Tax Notes logo

Farewell 2019, Hello 2020!

Posted on Dec. 16, 2019

This installment of Board Briefs asked Tax Notes State Advisory Board members to bid farewell to 2019 and say hello to 2020 by identifying pertinent issues for both years.

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. 

‘Loose Ends’ From 2019 Will Drive Agenda in 2020

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. In 2015 she was appointed to the California Board of Accountancy, which regulates the licensing and practice of CPAs.

Gov. Gavin Newsom (D) was sworn into office as California’s governor on January 7, 2019, and from that point forward, the fiscally conservative policies of former Gov. Jerry Brown were retired, and a new era of progressive liberal policies became law in 2019. This article summarizes the most noteworthy legislation signed into law in 2019 that has the potential to be a game changer in 2020.

S.B. 78: Healthcare

Although Congress was successful in repealing the penalty on individuals who do not have health insurance, California residents will again be subject to the penalty as of January 1, 2020, as a result of enactment of the same penalty by the state. This is because of the enactment of the California Individual Healthcare Mandate to be administered by the California Health Benefit Exchange and the Franchise Tax Board.

Under the Affordable Care Act, an individual was subject to a penalty for failing to maintain minimum essential healthcare coverage for each month of a tax year beginning before January 1, 2019. (IRC sec. 5000A; reg. 1.5000A-1.) The penalty (referred to as a shared responsibility payment) was reported on the individual’s income tax return for the year. With the enactment of S.B. 78,1 California residents will continue to be subject to an almost identical penalty if they fail to have health insurance coverage.2 S.B. 78 does not include employer penalties (although the employer penalties remain in place under federal law).

Perhaps the most significant impact of this legislation on California residents and businesses is the increased subsidies offered under the program. Under the federal program, financial assistance was provided if household income was at or below 400 percent of the federal poverty level. California will provide subsidies to California residents with household income at or below 600 percent of the poverty level. California’s program will be more expensive than the federal program, and there are no provisions in the bill to finance the increased cost (except the penalty assessed for not having health insurance). Subsidies will, however, only be provided through coverage year 2022.

This bill brings with it tax reporting requirements on the individual receiving the subsidy and on employers that must report the coverage provided for their employees for the prior calendar year.3

The financial impact of this legislation is worth watching in a state where we have the highest personal income tax rate and some of the highest sales tax rates in the nation.

A.B. 5: The Gig Economy

Work relationships have never been easy to classify. Prior to the California Supreme Court decision in Dynamex Operations West Inc. v. Superior Court of Los Angeles4 (Dynamex), and then A.B. 5,5 a worker could be classified as an independent contractor for one purpose and an employee for another. Different tests were used to determine employment/independent contractor status under the wage and hour laws, coverage under employee benefit plans, and federal/state income and employment tax purposes. The California Supreme Court decided in Dynamex that it was time to simplify the test used for this purpose (from a multifactor test to a three-factor ABC test) and place the burden of proof on the hiring entity to show that the worker was not meant to be covered under the wage and hour laws of the state.

This much simpler (albeit more onerous) test was codified in A.B. 5. The new statute expands the scope of the test stating that it applies under the Labor Code, Unemployment Insurance Code, and certain wage orders of the Industrial Welfare Commission. The ABC test states that it is up to the hiring entity to prove:

  • the worker is free from control and direction of the hiring entity in connection with the performance of the work under the contract with the worker and in fact;

  • the worker performs work that is outside the usual course of the hiring entity’s business; and

  • the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Every business in California sought to be included in an exception to the new standard, and the result is a patchwork of exceptions that include (in summary):

  • professionals licensed under the Business and Professions Code (think doctors, lawyers, accountants, and so forth);

  • select professional services6 if the service provider has their own business location, sets their own rates, sets their own hours, has other customers, and exercises independent judgment in providing the service;

  • businesses providing services to another business if certain tests are met;

  • select subcontractors in the construction industry;

  • select referral agencies7; and

  • select motor clubs and third parties that provide motor club services.

On September 11, 2019, a class action lawsuit was filed against Uber stating that Uber is now in violation of the law by refusing to reclassify workers as required by A.B. 5. Anticipating the pending financial disaster that could accrue if ride-share companies such as Uber and Lyft are required to reclassify their workers as employees, reimburse the driver expenses, comply with all wage and hour laws in the state, and provide unemployment and workers’ compensation insurance, several companies (including Uber and Lyft) filed an initiative with the attorney general’s office to appear on the ballot in November 2020.8 The ballot measure calls for app-based drivers to be independent contractors, not employees or agents, thereby overriding A.B. 5, signed in September 2019, on the question whether workers are employees or independent contractors.

This tempest in a teapot will certainly continue to garner headlines as the saga continues into 2020. The result of the worker classification issue has already put some app-based start-ups out of business and Uber’s financial condition is still struggling. (Uber reported revenues of $3.16 billion on losses of $5.2 billion for the second quarter of 2019.)

A.B. 147: Use Tax Collection

California was a little late in the game of enacting legislation to conform to the U.S. Supreme Court decision in South Dakota v. Wayfair Inc.,9 which held by a 5-4 majority that states may charge tax on purchases made from out-of-state sellers, even if the seller does not have a physical presence in the taxing state. Although the South Dakota statute required collection of the use tax by the out-of-state vendor if the total sales sourced to South Dakota exceeded $100,000 or were comprised of more than 200 transactions, California (a much larger state) opted for a single statutory threshold of $500,000 of sales of tangible personal property, effective April 1, 2019.

The decision in Wayfair is a game changer for all states, with state governments looking ahead to estimate how much incremental revenue will result from this policy change. California’s statute is noteworthy as it is one of the few states not to enact a “transactions threshold.” The business community was thankful for this small favor as that aspect of the test was what began to look like a real hornet’s nest.

A.B. 91: Conformity to TCJA

California was also late in the game with respect to enacting legislation that conformed to the Tax Cuts and Jobs Act,10 which was signed by the president on December 22, 2017, and largely effective as of January 1, 2018. California’s conformity legislation11 was sparse, picking up only a handful of provisions, and as a result, California taxpayers face a daunting list of nonconforming provisions and related complexity. Further, the bill was not typical of what we have seen in the past. The bill did not roll forward California’s date of conformity, which remains at January 1, 2015. This puts California’s conformity date way behind that of most other states, and leaves taxpayers (and their tax preparers) with a significantly increased workload. Hopefully, the Legislature revisits conformity legislation in 2020 and considers many overlooked federal changes that would not be that costly for the state yet go a long way to simplifying the tax preparation process.

The Digital and Tax Landscape

Sally Wallace

Sally Wallace is dean of the Andrew Young School of Policy Studies at Georgia State University.

To say that our world is changing rapidly — due to innovations around data, the Internet of Things, artificial intelligence, and other new technologies — is a colossal understatement. This changing landscape affects how people consume, work, and interact; how companies produce and evaluate success; and how the public and nonprofit sectors provide for their constituencies.12 Many of these changes in behavior will affect taxation in the short, medium, and long term. Tax policymakers, tax practitioners, and researchers have a unique moment to better understand and shape the impact of the future of work, production, and consumption on public finance.

There are numerous forecasts of the impacts of AI on the future of work and life. The intuition of these analyses is straightforward. Just as past workplace revolutions (agriculture, industrial, and computerization) affected the types of jobs and skills required to keep our economies working, to date, the digital revolution has been doing the same largely in the form of automating and computerizing routine tasks. The next steps in the current “revolution” may be in the speed of change, the type of change (computerizing cognitive tasks), and the prospect for furthering the significant polarities in the distribution of access, opportunity, and income. Economist Carl Benedikt Frey and Michael A. Osborne, professor of machine learning at the University of Oxford, note that three bottlenecks stand between the status quo of economic disruption and truly exponential change.13 These bottlenecks are processes that are not yet engineered and computerized: perception and identification, creativity, and social intelligence. And these processes are heavily used in the service sector.

With the bottlenecks still largely in place, Frey and Osborne estimate the probability that a particular job is at risk based on how much the job depends on the three bottlenecks. In their analysis of 702 occupations, they estimate that 47 percent are at high risk of automation. Most authors note loss of jobs to automation does not necessarily mean a symmetric loss of employment. Labor can be a complement to AI — with some retooling and other forms of investment in human capital.14 Complement or substitute, the future for human employment, earnings, and consumption is likely to be more service-sector-oriented than today.

How does this affect tax policy and administration? Service sector compensation can be more difficult to reach via traditional forms of voluntary tax compliance and audit because the tax handle is small. A capital/labor shift and the ubiquitous nature of digital commerce in the economy could increase the sophistication of base erosion and profit shifting. 15 A shift toward AI could put payroll taxes at a disadvantage.

