The SALT outlook for 2021

March 29, 2021 9:00 AM

State and local taxation administration and policy, as with most aspects of the economy, were molded in unforeseeable ways by the pandemic over the past year.

“No one could have predicted the imprint COVID-19 would bring to the state and local taxation landscape during the past year,” said Jamie Yesnowitz, state and local tax national leader in the Washington National Tax Office of Top Eight Firm Grant Thornton. Nevertheless, Yesnowitz sees some developing trends that foster his predictions for the year ahead in SALT.

As he does every year, Yesnowitz and his team have come up with predictions concerning the SALT issues they believe will be of major focus in 2021.

1. Continued CARES Act responses

A medical personal directs a patient at a free Covid-19 testing site in Hayward, California, U.S., on Monday, March 23, 2020. Governor Newsom on March 19 ordered that all of the states 40 million residents go into home isolation while saying outdoor activity is permissible with proper social distancing. Photographer: David Paul Morris/Bloomberg

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“States are re-evaluating what has happened over the course of the past year, when federal provisions were adopted as a result of the pandemic,” he said. “Since state legislative bodies quickly went out of session in March 2020 as a result of the pandemic, many conformity issues were left unaddressed. States are catching up in 2021, and given the budget situation in many states, some re-evaluation of how to conform or decouple from federal legislation might happen.”

Yesnowitz listed net operating loss carryback rules, modifications to the business interest expense deduction limitation, and the reclassification of qualified improvement property eligible for 100 percent bonus depreciation as key areas for state consideration.

Prediction: Grant Thornton predicts that at least three additional states will decouple from the three key CARES Act corporate income tax provisions through legislation, regulation or administrative action.

2. New and unusual taxes

New and acceptable sources of revenue for states hurt by the pandemic-induced shutdowns include a variety of “sin taxes,” according to Yesnowitz. “Rather than impose simple income tax rate increases across the board, it is likely that state legislatures will look to alternative methods to raise revenue,” he said. “Over the past several years, a number of states have adopted sin taxes. For example, many states have legalized the sale of marijuana and tax sales of the product as a means to generate substantial amounts of revenue. Legalized sports betting and taxes targeting the ‘sin’ of being a high earner are on the table in a number of states.”

Prediction: “During 2021, at least three states will enact legislation allowing for new sin taxes — legalization of marijuana and/or sports betting or adopting ‘millionaire’ taxes,” Yesnowitz and his team predict. “In addition, at least one state will enact a wealth tax of some form on high-earning residents.”

3. Tax treatment of telecommuting

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This became a major issue once the pandemic hit, and states are not providing a uniform response as to where they think telecommuters are working, according to Yesnowitz. “Some are treating the pandemic as a temporary event and are assuming that the employee is still working at their normal work office location. Others look to where the actual work is performed. Many states issued guidance relating to income tax withholding, and approximately one-third of the states issued guidance providing for the temporary suspension of corporate income tax and/or sales and use tax nexus thresholds where the pandemic has forced employees to work remotely. A number of states have provided specific end dates to their temporary guidance, while others have specified that the guidance would remain in effect for the duration of their state of emergency declaration. “

Prediction: The team expects that at least five states will extend their temporary guidance or release new guidance to address the issues related to income tax withholding, business tax nexus and/or income tax apportionment.

4. The PPP

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The Paycheck Protection Program, from the state perspective, is challenging, Yesnowitz indicated. “The IRS position initially was that expenses paid with forgiven PPP loans would not be deductible. The Coronavirus Appropriations Act signed on Dec. 27, 2020, included the COVID-related Tax Relief Act, which reverses the IRS guidance and allows taxpayers to fully deduct any expenses regardless of whether the forgiven PPP loan proceeds were utilized to pay for those expenses. For federal purposes, there were two separate enactments of PPP so states that don’t currently follow either of those provisions can argue that the loan forgiveness is taxable and expenses are deductible,” he said. “In states that fully follow PPP, the loan forgiveness is generally nontaxable and based on the latest federal legislation, the expenses are deductible as well. There’s a third group of states that conform just to the CARES Act and not necessarily the CAA where the loan could be taxable but expenses not deductible, so there are three separate models.”

Prediction: While many states will align themselves with the December 2020 federal law allowing deductibility of PPP-funded expenses, at least three states will choose to decouple from this provision in an effort to address state budget deficits.

