be unconstrained by physical presence.”⁴

The question, of course, then becomes precisely what constitutes sufficient economic and virtual contacts or significant and sustained engagement with market jurisdictions. For those who think the answer to this question is simple, I recommend they read the preceding Board Brief, “Post-Wayfair: Burden of Favor,”⁵ which demonstrates beyond a reasonable doubt that, whatever the answer to the question, the efforts to implement the “new nexus” will likely serve as a full employment act for many state tax professionals. I think one can also safely assume that the same will be true in the international cross-border context, when, as, and if, the new nexus standards are adopted by national taxing jurisdictions across the globe.

Digital platforms. Perhaps the most compelling example of the confluence of international and subnational cross-border tax issues in the digital economy is the role of digital marketplace platforms in the collection of VATs and retail sales taxes. Indeed, the role of marketplace platforms in today’s digital economy is difficult to overstate, and it is a role that has special significance in facilitating the collection of taxes on online sales, most of which occur over digital platforms. If any proof were necessary to demonstrate the significance of digital marketplace platforms in the collection of consumption taxes in the international context, one need look no further than the OECD’s report on the Role of Digital Platforms in the Collection of VAT/GST on Online Sales⁶ and the dramatic enactment within the past few years of platform-related tax collection legislation by every one of the 45 U.S. states with sales taxes.⁷

What is striking about the international and U.S. state digital marketplace platform developments is the similarity of the basic issues and the approaches to these issues in both contexts. To be sure, there are important differences between enlisting a platform to collect tax in a staged tax collection process under a VAT, where the seller ordinarily pays tax on its purchases and is entitled to an input tax credit against the taxes it collects on its sales, and enlisting a platform to collect tax under a single-stage retail sales tax, where the seller ordinarily is concerned only with collection of the tax. Nevertheless, the fundamental questions confronting jurisdictions that seek to enlist digital platforms in the collection of tax on sales they facilitate and possible answers to these questions in both contexts are often similar. These issues include the definition of such platforms; the specification of the platforms’ obligations; the delineation of the respective obligations of the platforms and those who sell over the platforms; and related questions regarding measures to support the practical implementation of platform legislation.

Income attribution. There plainly is no historical or conceptual connection in the U.S. subnational context between the advent of the digital economy and the adoption of formulary apportionment as method for attributing income to taxing jurisdictions.⁸ In the international context, however, the connection is undeniable. Less than two decades ago, the adoption of formulary apportionment as an alternative to the prevailing arm’s-length principle for attribution of income among national taxing jurisdictions was widely regarded as a poor solution to the problem of income allocation.⁹ Today, however, the international tax community has recognized formulary apportionment, albeit in limited and precisely defined circumstances, as a legitimate approach to assigning income among jurisdictions for tax purposes.¹⁰ Without suggesting that the confluence of the international and subnational concerns with formulary apportionment as a division-of-income method are as significant as those associated with nexus and digital platforms, it is nevertheless another example of these shared concerns.

The Beginning of the Return to Normalcy

Craig B. Fields is a partner in the New York City office of Blank Rome LLP.

I began 2022 with a virtual hearing before a state tribunal. All of our witnesses were in our office, the judge in her office, opposing counsel in his office, and the state’s auditors in another office. A little before a break for lunch in the third day of trial the person sitting next to me passed me a note saying that his child just tested positive for COVID. Ultimately, everyone was fine and the trial concluded.

It was a strange start to 2022 as people were generally still not meeting in person nor having many in-person trials. Almost everything was still being done virtually. However, as the year progressed, things began returning to the way they were prior to COVID. When I requested to physically attend a hearing in another jurisdiction, the hearing officer stated that she had not yet had any in-person hearings. However, since we had met numerous times in the past, she stated that she was willing to have me participate in the department’s first in-person hearing. It was great being able to again have the hearing in person rather than virtually.

A month or so later I met with opposing counsel in another jurisdiction in an attempt to resolve a matter. Unlike in the past, when I would go to security and provide my identification, I instead had to call opposing counsel’s mobile number and he came to get me. Indeed, when I signed my name on the sign-in sheet to his offices I noticed that the last person to sign the sheet had done so over a year earlier. It was strange as he and I were the only people on the floor. The meeting, however, was as meetings in the past had been. Indeed, we resolved the matter shortly thereafter. I am not as confident the matter would have been resolved as quickly with just a telephone call or a virtual meeting.

By the middle of the year, people were more willing to meet with others and attend conferences. For example, I participated in one conference on the West Coast where registration had to be closed two weeks prior to the conference because it had reached capacity as so many people wanted to attend. In the panel in which I participated there was standing room only. It was great to see so many people in one place. Other conferences were also being held in person (and some with a virtual component) and they were also well attended.

In the beginning of 2022 if I went to my office there were few people on the bus and very few in the building. Now the buses are crowded, and many people are in the building regularly.

I am also now regularly traveling to hearings, meetings with opposing counsel, and conferences. While people are still careful (and they should be), it is great to see the world returning to normal.

I expect that we will continue to see the world reopen in 2023. The issues the state tax world saw in 2022 will continue in 2023. Does anyone truly believe that Public Law 86-272 is violated when a business answers a question from a customer via the internet, but not when it responds by telephone? How is it determined where the benefit of a service (or an intangible) is received? Does a cost-of-performance sourcing statute really mean market? We will likely see many cases addressing these and other issues in 2023. I am looking forward to it all.

The State Tax World Has Gone MAD

Jeffrey A. Friedman is a partner in the Washington office of Eversheds Sutherland (US) LLP.

