The enactment of H.R. 1, the Tax Cuts and Jobs Act, has become a topic of extreme importance in the state and local tax area, dwarfing some of the typical issues SALT practitioners debate, according to Jamie Yesnowitz, principal and SALT National Tax Office leader at Grant Thornton.
“This is where we’ll see the most legislative action during the coming year,” Yesnowitz said. “What is most fascinating about this topic is the potential for some state governments to challenge the new federal regime. This aim may be accomplished by challenging the reach of new limitations on the SALT deduction taken on federal personal income tax returns, as well as by decoupling from certain amended provisions of the code.”
States will have to decide whether and how to conform to the Internal Revenue Code, Yesnowitz noted: “The question becomes whether a state conforms to the code on a static basis [as of a fixed date] or a rolling basis [incorporating the current code]. If they conform on a static basis, decisions have to be made as to when and how they will conform to the new provisions.”
In a Grant Thornton “SALT Alert,” Yesnowitz and his team made a number of predictions for the year ahead. “Historically, the trend has been for states to decouple from federal bonus depreciation provisions,” he noted. “State decoupling from federal bonus depreciation provisions is commonplace and automatic in many cases, and state legislatures that do not automatically decouple from these provisions have the means to do so in the next few months. In light of this, we predict that at least 80 percent of the states that impose corporate income taxes will decouple from the new 100 percent bonus depreciation provision contained in Code Section 168(k).”
The $10,000 cap on the state and local tax deduction for combined property and income taxes, in effect from 2018 to 2025, has already caused high-income-tax states to consider options to lessen the impact of the provision for their taxpayers. Some of the options under consideration include an employer-paid payroll tax to replace a portion of the income tax revenue, and an income tax credit for charitable contributions to the state government that could also be a deduction against federal tax liability. At least two states will challenge the new federal restriction on the SALT deduction through the enactment of provisions converting individual income taxes into payroll taxes or charitable contributions, Yesnowitz predicted.
Under the Tax Cuts and Jobs Act, unrepatriated foreign earnings are subject to a one-time transition tax of 15.5 percent for cash and cash equivalents and 8 percent for other assets applicable to specified U.S. shareholders. “States will have considerable issues in determining how to conform to the federal repatriation provisions, with at least two states deciding to impose either a state-specific surtax on deemed repatriation income, or a tax on the full amount of the deemed repatriation, without consideration for the Code Section 965 subtraction adjustment,” he predicted.
Beyond TCJA
In addition to the tax reform-related predictions, Yesnowitz and his team addressed a number of non-tax-reform SALT issues.
A number of states have a gross receipts tax — a tax on the total revenue of a company regardless of source — and Yesnowitz believes that more will try to implement such a regime. “Given the uncertain impact of federal tax reform on states, both from an overall economic perspective, and from a tax revenue standpoint, at least three states will propose, and one state will enact, legislation converting from a corporate income tax to a gross receipts tax.”
States will continue their efforts to expand the sales tax base, according to Yesnowitz. “These efforts are challenging to achieve, with strong lobbying groups often being successful in preventing the sales and use taxation of many service-based industries,” he said. “For example, in 2016, voters in Missouri approved an amendment to the state’s constitution that prohibited a new state or local sales, use or other similar tax on any service or transaction that was not subject to such a tax as of Jan. 1, 2015. We will see legislative proposals in at least 10 states to expand the sales tax base to a significant number of services, but with no success.”
As a result of the 1992 Supreme Court Quill decision preventing states from requiring out-of-state retailers to collect sales and use taxes on products sold within the state, and the growing volume of lost sales tax revenue due to online sales, the states have developed a number of weapons to counter the situation. These include economic nexus, click-through nexus, affiliate nexus, notice and reporting laws, and “cookie” nexus, according to Yesnowitz. “Four states — Pennsylvania, Rhode Island, Washington and Minnesota — all enacted legislation in 2017 based on the marketplace provider or facilitator concept.”
For example, Washington State’s new legislation requires that, beginning Jan. 1, 2018, marketplace facilitators with either a physical presence in the state or $10,000 or more in retail sales sourced to Washington must either collect and pay sales tax on sales to Washington purchasers, or follow the use tax notice and reporting requirements codified in the law. Yesnowitz believes that the marketplace provider or facilitator concept, like the notice and reporting requirement before it, will grow in popularity in 2018.
A number of states have shifted from the cost-of-performance method to market-based sourcing for revenue from the sale of services, thus sourcing income to the state where the service is received, rather than the state where the provider is located. Yesnowitz predicts that at least two different state courts will issue opinions on industry-specific cost-of-performance issues that reference cost studies, and at least one state court will issue an opinion analyzing a recent market-based sourcing statute.
Incentives and sins
Two large-scale developments in the tax incentive arena occurred in 2017, according to Yesnowitz: Wisconsin legislation to attract Foxconn Technology Group’s first U.S. manufacturing facility and the national bidding war among more than 200 jurisdictions to be the location of Amazon’s second headquarters.
“Once Amazon makes a final decision and the details of the incentives offered under the winning bid are made public, it is very likely that there will be a public evaluation of how fair the deal may be to the winning jurisdictions and its taxpayers, along with a critique of the incentives given to Amazon,” Yesnowitz said. He predicts at least one state will create reporting requirements designed to test the effectiveness of its incentives.
While the Multistate Tax Commission promoted a successful voluntary disclosure initiative for certain online sellers in 2017, the MTC lacks the resources to consider a second program. New Jersey had its own program to help certain out-of-state businesses comply with the state’s click-through nexus provisions. Yesnowitz predicts at least two states outside of those that participated in the MTC’s voluntary disclosure initiative will provide their own special voluntary disclosure initiative targeted toward remote sellers.
“Sin” taxes are growing in popularity as states seek new forms of revenue, Yesnowitz observed. “Traditionally, sin taxes have been imposed on liquor, gambling and tobacco. Newer forms of sin taxes include sugary beverage taxes and bag taxes,” he noted.
And marijuana taxes, once seen as a guaranteed revenue-raiser as a complement to legalization in many states, may see increased scrutiny in light of the Department of Justice’s rolling back of guidelines that prevented the government from enforcing its anti-marijuana laws in states that have legalized marijuana. As a result, there have been reports that governments are considering a meat tax as a way to improve public health and meet emissions targets in the Paris Climate Agreement, according to Yesnowitz.
Of course, the decision of the Supreme Court to hear South Dakota’s challenge to the 1992 Quill case could have huge implications for the year ahead in SALT, depending on the way the court rules, Yesnowitz observed.