5. PTE taxes

Seven states have adopted entity-level taxes allowing pass-through entities to deduct taxes paid at the entity level in an attempt to circumvent the $10,000 SALT cap on itemized deductions for individual taxpayers. The IRS has released guidance on the issue, confirming that PTEs may claim an entity-level deduction for state and local income tax paid under state laws that shift the tax burden from individual owners to the business entity. This will likely encourage additional states to enact such laws, absent a repeal of the SALT deduction limitation, Yesnowitz believes.

Prediction: Assuming that the SALT deduction cap is not adjusted this year, Yesnowitz and the Grant Thornton team predict that at least three additional states will enact pass-through entity tax regimes to the extent that the SALT deduction limitation remains in place.

6. Permanent extensions of state filing

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The 2020 filing season was extremely challenging, given the fact that the pandemic first became severe during the spring filing season, Yesnowitz observed: “Several states temporarily provided extra time to file state income tax returns as a result of the pandemic. Taxpayers sometimes are required to make complex adjustments to their federal taxable income when computing their state income tax liability. The difficulty in completing state income tax returns is expected to continue for the foreseeable future. Taxpayers and tax practitioners would benefit by having a period of time after filing federal tax returns to accurately compute state income tax liability.”

Prediction: At least three states will permanently extend their official due dates during 2021 to allow taxpayers to file at least 30 days beyond completion of their federal income tax returns.

7. Digital advertising taxes

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Earlier this year, the Maryland legislature overrode the governor’s veto and passed a digital advertising tax. “This is a very progressive tax that would be imposed on large companies that provide digital advertising services in the state,” according to Yesnowitz. “In its current form, those taxes could be passed directly on to customers. Despite policy and legal concerns, the taxation of digital goods and services seems to be gaining momentum as states are seeking revenue to address budget shortfalls resulting from the pandemic.”

Prediction: At least five states will introduce legislation attempting to adopt a special tax on digital goods and services, or expanding their sales tax bases to include digital goods and services, with at least two states successfully enacting this legislation.

8. Continued state responses to Wayfair

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With the exception of Missouri and Florida, every state that imposes a sales tax has adopted remote seller economic nexus and marketplace provisions, Yesnowitz noted: “In the search for additional revenue to close budget deficits, other states are likely to extend the application of Wayfair to beyond sales and use taxes.”

Prediction: The two remaining holdout states — Missouri and Florida — will enact remote seller and marketplace measures. In addition, Yesnowitz and the Grant Thornton team predict that at least two states will adopt an economic nexus standard for income tax via legislation, regulation or administrative action.

9. Property tax values and the pandemic

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“This is a story that’s just getting started,” said Yesnowitz. “The pandemic is likely to affect property values significantly. It has created commercial areas likely to fall in value due to lack of foot traffic and fewer people working in city centers. At the same time, residential property values appear to be increasing in many markets. Property tax revenue as a percentage of state and local general revenue was higher than general sales tax revenue, individual income tax revenue, and corporate income tax revenue in 2017.”

Prediction: In an effort to stabilize this revenue source, at least three jurisdictions will increase their general rates or adjust valuation formulas during 2021.

10. New Hampshire v. Massachusetts

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“Massachusetts adopted a policy to effectively maintain income tax collection from New Hampshire residents that had commuted to Massachusetts to work, and then stopped commuting during the pandemic,” Yesnowitz summarized. “In response, New Hampshire brought an action in the U.S. Supreme Court, arguing that the Massachusetts regulation unconstitutionally imposes income tax on New Hampshire residents lacking a connection with Massachusetts during the pandemic, in violation of the Due Process and Commerce Clauses. The complaint also alleged that Massachusetts infringed on New Hampshire’s sovereignty and discretion over its policy not to levy a personal income tax.”

The Supreme Court referred the issue to the Solicitor General for the government’s view of the litigation. That action, along with the pandemic and the change in administration, could delay the decision of the court on whether it will hear the case.

Prediction: Despite the important multistate income sourcing implications involved in the case, and the desire among SALT practitioners to see state tax litigation addressing cutting-edge topics at the Supreme Court, Yesnowitz and his team expect that the court will decline to grant review in New Hampshire v. Massachusetts.