2022 turned out to be an interesting SALT year. We saw interesting litigation, including a successful state court challenge to Maryland’s notorious digital advertising gross receipts tax; apportionment issues associated with nonunitary owners in Massachusetts and New York; nexus litigation involving marketplace sellers in Pennsylvania; and a host of challenges involving remote workers’ income tax obligations. That’s a pretty high bar, but I am confident that 2023 will be equally exciting. Now, on for some predictions. I have a habit of categorizing or “bucketizing” issues. For this Board Brief, I came up with M-A-D, as you’ll see below.

Marketplace issues will continue to capture our attention. The fallout from Wayfair was a massive change to state tax jurisdiction. However, the implementation of marketplace laws is resulting in a significant rewiring of sales and use taxation. Before, tax obligations almost universally fell on either a seller of taxable goods and services, or a purchaser. Interposing another taxable party — platforms that serve as an intermediary between sellers and purchasers — is leading to some interesting challenges, starting with the breadth of a state’s marketplace laws. In some states, a platform may qualify as a tax responsible party even if it does not facilitate payments. Other states allow marketplaces to bow out of tax collection if the seller and marketplace agree. And commendably, other states do not hold a platform responsible for wrong tax determinations if it reasonably relied on information provided from a seller. As for taxability prior to the implementation of marketplace laws, the Pennsylvania Commonwealth Court found that sellers are not liable for sales tax prior to the implementation of the state’s marketplace law.¹¹ The rewiring will set in over time, but we have a long way to go.

Apportionment has been the leading state corporate income tax policy and controversy area for as long as I can remember. In particular, the sales factor numerator continues to be an interesting topic and one that is getting more complicated. The shift to single sales factor with market-based sourcing has put a lot of pressure on defining who (is the customer — or the customer’s customer?), what (is being sold — services? intangibles?), and where (is the benefit or destination of the item being sold?). Each of these areas — and many more — will play out in 2023. Ohio’s litigation on look-through sourcing has been fun to watch. The recent decision by the Ohio Supreme Court is a great example as to the difficulty of determining where use of an intangible takes place.¹² The characterization of what is being sold determines a state’s applicable sourcing rule. So it’s not surprising that we’ve seen litigation in this area as well. Sirius XM prevailed (thankfully) in its attempt to characterize its satellite radio service as performed where decryption takes place for Texas margins tax purposes.¹³ We hope we will finally see an end to Pennsylvania’s dysfunctional Abbott & Costello routine as to which state agency — Department of Revenue or the attorney general — gets to call the balls and strikes in its apportionment litigation.¹⁴

Digital goods and services will continue to dominate state tax conference agendas, state legislative sessions, and courtrooms. A recent Tennessee ruling provides an example of the difficulty in discerning the difference between a taxable sale of software and a nontaxable sale of an exempt service. A taxpayer provided an online platform and mobile application to property management companies that could use the technology to advertise and market rental properties. The Tennessee DOR concluded that tax applied “because it is computer software that the [property management companies] employ to generate and manage their own advertising content.”¹⁵ The rationale of that ruling could turn nearly every service facilitated by software (or the internet) into a taxable sale of software. The Multistate Tax Commission’s foray into this morass will provoke significant policy debates. Not to sound dramatic, but the battle lines over what is and what is not a taxable digital good or service will be the most consequential state tax issue for decades to come. The Streamlined Sales Tax Project created some certainty in states that abide by its agreement. However, the SSTP’s digital product definitions are viewed by some as creating an incentive, or at least a pathway, for states to easily broaden sales taxes. If the MTC’s effort goes beyond those definitions — including the definitions already used by Washington state — we are looking at potentially billions of additional state tax revenues.

In some ways, the state tax world has gone MAD — but in an interesting (and fun) kind of way.

Hello 2023 — Are We Back to Normal? Unlikely

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

Pantone® has announced that its Color of the Year for 2023, is Viva Magenta, a new animated red that “vibrates with vim and vigor,” and “revels in pure joy, encouraging experimentation and self-expression with restraint, an electrifying and boundary less shade.”¹⁶ I suspect we may indeed see red in the field of state taxation, with experimentation and self-expression an apt description of states’ activities as they confront reduced federal monies and the challenges of the post-pandemic reshoring economy. Restraint will need to be exercised to get through what is certain to be a tumultuous year.

I limit my predictions of pertinent issues to three. First and foremost will be the continued focus on apportionment, apportionment, and apportionment, to which I include the transfer pricing initiatives of select separate-reporting states. The stakes have increased with the number of states using solely a sales factor, coupled with market placed sourcing. After VAS Holdings and the recent Florida decision in NASCAR, I predict we will see states revising and tweaking the langague of their apportionment methods, particularly for gain arising from the sale of intangibles, including interests in passthrough entities. Every state wants a piece of the pie, and they do not want to share. I include select state transfer pricing initiatives in this category because the end result is an assemblage of the business the state wants to tax, regardless of whether the jurisdiction adopts unitary combined filing or not. Under this approach, any linkage to a sale provides justification to assert a state’s taxing power on the resulting revenue, notwithstanding long-standing U.S. Supreme Court precedence. Of course, after 2022, Supreme Court precedence is not what it used to be. While I do not predict a challenge to a precedential state tax case to occur at the high court in 2023, case filings at the state trial level indicate that the journey has already begun to challenge long-standing cases regarding extraterritorial taxation.

Second, I predict further controversies arising from remote workers, whether from cases challenging temporary regulations that were put in place during the pandemic, or COVID-era challenges to the convenience of the employer rules that have always been unconstitutional. I hope Professor Edward Zelensky gets his day in court this time. There will be spin-off cases due to wandering employees who fail to inform their employer of their wanderlust, or have fully embraced the RV life, and I pity the human resources personnel who are the first line of defense in ensuring a business’s compliance with state unemployment taxes. In line with Viva Magenta’s boundary-less characteristic, let us expand this prediction to include a renewed focus on state unemployment taxes to be an increasing area of focus. It is ripe for improvement and modernization, and so few businesses (and practitioners) actually understand how the systems work. Michigan is spending $78 million in 2023 to replace their state unemployment system, the urgency for which was driven by the Michigan Supreme Court’s decision, which held that the state was not protected by government immunity for damages caused by the system when it erroneously determined that hundreds of thousands of residents who received unemployment during the last recession made fraudulent claims and automatically seized money from their bank accounts, leaving them penniless. The lack of any human intervention that allowed the erroneous system to proceed unfettered also played a role.

