State and local tax advisor: November 2021

The states covered in this issue of our monthly tax advisor include:

• Alabama
• California
• Colorado
• Connecticut
• Illinois
• Kansas
• Ohio
• Tennessee
• Texas
• Wisconsin

Alabama

Income tax: Alabama provides guidance for making pass-through entity tax election

The Alabama Electing Pass-Through Entity Tax Act (Act 2021-1 and Act 2021-423) allows Alabama S corporations and Subchapter K entities (pass-through entities or PTEs) to elect to pay Alabama income tax at the entity level. Electing PTEs must submit Form PTE-E via My Alabama Taxes (MAT). The Department of Revenue (DOR) expects Form PTE-E to go live in January.

Electing PTEs must register to use MAT and submit Form PTE-E through MAT prior to the 15th day of the third month following the close of the tax year for which they elect to be taxed at the entity level. They will need the following information to sign up for MAT:

• 10-digit account number, which is on all correspondence sent from the Alabama DOR.
• Sign-on ID, which was assigned and mailed upon registration of the account.
• Access code, which was assigned and mailed upon registration of the account.
• Valid email address, for receiving confirmation emails and authorization code messages.

New entities without an Alabama DOR account must first complete a new taxpayer/account registration application using MAT. They should click on the link to register a business/obtain a new tax account number in the “Businesses” section of MAT. Then, they should select the “Pass Through Entity” account as the type of account.

Anyone who needs assistance setting up an account or who has questions related to the election process can contact the “Pass-Through Entity Tax” section at 334-242-1170, Option 6. The DOR also provides additional information on electing PTEs on its website at: revenue.alabama.gov/individual-corporate/electing-pass-through-entities/.

Notice - Alabama Electing Pass-Through Entity Tax Act Guidance, Alabama Department of Revenue, Oct. 19, 2021.

California

Corporate income tax: Unitary business determinations for holding company situations addressed

The California Franchise Tax Board analyzed whether pass-through holding companies are unitary with other pass-through entities in a number of different scenarios. A unity determination in the context of holding companies requires additional considerations beyond those in a traditional analysis.

First, the fact that holding companies have limited, if any, operations, means that some nontraditional factors are more heavily weighted in determining unity.

Second, the purpose of the holding company in the structure of a business can evidence unity. For instance, where a holding company functions as a conduit for its owners, or as a focal point for an operating business, that can support a finding of unity between the holding company and the operating business. By contrast, where the structure of ownership through a holding company evidences an investment purpose, the holding company will not be treated as unitary. For instance, where a parent company utilizes a holding company solely to hold an interest in a nonunitary subsidiary, the holding company is not unitary with either the parent company or the entity it holds.

Third, when a holding company is affiliated with only one operating business, unity is very likely present. On the other hand, when a holding company holds interests in several unrelated operating companies that lack unitary connections, it’s more likely that the holding company merely serves an investment purpose.

Finally, the traditional tests for a unitary business are not an exact fit in the context of pass-through holding companies. In instances where a holding company holds less than a controlling interest in an operating entity, the holding company can still be unitary with the operating entity, to the extent of its ownership interest in the entity. Pass-through entities need not hold more than 50% of an entity to be unitary with that entity. As long as unitary indicia exist, a holding company can be unitary with an operating entity. If the holding company provides value and support to the operating business, it will be treated as unitary with that business.

Legal Ruling 2021-01, California Franchise Tax Board, Oct. 25, 2021.

Colorado

Sales and use tax: Heart monitors don’t qualify for medical devices exemption

The Colorado Department of Revenue (department) issued a letter ruling discussing the application of sales and use tax on the retail sale of heart monitors. In this matter, a company (taxpayer) sold heart monitors to healthcare providers not for resale but to treat patients by implanting it for diagnostic purposes.

The heart monitor is considered tangible personal property under Colorado law because it’s a product and is capable of being possessed and exchanged. The sale of the heart monitor to Colorado customers is a retail sale of tangible personal property subject to state and state-administered local sales tax, unless a specific sales tax exemption applies.

The department determined that the heart monitor did not qualify for sales tax exemption under “prosthetic device” as it was a diagnostic tool and it did not replace, correct, or support any portion of the body. Additionally, the heart monitor did not qualify as “durable medical equipment” either, because it was implanted in the body and could not withstand repeated use. Accordingly, without an applicable exemption, the taxpayer was required to collect state and state-administered local sales tax on the retail sale of the heart monitors.