There are other changes to the tax base we can anticipate in the AI future. And we have been through this before. Moving from agriculture to manufacturing to a service-based economy significantly changed the flavor and location of value added, profits, compensation, and consumption. Tax bases grew and shrank depending on the economic activity of the generation (states that do not tax services are still grappling with the shrinking taxable consumption base). AI and the digital world could further erode the consumption tax base as more transactions occur online (complicating tax nexus and reducing tax handles). Income and consumption tax bases are at risk as data grows as a commodity that fuels markets, adds value, and is difficult to tax; interest and experimentation in hard-to-track cryptocurrencies grows; and we learn how to access and tax the value added of AI itself.

The technologies bringing us some angst about the future of taxation also bring us unique tools to understand and affect that future. Data footprints provide information on location, consumption, and other activity that may lead to more precise (and potentially less expensive) auditing techniques. These data can also be helpful in finding noncompliant business through tracking online transactions. Businesses have made use of AI to reduce their cost of compliance as it is harnessed to classify transactions, track and log expenditures, and perform automated checks on tax return filings. The sharing-economy services, including Uber and Airbnb, are adapting platforms and data sharing to reduce the cost of complying with tax authorities across the globe. For individuals, submitting tax returns via online systems continues to grow as taxpayers adapt to more user-friendly software that can increasingly engage with taxpayers in an online setting, saving time for taxpayers and tax administrations.

The amount of data available coupled with machine learning and other predictive techniques doesn’t change the questions we ask, but provides the opportunity to answer the questions more thoroughly than before. Machine-learning tools can be used to produce more robust forecasts of revenue using unique information regarding economic activity at the business and individual level by finding relationships among data that were previously unknown. Prediction of taxpayer behavior (compliance and noncompliance) can be improved with use of bigger data and advanced empirical techniques. Even the usage of public funds at all levels of government is more widely available to constituents, increasing the accountability of the public sector.

The digital world presents challenges and opportunities in the public finance space. An economic base that is grounded in hard-to-tax value added, the digitization of transactions, and the increased use of AI in production could make it difficult to assign and collect traditional income and consumption taxes. At the same time, tax administrations have an unprecedented amount of data and analytical tools to elevate their ability to carry out their obligations. It is time to grapple with these tensions in the tax space. Is a digital tax in our future? Generally, taxation of a specific industry is a bad idea and is done in frustration over a complex system (corporate taxation) and a complex landscape (the digital world). For corporate taxation, the march of the digital world is just the newest issue in a long line of concerns over base erosion and profit shifting. A digital tax is likely to be a short-term band-aid as our economies continue to grow in the digital space. Coordinated reform along the lines of the OECD’s work could reduce the fears of further tax revenue erosion. There are local tax issues to grapple with that could be more manageable, including serious reform of consumption tax basis. These are not new reform suggestions, but the exponential growth of the digital sector may move more tax policymakers to action.

Wow — We Are Living It!

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.

Dare I say that after more than 30 years of private practice in tax, especially in state and local tax matters, over the last 12 months (and likely for the coming 12), we have seen a complete shift in paradigm as to what matters in SALT, what’s important, how it happened, and the consequential effect of each. 2019 was a challenging year in state tax matters, and 2020 looks to be no different.

Let’s start with issues affecting compliance — marketplace legislation and compliance was front and center during 2019 after the Wayfair decision. Taxpayers scrambling in virtually every corner of the country to understand how to comply and then take the steps — some simple, some not so simple — to comply. And this process continues and will continue into 2020.

Why is the marketplace legislation so critical to taxpayers? Because of the ever-continuing challenges facing taxpayers for being out of compliance in sales and use tax matters. There are qui tam and private attorney general actions, whistleblower-type actions like we have seen in New York, or perhaps the plethora of consumer protection claims via class action lawsuits for overcharging or undercharging sales and use tax. It’s a completely new world in terms of collecting and giving “that which is Caesar’s unto Caesar.”

Let’s not forget about business taxes and corporation income tax. Post-Wayfair, the next chapter in these taxes seems to be the narrowing, if not virtual elimination, of P.L. 86-272 protection. Granted, the public law was created as a “temporary” fix, but come on, after several generations, even a temporary law has to become a bedrock principle of SALT law. It has been under attack and will continue to be attacked in 2020.

Mandatory combined reporting has continued its turtle-like path, with a couple more states (Kentucky and New Jersey) added to the list of states imposing mandatory combined unitary reporting. So many states are using this that now more than 50 percent of the jurisdictions imposing a corporation income tax use mandatory combined filing. I suggest what was once primarily a West Coast concept has been “normalized” across the Midwest and into the Southeast. We can expect more of this in the coming year during the legislative season.

When times are good, as they have been over these past many years, enforcement action by state revenue departments seems to take a back seat to policy and legislative initiatives. While no one can predict a recession, all who operate in the world of SALT can agree that a recession is coming, and the only variable is when. When it happens, look for the tried-and-true path of state revenue departments to step up compliance efforts for no reason other than tight budgetary situations in their respective state.

Finally, with 2020 being a presidential election year, state tax issues will again be front and center. Whether it is red state/blue state policy differences, such as the $10,000 federal tax deduction cap on SALT, or some other federal legislation that greatly affects the respective states for fiscal and tax policy purposes, look for more dialogue at the national level on policies and initiatives that directly affect or simply trickle down to the local level in a manner that creates significant consternation and concern.

Writing columns like this is always a fun effort for those of us who make our living in this space — perhaps next year, Tax Notes State will take a look back at the multiple predictions in this edition to see how all its columnists scored as to their forecasts in reading the tea leaves. Here’s to a great 2019 and an even better 2020 in matters of state and local taxation!

Looking Ahead to 2020

Arthur R. Rosen

Arthur R. Rosen is a partner in the state and local tax practice at McDermott Will & Emery.

The editors of Tax Notes State — in sympathetic acknowledgment of 2019 having been my 45th year playing in the state and local tax mines — have graciously allowed me to share my thoughts from a more high-level, nontechnical perspective than they are likely expecting from my fellow contributors.

I wish to sound the alarm, in a manner similar to the warnings being sounded concerning global climate change, in response to the increasing danger being posed by unbridled state executive branch agencies, specifically state revenue agencies. This threat is a result of:

  • the co-equal government branches (the judiciary and the legislature) routinely abdicating their powers to the revenue agency;

  • the lack of a truly independent review of agency action by the state judiciary; and

  • agencies’ focus on raising revenue rather than on exercising balanced enforcement of legislative enactments.

Similar to the flooding we may soon see in coastal areas, the erosion of a properly operating tax appeals system undermines tax systems that have been showing signs of stress for decades. But like certain cities’ ambitious plans to protect their coastline from rising water levels, the distressed state tax systems can be reversed and the systems protected if enough stakeholders act promptly.

The lack of pathways to a truly independent judicial forum was, unfortunately, calcified this year. Joel Hyatt, the individual taxpayer in Franchise Tax Board v. Hyatt,16 was initially successful in utilizing the Nevada court system to have his tort complaints fully heard by tribunals that were not part of the same system (the California government) as the party against which he had filed his complaint (the FTB). Ultimately, however, the U.S. Supreme Court concluded that the principles of sovereign immunity were paramount and, consequently, that the California government could not be subject to the jurisdiction of a sister state. Another example of a failed attempt to get an independent judicial review of a state tax imposition was Crutchfield Corp. v. Harding,17 in which the taxpayer was seeking an independent review (by a Virginia court) of an action taken by Massachusetts.

The bottom line: Since state courts are overwhelmingly (embarrassingly?) protective of their own executive branch agencies, those agencies are now feeling freer than ever to expand their impact beyond traditional perimeters.

But what indications are there that state courts do not apply the law in a fair-handed, objective manner when policing their taxing agencies? Three recent examples dramatically demonstrate this. In Steiner v. Utah State Tax Commission,18 the state court blithely decided not to apply dormant commerce clause principles to a foreign individual; the court reached this result even though the U.S. Supreme Court made clear: (1) in Comptroller of the Treasury of Maryland v. Wynne 19 those principles do apply to an individual engaged in interstate commerce, and (2) in Japan Lines v. County of Los Angeles,20 if a dormant commerce clause principle applies in interstate commerce, it applies — a fortiori — in foreign commerce. Similarly, the New York courts in Edelman v. New York Department of Taxation and Finance and Chamberlain v. New York Department of Taxation and Finance21 were somehow able to “keep a straight face” (at least on paper) when concluding that dormant commerce clause principles, such as internal consistency and external consistency, do not apply to individuals — the tax world had thought this issue was fully settled by the Court in Wynne. Further evidence is found in the somewhat older cases of Equifax Inc. v. Mississippi Department of Revenue22 and Vodafone Americas Holdings Inc. v. Roberts,23 in which state courts condoned the state taxing agency applying a “we have a creative way of getting more revenue from a remote business than the standard statute allows” approach.

