State and local tax advisor: April 2023

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

• Arkansas
• District of Columbia
• Kentucky
• Maryland
• Michigan
• Mississippi
• New York
• North Carolina
• Ohio
• Utah
• Virginia
• Washington
• West Virginia

Arkansas

Corporate income tax: Throwback rule phase out

Arkansas has enacted legislation that will phase out and eventually repeal the state’s throwback rule. The throwback rule treats income a business receives certain sales of tangible personal property shipped from Arkansas to other states as taxable to Arkansas, even though income from sales of tangible personal property is typically treated as taxable to the state to which the business ships the item.

Starting in the tax year beginning Jan. 1, 2024, Arkansas will treat a percentage of sales to which the throwback rule applies as taxable to Arkansas and a percentage as taxable to the destination state, with the amount taxable to the destination state increasing each year as the amount taxable to Arkansas decrease. The percentages will be as follows:

• 2024: 85.71% to Arkansas and 14.29% to the destination state.
• 2025: 71.42% to Arkansas and 28.58% to the destination state.
• 2026: 57.13% to Arkansas and 42.87% to the destination state.
• 2027: 42.84% to Arkansas and 57.16% to the destination state.
• 2028: 28.55% to Arkansas and 71.45% to the destination state.
• 2029: 14.26% to Arkansas and 85.74% to the destination state.

For tax years beginning on or after Jan. 1, 2030, these sales will be treated as entirely taxable to the destination state, and the throwback rule will be repealed.

Act 485 (H.B. 1045), Laws 2023, effective for tax years beginning on or after Jan. 1, 2024.

District of Columbia

Sales and use tax: Refund denied due to failure to provide resale certificate at time of purchase

A hospital (taxpayer) wasn’t entitled to a refund of District of Columbia sales and use tax paid on its purchase of prepared meals from a vendor because the taxpayer failed to provide the vendor with a resale certificate at the time of purchase. Generally, purchasers who wish to avoid sales tax on purchases for resale must, at the time of the purchase, provide the vendor with a certificate stating that the purchased items are intended for resale. In this matter, the taxpayer paid tax on its purchases of the prepared meals, but it didn’t provide the seller with a certificate. Later, the taxpayer sought a tax refund from the Office of Tax and Revenue, arguing that a purchaser who fails to provide the required certificate and instead pays sales tax at the time of a purchase can later obtain a refund by proving that the purchased items were intended for resale and in fact were resold.

The Court of Appeals wasn’t persuaded by the taxpayer’s arguments and concluded that the applicable statute precludes the taxpayer’s claim for a refund. Accordingly, the denial of refund claim was sustained.

District Hospital Partners, LP v. District of Columbia, District of Columbia Court of Appeals, No. 22-TX-0088, March 2, 2023.

Note: This case highlights the importance of obtaining valid sales tax exemption certificates in a timely manner. While many states allow businesses to provide exemption certificates subsequent to a purchase date, the state’s sales tax laws may not require the state to accept a retroactive exemption certificate. There are other nuances that businesses should be aware of regarding exemption certificates, including whether the issuing purchaser is required to be registered for sales tax purposes and/or the vendor is required to confirm the issuer is properly registered.

Kentucky

Corporate, personal income taxes: PTE tax repealed and reenacted with changes

Kentucky repealed and reenacted its elective pass-through entity (PTE) income tax with significant changes that:

• Replace references to “individual partners, members, or shareholders” with “entity owner.”
• Modify the election process and extend the deadline for the 2022 tax year.
• Require estimated PTE tax payments for tax years beginning on or after Jan. 1, 2024.
• Provide the owners with a refundable, instead of a nonrefundable, credit for tax paid by the PTE.

Entity owner defined

An “entity owner” is a direct or indirect owner of an electing entity receiving a proportionate share of the entity’s income. A direct owner is a partner, member, or shareholder that holds an interest directly in a PTE. An indirect owner is a partner, member, or shareholder that holds an interest indirectly in a PTE, or through another indirect partner, member, or shareholder. An owner is a direct or indirect partner, member, or shareholder of an electing entity and includes a beneficiary of an estate or trust.

