The top SALT stories of 2021

February 1, 2022 9:00 AM

The intersection of federal and state issues was a dominating theme of the most important SALT stories of 2021, underscoring the fact that what happens in Washington doesn’t stay there. It gets played out in every state capital in the debate on social, budgetary and state and local tax matters as well.

“It’s not surprising that many of the past year’s top SALT stories revolve around reactions to the pandemic, and to the increased visibility of SALT as issues play out in both the federal legislative and judicial domains,” said Jamie Yesnowitz, state and local tax leader in Grant Thornton’s Washington national tax office. “Moreover, the return of live legislative sessions in many state capitals that were forced to shut down in 2020 gave legislators the ability to address short-term concerns as well as long-term tax reforms.”

Each year the Grant Thornton SALT team chooses the most important developments of the past year, and ranks them in order of perceived importance. “We reached a unanimous opinion that the first three developments were head and shoulders the most important from a state tax perspective,” said Yesnowitz. “The other seven were very important, but the first three were really prominent.”

1. SALT cap spurs PTE tax regimes

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Heading this year’s list are the pass-through entity state tax regimes enacted as a workaround to the Tax Cuts and Jobs Act’s SALT Cap. “Any year in which you have 15 states react to a development, that will land it at or near the top of the list,” said Yesowitz.

In 2018, states first began enacting elective PTE tax regimes in reaction to IRS Notice 2020-20, which clarified that state and local income taxes imposed on a partnership or S corporation — PTE taxes — are deductions allowable in computing the non-separately stated income of such entities.

“An interesting component of state activities is the diversity in approaches for the different states,” said Yesnowitz. “Under these regimes, the PTE is permitted to deduct its state and local income taxes as a tax on the business at the federal level, followed by a deduction for the PTE tax on the distributive share of the owner’s income. Depending on the structure of the PTE tax, the owner generally claims a corresponding tax credit against personal tax liability or an exclusion on the portion of the owner’s pass-through income subject to the entity tax.”

Seven states enacted PTE taxes prior to Notice 2020-20, when the IRS said that PTE tax regimes would be respected for federal income tax purposes, according to Yesnowitz. “Since that time, states moved at a rapid pace to adopt their own elective state PTE regimes, with 14 additional states having done so in 2021,” he said. “Notably, New York adopted a PTE tax as part of its 2022 fiscal year budget in April 2021, first applicable to the 2021 tax year.”

While the fate of Build Back Better is not yet clear, Yesnowitz feels that if something is passed, “changing the SALT cap will likely be a component of that.”

2. States challenge ARPA tax mandate

The American Rescue Plan Act created the Coronavirus State Fiscal Recovery Fund and the Coronavirus Local Fiscal Recovery Fund, which offered state governments hundreds of billions of dollars to assist with recovery from the economic damage inflicted by COVID. However, as part of the legislation, states are required to use the funds for either a wide variety of pandemic-related purposes, or to make necessary investments in water, sewer or broadband infrastructure. The legislation prohibits states from using the funds to offset a reduction in state net tax revenue resulting from a change in law, regulation or administrative interpretation during a period that reduces any tax, or from depositing the funds into a pension fund. States have responded with a number of lawsuits challenging the constitutionality of the provision.

The mandate has led to a number of constitutional challenges, resulting in three significant court decisions during 2021 granting injunctive relief against enforcement, with further challenges remaining outstanding. Despite federal court losses in the three cases, the Treasury has left the tax mandate largely unchanged in its new final rule.

“Given the distinctive and compelling sovereignty issues raised by the ARPA tax mandate, the potential conflicting views of different circuit courts, and the effect that the mandate could have on future state taxation policies, it may only be a matter of time until the ARPA tax mandate controversies are raised before the Supreme Court,” Yesnowitz predicted.

3. SALT implications of COVID telework

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The ongoing nature of the pandemic, with delta and omicron variants continuing to pose risks, has led to changes in workplace arrangements, Yesnowitz noted. “That has led to significant issues. Continued remote work brought new state and local tax challenges for employers in 2021, as taxing authorities began rescinding temporary payroll tax withholding and nexus policies, many of which were in effect since the early days of the pandemic,” he explained. “As a result, businesses growing mobile workforces were left to navigate conflicting state and local tax approaches to remote work in 2021.”

Massachusetts adopted a temporary emergency regulation that allowed it to tax the income of nonresident employees who worked in the state prior to the pandemic, but who were teleworking during the pandemic. In response, New Hampshire, which does not impose a personal income tax, asked the Supreme Court to rule on whether Massachusetts could constitutionally tax nonresidents working in New Hampshire and lacking a connection with the taxing state during the pandemic.

“We had thought there was a possibility that the court would take the case,” said Yesnowitz. “We were somewhat disappointed that it didn’t decide to hear the case. Potentially, they may have denied [certiorari] because of the temporary nature of the Massachusetts legislation that was being questioned.”

“Expiring administrative guidance in 2021 is likely to impact companies with employees working in locations different from their traditional location prior to the pandemic,” he observed. “Some companies may have started tracking employee location for the first time to make accurate payroll tax reporting and business tax filing decisions. Others may have given more thought to crafting policies setting remote work parameters to minimize additional tax withholding and filing obligations. Beyond 2021, employers will likely need to revisit their policies and update their systems and processes on a regular basis to address the continued disparity in state tax approaches to remote work.”