Lastly, I predict attempts to expand states’ sales tax bases, with an increasing emphasis on taxing services and digital goods. The federal funds hemorrhaged to the states will soon be spent, as most states have a June 30 deadline to disburse the last tranche of CARES Act monies. State tax revenue estimates are already trending downward, notwithstanding the largest Cyber Monday shopping day ever held. Raising rates is never popular, so revenue raisers will be stealthy, which may be easier to do if you target discretionary spending on services and digital goods that are provided through the metaverse.

As a bonus of predictions for 2023, I will add a sprinkling of procedural changes as states confront the increased need for modernization and efficiency. Whether due to the adoption of work from home for state employees, or the need to accelerate system enhancements to handle increased electronic payments, filings, and communications, this modernization process has accelerated. There is no reason for any assessment to be delivered to a taxpayer via certified mail; the use of electronic portals, secured filing sharing, and other communication options alleviates the need to add the U.S. Postal Service as a participant to tax reporting.

Happy holidays to all; see you in 2023. Viva Magenta!

After the Tax Cut Fever Breaks

Billy Hamilton is the deputy chancellor and CFO of the Texas A&M University System.

It was hard to appreciate at the time, but the states are coming to the end of the two best fiscal years they’ve experienced in decades.

Fiscal 2022, which ended on June 30 for most states, marked the second straight year of strong tax revenue growth. States also were flush with cash from federal pandemic aid. Many states reported their largest-ever surpluses, and many states built their reserves to record levels.

The tax growth has continued into fiscal 2023. A recent analysis of the 15 largest states by Fitch, the debt rating agency, reported that total tax revenues from July through September 2022 grew at a median rate of 7.6 percent year-over-year, with only California reporting a decline. “Sales tax and income tax revenues continued to grow at a healthy pace, driven by the strong labor market, consumer spending and inflation,” the report noted.

Following a basic law of politics, states didn’t stint on returning some of the bounty to taxpayers. The result was that 2021 and 2022 was not only a time of recovery from the COVID pandemic but also a time states contracted a bad case of tax-cut fever.

In 2021, 29 states and the District of Columbia passed some form of tax cuts. This year was even more active, with at least 34 states cutting taxes at some point. I can’t find a count, but several states claimed to have passed the largest tax bills in their history in the last two years. And as the year ends, some states, notably Massachusetts and Montana, already are discussing more tax cuts next year.

Among the many tax cut bills passed, some were either temporary or came in the form of rebates. Other states adopted tax reductions that could make it difficult to replace lost revenue from those cuts and maintain spending levels in a period of rising inflation.

Next year will be the year the tax cut fever breaks, although there will be some lingering cases. Texas, for example, sat on the sidelines this year because of its legislative cycle. As the year ends, state lawmakers have prefiled dozens of bills to cut property taxes. Without an income tax, Texas has property taxes that are among the nation’s highest. Gov. Greg Abbott (R) has said that half of the projected $27 billion state surplus should be used to reduce property taxes. If that happens, it would be — you guessed it — the largest tax cut in state history.

The coming year is shaping up as one of transition — the blahs that come after a fever breaks — or the party ends — pick your metaphor. With high inflation and interest rates, key economic indicators are slowing. Many economists forecast a mild recession toward the end of 2023. As the economy goes, so goes state revenue. But nothing now suggests 2023 will mark a complete reversal of fortune for state budgets. Most states are ready at least for a mild downturn. “I don’t think there’s been a time in history where states are better equipped to ride out a potential recession,” said the Tax Foundation’s Timothy Vermeer in an interview. “A majority, if not all, of the rainy day funds are in a really healthy position.”

But, as a former boss of mine used to remind legislators: “There are thorns among the roses.” The next couple of years will be the test that shows just how well lawmakers gauged their tax cuts, whether they responsibly returned some of their surplus to taxpayers or whether they overshot the mark and set themselves up for a hard landing.

Already in California, with its volatile income tax, the state’s legislative analyst is forecasting a $25 billion deficit. Much hinges on how 2023 plays out economically — not just for California but in all of the states. “The longer inflation persists and the higher the Federal Reserve increases interest rates in response, the greater the risk to the economy,” the California legislative analyst wrote. “The chances that the Federal Reserve can tame inflation without inducing a recession are narrow.” For the most part, tax cut fever is over. It’s time for the states to get back to business as usual.

The Fool’s Errand

Helen Hecht is uniformity counsel to the Multistate Tax Commission.

A lawmaker recently asked me — what’s the biggest problem with our tax system that no one notices? I thought about it for approximately two nanoseconds. Then I said, complexity.

Too obvious? Well, the complexity of our tax system is hard to miss, I grant you, but what it seems like no one notices is that it is, in fact, a problem.

Nonexperts assume the complexity they experience is due to their lack of knowledge, or that taxes are just inherently complicated — like calculus. Experts may know better. But they often fail to call out complexity as a problem due to their own self-interest. Many enjoy it, and most benefit from it. Then there are the economists and academics, who have their own blind spots. And don’t get me started on politicians and their reluctance to fund the agencies that have to make this stupidly complex system work. After all, how hard can it be?