Election process and deadline

Effective for tax years beginning on or after Jan. 1, 2022, an authorized person for the PTE can elect to have the Kentucky personal income tax imposed on the entity. An “authorized person” is any individual with the authority to bind the PTE or sign the PTE’s returns.

The election for tax years beginning on or after Jan. 1, 2022, and before Jan. 1, 2023, can be made after March 31, 2023, and before Aug. 31, 2024. Kentucky will not impose late payment or filing penalties and interest on PTE’s making the election.

The deadline for the annual election beginning with the 2023 tax year is:

• The 15th day of the 4th month after the close of the tax year.
• The 15th day of the 10th month after the close of the tax year, if the entity files a return extension.

The election is binding on all entity owners after it is made. Consent to the election by the PTE's majority owners is no longer necessary.

Determination of taxable income

Kentucky generally follows federal income tax law in determining:

• A PTE’s ordinary and separately stated items of income.
• A PTE owner’s distributive share of that income.

Credits for taxes paid

The refundable credit for Kentucky income tax paid by the PTE equals 100% of the entity owner’s proportionate share of the tax paid for the tax year. The entity owner can apply the credit against the owner's Kentucky personal income tax liability based on the owner's proportionate share of income from the PTE.

A Kentucky resident who is an owner of an electing PTE can also claim a credit for any entity-level income tax paid by the PTE to another state. The credit equals the amount of the owner's distributive share of the electing PTE’s income, loss, deductions, and credits.

Ch. 148 (H.B. 5), Laws 2023, effective March 31, 2023, and as noted.

Maryland

Corporate income tax: Pass-through entity election procedure change

Maryland has changed the procedure for taxpayers to elect whether or not to pay the elective entity-level pass through entity income tax for tax years beginning after Dec. 31, 2022. Taxpayers must now decide whether to elect to pay the entity-level tax with their first filing or payment of the year. Therefore, taxpayers who make estimated payments must indicate whether they have made the election on the Form 510/511D accompanying their first payment. The election must be made separately each year and is irrevocable for the tax year once made.

Tax Alert: Process Change: Instructions for Electing and Nonelecting Pass-Through Entities for Tax Years Beginning after Dec. 31, 2022, Maryland Comptroller, April 11, 2023.

Michigan

Personal income tax: Tax rate will temporarily decrease for 2023

The Michigan personal income tax rate will decrease from 4.25% to 4.05% for 2023. Treasurer Rachael Eubanks announced that strong economic growth and robust state revenues will automatically trigger the rate reduction.

Michigan law requires a reduction in the personal income tax rate beginning in 2023 if general revenue fund grew from the preceding year faster than the rate of inflation for the same period. This determination requires consensus by the State Treasurer, the Director of the Senate Fiscal Agency, and the Director of the House Fiscal Agency. But it is anticipated that the formal step of adopting a consensus will occur as a procedural matter at the May Consensus Revenue Estimating Conference.

Attorney General Dana Nessel issued an opinion indicating that this rate reduction will be temporary, for one year only, and that the rate will revert to 4.25% the following year.

Press Release, Michigan Department of Treasury, March 29, 2023.

Mississippi

Pass-through entity tax election procedure modified

Mississippi has enacted legislation that modifies the procedure by which an entity may elect to pay Mississippi's elective pass-through entity tax. The legislation changes the deadline by which an entity may make or revoke this election to the later of the end of the tax year for which the taxpayer wishes to make or revoke the tax year, the deadline for the affected tax return, or the date the affected tax return is actually filed.

The legislation also provides that an entity may approve the election by whatever means the entity's governing documents allows the entity to take official action. An entity whose governing documents do not specify a procedure for taking official action must approve the election by a vote or written consent of those holding greater than 50 percent control of the entity, and, if the entity has a governing body, the governing body must also approve the election by vote or written consent.