PLR 21-006, Colorado Department of Revenue, Oct. 20, 2021.

Connecticut

Multiple taxes: Tax amnesty program launched

Connecticut has announced a tax amnesty program, which begins Nov. 1, 2021, and ends Jan. 31, 2022, for purposes of all taxes administered by the Department of Revenue Services.

2021 tax amnesty program

The program:

• Provides a 75% reduction in interest.
• Waives penalties.
• Waives the possibility of criminal prosecution to those who have not filed, have under reported, or have existing liabilities related to taxes owed to the state for any tax period ending on or before Dec. 31, 2020.

Once amnesty ends, taxpayers will be liable for the full tax, penalty, and interest on any amount owed.

Press Release, Connecticut Department of Revenue Services, Oct. 29, 2021.

Illinois

Personal income tax: Waiver of late estimated payment penalty for newly enacted entity-level tax announced

For personal income tax purposes, Illinois announced that it will waive the penalty for late estimated payments for the newly enacted entity-level tax. The Department of Revenue (department) clarified that:

• It will not assess a penalty for late estimated payments due for tax years ending before Dec. 31, 2022, for partnerships and subchapter S corporations who elect to pay the new pass-through entity-level tax.
• Individual partners and shareholders of these entities are not eligible for the penalty relief.
• Partners and shareholders can claim a tax credit against their own tax liability for distributive shares of the pass-through entity-level tax credit they receive and may adjust their estimated payments accordingly. 

Corporate income tax: Recent changes may require taxpayers to make or increase estimated payments

Illinois issued a bulletin informing corporate and personal income taxpayers that recent legislative changes may require corporations, individuals, S corporations, and partnerships to make or increase estimated tax payments for the remainder of the tax year to avoid or minimize a late payment penalty for the underpayment of estimated tax due. The changes impact bonus depreciation, net loss deductions for corporations, and foreign dividend reporting.

Among other topics, the changes may impact:

1. Estimated payment requirements for corporations who file Form IL-1120 and individuals who file Form IL-1040.
2. Actions that taxpayers who are or are not already making estimated payments should take to minimize or avoid the penalty.
3. Effects of the new estimated payment requirements on pass-through entities.

Informational Bulletin FY 2021-01, Illinois Department of Revenue, September 2021.

Sales and use tax: Taxability of online sales fulfilled from different inventories

The Illinois Department of Revenue (department) issued a letter ruling discussing the sourcing of Illinois sales and use tax for online sales fulfilled from different inventories located in or outside Illinois.

The taxpayer is a retailer headquartered outside of Illinois that makes sales of tangible personal property to Illinois customers through its website, fulfilled either from taxpayer-owned inventory located inside or outside of Illinois, a wholly owned subsidiary operated brick-and-mortar retail store located in Illinois, or unrelated third party-owned inventory located in Illinois.

Illinois applies a presumption to internet sales, which states that the department will presume that the retailer’s predominant selling activities take place outside of this state. Such a sale will be subject to the Illinois Use Tax Act unless there is clear and convincing evidence that the retailer’s predominant and most important selling activities take place in this state.

For sales and excise tax purposes, the department generally treats a parent company and its subsidiaries and affiliates as separate and distinct companies. The department stated that the taxpayer’s online sales to Illinois customers may be fulfilled by the taxpayer using inventory from four different inventories. However, without more information and documentation, the department could not say without reservation that the taxpayer did not have possession of the inventory in subsidiary or third-party inventories if the taxpayer was free to fulfill orders from these warehouses.

General Information Letter ST 21-0035-GIL, Illinois Department of Revenue, Sept. 9, 2021.

Corporate income tax: NOL carryforward period extended

Illinois extended the carryforward period for corporate income tax net operating loss (NOL) deductions from 12 to 20 years.

When does the new carryforward period apply?

The new carryforward period applies to:

• NOLs for tax years ending on or after Dec. 31, 2021.
• Unused NOLs from tax years ending before 2021 if the statute of limitations period is open.

Are there limits on NOL carryforwards?