And we also fail to notice complexity’s problematic side effects. Take a recent poll by the Pew Research Center. In it, almost 60 percent of respondents worried “a lot” about corporations and wealthy people not paying their fair share of taxes, while only 47 percent worried “a lot” about the tax system’s complexity.¹⁷ But there’s a fundamental reason why the tax gap for corporate and investment income is much higher than for wages. You guessed it. Complexity.

Or take a recent series of articles in this publication on the challenges of hiring tax professionals.¹⁸ (I can scarcely have a conversation with any practitioner or tax administrator where this problem doesn’t come up.) The author lists several reasons why hiring tax experts is harder now than years past, including, especially, that the needed skill level is rising. And why is that? Again, complexity.

So let’s be clear. Complexity is a problem. It wastes resources. It increases risks for those who simply want to pay what they owe. It favors large, prosperous taxpayers, contributing to disparity and eroding faith in government. And at some point, it’s unsustainable.

I wish I could say we haven’t already passed that point. But we’ve even passed the point where we can just stop making things worse. (Although, yes, let’s do that.) We need policy solutions that will make things better.

In the short-term, here are a couple suggestions:

• Clear thresholds for when state tax will be imposed. This includes factor presence thresholds for business income and days thresholds for when temporarily working in a state will raise tax obligations. The Multistate Tax Commission has models for both.

• Combined filing for corporate income tax. My friends at the Council On State Taxation always talk about how complicated the unitary business principle is. As compared to what? Transfer pricing? Here’s an experiment: Type “transfer pricing jobs” into your favorite internet browser. Then do the same with “unitary business principle jobs.” If there are two options — one that has spawned an entire sub-industry and another that hasn’t — guess which one is more complicated. Again, the MTC has models for combined filing.

But what about the long term? States, practitioners, and taxpayers should continue to work together on policies that address areas of complexity. As it happens, this is often the focus of the MTC’s efforts, including our current work to update market sourcing regulations, assist in the development of a universal power of attorney, address needed rules for state taxation of partnerships, and modernize state sales taxes.

Yes, these are big projects. And yes, some have expressed doubts about how much can be accomplished. But that’s just complexity’s most insidious effect — its very existence implies inevitability. And justifications are always abundant. As one expert commenting on the sales tax project recently put it: “There is no solution to [the complexity]. Our federal system of government precludes it, and short of a federal mandate, which we’re never going to see, it’s a fool’s errand to try, as history has shown.”

Of course, I have to take issue. First, history hasn’t shown any such thing — unless, by “history,” you mean “very recent history.” In which case, “history” has also shown that humans can’t land on the moon and the Dallas Cowboys can’t win the Super Bowl. Second, anyone who thinks the federal government knows anything about tax simplification needs to open up the Internal Revenue Code once in a while. And third, my mama didn’t raise no fool.

But that’s also why I’m OK with low expectations—all the easier to exceed them. And it wouldn’t be the first time that the states, working together, have done that. In fact, they do it all the time. It’s just that, often, no one notices.

A Backward Glance and a Forward Glimpse

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.

As we look back on 2022, it saw employers coping with the tax consequences of a dramatic change in where and how their employees work. Three primary factors contributed to this accelerated development.

First, of course, is COVID. As offices closed due to the pandemic, working from home was often mandated by companies. Not surprisingly, many workers found that there are numerous benefits associated with the new working arrangement, including avoiding time-wasting commutes and expensive transportation costs (for example, rising gasoline prices), frequent interaction with children and other family members, and a more comfortable and relaxing work environment.

A second contributing factor has been technological advancements. A relatively inexpensive home computer, with company-provided software, enables a telecommuting employee to be as connected to data, colleagues, and customers as would be possible while sitting at a desk in an office at corporate headquarters.

Third, the current generation of young workers values lifestyle preferences over traditional career considerations. IT specialists, marketing managers, accounting staff, HR administrators, and so on, can perform their jobs as efficiently from home as in the office. Consequently, a talented individual who wants to fish and hike in Maine can still live in the Pine Tree state and work for a start-up company in California. Or a ski enthusiast can work for a Florida shipping line in the morning and be on the Colorado slopes in the afternoon. This disconnection of work and workplace is historically unprecedented, and it seems likely to be the new normal for a significant portion of the workforce.

The state tax consequences? There are many. For example, companies that relied on P.L. 86-272 as protection from liability for state income taxes may find themselves with filing obligations in multiple states. This federal statute prohibits states from imposing a net income tax on businesses where the sole in-state activity is the solicitation of sales of tangible personal property. However, P.L. 86-272 does not provide protection for in-state activity that exceeds mere solicitation. Consequently, when remote employees perform functions other than sales solicitation, the employer may find itself having established income tax nexus and therefore obligated to apportion income to the state where the remote worker resides and file tax returns with that state. And, of course, there are other state and local taxes to which the employer may become subject, including gross receipts taxes, franchise taxes, and payroll taxes.

At the height of the pandemic, several states provided various forms of relief for employers with telecommuting employees who were encouraged (or required) to work from home. However, many of these filing protections have now expired, and companies find themselves in unfamiliar compliance territory.

Looking forward to 2023, there are two interesting and consequential cases challenging state revenue department overreach, both of which are in active litigation. The first is in Massachusetts, where the DOR has taken the position that the U.S. Supreme Court’s Wayfair¹⁹ economic presence nexus standard can be applied retroactively to tax periods preceding the announcement of the Wayfair decision. The department has issued numerous sales tax assessments to out-of-state e-commerce companies based on this novel retroactivity theory. In a case involving an appeal by a California online auto parts company, the Massachusetts Appellate Tax Board found for the taxpayer and rejected the department’s retroactivity argument. The department appealed that ruling to the Massachusetts Supreme Judicial Court, where oral argument was heard in November, and a decision is expected in early 2023.