Where will this trend likely take hold the most in the near future? For example, applying sales and use taxes to the sale of cloud computing services seems to be a ripe area for state courts (and state legislatures) to abdicate their responsibilities to the executive branch taxing agency. Several states’ taxing agencies have taken the position that the purchaser of a cloud computing service obtains constructive possession of the service supplier’s application software. Each of these states, however, has abundant legal precedent demonstrating that the nature and extent of possession transferred in such situations does not equate to that needed to establish a taxable transaction (since the purchaser cannot access or alter the source code, cannot access or affect the operating system, and cannot access or affect the hardware).24 Can we count on state courts to recognize such clear precedent and rule against their revenue agencies? Based on the examples set forth above, I am not optimistic. Another area of clear risk is application of federal reform to state income tax regimes. Already, some anti-business (that is, anti-jobs) consultants are suggesting to state tax authorities ways to tax IRC sections and global intangible low-taxed income, even if the legislature excluded such deemed artificial income from taxation. If state agencies follow this approach, will state judicial forums correct this course? Again, I’m not optimistic.

What can be done? Taxpayers and taxpayer organizations can increase their efforts of encouraging state legislatures to take back their area of authority and responsibility — to set tax policy. This can be done both through substantive tax legislation (such as democratically making a decision whether or not to impose sales and use tax on purchases of cloud computing services) and procedural legislation (for example, changing the standard of proof in a tax case from the prevalent “clear and convincing” to “preponderance of the evidence” and/or statutorily providing that no deference in statutory interpretation should be afforded executive branch agencies). And, of course, persuading Congress to limit or repeal the Tax Injunction Act and simultaneously affirmatively giving a federal court jurisdiction over interstate tax matters remains the holy grail of independent judicial review possibilities.25 My fingers are crossed.

The 2019 Post-Wayfair World and the Additional Shoes We May See Drop in 2020

Mark J. Richards

Mark J. Richards is a partner with Ice Miller LLP.

Following the Court’s decision in Wayfair,26 the process promptly commenced for how states would pursue this new revenue opportunity. Despite some efforts at uniformity, states predominantly acted on their own, and their disparate approaches on thresholds, timing, and a host of other issues have created a compliance challenge.

One idea that quickly gained traction was the imposition of this new collection/remittance obligation on those deemed to be “marketplace facilitators.” Instead of processing registrations, returns, and payments for numerous remote marketplace sellers, chasing noncompliant remote sellers, and potentially auditing many of them, this new approach was designed to make the “facilitators” do the state’s work — one-stop shopping for the states. And in 2019 we saw a proliferation throughout the country of states individually deciding to impose obligations on marketplace facilitators through legislation, administrative actions, and in a few instances, court cases.27

Unfortunately, as with the disparate state approaches to Wayfair, we saw disparate approaches to imposing these obligations as well. For example, while many states took a narrower view in defining a “marketplace” and a “facilitator,” several states took an extremely broad approach. There wasn’t much appetite to wait for reasoned, model legislation. This “ready, fire, aim” race to create new tax collectors created significant inconsistencies from state to state, as well as uncertainty as to how these rules will be interpreted, thereby creating risk and undoubtedly future litigation.

Looking back, a “facilitator” was not a generally recognized term of art in sales tax parlance before Wayfair. However, with this year’s flurry of action, it is now — although it is subject to many different definitions. This term has taken on a life of its own, not only with its general use with “marketplace,” but in some cases, with “accommodations” and “car sharing.” On the heels of the creation of this new world order in 2018-2019, here is a list of potential, additional shoes that may drop in 2020.

Continued Changes to the Wayfair/ Marketplace Playing Rules

States are likely not done tinkering with these new collection tools. States may revisit what they initially adopted in light of the continuous identification of issues, efforts at a “model approach,” and the development of what appears to be “best practices.” That could be a positive, if it improves and clarifies rules for compliance and creates more uniformity, but of course, it could also include changes that are detrimental to businesses. In any event, this ongoing evolution will require continuous monitoring, adapting, and cost.

Less Friendly Enforcement and Start of Remote Seller and Facilitator Audits

Many states initially took a “friendly” approach to coaxing remote sellers to voluntarily register, and at least one state, Indiana, worked with some of the larger platform “facilitators” on Indiana’s facilitator legislation. But in time, that spirit of cooperation will undoubtedly change with perceived noncompliance, disagreements, and audits. One Indiana Department of Revenue representative (who will remain unnamed) likes to quote Patrick Swayze from the movie, Road House: “Be nice until it’s time not to be nice.” The “not nice” time is approaching throughout the states, and that could commence as soon as 2020. And that might include claims against “responsible officers.”

Spotlight on Specific Issues

This marketplace facilitator trend isn’t just a shift in the compliance cost to the facilitators; this is a shift in the risk as well. Will facilitators have enough information about the seller, the seller’s product or service, or the buyer to know if a transaction is taxable, exempt, or partially taxable? Will the facilitator need to make decisions with the applicable law of a state unclear, such as with cloud computing type transactions? Will the facilitator and the states disagree on where a transaction should be sourced, or will states take inconsistent positions on sourcing? While many laws protect facilitators if the seller gives the facilitator bad information, that protection may not cover several other scenarios. States will want their money and may cast a broad net.

Collecting and Remitting Other Transaction Taxes

Will states increasingly add to the facilitators’ obligations by adding a collection/remittance obligation as to other transactional taxes? After all, a seller doesn’t want its customers receiving multiple invoices for the same transaction, but the more taxes that are added, the higher the cost of compliance, and the risk, to the facilitator.

More Aggressive Approach to Income Tax Nexus?

Finally, will states attempt to apply an interpretation of Wayfair that justifies a more aggressive approach to income tax “economic” nexus? Will states respect the boundaries of P.L. 86-272? In 2019 the Indiana legislature passed a law expanding income tax nexus “to the fullest extent permitted by the Constitution of the United States and federal law,” and the Indiana DOR has not yet expressed its view on what it believes that means. Some lucky taxpayer may find out on audit.

We are living in a time of virtual instant access to information, and with states willing to use that information to move quickly and independently to implement change. There is no reason to anticipate this slowing down in 2020, so hold on for the ride.

From 30,000 Feet Into the Weeds

Richard D. Pomp

Richard D. Pomp is the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law.

In the early days of the internet, no one could have predicted the transformative forces being unleashed that would irrevocably change the essence of our culture. So it will be with artificial intelligence, which may represent even a greater force for change.

In general, AI involves processes that can learn, reason, plan, perceive, problem solve, or process phenomenon imitating human intelligence.

In our world of taxation, the IRS is using AI to predict: the risk of nonpayment, the likelihood of abusive tax returns, underreporting, and nonfiling. The IRS is at work in using neural networks to identify emerging areas of noncompliance. It is using AI to mine personal information posted on social media to identify identity theft and tax refund fraud. No doubt there are other secret uses of AI by the IRS that have not yet surfaced.

A Toronto-based start-up is using AI to predict how courts will resolve legal issues in tax cases. Corporate tax departments are using AI to sift through large volumes of documents to determine eligibility for research and development credits. Litigation firms are using AI in analyzing large-scale data.

And this is just the start, of course.

Descending into the weeds, what can we expect on a more mundane level in state tax in the next few years? We can anticipate a string of cases dealing with market-based sourcing and ambiguous terms like “benefit,” “delivery,” and “use.” We can expect more challenges to the intersection of market-based sourcing and single-sales-factor apportionment, a method no state has adopted because it produces a more refined measure of income attributable to that state — which it does not. There will be a rash of constitutional and “as-applied” challenges and appeals to equitable apportionment.

Hopefully, there will be a rejection of “but for” reasoning by the states that try to take a complicated multistate transaction and look only to the last step — payment by that state’s customer. The states argue that “but for” that payment, there would be no income to apportion, and under single sales apportionment with market-based sourcing, this reasoning can apportion 100 percent of income to a state. These states are oblivious or indifferent to the fact that “but for” all the value added outside that state, there would be no income to apportion in the first place. “But for” reasoning simply proves too much (as it typically does when used to show causality in tort cases).

We should expect more attempts by states to look to the customer of the taxpayer’s customer in assigning receipts, using metrics that do not generate the very income that is being apportioned in the first place.

It will be nice to watch further recognition by the European Union and the OECD that the states came up with a better mousetrap — formulary apportionment — decades ago, rather than arm’s-length accounting.

And we should see more attempts by taxpayers to enter into joint ventures with American Indian tribes, to exploit the somewhat incoherent and bankrupt case law on tribal sovereignty and immunities.