Illinois limits the NOL carryforward deduction to $100,000 tax years ending on or after Dec. 31, 2021, and before Dec. 31, 2024.

P.A. 102-669 (H.B. 1769), Laws 2021, effective Nov. 16, 2021, and as noted.

Kansas

Sales and use tax: Remote seller requirements explained

The Kansas Department of Revenue has issued guidance on the expansion of sales tax requirements to remote sellers enacted by S.B. 50. The law required the collection of sales and use tax by remote sellers as of July 1, 2021.

De minimis threshold

The legislation expanded the definition of retailer doing business in the state, to include (i) for the period of Jan. 1, 2021 through June 30, 2021, a retailer that had in excess of $100,000 of cumulative gross receipts from sales to customers in the state; or (ii) during the current or immediately preceding calendar year, a retailer that had in excess of $100,000 of cumulative gross receipts from sales to customers in the state. A remote seller is not required to collect tax on the first $100,000 of sales made to customers in Kansas during the year the remote seller is first required to collect and remit tax. However, a remote seller may collect tax on the first $100,000 of sales for the benefit of their customers.

Once a remote seller has made sales to Kansas customers that equal or exceed the $100,000 threshold, they must collect and remit tax on any additional sales. The remote seller is required to collect tax on all sales made to Kansas customers in the following year. The requirement to collect and remit Kansas tax terminates if the amount of sales to Kansas customers falls below $100,000 in the preceding year.

Registration

A remote seller must register, collect, and remit tax on the next transaction after meeting or exceeding the threshold. The remote seller should register with the department no later than thirty days after their sales for the year exceed $100,000.

Notice 21-7, Kansas Department of Revenue, Nov. 1, 2021.

Ohio

Sales and use tax: Leased equipment not qualified for casual sales exemption

A road construction company (taxpayer) was properly denied Ohio casual sales tax exemption as the taxpayer’s leases ceased to be occasional, casual, or isolated and instead became a business. In this matter, the taxpayer usually provided and installed traffic maintenance equipment during its projects. The taxpayer was assessed use tax on the rented equipment.

The taxpayer argued that the leases of equipment should have been exempt as “casual sales.” To qualify for the casual sale exemption, the person making the sale must have acquired the tangible personal property for his own use in this state.

Upon review, the Board of Tax Appeals determined that the records showed that upon purchase, the taxpayer initially used the property for its own excavation work. But then it continued as a business that leased equipment as needed. Once the taxpayer developed this systematic recurrence of leasing, these leases ceased to be occasional, casual, or isolated and instead became a business. Accordingly, the assessment was affirmed.

Karvo Paving Co., v. Tax Commissioner, Ohio Board of Tax Appeals, No. 2016-782, Nov. 3, 2021.

Tennessee

Sales and use tax: Tax treatment of subscription packages discussed

For sales and use tax purposes, Tennessee discusses tax treatment of subscription packages.

If a taxpayer’s software package is purchased from a business location in Tennessee, then the sale is sourced to that location and the local sales tax rate that applies is the local rate for the business location.

If a software package includes tangible personal property that’s shipped or delivered to the purchaser or the purchaser’s done in Tennessee, the sale should be sourced to Tennessee.

If a software package doesn’t include tangible personal property but includes a specified digital product, a video game digital product, and/or a warranty contract covering tangible personal property, the sale of the package should be sourced to the Tennessee purchaser’s/subscriber’s residential or primary business address.

Letter Ruling No. #21-04, Tennessee Department of Revenue, Aug. 1, 2021.

Texas

Corporate income tax: Research and development credit rule amended

Texas has adopted changes to its franchise tax credit rule for research and development activities. The changes include:

• Incorporating the four-part test for “qualified research” in IRC Section 41(d).
• Clarifying the application of federal regulations.
• Defining “qualified research expenses” as the sum of in-house research expenses and contract research expenses.
• Addressing the treatment of software development activities.
• Listing a number of activities that do not constitute qualified research.
• Declaring that a determination of eligibility for the federal credit is not binding on the determination of eligibility for the state credit.
• Requiring that taxpayers prove entitlement to the credit by clear and convincing evidence, with proof of qualified research expenses supported by contemporaneous business records.
• Providing some guidance for combined reporting groups that claim the credit.
• Stating that the comptroller may verify credit carryforwards even if the statute of limitations for the year in which the credit was created has expired.