The second case involves the California Franchise Tax Board, which published a new regulation reinterpreting P.L. 86-272 to treat the placement of cookies and apps on a customer’s computer, or providing post-sale assistance to customers via the internet or electronic chat, as constituting in-state physical presence by an out-of-state merchant that is outside the protective umbrella of P.L. 86-272 and, therefore, requires the merchant to apportion income to the Golden State (which has one of the highest income tax rates in the country) and file California tax returns. The lawsuit challenging the new regulation was filed by a national trade association on behalf of its members and is pending in California Superior Court in San Francisco. The issue being litigated concerns a potential tax liability for thousands of e-commerce sellers throughout the country.

2023 promises to have its exciting moments.

Observations Made While Updating the Chocolate Turkey Cookie List

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

One of my favorite traditions is sending modest gifts of chocolate turkey cookies to people for whom I am truly thankful right before Thanksgiving. I feel very blessed because The List, which started with just six individuals back in 1998, has expanded exponentially over the past 24 years to include so many of the wonderful folks who have helped me grow my SALT practice. It should not surprise anyone that the vast majority of those on The List are part of our SALT world.

Although just keeping The List current has become a real challenge, it certainly reflects the avalanche of changes in our manner of practice that are crashing around SALT professionals. Here are a few of my predictions about practice changes for the future, based on my observations while updating The List.

The new normal — many SALT professionals are becoming shameless job-hoppers. Based on The List, the clear trend is for SALT professionals is to change jobs at the drop of a hat, and this trend is likely to continue. The most logical explanation for this seems to be a dearth of SALT professionals compared with a growth in the need for them,²⁰ but I can verify that a large number of Listers are currently on the move! Gone are the days of joining a firm or company with the intent to stay there through retirement. Although there was much movement going in all directions, clearly what surprised me was to see how many Listers were moving away from industry to join consulting, law, or accounting firms. When I was a youngster, the goal was just the opposite — to get away from inequitable firm positions where young professionals were paid a fixed salary and the firms worked them death because the firms resold the same services by the hour. Maybe the shortage of SALT professionals is making firms kinder and gentler places to work?

Firms are permitting remote work and saving on rent. During COVID, many firms realized that they could do very well, despite the fact that they were required to send everyone to work from home. Even though the COVID crisis has (somewhat) subsided, many companies and firms are now permitting both their professionals and staff to work hybrid work/home schedules. Many of the Listers who did not make career switches did, however, have changes in office addresses. I’d bet that the primary reason is due to the new remote work environment; that is, why pay for unneeded excess office space? The volume of office moves indicates to me that hybrid remote work is here to stay. This is not good news for landlords of office rental space, because offices once filled by office-only workers are slowing being replaced with cheaper, more efficient smaller spaces as the large leases are coming up for renewal.

Retirees are not necessarily retiring. Although some of my contemporary Lister buddies have truly decided to call it quits, over half of my contemporaries who have officially retired from their SALT positions are simply changing careers. Many large companies and firms have mandatory retirement ages, which I always thought was insane. Why push people out when they have finally reached their prime? Well, it seems that smarter companies without mandatory retirement ages are actively recruiting these remarkable seniors, and, accordingly, second SALT careers among boomers are becoming much more common. Watch out — some of the boomers are going to work in the public sector, too, and are loving it!

Get ready for the big divide. At one of the SALT conferences this fall, I was fortunate to have dinner with an outstanding colleague (who possesses to-die-for credentials) and who was recently required to retire as a partner at a Big Four firm. Of course, I was securing her home address for The List, but, as alluded to above, I don’t think there is much chance that her immense talent will be wasted. Her situation, however, also made me focus on the tsunami that is about to hit the accounting firm world. That is, the European Union is going to prevent some large auditing firms from performing tax return and audit services for the same clients. At least one Big Four firm, EY, has announced its plans to follow suit in the U.S. by spinning off its tax function.²¹ I agree with Tony Santiago, founder and president of TaxSearch Inc., that if EY really does reorganize its U.S. tax and audit functions into separate entities, it “is likely to have a ripple effect on the tax profession.”²²

Actually, it might be more like an accordion effect. Back in 1979 when I started my career at Touche Ross & Co., the largest accounting firms were called the Big Eight²³ and full-service firms were merging, not divesting. Over the next two decades, the members of the Big Eight continued to merge, both with each other and other accounting firms until, by the end of 2001, the Big Eight had become the Big Five.²⁴ Unfortunately, however, the Big Five quickly became the Big Four when one of their number was decertified by the Securities and Exchange Commission in August 2002.

Truthfully, it amazes me that it took 20 years for the Big Four to start this division of tax/audit functions. U.S. external auditing firms governed by the Sarbanes-Oxley Act of 2002 are prohibited from simultaneously performing internal audit, actuarial, valuation, appraisal, bookkeeping, and other financial information services, but the Act stopped short of prohibiting auditing firms from providing all tax services. Whether performing tax services and auditing services simultaneously creates actual conflicts of interest depends on the facts and circumstances (and the provision of such simultaneous services generally requires a company’s audit committee approval, anyway), but a complete separation of those two services will certainly kill the issue. If these audit/tax splits do happen and the pundits are correct, however, they likely will exacerbate the evident shortage of SALT professionals.

Which, from a SALT professional’s standpoint, is terrific news! I think I’ll go celebrate by enjoying (another) chocolate turkey cookie and be thankful that no one is forcing me to retire (yet)! Happy holidays!

Rising Apportionment Issues Ahead for 2023

Alysse McLoughlin is a partner at Jones Walker LLP in New York.

As we head into a new year, the issue that is front and center on my mind, in addition to what will be my cocktail of choice this holiday season, is apportionment.