Finally, the gig economy and marketplace statutes will provide us all with work.Happy 2020.

Luckily, I feel confident in making these predictions because no one ever looks back on prognosticators five years later to determine whether they were right or not (a phenomenon that also saves revenue estimators from criticism).

A Lot of ‘Huge’ Audits to Look Forward To?

Timothy P. Noonan

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

As 2019 fades into 2020, we bid at least a temporary farewell to the post-Wynne challenges to New York’s double tax on dual residents. This is, in fact, a personal farewell for me, having represented the two taxpayers who had the courage and fortitude to take on such a noble effort. The taxpayers in Chamberlain28 and Edelman29 argued that New York’s statutory residency taxing scheme, which subjected taxpayers who qualified as dual residents of New York and Connecticut to double taxation, was unconstitutional and in violation of the commerce clause.

The cases, which were covered extensively this past year in this and other publications,30 were grounded in the Court’s 2015 decision in Wynne,31 when the Court made clear the protections of the commerce clause extended to individual income taxes, and that the commerce clause could be used to protect in-state residents from discriminatory or burdensome state taxation. After a long fight through the New York courts, the cases reached their pinnacle this year, getting all the way to the doorstep of the Supreme Court, after our petition for certiorari was filed in June.32 Unfortunately, and despite significant support both from the practitioner community as well as from five outside organizations that filed amicus briefs, the Court denied cert in early October. This leaves intact, for now, what many believe is at least an unconstitutionally discriminatory and burdensome double taxation regime in New York. And long term, the New York decisions could have the more nationwide ripple effect of limiting the impact of the dormant commerce clause analysis applied by the court in Wynne.

As for what’s on the horizon in a 2020 state tax world, I envision audits. And lots of them, particularly in the personal income tax space. One of the least technical but most publicized provisions of the Tax Cuts and Jobs Act was the significant limitation put on a taxpayer’s ability to deduct state and local taxes as itemized deductions. As many blue-state politicians predicted, it has been widely reported that this one change alone has caused many a taxpayer to reconsider their life decisions and seek safe haven in states like Florida, Nevada, Tennessee, or New Hampshire.33 Are such changes merely weather-related?34 Not likely. The near-elimination of the SALT deduction seems more like the straw that broke the camel’s back, leading taxpayers to realize that the best way to limit the impact of the elimination of the SALT deduction is to simply eliminate their SALT all together. We’ve seen this in our own practice anecdotally, and we can expect that 2020 will bring significant enforcement efforts by states like California, New York, Connecticut, and maybe even New Jersey, seeking to audit all those nonresident or part-year resident 2018 returns that were likely filed a couple months ago.

I certainly know of one nonresident tax return that the New York tax department will be especially interested in auditing!35 So as the calendar turns to 2020, a new and potentially explosive audit season could be on the horizon.

New Decade, Same Old Issues?

Amy Nogid

Amy F. Nogid is counsel in Mayer Brown LLP’s New York office.

The views expressed here are hers and hers alone and should not be attributed to Mayer Brown or any of its clients.

It’s hard to believe that yet another year is almost behind us and a new decade is about to be heralded in. Frankly, 2019 does not particularly stand out as a beacon of state and local tax wisdom; few significant tax decisions were rendered, and states have not opted to shift tax policy in any distinctive directions. Instead, 2019 seemed to be a year of catching up, addressing (and modifying) the treatment of the Tax Cuts and Jobs Act for SALT purposes, and puzzling out some of the practical issues of complying with Wayfair for both sales/use and income/franchise taxes.

I keep hoping (they do say that hope springs eternal) that states (including their legislatures, their judiciary, and their tax administrative agencies) will respect taxpayers, each other, federal law, and the U.S. and state constitutions. So, as my toast to the new decade, I offer seven goals to which I hope states ascribe, based on some unfortunate SALT trends seen in this closing decade.

1. Legislatures should avoid enacting any tax imposition statute with anything other than a modest retroactive effective date; administrative agencies should avoid promulgating regulations that have a detrimental retroactive impact on taxpayers; and courts (including administrative agencies and quasi-judicial forums) should not countenance legislative or administrative agency overreaching. Decisions such as Dot Foods Inc. v. Department of Revenue,36 the Michigan compact cases,37 and regulations like 830 Mass. Code Regs. 64H.1.7, Massachusetts’s “cookie” nexus provision, which has a pre-Wayfair effective date, come to mind.38

2. Courts, administrative agencies, and quasi-judicial forums should avoid judicial legislation, particularly since doing so may be contrary to the intent of the legislature and result in a retroactive tax imposition. A couple of recent decisions come to mind: Amazon Services LLC. v. South Carolina Department of Revenue39 and City of Phoenix v. Orbitz Worldwide Inc.,40 which arguably impermissibly stretched statutory language to shoehorn new business models into old legislation, with the effect of shifting tax burdens onto those who had reasonably believed they were not subject to the taxes.

3. Courts should heed precedent and not be cavalier in tossing aside commonly understood interpretive guidance. In the SALT world, the notion that “exemptions” and “exclusions” from taxation require the application of different deference standards, i.e., exemptions are narrowly construed and any doubts as to their applicability are to be resolved in favor of the government, while any doubts concerning exclusions from taxation are to be determined to the benefit of the taxpayer, has been a long-standing staple in New York and elsewhere. A recent New York Court of Appeals decision, Wegmans Food Markets Inc. v. Tax Appeals Tribunal,41 appears to have tossed out those basic precedential interpretational precepts, which a dissenting justice characterized as “a new rule: in New York, the taxpayer always loses.”

4. States should show some respect to the federal government. While states understandably don’t cotton the federal government treading on their sovereignty, they are, however, required to abide by the U.S. Constitution or federal law. Some state legislatures have an unfortunate tendency to avoid federal laws that constrain their ability to impose tax. P.L. 86-272, enacted in 1959, for the purpose of restricting states’ power to subject multistate businesses to a net income tax if the business merely solicits business in the state, is one example in which some states have effectively flipped the bird to Congress. For example, states have expressly denominated taxes as other than net income taxes (think: Ohio commercial activity tax) to avoid the impact of P.L. 86-272. One recent decision, Stanislaus Food Products Co. v. Director, Division of Taxation,42 struck down, on supremacy clause grounds, New Jersey’s attempt to target companies with P.L. 86-272 protection by imposing an alternative minimum assessment just on such companies.

5. States should rein in their municipalities. Companies are in the business of being in business and are not in the business of complying with tax laws. Nonetheless, comply they must. Yet businesses are burdened with a welterweight of federal, state, and local tax laws, regulations, case law, and other guidance. Even inadvertent noncompliance can result in a business being subjected to penalties, qui tam actions, or class action litigation, eating up businesses’ resources and distracting them from building their businesses and earning revenue. The proliferation of home-rule substate jurisdictions and their own imposition of taxes can be particularly troubling to businesses, especially when the locality interprets its provisions differently from the state’s equivalent provisions. While local self-rule may be valuable to a state’s citizens, states should consider ways to streamline compliance and promote consistency to minimize business burdens and maximize compliance.

6. And, states, if you’re thinking of enacting tax qui tam (whistleblower) legislation, please don’t. Since state qui tam legislation has expanded outside its traditional Medicaid/Medicare fraud boundaries and into the realm of state tax, it has mainly benefited relators. Some of those relators are exceedingly prolific in ginning up litigation often in matters that relate not to fraud, but simply to questionable interpretations of the law, including their pursuit of taxpayers that have already undergone audits involving the target issue without change. The states, their attorneys general, and tax departments do not seem up to the task of reigning in relator abuses and appear not to appreciate the enormous costs to defendants to defend themselves from relator assertions, even if meritless. States already have the ability to audit and address legal issues and enforcement mechanisms to pursue fraud. The intercession of mercenaries into the process undermines revenue departments’ role of administering and enforcing the tax law.

7. One of the biggest games long played by states is “How to Shift Our Tax Burden to Out-of-State Companies.” The shift by many states to a single sales factor to apportion income is one example. Unitary combination (forced via discretionary adjustment provisions or mandatory), often employed to target multijurisdictional businesses, is another. Fairness, as required under the due process clause, and the commerce clause, including the four prongs of Complete Auto Transit Inc. v. Brady,43 should, however, not be given short shrift by state revenue departments. Corporate taxpayers do not appreciate hearing: “You’re a big company; you can afford to pay the tax.” Remember, your corporate “citizens” may be out-of-state companies in other jurisdictions.

As we march into the next decade, regardless of which side of the aisle we hail, may we all strive to make the SALT world a better place.