Four-part test

The four-part test applies separately to each of a taxable entity's business components. It includes the following parts:

• Section 174 Test — Expenditures related to the research must be eligible to be treated as expenses under IRC Section 174.
• Discovering Technological Information Test — The research must be undertaken for the purpose of discovering information that is technological in nature.
• Business Component Test — The application of the technological information for which the research is undertaken must be intended to be useful in the development of a new or improved business component of the taxable entity.
• Process of Experimentation Test — Substantially all of the research activities must constitute elements of a process of experimentation for a qualified purpose.

Shrink-back rule: The four-part test applies first at the level of the discrete business component used by the taxable entity. If the requirements of the test are not met at that level, then they apply at the next most significant subset of elements of the business component. This shrinking back of the product continues until either a subset of elements of the product that satisfies the requirements of the test is reached, or the most basic element of the product is reached, and that element fails to satisfy any part of the test.

Federal regulations

For purposes of the state credit, references to the IRC generally mean the code in effect on Dec. 31, 2011. But, a federal regulation adopted after that date will apply to the extent it requires an entity to apply the regulation to the 2011 federal income tax year.

Qualified research expenses

“Qualified research expenses” are the sum of in-house research expenses and contract research expenses.

In-house research expenses include:

• Wages paid or incurred for qualified services performed by an employee
• Amounts paid or incurred for supplies used for qualified research
• Amounts paid or incurred for the right to use computers for qualified research
• Contract research expenses are generally 65% of the amount paid by a taxable entity to another person, other than an employee, for qualified research.

Software development activities

Software development activities likely to be qualified research include:

• Developing the initial release of an application software product that includes new constructs.
• Developing system software.
• Developing specialized technologies.
• Developing software as part of a hardware product where the software interacts directly with that hardware in order to make the hardware/software package function as a unit.

Software development activities unlikely to qualify include:

• Maintaining existing software applications or products.
• Configuring purchased software applications.
• Reverse engineering of existing applications.
• Performing studies, or similar activities, to select vendor products.
• Detecting flaws and bugs directed toward the verification and validation that the software was programmed as intended and works correctly.
• Modifying an existing software business component to make use of new or existing standards or devices or to be compliant with another vendor’s product or platform.
• Developing a business component that’s substantially similar in technology, functionality, and features to the capabilities already in existence at other companies.
• Upgrading to newer versions of hardware or software or installing vendor-fix releases.
• Re-hosting or porting an application to a new hardware or software platform or rewriting an existing application in a new language.
• Writing hardware device drivers to support new hardware.
• Performing data quality, data cleansing, and data consistency activities.
• Bundling existing individual software products into product suites.
• Expanding product lines by purchasing other products.
• Developing interfaces between different software applications.
• Developing vendor product extensions.
• Designing graphic user interfaces.
• Developing functional enhancements to existing software applications or products.
• Developing software as an embedded application.
• Developing software utility programs.
• Changing from a product based on one technology to a product based on a different or newer technology.
• Adapting and commercializing technology developed by a consortium or open software group.

Excluded research activities

“Qualified research” doesn’t include the following activities:

1. Research after commercial production
2. Adaptation of existing business components
3. Duplication of an existing business component
4. Certain surveys and studies
5. Research activities with respect to internal use software
6. Research in the social sciences, arts, or humanities
7. Research funded by another person or governmental entity

34 TAC 3.599, Texas Comptroller of Public Accounts, effective Oct. 24, 2021.

Wisconsin

Corporate, personal income taxes: End of COVID-19 nexus relief for telecommuting employees announced

Wisconsin issued a withholding tax update discussing how the state previously relaxed its enforcement of nexus provisions on an out-of-state business whose only Wisconsin activity was having an employee working temporarily from home during the COVID-19 national emergency. The update notes that this nexus relief no applies beginning Jan. 1, 2022.

The update also addresses a number of other topics, including: Wisconsin and federal differences for 2021 under the dependent care assistance program; an electronic filing mandate for Form PW-2; employers using a payroll service provider; the combined federal/state filing program; and Form 1099-NEC.

Withholding Tax Update 2021-1, Wisconsin Department of Revenue, November 2021