Lately, some of my most challenging client issues have involved apportionment, including analyzing whether a statutory apportionment method results in distortion, determining where the benefit of a digital product is received, or analyzing whether receipts should be sourced to the location of the customer’s customer. While most of these issues arose in market-sourcing regimes, issues concerning sourcing rules based on the location of the performance of the activity are still relevant in some states. Two decisions from November highlight the continued relevance of the location of the activity issue — the Sirius case from Texas and the Target case from Florida.

For many years we have seen states that source receipts for services based on the location where the services are performed attempt to apply market-sourcing concepts to select taxpayers, generally using one of two rationales — either that alternative apportionment must be used because application of the statutory sourcing provisions do not clearly reflect activity in the state, or that the relevant income-producing activity is the last stage of the process — delivery of the product to the customer — thus resulting in sourcing of the receipts for such services to the location of the customer.

These cases trouble me because taxpayers should have some sense of certainty when they file their returns, and transformation of a sourcing method based on the location of the performance of services to a market-sourcing method during an audit deprives taxpayers of such certainty. States have the ability to draft their taxes as they choose, and it is well accepted that states can choose to adopt market sourcing for purposes of the receipts factor; however, if a state has enacted sourcing provisions that rely on the location of the performance of the activities involved instead of market-sourcing provisions, the state should be required to use those statutorily mandated provisions.

This is what the courts recently confirmed in the two cases. In Sirius XM,²⁵ at issue was the method Sirius XM used to source its receipts from its provision of satellite radio to its customers. Sirius XM is headquartered outside Texas, its shows are produced predominantly outside Texas, and its transmission equipment is located predominantly outside Texas. Sirius used the location of production to source its receipts, with Texas receiving less than 1 percent of such receipts due to the production of one radio show in Texas. The Texas comptroller asserted that such receipts should be sourced based on the location of Sirius’s customers because the services are performed at the location of the customers’ receivers, where the signal for the shows is unscrambled. The Texas Supreme Court previously “rejected the Comptroller’s ‘receipts-producing, end-product act’ standard for determining where a service is performed” and, in November, on remand, the Court of Appeals determined that Sirius could use its cost-of-performance data to prove the location of its service performance.

In Target,²⁶ which involved the proper sourcing of receipts for merchandising, marketing, and management services provided by a subsidiary to the Target parent that operates retail stores nationwide, the Florida court determined such sourcing should be based on the location of the subsidiary’s employees. Fewer than 1 percent of the subsidiary’s 11,000 employees were based in Florida, with almost 95 percent of its employees based in Minnesota. After first determining that the subsidiary’s apportionment workpapers were sufficient to support the use of the cost-of-performance method, the court determined that even if the subsidiary’s workpapers had not been sufficient, the Florida DOR’s proposed method of using location of the square footage of the parent’s stores “bears no relevant relation to [the subsidiary’s] business activity in the State of Florida. The purpose of state apportionment rules is to impose tax commensurate with the taxpayer’s business activities in the taxing state.” The subsidiary performed select services in Minnesota for its parent. That the parent chose to use the services in its retail stores in no way affected the subsidiary’s entitlement to those receipts. The DOR’s proposed usage of the location of the parent’s retail stores “conflates [parent’s] business activity in Florida with [subsidiary’s] business activity. [Subsidiary] is a distinct legal entity separate and apart from [parent].”

I believe that we will see more apportionment issues arising in 2023.

Here’s to hoping that 2023 is a great year for everyone!

A New Year, Same Old SALT Issues?

Amy F. Nogid²⁷ is counsel in the Alston & Bird LLP New York office.

Another year has flown by and it’s time to take out my crystal ball to predict what we may see in 2023 from a SALT perspective.

I dusted off last year’s predictions, and the prominent (and very predictable) issues that I envisioned in 2022 — nexus, apportionment, and local taxes — did indeed take center stage. I predict that those issues will continue to play a leading role in 2023, perhaps with some interesting twists. The significance of apportionment as a nexus determinant will likely grow as states and localities aggressively deem their jurisdictions to be the benefit-received situs.

Attributional look-through nexus may also take a prominent role, and state courts will continue to be tasked with grappling with nexus for sellers using platforms; that is, will the marketplace facilitator’s unilateral decision to transfer inventory into a particular jurisdiction trigger nexus for the seller? To date the courts seem split, and, perhaps, the U.S. Supreme Court will be asked to weigh in on the issue as it intimated it might do in Ford Motor.²⁸ In Ford Motor, a due process case, the majority opinion written by Justice Elena Kagan suggested that the hypothetical “retired guy in a small town” in Maine who carves decoys that he sells over the internet might not have established jurisdiction in the states into which he sells his decoys if his activities are isolated and sporadic, even though he purposefully availed himself of the states’ marketplaces.²⁹

The SALT cap and the passthrough entity taxes remain part of the landscape and will likely stay with us in 2023, with litigation over credits a possibility. As remote work continues to be the norm for many workers, the issues generated from such arrangements will also continue for individuals and their employers. The convenience of employer rule is still with us in a small handful of states; but New Jersey has not yet sued New York as I predicted, and the U.S. Supreme Court has still not considered the issue. Courts in Ohio have addressed the issue in the context of H.B. 197, with varying results. Perhaps 2023 will bring some closure to the issue; my prediction is that the court of last resort will hold that nonresidents of Ohio cannot be taxed on work performed outside the Ohio localities, but Ohio residents will not fare so well.

We may finally get some guidance from the Court on the scope of the federal Disposition of Abandoned Money Orders and Traveler’s Checks Act in the consolidated cases of Delaware v. Pennsylvaniaand Arkansas v. Delaware (commonly referred to as the MoneyGram case), which pits 30 states against Delaware for the right to claim uncashed agent check money orders, agent checks, and teller’s checks. The Court may opt to split the baby on this one, with Delaware having the right to hold teller’s checks lacking owners’ addresses, but the other states having the right to hold the agent check money orders and agent checks. Since so little unclaimed property remitted to states to hold for owners is ever claimed, states tend to view unclaimed property as a revenue source.