The legislation also clarifies that an individual taxpayer's tax credit for elective pass-through entity tax paid by an entity in which the taxpayer owns an interest is equal to their pro rata or distributive share of tax due before the application of any entity-level credits by the entity. Additionally, the legislation provides that any additional income tax credits generated by the entity will pass through to the owners of the entity on a pro rata basis and may be claimed on the owners’ individual tax returns.

H.B. 1668, Laws 2023, effective Jan. 1, 2023.

New York

Corporate income tax: Manufacturing group did not qualify for preferential rates

The preferential corporate franchise tax rates for qualified New York manufacturers didn’t apply to a combined group, although manufacturing was the group's primary business activity. Because there was no manufacturing occurring within New York, the group didn’t satisfy the provision’s property requirement. The group argued that the in-state property requirement violated the Commerce Clause of the U.S. Constitution. However, that argument wasn’t addressed because the Division of Tax Appeals lacks jurisdiction to consider facial validity challenges of statutes. The group’s alternative argument, based on its claimed status as a qualified emerging technology company (QETC), was also rejected.

The Division of Taxation successfully asserted that each member of a combined group must meet the definition of a QETC for the combined group to qualify for the preferential tax rates at which QETCs were taxed during the years at issue. Finally, penalties for understatement of tax were sustained.

Raytheon Co., New York Division of Tax Appeals, Administrative Law Judge Unit, DTA Nos. 829739 and 829740, March 16, 2023.

North Carolina

Corporate, personal income taxes: IRC conformity updated, changes to PTE tax enacted

North Carolina enacted legislation that:

• Updates the IRC conformity tie-in date for determining corporate and personal income tax liability from April 1, 2021, to Jan. 1, 2023.
• Requires sole proprietorships doing business in and outside the state to determine taxable income using the same allocation and apportionment rules as corporations.
• Expands eligibility for the elective pass-through entity (PTE) income tax to partnerships with partners that are partnerships or S corporations.
• Requires income tax withholding by partnerships with nonresident partners that are partnerships or S corporations, if the partnership elects to pay income tax for those partners.
• Allows residents who are partners or shareholders in a partnership or S corporation that paid a PTE income tax to another state or the District of Columbia to claim a credit or deduction for the tax paid.
• Makes the PTE tax election binding after a partnership or S corporation files its return, instead of after the original or extended due date for the return.

The changes to PTE tax eligibility and partnership withholding are effective beginning with the 2022 tax year. The credit for PTE tax paid to another jurisdiction is also effective beginning with the 2022 tax year. The other changes to the PTE tax are effective for tax years beginning on or after Jan. 1, 2023.

Ch. 12 (S.B. 174), Laws 2023, effective April 3, 2023, and as noted.

Corporate income tax: Taxpayer’s request to file combined income tax return denied

The North Carolina Department of Revenue declined a taxpayer’s redetermination request to file a U.S. water’s edge unitary combined corporate income tax return for the fiscal tax year at issue because the taxpayer didn’t establish an adequate basis for a redetermination. Generally, the Secretary of Revenue has discretionary authority to allow an alternative filing methodology if the Secretary has reason to believe that any corporation’s state net income properly attributable to its business carried on in this state isn’t accurately reported on a separate return because of intercompany transactions.

In this matter, the Secretary noted that the taxpayer, a food and beverage distributor, didn’t articulate or provide documentation to warrant redetermination. The mere fact that a combined return would result in a filing convenience for the taxpayer or more certainty in projecting and accounting for its state income tax liability wasn’t a standard to allow a redetermination.

Private Letter Ruling, North Carolina Department of Revenue, Jan. 6, 2023, released March 2023.

Ohio

Corporate, personal income taxes: Additional PTE tax guidance issued

Ohio has issued pass-through entity (PTE) tax updates and reminders for filers.

What is the filing due date?

The due date to file the 2022 IT 4738 return is April 18, 2023. Ohio will honor the federal extension to file the IT 4738 to the same federal extended due date. Taxpayers should attach a copy of the federal extension when filing the IT 4738. A federal extension is not an extension to pay.