Much Ado About Nothing (Taken With a Grain of SALT)

Janette M. Lohman

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

My predictions for the year 2020 may appear to have a Shakespearean flair, so I submit my apologies to the late, great Bard of Avon, albeit posthumously. His comedies were the best and generally had a happy ending. Some current state and local tax antics by state Departments of Revenue, however, may give Shakespeare a run for his money (or rather, a run for yours), and no happy endings are in sight.

In the beginning of The Tempest, Prospero magically conjured up a perfect storm to victimize a few shipwrecked stragglers. This is highly analogous to the U.S. Supreme Court’s actions in Wayfair. In one fell swoop, SCOTUS dramatically eliminated 50 years of “substantial, actual physical presence nexus” precedent, thus placing every tiny web-based business in financial peril under the new “economic nexus” standards, which vary widely among the states. I predict that this situation will continue until Congress decides to act.

Over the past several years, poor, unfortunate entrepreneurs and other relatively tiny taxpayers are facing the costs of the now “annual” sales tax analyses and the ever-increasing compliance costs for up to 45-plus states, which together may, in fact, cost more than the taxes they owe, particularly in the “early years.” Every potential sale of even the smallest businesses will require economic nexus due diligence, not only for sales/use taxes, but also for income taxes. For instance, I recently prepared a 45-plus state sales and use tax computation for the owner of one such small business in anticipation of the owner selling his company. He was terrified of his potential Wayfair liability, given that his company was only compliant in his home state. My analysis concluded the amount of taxes his company owed in just two other states under the new and varying economic nexus standards was less than the cost of my tax calculation services. As some of the Wayfair amici aptly noted at the time this decision was handed down, most of the really big internet sellers were already compliant with their sales and use tax obligations in most states. So, what is left? And will the revenues collected from similarly situated tiny taxpayers make a noticeable difference in state revenue collections? I seriously doubt it, but time will tell.

Speaking of confusion, trickery, and misdirection of Shakespearean magnitude, the increasing popularity of states asserting “economic nexus” for income tax purposes seems to have energized state revenue departments to perform politically correct income tax audits of out-of-state service providers with little or no actual or economic nexus, and as a bonus, at a completely disproportionate compliance cost to the taxpayers. This is another trend, and I predict it will continue until states realize this tactic causes “much ado about nothing” for them. For the victimized taxpayers, however, we return to the Tempest.

A few weeks ago, at the Hartman SALT Forum, many of my colleagues were complaining about states going after out-of-state services partnerships (that is, brokerage firms, consulting firms, law firms, accounting firms, other professional services firms, etc.) for income tax purposes. These businesses have no actual physical presence, offices, or employees in the attacking states, and many professional service firms cannot even solicit business in them because they have no partners licensed to practice there. How did the state auditors find them? Primarily through their websites!

Some of the stories exchanged were, in fact, as dark as Hamlet. The trends for states to move away from cost-of-performance to market-based sourcing, combined with implied economic nexus for all tax types, means that all service providers that have internet websites are at risk for some type of tax exposure in virtually all states, even if their services are provided from only one or a few states. Everyone has economic nexus everywhere now, and the big question is, where are your customers located, or worse, where do your customers receive the benefit of your services?

One of our Ohio colleagues commented that Ohio is an economic nexus, market-based state and requires mandatory withholding for all nonresident partners. Once Ohio determines that the nonresident partnership, as a whole, has any Ohio-based clients, and thus, Ohio-source income, it imposes mandatory withholding at the partnership level. If Ohio has overcollected what the nonresident partners would actually owe, the taxpayer’s only remedy is to have each nonresident partner file a nonresident Ohio personal income tax return to claim a refund for overpaid taxes for each year during the audit period. This seems harsh, given that Ohio passed a passthrough income exemption a few years ago, and most, if not all, of the nonresident partners would probably owe little or no Ohio taxes at all! In those cases, the taxpayer’s costs of the audit (analyzing every invoice to determine where every customer receives the benefit of your services for every year under audit), coupled with the costs of its partners having to file nonresident individual returns to claim refunds for very small amounts every year under audit, would ensure that Ohio will keep the funds. Really?

Others commented that not all states are as vicious as Ohio. For example, Michigan (another market-based, economic nexus state) has a reputation for “going after” nonresident service firms, but at least Michigan is comparatively “fair” — service providers still must go through the same aggravating and staff-consuming annual computations, but they compute the liability at the partner or member level. The results? The taxpayer gets to pay the annual $100 minimum tax, of course! Bravo!

Contesting the nonresident audits is always another expensive option, but what’s the point? Most states with income taxes give their residents credits against income taxes paid to other states, so assuming taxpayers can cope with the annual compliance requirements, their service partners’ tax liabilities probably won’t change that much. In the long run, the economic nexus, market-based states are simply taking away a share of the taxes that the same taxpayers would otherwise have to pay to the states in which their income was actually earned. Meanwhile, other states are doing the same thing. Isn’t that just a senseless “revenue wash” on the state side, too?

I’m wondering how many big tax cheats are getting away with not paying really big bucks actually owed to these states, while their audit staffs are busy making much ado about nothing. As a former director of revenue for Missouri, I would seriously question whether each state’s admittedly scarce number of auditors should be spending their precious little time auditing such “high maintenance, low return” prospects. As much as they like it, it is not what it seems.

Although I predict that this annoying and costly trend will continue, one of these days, some services-based firm faced with similarly situated “tempests” will in fact decide to make “much ado about nothing” and take one of these aggressive states to court. With any luck, this intrepid taxpayer will throw all caution and resources to the wind and resurrect the long-forgotten principles of due process, by arguing that for these states to extract their pound of flesh, they may not spill a drop of blood.

Happy New Year, and in 2020, may each of us learn to “love all, trust a few, [and] do wrong to none.”

2020: Looking Forward to Looking Backward

Brian J. Kirkell

Brian J. Kirkell is a principal with the Washington National Tax office of RSM US LLP.

Wayfair and federal tax reform dominated the state tax landscape throughout 2018 and 2019, and 2020 will be more of the same — albeit with a twist. Over the last two years, the focus has been on what was going to happen, and when it did, how we were going to deal with it in a compacted time frame. For 2020 we will get our first real opportunity to take a deep breath, look back, and explore whether we actually managed to get it right.

From a legislative and regulatory standpoint, this will mean tweaking across the board with narrow, more practical considerations at the forefront. We will see an increasing flow of guidance regarding how transactions count against the states’ new sales and use tax economic nexus thresholds. For example, sellers of multiple points-of-use software and digital goods and services will get more clarity regarding whether their sales count against the threshold based on contract address, billing address, seat license usage, or using some other method, and will have a solid starting point to tie together nexus and sourcing. Similarly, there will be a good deal of catch-up from a federal tax reform perspective, with problematic issues, such as the applicability of the section 163(j) limitation in a separate return context, finally getting much-deserved attention.

However, the real action will be on the administrative controversy side of the equation. At this point, most taxpayers have filed their 2018 state tax returns, marking the first full year of effect for most of the provisions of the Tax Cuts and Jobs Act. With the clock on statutes of limitations ticking, taxpayers that — in the absence of necessary guidance — took a hyperconservative approach on their original returns, will be filing amended returns and get the ball rolling on refund claims. Audits and assessments will not be far behind. Similar activity will spike in the sales tax space, as state tax authorities home in on marketplace facilitator collection and remittance responsibilities, taxability, and sourcing after an initial wave of nexus-related enforcement actions particularly focused in the middle market.

Lastly, as an election year and following a solid revenue collection, 2020 likely will not be a bellwether for comprehensive state tax reform. With that said, depending upon where the economy stands come year-end, be on the lookout in 2021. Gross receipts taxes, credit and incentive programs, sourcing, and base broadening may all be on the table. But for now, you should be prepared to spend a good deal of 2020 looking backward.

Through the Looking Glass

George S. Isaacson

George S. Isaacson is a senior partner at Brann & Isaacson in Lewiston, Maine.

When asked to look at the year past and the year to come, one might draw very different conclusions depending on the lens through which you gaze. For the myopic, the focus may be on such immediate issues as market-based sourcing, state responses to federal tax reform, classification of individuals as independent contractors or employees, taxes on sports betting and marijuana sales, and trends in combined reporting. But if one peers through a telescope to obtain a long-term view of the state tax scene, the concerns differ considerably.

In the United States, 50 state tax regimes, supplemented by thousands of localities and special-purpose districts, have created the most complex and confusing tax structure of any major economically developed country in the world. Enormous variations exist in the types of taxes imposed, rules governing the scope and administration of taxes, judicial interpretation, filing requirements, appeal procedures, and the list goes on. States have made little effort toward achieving greater uniformity or centralized administration, and any movement in that direction has now largely been abandoned. The result is a crazy quilt of disparate and inconsistent tax obligations.

