Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...
The recent federal tax changes are a focus of state legislatures—but the new law likely won’t dictate states’ pursuit of broader legislative trends, according to a leading state and local tax practitioner.
States have demonstrated a growing appetite for select changes in recent years—including shifting to combined reporting and market-based sourcing for corporate tax purposes. And migration toward these new regimes will continue regardless of the 2017 federal tax act ( Pub. L. No. 115-97), according to David Brunori, a Washington-based partner with Quarles & Brady LLP.
Officials in select states, such as Maryland and Pennsylvania, already have renewed their calls to adopt combined reporting this year. “I think they’re making those proposals regardless of what’s going on at the federal side,” Brunori said during a Feb. 21 panel hosted by the State and Local Taxes Committee of the D.C. Bar Taxation Community.
Likewise, the migration toward market-based sourcing “seems like it’s on automatic pilot,” Brunori said. Proposals surface every year as states abandon the cost-of-performance approach, responding to an evolving economy that is more service- and intangible-based. However, recent proposals likely aren’t related to the federal tax changes, he added.
On the other hand, the federal tax law may stir consideration of gross receipts taxes among states, according to Jamie Yesnowitz, a Washington-based principal with Grant Thornton LLP. Gross receipts taxes, such as the version adopted (and that withstood legal challenges) in Ohio, typically have a broad base and a very low rate. However, gross receipts regimes have generated significant criticism—such as concerns with pyramiding—and several state proposals to impose gross receipts taxes died in 2017.
However, states may come to the conclusion that the “federal base is so unreliable,” which could trigger consideration of gross receipts regimes, particularly in states facing significant fiscal challenges, said Yesnowitz, who is Grant Thornton’s SALT practice and National Tax Office leader. Brunori advised against this movement, characterizing the regime as the “single worst tax” imposed.
Meanwhile, state tax officials and practitioners are awaiting for the outcome in South Dakota v. Wayfair, which could undo the U.S. Supreme Court’s 1992 ruling in Quill Corp. v. North Dakota. That 26-year-old decision prohibits states from imposing sales tax collection obligations on vendors without a physical presence in-state.
Despite the judicial restriction, states have intensified efforts during the past few years to capture taxes lost in the modern e-commerce economy. According to MultiState Associates Inc., 34 states introduced 81 pieces of legislation during 2017 to recover revenue from digital commerce, and at least 14 measures have surfaced in six states during 2018—although a few bills have already died in New Mexico.
Brunori said that the Wayfair case, not the federal tax changes, will be the dominant development for sales tax purposes. In particular, there’s been a push among several states to implement Colorado-style notice and reporting regimes.
“What I’ve heard from a couple of states is, whether Quill stands or falls, we’re going to keep pursuing this,” Brunori said regarding the notice/reporting trend.
Aside from the state-level tax trends, several jurisdictions are mulling different approaches designed to mitigate the increased state and local tax burdens from the federal tax changes. Under the new law, taxpayers who itemize deductions on their federal return may deduct up to $10,000 in state and local sales, individual income, and property taxes. Previously the SALT deduction was unlimited.
Legislation allowing for charitable contributions to avoid the cap has been filed or is being considered in several states, including California, Connecticut, Illinois, Maryland, Nebraska, New Jersey, New York, and Virginia for income tax, and Washington for sales tax.
“I would be surprised if it worked,” Yesnowitz said.
He further highlighted issues with another SALT deduction workaround—shifting from taxing wage earners’ personal income to an employer payroll tax system—which has generated several concerns. In New York, for example, Gov. Andrew M. Cuomo’s proposed voluntary payroll tax would be phased in over three years beginning in the 2019 tax year. Employers would pay a 1.5 percent payroll tax in the first year, 3 percent in the second year, and 5 percent in the third and final year.
The payroll tax structure “works for payroll tax. It doesn’t work for partners and professional services firms,” Yesnowitz said. “It doesn’t work for non-wage earners.”
Meanwhile, the new federal “deemed repatriation” provisions might provide the impetus for states to repeal their tax haven laws.
Six states and the District of Columbia have enacted tax haven laws. In general, states have adopted one of two strategies. Montana and Oregon identify specific jurisdictions as tax havens, the “blacklist” approach. Tax haven laws in Alaska, Connecticut, Rhode Island, West Virginia, and the District of Columbia attempt to define what makes a country a tax haven, according to Bloomberg Tax data.
Through the federal tax law, Congress scrapped the previous international tax system for corporations—an unusual arrangement that allowed companies to defer U.S. income taxes on foreign earnings until they returned the income to the U.S. That “deferral” provision led companies to stockpile an estimated $3.1 trillion offshore and many, including Apple, were criticized for the moves.
From the audience, Doug Lindholm, president and executive director for the Council On State Taxation, said the return of money held offshore should encourage states to repeal tax haven regimes. A measure is advancing through the Oregon Legislature to repeal its tax haven statute.
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