How are payments made and claimed?

A new Universal Payment Coupon (UPC) for the IT 4738 is now available and posted to the Ohio’s website on the forms page. If the entity needs to make 2023 estimated payments or needs to make a payment of total amount due for the 2022 IT 4738, use the IT 4738 UPC.

If an entity elects to file the 2022 IT 4738, the payments need to be separated as follows:

• Line 11: Ohio IT 4738 estimated UPC/electronic payments for the taxable year. Only use this line to claim actual payments for which the entity used the IT 4738 UPC (was first available on 1/19/2023).
• Line 12: IT 1140 and IT 4708 estimated UPC/electronic payments claimed on this return. Use this line to claim actual payments for which the entity used either the 1140 or 4708 UPC.

How do entities complete the IT 4738?

There is no line available on the IT 4738 for the electing pass-through entity (EPTE) to report the tax paid expense (as reported on the federal 1065 or 1120-S). Ohio is seeing entities erroneously using Line 31 of the IT 4738 to report this tax paid expense add-back. The add-back of the EPTE tax paid is made on the individual income tax return, IT 1040, Schedule of Adjustments line 2.

Don’t self-assess the IT 2210 interest penalty on the 2022 IT 4738. Ohio isn’t applying this interest penalty for tax years starting prior to 01/01/2023.

There are no credits permitted to be taken on the IT 4738. If a PTE files an IT 4738 and has been made aware of credits that they may otherwise have been able to take, the PTE must pass those credits to its owners/investors via an Ohio IT K1 (line 4) instead of reporting them on the IT 4738.

Taxpayers should include any federal return information or other supporting schedules when filing the IT 4738.

Who can claim a bonus depreciation add-back and deduction?

Only an individual investor/owner and/or entity that has made a depreciation add-back in a previous tax year can claim the subsequent depreciation deduction in the current year. Ohio is seeing entities who have never filed an Ohio PTE return for a previous tax year (IT 1140 or IT 4708) attempt to claim a depreciation deduction on their initial 2022 IT 4738. Only the entity that made the depreciation add-back on a previous year PTE return (IT 1140 or IT 4708) can claim the depreciation deduction on the 2022 IT 4738 return due April 18, 2023 (or the extended due date).

Update Regarding Ohio’s PTE Tax for Electing Entities, Ohio Department of Taxation, April 6, 2023.

Utah

Corporate, personal income taxes: Pass-through entity provisions amended

Utah enacted legislation that:

• Establishes requirements for pass-through entities when filing an amended return.
• Makes other amendments relating to pass-through entities.

Requirements when filing an amended return

If a change is made in a pass-through entity's net income or loss on its federal return because of an action of the federal government or the filing of an amended federal return, the entity must file with the State Tax Commission within 90 days after the final determination of the federal action or the filing of an amended federal return:

• A copy of the amended federal return or federal adjustment.
• An amended state return that conforms with the changes made in the amended federal return.

Also, unless an exemption applies, a pass-through entity that files an amended state return:

• Must pay or withhold tax on any increase in income on behalf of a pass-through entity owner.
• Remit that tax to the Commission.

These requirements apply for taxable years beginning on or after Jan. 1, 2022.

Other amendments related to pass-through entities

Other amendments include:

• Clarifying that the addition to tax for elective pass-through entity tax paid on income attributed to an individual applies only to the extent the income wasn’t included in the individual’s adjusted gross income.
• Specifying that the form that an electing pass-through entity uses to report tax paid on income attributable to each final pass-through entity owner must be filed with the Commission on or before the last day of the entity’s taxable year (previously, with the entity’s return).
• Clarifying that a pass-through entity taxpayer may carry forward the credit for elective pass-through entity tax paid to the extent the credit exceeds the taxpayer’s (previously, the entity’s) tax liability.
• Excluding income taxed by another U.S. state, the District of Columbia, or a U.S. possession from the definition of “voluntary taxable income” for purposes of the elective pass-through entity tax.
• For taxable years beginning on or after Jan. 1, 2022, stating that a payment of elective pass-through entity tax may not be refunded.

