Corporate Close-Up: State Tax Controversies Offer Food for Thought for Thanksgiving and Beyond


Turkey

 

Today is State Taxgiving Day at Bloomberg BNA! The usual bag lunch is replaced by homemade dishes such as Quill-Lime Pie, Market-Based Sourcing Macaroni and Cheese as well as Green Incentives Green Bean Casserole. This is also a time to give thanks for the following issues and open questions that are enough for State Taxgiving Day Feast:

The Multistate Tax Compact Apportionment Election Controversy. At issue is whether taxpayers operating in MTC member states can elect to apportion income using the MTC Compact’s three-factor apportionment formula instead of the method (e.g., single-sales factor) purportedly required under state statute.  Litigation on this question is pending in California, Michigan, Minnesota, Oregon and Texas.  After having originally won on this issue in California, the prospects for the taxpayers’ success appears to have dimmed, based on oral arguments before the state’s supreme court. 

Food for Thought: Rulings for the states--and against requiring them to adhere to compact provisions--could doom the prospects for greater uniformity among the states on other important provisions such as market-based sourcing

Retroactive Legislation.  A sub-issue in the MTC Compact controversy discussed above is whether an MTC member state may retroactively repeal their adoption of the compact. The most recent ruling on this issue came in September when taxpayers lost their bid in challenging Michigan’s retroactive repeal of the MTC Compact in Gillette Commercial Operations N. Am. v. Dep't of Treasury, No. 325258 (Mich. Ct. App. Sept. 29, 2015).  Retroactivity has arisen on other contexts as well. Last year, Washington state’s high court upheld a 2013 legislative amendment to  estate tax provisions that apply to “estates of decedents dying on or after May 17, 2005” against a due process challenge. The U.S. Supreme Court recently denied cert. in that case. previous hit (Hambleton v. Washington Dep't of Revenue, 2015 BL 335688, U.S., No. 14-1436, cert. denied, 10/13/15).

Food for Thought: The seminal case on the constitutionality of retroactive tax legislation (United States v. Carlton, 512 U.S. 26 (1994)) turned 20 last year. In Justice O’Connor’s concurring opinion, she said: “A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions.” The retroactivity question seems ripe for a revisit by the U.S. Supreme Court.

Corporate Income Tax Sourcing. Determining which states are owed corporate income tax on sales of services or intangibles continues to grow in complexity. The states have adopted a varying patchwork of conflicting rules on this issue. Most states follow the cost of performance approach, which is an “all-or-nothing” approach that sources all of the receipts to a single jurisdiction based on where most of the costs of performance occurred.  Other states use a proportionate method, or pro rata approach, in which receipts from the income-producing activity are sourced proportionately to each state based on where the cost of activity occurs. A growing minority of states use a market-based sourcing approach, which sources receipts to the state where the taxpayer’s market for the sale is located.

One result of these contrasting approaches is that it is not uncommon for more than one state to conclude that it’s entitled to impose tax on 100 percent of the receipts of a given transaction. In AT&T Corp. v. Dep't of Revenue, No. S060150, 2015 BL 294190 (Or Sept. 11. 2015) the court found that AT&T failed to show that the majority of its costs arose in New Jersey. Instead the court concluded that most of the company’s costs of performance occurred in Oregon. As a result, the income from its transactions was properly subject to Oregon’s income tax.

Food for Thought: What relief would be available to the taxpayer if New Jersey reached the same conclusion as Oregon and both states taxed 100 percent of the income? The taxpayer would be barred from directly challenging this result in federal court under the Tax Injunction Act. The only hope would be for New Jersey Court to strike down its statute or the U.S. Supreme Court to hear the case on appeal and side with the taxpayer.

As we approach Thanksgiving, I am thankful for the cornucopia of issues that exist in state corporate income tax.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What are some other state tax issues that offer food for thought?

Take a  free trial to Premier State Tax Library , a comprehensive research service that delivers deep, unique analysis, and time-saving practice tools to help practitioners make well-informed decisions.