Fortunately, my 2022 prediction that expansion of False Claims Act provisions to cover taxes did not (yet) come to pass, but 2023 may herald some unwelcome changes. Likewise, the global changes I thought might occur have been slow in coming, but states are continuing to consider adopting worldwide combined reporting.

In 2022 we saw many state and local revenue agencies struggling to retain seasoned auditors, particularly in states or localities where remote work is not provided as an option. These challenges are likely to continue in 2023, adversely impacting tax administration.

Finally, given the state of the global economy, some states may struggle with revenue issues. We all know what that means — aggressive tax administration and new taxes and fees. This is one prediction, however, that I hope does not come to pass.

Wishing all in the SALT community a wonderful 2023! May the Force be with us in 2023 (and always).

The Future of Telecommuting and State Taxes

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

Coming out of the COVID pandemic (we’re out of it, right?), one of the major SALT issues surrounds telecommuting. More specifically, the question of how and where a remote worker should be taxed is taking center stage as remote work becomes the new normal in many industries. Historically this wasn’t that big of a SALT issue, since remote work wasn’t the norm for most white-collar workers. And a handful of states, most famously New York, had in place what was for a time considered a controversial “convenience of the employer” rule, where days worked at home were treated as days worked in the taxpayer’s employer’s state in most circumstances.³⁰ But this issue was somewhat limited to New York, given the prevalence of commuting from neighboring states like New Jersey and Connecticut, and because of New York’s aggressive enforcement of its convenience rule. And for the most part, after New York’s highest court sustained the application of the convenience rule despite arguable constitutional infirmities,³¹ the remote-work issue hasn’t been all that prevalent in state tax circles.

But when COVID hit, and millions of Americans retreated to all sorts of places to work, the question became paramount for pretty much every state. And oddly, as is often the case in our wonderful world of state taxes, some states went one direction and others went in the exact other way. States like Massachusetts imposed rules that essentially amounted to temporary convenience rules,³² sourcing days worked by remote workers out of state to the location of the in-state employer. But other states went a different direction, such as Delaware, a state that historically had a convenience rule like New York’s, but for some reason suspended its application during COVID.³³ This led to a mishmash of rules, with some states following physical presence rules that treated work-at-home days as days worked in the employee’s home state, while other states imposing convenience-type rules sourcing work-at-home days to the employer’s state.³⁴

Thankfully, most of these temporary rules have gone away, as COVID-related states of emergency have ended in most states. So while we’re back to only a small handful of states with convenience rules, how will other states react now that remote working has become so normalized? Even New Jersey, which historically acquiesced to New York and allowed its residents a credit for New York taxes on convenience days, has jumped into the game, proposing legislation that would create a convenience rule on a reciprocal basis if the employee worked or lived in a state that also had a convenience rule.³⁵ This is a move Connecticut took in 2019 after a decades-long battle with New York on double taxation that was resulting for Connecticut residents under New York’s convenience rule.³⁶

So as the calendar turns to 2023, we will see how states adjust to the new normal around remote work, and whether there is a push for more convenience-type rules in various states. Also in 2023, we may see state tax appeals agencies or courts jumping into the fray, particularly with New York’s recent push to enforce its convenience rules to COVID-related remote work. Indeed, Professor Zelinsky — one of the taxpayers who unsuccessfully challenged New York’s convenience rule two decades ago — has revived his quest to invalidate the rule on constitutional grounds, with a new appeal in the New York Division of Tax Appeals for the 2019-2020 tax years.³⁷ This may be one of several cases where taxpayers test the limits of the application of the convenience rule, and we can expect many state agencies (and taxpayers) to be watching these developments very closely.

Where Do We Go From Here?

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.

End-of-year pieces in combination with the next year’s prognostications cannot only be difficult to pen but also difficult to believe.

2022! Yet another unbelievable year in all of our lives, SALT being no different. Continuing with the fallout from the 2018 Wayfair case, state tax policy on a national scale continues to move at a breakneck pace. Who would have thought P.L. 86-272, something that’s been around since before I was born, would take center stage again in the SALT policy arena? SMH. And yet it continues and will do so, I suggest, far beyond 2023.

And let’s not forget the herculean efforts by Maryland to take the taxation of the digital world to new and unprecedented levels. This could be the tax practitioner community Holiday gift that keeps on giving year over year if the battles fought so far in Maryland are any indicator of what is to come as this policy shift continues, which it will. Lest we SALT policy wonks forget; it took decades to end up with Wayfair’s dismantling of the physical presence standard for SALT purposes. Regardless of how the Maryland actions come down, this is something we will see more of each year hence.

And what of the Big Four accounting firm trend to bifurcate their operating firms into stand-alone consulting (read: tax) and auditing firms? This is a huge, almost seismic shift in the SALT community and will put great strain on the talent pool both for consulting firms (accounting firms, law firms, specialized tax firms, etc.) but also on corporate America. The Big Four have served a primary role in training each generation of SALT practitioners, and now with these impending splits, coupled with an extremely challenging labor dynamic brought about in part by aging baby boomers, look for continued challenges in recruiting, hiring, training, and retention of the next generation’s SALT professionals.

And what to become of the federal judiciary’s role in SALT policymaking? The tremendous scope and scale of additions to the federal judiciary brought about by the Trump administration — generally more conservative than less, generally more strict constructionist than less, generally more focused on the Constitution rather than statutes — I expect will lead to much more SALT dispute resolution in the federal courts. This door could swing both ways, at first assisting the business community in having a fresh avenue for dispute resolution rather than what some may suggest are generally pro-government state-level tribunals, but also leading to fresh thought and a harking back to the words of the Founding Fathers in the Constitution, as applied in 2023 and beyond.