Ch.470 (H.B. 56), Laws 2023, effective May 3, 2023, except as noted.

Corporate income tax: Net loss provisions amended

Utah amended its corporate franchise and income tax provisions related to Utah net loss to provide that: 

• A corporate taxpayer may carry forward a Utah net loss arising from a taxable year beginning on or after Jan. 1, 2008, for an unlimited number of years until the Utah net loss is exhausted.
• For a Utah net loss carried forward to a taxable year beginning on or after Jan. 1, 2023, the amount of Utah net loss carried forward cannot exceed 80% of Utah taxable income calculating before deducting any Utah net loss from Utah taxable income.

Ch.506 (S.B. 203), Laws 2023, operative for taxable years beginning on or after Jan. 1, 2023.

Virginia

Income tax: Single sales factor election enacted for certain affiliated groups with retail company activities

Beginning with taxable year 2023, a new Virginia provision allows affiliated corporations filing on a consolidated basis to elect to apportion the taxable income of all members of the affiliated group using just the sales factor, even if some group members would be required to use different apportionment factors if they were filing separate returns. The election is valid only in taxable years when at least 80% of the affiliated group's sales are derived from retail company activities. Once made, the election cannot be changed without permission.

Ch. 38 (H.B. 1978) and Ch. 39 (S.B. 1346), Laws 2023, effective July 1, 2023, applicable as noted.

Corporate, personal income taxes: Pass-through entity tax revised

Virginia has enacted changes to its pass-through entity tax (PTET), relaxing the requirements to qualify for the tax election and altering how the tax is calculated. In addition, the Department of Taxation has issued a bulletin to provide guidance on how the law affects taxpayers’ 2022 returns.

Eligible owner requirement: The law replaces the existing qualifying pass-through entity requirement with a new eligible owner requirement. Previously, under the qualifying pass-through entity requirement, a pass-through entity could make the PTET election only if it was 100% owned by natural persons or persons eligible to be shareholders of an S corporation. Accordingly, for example, pass-through entities owned by corporations and other pass-through entities were prohibited from making the election.

However, under the eligible owner requirement, only a direct owner of a pass-through entity who is (1) a natural person subject to Virginia’s individual income tax or (2) an estate or trust subject to Virginia’s fiduciary income tax may claim a refundable PTET credit. Therefore, all pass-through entities can make the PTET election, but only owners meeting the eligible owner requirement can claim refundable PTET credits.

Computation of the tax: Under the new law, only the pro rata or distributive share of income, gain, loss, or deduction attributable to eligible owners is subject to the PTET. Therefore, amounts attributable to non-eligible owners, including corporations and other pass-through entities, aren’t subject to the PTET.

Effective date: The changes made by the new law are effective beginning with taxable year 2021. For 2022, unless a pass-through entity is taking advantage of the automatic filing extension, all pass-through entities choosing to make the PTET election (including those that didn’t meet the qualifying pass-through entity requirement under prior law) should file their taxable year 2022 PTET return and pay the amount due by the original filing deadline, which is April 17, 2023, for calendar year filers. It should be noted that for qualifying pass-through entities that have already filed a taxable year 2022 PTET return, no action is generally required as a result of this law because it doesn’t change the computation of PTET for them.

Those interested in making the election for taxable year 2021 should continue to follow Tax Bulletin 22-6 for now, because the department is required to delay implementation of the PTET for taxable year 2021 until at least Oct. 15, 2023. Subsequent guidance will be published by the department regarding how to make the election for taxable year 2021, and that guidance will incorporate the changes made by the new law.

Automatic filing extension: All pass-through entities choosing to make the PTET election can take advantage of the automatic 6-month filing extension if they are unable to file by the original deadline. No application is required to file on extension, but the PTET filer is required to make an extension payment equal to at least 90% of the tax owed by the original due date to avoid extension penalties. Interest is assessed on all tax not paid by the original due date until the tax is paid in full. The extension payment should be computed based on the changes to the PTET computation made by the new law.