The defense advanced for such extreme diversity within a single nation’s tax system is grounded on the ostensible value of federalism. Each state in our federal structure retains substantial prerogatives of sovereignty, including the power of taxation — a power shared with the national government. There are certainly positive features to federalism, especially in keeping government closer to the people. Historically, in regard to taxation, such wide variations in state taxes were not particularly problematic, as long as states confined the application of their tax systems to the individuals and businesses located within their borders. Indeed, it is not unreasonable to expect that persons and companies located in a state, and participating in the political process, will be subject to that state’s tax requirements.

Federalism, however, has always presented a trade-off between the benefits and burdens of 50 sovereign states all existing within a single sovereign nation. The downside aspect of federalism is enormously exacerbated when states (and localities) seek to export their tax systems across borders to companies with no facilities or employees within their territory. The recent Wayfair decision, which replaced long-standing “physical presence” nexus with an “economic presence” standard for sales/use tax collection, has unleashed the ambitions of state legislators and tax administrators. States and municipalities have seized upon the Supreme Court decision to expand aggressively the reach of their taxation authority, including for gross receipts, excise and income taxes. For example, Hawaii, Massachusetts, Oregon, Pennsylvania, and Washington have adopted post-Wayfair “economic presence” thresholds for their business activity taxes, and more states are lining up to follow this course.

At the same time, state governments are attempting to narrow the protection from corporate net income taxes provided by P.L. 86-272. For example, a Multistate Tax Commission work group was tasked with updating the MTC guidance on those business activities that are treated as protected or unprotected under P.L. 86-272. This group has proposed that when a business interacts over the internet with a customer via a website or app, the company is engaging in an activity in the customer’s state not protected by P.L. 86-272 and may, therefore, be subject to that state’s income tax. Given the ubiquity of interactive websites and apps, the strategy is clear — states intend to treat almost any form of e-commerce activity as a basis for eliminating barriers to the beyond-borders imposition of their taxes.

As state tax systems expand their reach, the costs of compliance become oppressively greater — a burden which falls especially hard on small and medium-size companies. The states, and their organizations, have refused to take collective action to make their tax systems simpler, more uniform, and better coordinated. For example, no new state has signed on to the Streamlined Sales and Use Tax Agreement since the Wayfair decision, and the MTC, the Federation of Tax Administrators, and the National Conference of State Legislatures are more interested in expanding state tax jurisdiction, and increasing tax revenues than in fixing a distended system that is unfair to taxpayers and has become an impediment to economic expansion. When taking a telescopic view of developments during this past year and their troubling implications for the future, the logical conclusion is that the solution must lie with Congress. If “economic presence” will now subject most businesses in the country to every state’s tax laws, then Congress will inevitably, at some point, exercise its commerce clause power to require substantial simplification, uniformity, and even centralization in the administration of state taxes.


Helen Hecht

Helen Hecht is general counsel for the Multistate Tax Commission.

Before you read this column, you would do well to adjust your expectations. The relationship between past and future has inspired far greater writers than this one — albeit with less than spectacular results. Shakespeare, for example, famously said: “The past is prologue.” In other words, the past comes before whatever comes after. Not that helpful. Similarly, George Santayana’s famous quote, “Those who cannot remember the past are condemned to repeat it,” is confusing at best. What should I do if I want to repeat the past? Forget it?

Then there’s Mark Twain, who may or may not have said: “History does not repeat itself, but it often rhymes.” Note the word “often,” however, because not everything rhymes. “Chaos,” for example, describes 2019 pretty well. But what does it rhyme with? Nothing. The same with “angst.” And, if you’re a stickler, you may also have trouble finding words that rhyme with “corporate,” “federal,” “foreign,” “interest,” and “guilty” (however spelled). “Nexus” rhymes with just two words, “plexus” and “Texas.” You begin to see the problem. Poetic state tax predictions are simply impractical. (Trust me.)

But surely, you say, tax experts are capable of predicting future tax developments. As it turns out, maybe not. Experts can be awful predictors. Research conducted by the U.S. intelligence community shows that experts are much more likely than generalists to be victims of confirmation bias.44 Consequently, an expert’s predictions often reflect what they hope will happen, not what is objectively likely. So, with this in mind, I make the following predictions.

At the global level, the OECD’s Base Erosion and Profit Shifting task force is in the process of helping “over 130 countries . . . to put an end to tax avoidance strategies that exploit gaps and mismatches in tax rules to avoid paying tax” (to quote the website). The task force plans to wrap up its efforts in 2020. What I hope is that those efforts will be successful. But objectively, it will be exceedingly difficult to get agreement from 130-plus countries whose economies vary enormously. Nor will it be easy to counter powerful multinationals intent on retaining the benefits of the current system. Consequently, I expect countries, including France, the U.K., Italy, and Austria, will take matters into their own hands with a digital gross receipts tax — likely to spark a reaction from the U.S. government and domestic tech giants.

At the national level, 2020 will be an election year. The big tax issue being debated is whether to adopt a national “wealth tax” and whether such a tax is workable. But the U.S. already has (had) a kind of wealth tax — known as the estate tax — which is (was) workable. What I hope is that the debate over a wealth tax will lead to a decision to refurbish the estate tax, which could benefit both federal and state tax systems. But from what I know about politicians, I think it is more likely they will continue to debate the idea of a “wealth tax,” and as a result, the estate tax is likely to languish.

Finally, at the state level, whether you spent the last year as a taxpayer trying to figure out what Tax Cuts and Jobs Act and Wayfair mean for your business, as a tax administrator trying to respond to ever-increasing complexity with ever-diminishing resources, or as a tax policymaker thinking that there must be a better tax system somewhere — I’m sure you hope that 2020 will be less chaotic than 2019. I hope so too. But objectively, significant questions remain around TCJA and Wayfair implementation. And after 37 years in this business, I would be shocked if tax administrators (including the IRS) were suddenly given sufficient resources to do their essential work. Nor is the road to a simpler tax system any clearer at the end of 2019. So I expect the only constant, for the foreseeable future, will be change. And change — even good change — is hard.

As readers of these columns know, I’m prone to quote philosophers. 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.

2020: Our Life in the Future

Billy Hamilton

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

In 2015 Hamilton led Texas Republican Gov. Greg Abbott’s Strike Force on the Health and Human Services Commission to complete a management analysis of the agency. Before that, Hamilton was the deputy comptroller for the Texas Office of the Comptroller of Public Accounts from 1990 until he retired in 2006. He is also a private consultant, advising on numerous state tax matters.

The theme of this quarter’s Tax Notes State Board Briefs is “looking ahead.” That, as I’m sure you are astute enough to realize, means predicting the future — in this case, our life in the year 2020.

At one point in my career, a long time ago, I forecast the future professionally as part of my job as a revenue estimator. It wasn’t fun because I don’t like being wrong, and forecasts are almost always wrong. At least that is the lesson I took from the experience, the only job I have ever had that gave me a case of the hives.

So now I am back, temporarily, in the forecasting business, hopefully sans hives, and my prediction is that the most important tax story of next year will be the impact of a recession on state and local finances, and whatever state and local governments do to their tax systems to deal with the problem.


I mean, who knows? I’ve been predicting a recession as part of my personal investment strategy for the last five years, and everyone knows that if you predict something long enough, you will eventually be right.

There is, however, at least some reason to believe that the day of economic reckoning may finally be approaching. The current economic expansion became the longest in U.S. history on July 2, and the simple logic of a born pessimist suggests to me that if something can go wrong, it probably will — and soon.

Surprisingly, that view is supported by the National League of Cities (NLC), which recently released a survey showing that almost two-thirds of large city finance officers are predicting a recession as soon as next year.

The finance officers simply may share my ingrained pessimism, but they also have evidence: The NLC survey showed city revenues are failing to keep pace with inflation for the first time in seven years based on data supplied by 554 cities. Revenue growth faltered in fiscal 2018, and growth rates in property, sales and income taxes all trended downward in 2019 after inflation adjustment and was slower than in recent years.

The league says the downward trend may reflect a broader economic slowdown that began as long as two years ago. The danger signs are more pronounced in larger cities, the report says, in part because business investment is declining and that typically hits larger cities first.

“Fiscal trends are beginning to align with some of the negative economic trends that we’ve seen in past downturns,” Christiana McFarland, NLC’s director of research, said during a televised discussion of the report. Still, the finance directors were quietly confident their cities would be OK, which is what you would expect them to say since no lie detectors were used to conduct the survey as far as I can tell.