4. Conformity to CARES Act/PPP loan forgiveness

States have had to react to federal tax developments, Yesnowitz indicated. “And the CARES Act is no exception. The unique approaches taken by several states on the CARES Act will reverberate for a period of time, as taxpayers adjust to how states conform to or decouple from federal enactment. Although many states addressed CARES Act conformity during 2020, a significant number of states first considered the CARES Act during their 2021 legislative sessions. Some states that adopt the Internal Revenue Code as of a specific date were required to consider the CARES Act as they enacted legislation in 2021 that advanced their IRC conformity dates past the enactment date of the CARES Act.”

5. Remaining states enact remote-seller laws

2021 was the year in which all the states completed legislative action as a result of the Wayfair decision by adopting remote-seller and marketplace-facilitator provisions.

By the end of 2020, nearly all states imposing a sales tax had adopted remote-seller and marketplace-facilitator nexus legislation in response to Wayfair, Yesnowitz observed. “As a result of legislation enacted by Florida, Kansas and Missouri during 2021, this trend has become unanimous and all states with a sales tax have adopted remote-seller and marketplace-facilitator nexus provisions. This is particularly noteworthy because all states with a sales tax decided to follow Wayfair within just three years of the decision.”

6. Courts decline remote-seller sales tax challenges

During 2021, a number of federal courts decided not to hear challenges brought by remote sellers. “This was particularly the case when an alternative remedy could be obtained at the state level,” noted Yesnowitz. “An interesting development at the end of the year was a challenge to the complexity of Louisiana sales tax law.”

Louisiana’s constitution requires each of the state’s 64 parishes to collect sales and use taxes, with each parish setting its own tax rates and categories, and state law requires out-of-state businesses that sell to Louisiana customers to register and file reports in each parish where sales are made. The plaintiff, a family-owned business located in Arizona, sells to customers across the country but avoids sales to Louisianans because of the immense burden placed on small businesses, especially online retailers, by the sales tax system.

“There are several other states that base sales tax on locality rather than by state, so the obligation is challenging jurisdictions that have complexity in sales tax as well as jurisdictions that do not comply with [the Streamlined Sales Tax agreement],” said Yesnowitz. “The taxpayer is arguing that Louisiana’s requirement that out-of-state sellers register and file reports with every parish is ‘an undue burden on interstate commerce and a violation of due process.’”

7. Digital advertising taxes considered

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Maryland became the first state to enact a gross receipts tax on proceeds derived from digital advertising services in the state in February 2021.

“The tax has been the source of controversy since the day it was enacted,” observed Yesnowitz. “Legislation has delayed the effective date of the tax to the 2022 tax year due to various difficulties in implementing the tax, and also to lawsuits that were filed in both state and federal court alleging a violation of electronic commerce under the Internet Tax Freedom Act as well as the Commerce and Due Process Clauses of the U.S. Constitution. While we’ve seen other states start to consider similar legislation, I don’t expect much activity in this area until the Maryland litigation is resolved.”

8. Recent NOL developments

The net operating loss, in states that have such provisions, operates differently than the federal NOL, Yesnowitz observed.

“Over the past 12 months, as states have reckoned with their financial difficulties and made decisions regarding whether and how to conform to the many significant tax provisions included in the Tax Cuts and Jobs Act and the CARES Act, NOL treatment has not escaped notice,” he said. “In an effort to address their budgetary woes and maximize revenue, several states have acted to limit taxpayers’ ability to offset taxable income with recognized losses. Legislative and judicial developments in Illinois, Pennsylvania and New Jersey highlight imposed limitations on NOL usage. We expect more activity in this area as long as the pandemic impacts the economy.”

9. MTC updates statement on Public Law 86-272

P.L. 86–272 is the 1959 law that limits the state taxation of income from sales of tangible personal property if the taxpayer’s only business activities in the state are the solicitation of orders that are approved and shipped from outside the state. “After approximately two years of work, the Multistate Tax Commission voted in August 2021 to adopt revised guidance interpreting this legislation. After survey and approval by the MTC’s 16 compact member states and eight sovereignty member states, the statement was approved by the MTC’s Executive Committee. The adoption marks the most significant revisions to the statement since its last revision in 2001,” said Yesnowitz.

“Most significantly, the revised statement includes a new subsection to determine what constitutes protected or unprotected activities under federal law, specifically addressing activities conducted using the internet,” he added. “The statement establishes the general rule that when a business interacts with a customer via the business’s website or app, it is engaged in ‘business activity’ within the customer’s state, meaning that the activities extend beyond the solicitation of order for sales of tangible personal property, and therefore exceeds the protections of P.L. 86-272. But if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state.”

10. Tax regimes targeting the few

The economic pain generated by the pandemic has caused some states and localities to impose new sources of tax revenue that intentionally target small groups of taxpayers, according to Yesnowitz: “Prime examples are the adoption of billboard taxes by Cincinnati and Baltimore, and a long-term capital gain tax, as well as a business and occupation surtax on large financial institutions by Washington State. A Maryland Court of Appeals decision upheld Baltimore’s tax on the privilege of selling advertising space on billboards, while the Ohio Supreme Court ruled that Cincinnati’s tax violates the rights to freedom of speech and free press protected by the First Amendment.”