Ch. 686 (H.B. 1456) and Ch. 687 (S.B. 1476), Laws 2023, effective as noted; Tax Bulletin 23-3, Virginia Department of Taxation, March 29, 2023.

Washington

Miscellaneous tax: State Supreme Court upholds capital gains tax

The Washington Supreme Court has ruled that the state's capital gains tax is valid. A lower court had found the tax to be a property tax that violated the state constitution's uniformity requirement. However, the state high court held that the tax should be characterized as an excise tax, as it is levied on the sale or exchange of capital assets rather than on capital assets or gains themselves. Because the tax is an excise tax, it isn’t subject to the uniformity and levy requirements of article VII of the state constitution. In addition, the tax is consistent with the state constitution's privileges and immunities clause and the federal dormant commerce clause.

Privileges and immunities: The privileges and immunities claim failed because the challengers didn’t establish that the capital gains tax implicates a fundamental right of state citizenship. Even assuming that the capital gains tax grants a privilege or immunity implicating a fundamental right, the claim still failed because reasonable grounds supported the legislature's classification choices. The challengers might disagree with the legislative policy behind the capital gains tax (i.e., to help meet the state's paramount duty to amply fund public education and to make material progress toward rebalancing the state's tax code), but they fell short of demonstrating that the policy is unreasonable.

Dormant commerce clause: The capital gains tax is not facially discriminatory because the plain text of the law doesn’t treat out-of-state individuals unfavorably. Further, the capital gains tax doesn’t subject an individual to multiple taxation because it provides a method for allocating capital gains to Washington, and the tax credit removes any risk of actual multiple taxation. Accordingly, the challengers failed to demonstrate a dormant commerce clause violation. While their facial challenge failed, the court noted that its holding didn’t foreclose future as-applied challenges under the dormant commerce clause, in the event that factual circumstances arise in which the tax cannot be constitutionally applied.

Due date: The capital gains tax is due April 18, 2023, and the Washington Department of Revenue has issued a set of Frequently Asked Questions about the tax.

Quinn v. State, Supreme Court of Washington, No. 100769-8, March 24, 2023.

West Virginia

Corporate, personal income taxes: Elective PTE tax established

West Virginia established an elective pass-through entity (PTE) income tax for:

• Partnerships
• S corporations
• Other business entities that aren’t subject to the state's corporate income tax.

The elective PTE tax is effective for tax years beginning on or after Jan. 1, 2022. PTEs can pay the tax for any person who is a partner, member, shareholder, or investor (owner) for any part of the tax year.

Election deadline

A PTE can make an annual election to pay the tax by the filing deadline for its original or extended West Virginia return. The election is binding after it is made.

Tax rate and computation

Taxable income is the owners’ distributive share of the income, gain, expense, or loss reported on the electing PTE’s federal income tax return. The PTE must compute the tax without any deductions or credits each owner can claim in computing their West Virginia income tax liability. It must pay the tax at the highest marginal West Virginia personal income tax rate.

A PTE that elects to pay the tax can claim West Virginia credits, deductions, or other adjustments, including the credit for income tax paid to another state. But it must addback any federal deduction for state and local income taxes.

Tax underpayments or overpayments

The electing PTE is responsible for any underpayment of tax. If the PTE doesn’t pay the tax or West Virginia cannot collect it, then the owners are responsible for the underpaid tax. If there is a tax overpayment, only the PTE can claim a refund for the overpaid tax.

Credits for tax paid

Each owner can claim a credit against West Virginia personal income tax liability for income tax paid by an electing PTE. The credit equals the owner’s proportionate share of the tax paid for the tax year. An owner can carry forward any unused credit for up to 5 tax years.

A West Virginia resident who is an owner of a pass-through entity that pays a similar entity-level income tax to another state can claim a credit for the tax paid. The credit also applies to income tax paid by the PTE through withholding, a composite return, or other methods.

S.B. 151, Laws 2023, effective June 8, 2023, and as noted.