The states are in much the same boat. In a recent column, I looked at how states might fare in the next recession and found similar quiet confidence — or possibly nervous bravado. The experts believe that the states are better prepared now for a recession than at any time since the end of the last recession. Nevertheless, some will be in real trouble if a recession comes in the near term, and a really bumpy ride will be good for none of them, just as it won’t be for the cities. How well they ride out the storm depends on the nature of the recession, its duration, and the accuracy of their forecasts. Did I mention that forecasting is a miserable job?

Another factor to consider for 2020 is whether there’s likely to be a recession during a presidential election year, which isn’t common. By the same token, eight of the last 11 recessions have coincided with the first year of a presidential term.

I may be wrong about 2020. If so, I will return next year to eat crow. But don’t bet your 401(k)s on 2021.

Looking Ahead

Craig B. Fields

Craig B. Fields is a partner in the New York City office of Morrison & Foerster LLP.

This past year has been an exciting one in state tax. There were many positive and, unfortunately, some negative developments. I address three of the more interesting issues of 2019, which will certainly carry into 2020 and beyond.

First, statutes requiring the addback of payments between affiliates (whether royalties, interest, or some other intercompany payment) have been around at least since Ohio enacted its addback statute in 1991. However, the different statutory provisions, including the various exceptions, enacted by the states have been a source of tension between taxpayers and states that will continue in 2020. In Lorillard Tobacco Co. v. Director, Division of Taxation,45 the New Jersey Tax Court issued a published, precedential decision holding that, when considering the “unreasonable” exception to the related-party royalty expense addback, the relevant consideration is whether the recipient of the royalty payment paid tax in New Jersey on the income. The Court stated that if the royalty recipient pays tax, the payer’s and the recipient’s relative apportionment factors are irrelevant and cannot be the basis for denying the unreasonable exception. There are many other challenges to addback statutes pending across the country, many of which will be decided in 2020.46

Second, sales sourcing and nexus are issues that continue to abound. Historically, nexus created the need for apportionment and sourcing. Today, many states are attempting to use apportionment and sourcing to create nexus. This will continue as more states adopt market sourcing and enact statutes that deem a corporation to be doing business in the state if it surpasses a certain level of sales sourced to the state (using the state’s sourcing scheme).

An example of this is Greenscapes Home and Garden Products Inc. v. Testa,47 in which the Ohio Court of Appeals held that a Georgia company whose only connection with Ohio was that some of its customers had a presence in the state was nonetheless subject to the Ohio commercial activity tax (CAT). This was the case even though it was the company’s big-box retailer customers that arranged for a carrier to pick up the product at the company’s facility in Georgia and once loaded, the product became the retailer’s property. Indeed, after the product left the facility, the company could not track its final destination, and Ohio may not have even been the final destination for the product as it was sent to Ohio distribution centers. The Court, however, ruled that because the company knew its products were destined for Ohio distribution centers at the time the orders were placed and also satisfied the $500,000 sales receipts threshold for the tax period at issue, it was subject to the CAT. One must wonder whether a corporation that merely believes that a customer is bringing the corporation’s products to a location in a state has purposefully directed its activities into that state sufficient to satisfy the due process clause. It is almost certain that we will see more cases in this area in 2020 and beyond.

Finally, as more states enact combined reporting (New Jersey did so for 2019), the issue of which companies are included in the combined group will continue to arise. This past year, the Colorado Supreme Court unanimously held that the Department of Revenue could not force a corporation to file a combined tax return with its subsidiary, a holding company with no property or payroll that derived its income solely from investments in foreign entities.48 Under Colorado law during the years at issue, only corporations with more than 20 percent of their property and payroll in the U.S. were includable in a combined report. The Court held that the subsidiary was properly excluded from the combined report because a corporation with no property or payroll cannot have more than 20 percent of its property and payroll in the U.S. The Court also concluded that the subsidiary could not otherwise be included in the combined report under the state’s authority to reallocate income to avoid abuse and to clearly reflect income.49

In 2020 issues of which corporations are included in combined reports will continue to arise, including several in which the taxpayer is asserting the affiliate is not unitary, the affiliate is included or excluded because of an 80/20 statute (remember Ashland Inc. v. Commissioner of Revenue,50 in which the Minnesota Supreme Court held that a taxpayer may include in its combined report an entity organized under foreign law that elects to be treated as a disregarded entity for federal income tax purposes), or that the ownership requirement for combination is not met.

While 2019 was an exciting time in state tax, I expect 2020 to be replete with many continuing issues, as well as new and exciting ones. I look forward to the upcoming year.

A Top 5 California Tax Hello to 2020

Eric J. Coffill

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

2020 is looking like an active and interesting year in California for state tax developments. Here are my top 5 items to watch in the upcoming year.

1. The 2020 Ballot Threat to Proposition 13 on Commercial Property Taxation

Proposition 13 was enacted by initiative in California in 1978, and limited property tax base value to acquisition value, subject to an annual inflation increase of up to 2 percent or a reassessment based on “change of ownership” or new construction. It is still the law today, and applies to both residential and commercial property. But it is coming under attack. Initiative 17-0055 has now qualified for the November 2020 general election ballot. That initiative would require certain commercial and industrial property to be regularly reassessed (every three years) at full market value (with certain exceptions) absent a change of ownership. Ballot proponents expect it to increase property tax on businesses by approximately $11 billion. To further complicate matters, a new version of the initiative, which could potentially replace 17-0055 on the November ballot is gathering signatures.

2. Anticipated Legislation to Extend the California False Claims Act to Taxes

The California False Claims Act dates to 1987 legislation and currently does not apply to taxes. However, A.B. 1270 (author by Assembly member Mark Stone (D)) would have extended it, beginning January 1, 2020, to claims, records, or statements made under the California Revenue and Taxation Code, meaning to taxes administered by the State Board of Equalization (BOE), the California Department of Tax and Fee Administration (CDTFA), and the Franchise Tax Board (FTB). A.B. 1270 did not pass this year, but it was still pending in committee (i.e., the Senate Appropriations Committee) when the legislative session ended this fall. It is expected that Stone will push his proposal again when the Legislature reconvenes in January 2020.

3. Continuing Litigation Following Upland Regarding a 2/3 Vote Requirement for Imposing Local Taxes

The California Supreme Court’s 2017 decision in California Cannabis Coalition v. City of Upland51 held that the California Constitution does not require local general taxes be submitted to the electorate at a general election, as opposed to a special election, where the taxes voters seek to impose are by the initiative process. California Cannabis has touched off a firestorm of litigation over whether it can be read for the proposition that local taxes imposed by voter initiative are not imposed by a “local government,” meaning they can be approved by a simple majority vote instead of a two-thirds supermajority vote. For example, Proposition C, a gross receipts special tax on commercial rents, was approved with only 50.87 percent San Francisco voter approval at the June 2018 election, and a San Francisco trial court ruled in July of this year that the tax was not imposed by a “local government” and required only a simple majority vote to pass.52 Going the other direction, a City of Fresno ballot initiative to impose a local three-eighths percent sales/use tax was approved with only 52.17 percent voter approval, and a Fresno County trial court ruled that tax invalid because the California Constitution requires a two-thirds vote requirement on special local taxes.53 Both decisions looked to Upland. Similar cases are pending elsewhere in California at the trial court level on whether local taxes can be imposed by a simple majority instead of a two-thirds vote, and both the above trial court decisions are headed to the California (intermediate) courts of appeal. While 2020 may bring one or more decisions from the courts of appeal, it is inevitable the issue will reach the California Supreme Court, which created this problem in Upland. But a decision by the California Supreme Court certainly will not happen in 2020.

4. New Discussions on Imposing Sales Tax on Technology Transfer Agreements and Imbedded Software

The CDTFA, successor to the BOE as the agency administering sales/use taxes, has at long last, restarted its interested parties process to amend its regulations to address sales tax on technology transfer agreements, especially those involving embedded software. The BOE lost two major cases on this issue: Nortel Networks Inc. v. State Board of Equalization54 and Lucent Technologies v. Board of Equalization.55 Although Nortel was decided eight years ago, and Lucent was decided four years ago, neither the BOE nor the (now) CDTFA has yet to address the ramifications of those decisions on their prior (invalidated) policies/regulations on when and how sales tax can be imposed on technology transfer agreements under Revenue and Taxation Code sections 6011 and 6012, which transfer both tangible and intangible property. An interested parties meeting was held in early November, and proposed draft regulatory amendments have been offered by the CDTFA, but the draft was met with a wave of criticism and this process is far from over. Look for additional discussions, perhaps a formal regulatory change, and possible further litigation on this subject in 2020.