And finally, let’s remember our SALT colleagues who left us during 2022, respect their contributions to our fairly small community, and try to pay it forward in a way that would make our departed colleagues proud to have devoted their life’s attention to our world. Happy New Year!

A Preliminary View of the State of the State: The Pandemic Hits Home

Kathleen K. Wright is the director of the SALT program in the School of Taxation at Golden Gate University, San Francisco.

Recovery From the Pandemic and Inflation Woes: The State

The first prediction of the fiscal future of California has been released by the Legislative Analyst’s Office (LAO). This is a nonpartisan government agency that has provided fiscal and policy advice to the California Legislature since 1941. The office was founded when the Joint Legislative Budget Committee appointed the first legislative auditor on October 8, 1941, to assist with the state budgeting process. To meet that goal, the LAO publishes a fiscal outlook in anticipation of the budget process that begins in January — when the governor presents his formal budget to the Legislature. The fiscal outlook is intended to assist the Legislature with developing the 2023/2024 budget.

The LAO’s 2023/2024 fiscal outlook was released November 16 and it was shocking. The report projects that the state faces a $25 billion deficit, which appears to be ongoing. This compares with a budget surplus of $52 billion in last year’s fiscal outlook. So what happened to trigger such a dramatic shift in the state’s outlook?

The LAO report indicates that the budget problem largely results from lower revenue estimates, which are lower than budget act projections from 2021/2022 by $41 billion. Corporate tax revenue is projected to decline approximately $6 billion from the projection in 2021/2022 and personal income tax is projected to decline $13 billion.

The outbound trend. The financial impact of the migration of businesses and workers out of the Golden State is finally reflected in the revenue estimates. Although the fiscal outlook does not discuss this impact on projected revenues, it is apparent in the numbers reported so far in the state controller’s cash receipts and disbursements report for October. The report shows that corporate income tax collections from July 1 (beginning of the fiscal year) through October 31 is $4,322 million compared with the same period in 2021 of $4,815 million. The controller’s report shows that the personal income tax collections for July 1 through October 31 is $33,278 million compared with $36,504 million for 2021.

Inflation and spending. The LAO report concludes that the large interest rate increases that have continued throughout 2022 are having the intended effect of slowing down the economy — seen most directly in the housing market. Increased borrowing costs have priced many homebuyers out of the market with the result that home sales have dropped by one-third compared with last year. The slowing of the economy has impacted state tax collections, which are weaker than 2021. Virtually all of the shortfall is in the personal income tax, which generally accounts for three-quarters of the state’s general fund revenue.

The majority of the personal income tax comes from a relatively few high-income taxpayers, whose incomes are impacted by fluctuations in stock prices and other capital investments. The stock market has taken a beating from the Federal Reserve’s sharp increases in interest rates and the windfall that California sometimes encounters from capital gains (taxed as ordinary income under California law) has not materialized. This factor alone has a significant impact on revenue collections.

So what should the California Legislature do? The Legislature must pass a balanced budget before the end of the fiscal year (June 30). If the state has a budget problem, then it has several tools to assist with the resolution.

According to the LAO report, the primary budget tool is the state’s reserve. If the reserves are insufficient to deal with the budget problem, then other tools the Legislature has at its disposal is to cut expenses or increase revenue.

Drawing on reserves. The LAO report recognizes that the balance in general purpose reserves (which could be allocated to general fund programs) is about the same as the projected deficit (about $23 billion). The LAO report does not factor in a full-scale recession, which could easily occur as a result of the Fed policy to raise interest rates to curb inflation. If this occurs, then the existing reserves would not be sufficient to cover the budget shortfall. Further, the LAO warns that the reserves should be kept intact to cover a much larger budget gap that might develop.

Raising revenue. That leaves the state with the option of raising revenue or cutting expenses (or some combination of both). It does not look like the voters have an appetite for increasing taxes (at least on individuals) based on results from the November election.

Proposition 30 was defeated by a wide margin (42.3 percent to 57.7 percent). This ballot measure would have required wealthy Californians to pay an additional 1.75 percent in personal income taxes on annual earnings above $2 million starting in 2023. The revenue collected from this additional tax would have supported zero-emission vehicle programs and wildfire response and prevention efforts. Eighty percent of the revenue would have been used to help individuals, businesses, and governments pay for zero-emission vehicles, as well as to install and operate charging stations. The voters just did not want another layer of tax regardless of the motive behind the initiative.

Reducing spending. That leaves cutting spending — never a popular remedy with a Democratic state government.

Recovery From the Pandemic: The Local Economy

Not only is the state in potential financial trouble, so are the cities. California is a melting pot of ethnic diversity and cultures that live together in an equally diverse aggregation of rural small towns and bustling big cities. San Francisco stands out as a city that has experienced significant changes (not all for the good) as a result of at least one outcome associated with the pandemic, and that is remote work. San Francisco is heavily dependent on a large technology and professional services sector. These jobs can in many cases be done from home, eliminating a commute of over an hour each way to and from the city. Office vacancy rates are at 24 percent (compared with 5 percent in 2019). Small businesses are struggling to stay open, evidenced by For Lease signs in one storefront after another. Taxable sales have declined by more than 25 percent, according to the controller’s office. The office has also estimated that property tax revenue could be reduced by between $100 million and $200 million annually.

Over a year ago Mayor London Breed announced a downtown recovery plan that included a series of performances and events, downtown community ambassadors, and improvements to beautify and reactivate key public spaces throughout downtown and Union Square, and welcome the return of downtown employees and visitors. This did not come together as quickly as thought and downtown shows only modest signs of recovery.

In summary, the rosy picture that the state faced last year with huge budget surpluses is now long gone. Belt-tightening and a recession may be what we can expect for the next three to five years. The fiscal year 2023/2024 could be a bumpy ride.