5. Anticipated Legislation to Extend the Sales Tax to Services

Sen. Robert M. Hertzberg (D) has introduced legislation (i.e., a spot bill) for the last five years to extend the California sales tax to services. His bill this year was S.B. 522 and, again, was a spot bill with few specifics. Typically, the bills contain little detail, but it has been estimated that a sales tax on services would cost taxpayers approximately $14 billion annually. S.B. 522 was still pending in committee (i.e., the Senate Rules Committee) when the legislative session ended in the fall, but Hertzberg is expected to continue his efforts to expand the sales tax to certain (but not all) services in the 2020 session.


1 Ch. 19-38.

2 Gov’t. Code section 100705.

3 Cal. Rev. & Tax. section 61005.

4 Case No. 222732 (2018).

5 Ch. 296 (Sept. 18, 2019).

6 Professional services is defined to include marketing, administration of human resources, travel agent, graphic design, grant writer, fine artist, enrolled agents, payment-processing agent, photographer, freelance writer, and salon workers.

7 Although the referral agency exception may seem to cover workers in the gig economy, the statute defines “referral agency” as including businesses with service providers that provide graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, or yard cleanup. Drivers providing transportation services are not on the list.

8 Initiative 19-0026 (Oct. 29, 2019).

9 585 U.S. ___ (2018).

11 A.B. 91, Ch. 39 (July 1, 2019).

12 Sally Wallace et al., “Identifying the Landscape of New Technology,” Andrew Young School of Policy Studies, Georgia State University (Feb. 2019).

13 Frey and Osborne, “The Future of Employment: How Susceptible Are Jobs to Computerisation?” 114 Tech. Forecasting & Soc. Change at 254-280 (Jan. 2017).

14 The McKinsey Global Institute in a 2017 report estimates that at least 30 percent of activities are automatable in about 60 percent of occupations. But the report cautions that such automation will not necessarily substitute for labor and reports that less than a fifth of respondents said AI was being adopted to reduce labor costs. More respondents report that AI is used to improve capital efficiency or enhance existing products. A similar study by the World Economic Forum (2018) finds that 50 percent of responding firms expected new automation would lead to some reduction in their full-time workforce by 2022. Also, 54 percent of all employees will need significant improvements to their existing skills by 2022, as a result of changes in technology. Jacques Bughin et al., “Artificial Intelligence: The Next Digital Frontier?” McKinsey Global Institute (June 2017).

15 The OECD focuses on this issue in “Addressing the Tax Challenges of the Digitalisation of the Economy” (2019).

16 587 U.S. ___ (2019).

17 No. CL17001145-00 (Va. Cir. Ct. Oct. 24, 2017).

18 Case No. 170901774 (Jan. 30, 2018).

20 441 U.S. 434 (1979).

21 166 A.D.3d 1112 (3d Dept. 2018), 104 NYS3d 550 (2019); 162 A.D.3d 574 (1st Dept. 2018), 98 NYS3d 759 (2019), cert. denied, 140 S. Ct. 134 (2019).

22 125 So. 3d 36 (Miss. 2013), cert. denied, 134 S. Ct. 2872 (2014).

23 486 S.W.3d 496 (Tenn. 2016).

24 See Rosen and Hayes R. Holderness, “Cloud Computing: 1.5 Steps Forward, 2 Steps Back,” State Tax Notes, June 26, 2017, p. 1257.

25 See Rosen and Mark W. Eidman, “Non-Legislated Tax Legislation,” State Tax Notes, Jan. 24, 2011, p. 301.

26 585 U.S. __ (2018).

27 Amazon Services LLC v. South Carolina Department of Rev., No. 17-ALJ-17-0238-CC (S.C. Admin. Law Ct., Sept 10, 2019) and Normand v. USA LLC, 263 So. 3d 974, 18-211 (La. App. 2018) (appeal pending).

28 166 A.D.3d 1112 (3d Dept. 2018), 104 NYS3d 550 (2019).

29 162 A.D.3d 574 (1st Dept. 2018), 98 NYS3d 759 (2019).

30 There were around 20 articles in this publication, just in the past year on the cases. See, e.g., Edward Zelinsky, “Wynne and the Double Taxation of Dual State Residents,” Tax Notes State, Apr. 1, 2019, p. 31. Jennifer Carr, “New York Can’t Ignore Wynne Forever,” Tax Notes State, Feb. 18, 2019, p. 571. Andrea Muse, “Court Rejects Challenge to Credit Denial,” Tax Notes State, Apr. 1, 2019, p. 72. Muse, “Appellate Court Rules No Credit for Taxes Paid on Intangible Income,” Tax Notes State, July 2, 2018, p. 101. Muse, “Organizations Urge Supreme Court to Hear New York Credit Case,” Tax Notes State, Aug. 5, 2019, p. 544.

32 Natasha Mishra, “Taxpayers Ask Court to Review Tax Credit Denial,” Tax Notes State, July 1, 2019, p. 66.

33 Lukas Mikelionis, “As Residents Flee New York High Taxes, State Uses Intrusive Audits to Get Cash From Defectors,” Fox News — State & Local Alert (Mar. 9, 2019). Zak Failla, “Here’s Why Rich Are Fleeing New York, According to Cuomo,” Daily Voice (Feb. 24, 2019).

34 At one time, New York’s governor suggested that taxpayer migration had more to do with climate than taxes. See Jimmy Vielkind, “Cuomo Blames Cold Weather on New York’s Population Drain,” Wall Street Journal (Sept. 26, 2018). This narrative changed after the near-elimination of the SALT deduction.

35 Ashlea Ebeling, “President Trump Thumbs Nose at New York Tax Collector With Move to Florida,” Forbes (Oct. 31, 2019).

36 372 P.3d 747 (Wash. 2016), cert. denied, 137 S. Ct. 2156 (2017). In Dot Foods, 27-year retroactive legislation that was enacted to reverse a state-adverse court decision and prevent a “large and devastating loss” of tax revenue was upheld by the Washington Supreme Court.

37 See, e.g., Gillette Commercial Operations North America v. Michigan Department of Treasury, 878 N.W.2d 891 (Mich. Ct. App. 2015), rev. denied 880 N.W.2d 230 (Mich. 2016), cert. denied (137 S. Ct. 2157). Use of Multistate Tax Commission’s compact, which allowed taxpayers to elect to use a three-factor apportionment formula, was held not impliedly repealed by the state’s enactment in 2008 of single sales factor. In 2011 the Legislature repealed the compact election, and in 2014 further legislation was enacted retroactive to 2008 to provide that the compact election was unavailable since 2008.

38 The notion of “cookie nexus” is an outgrowth of the physical presence requirement of Quill Corp. v. North Dakota, 504 U.S. 298 (1992). However, once Wayfair was decided on June 21, 2018, the sophistic gyrations employed by 830 Mass. Code Regs. 64H.1.7 to convert economic nexus into purported physical manifestations became unnecessary. Rather than returning or crediting monies collected under the regulation pre-June 21, 2018, the commonwealth opted to continue to hold tight to its regulatory position.

39 No. 17-ALJ-17-0238-CC (S.C. Admin. Law Ct. Sept. 10, 2019). The administrative law court held that prior to enacting its marketplace facilitator law, Amazon in its role as a market facilitator for third-party merchants, was required to collect tax on transactions even though it was not the seller, did not pass title to the customer, and did not receive compensation from the customer.

40 448 P.3d 275 (Ariz. 2019). The Arizona Supreme Court held that online travel companies that offer travel facilitation services are subject to various Arizona cities’ hotel privilege taxes imposed on “every person engaging or continuing in the business of operating a hotel charging for lodging and/or lodging space” because they were “brokers.”

41 33 N.Y.3d 587 (2019).

42 No. 011050-2017 (N.J. Tax Ct. June 28, 2019) (unpublished decision). The author is involved in this litigation.

43 430 U.S. 274 (1977).

44 See the results of a study conducted by the U.S. intelligence community on whether generalists or experts were better predicting future world events at the Office of the Director of National Intelligence’s website and on many other websites taking off on this research.

45 31 N.J. Tax 153 (N.J. Tax Ct. 2019).

46 It is noted that Morrison & Foerster represented Lorillard Tobacco Company in this matter.

47 129 N.E.3d 1060 (Ohio Ct. App. 2019), jurisdiction declined, 123 N.E.3d 1042 (Ohio 2019).

48 Department of Revenue v. Agilent Technologies Inc., 441 P.3d 1012 (Colo. 2019).

49 It is noted that Morrison & Foerster was lead counsel for Agilent Technologies Inc. in this matter.

50 899 N.W.2d 812 (Minn. 2017).

51 3 Cal. 5th 924 (2017).

52 Howard Jarvis Taxpayers Association v. City and County of San Francisco, No. CGC-18-568657, opinion filed July 5, 2019.

53 City of Fresno v. Fresno Building Healthy Communities, No. 19CECG00422, order filed Sept. 5, 2019.

54 191 Cal. App. 4th 1259 (2011).


Copy RID