State and local tax advisor: April 2024

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

• California
• Colorado
• Illinois
• Indiana
• Minnesota
• New Jersey
• Ohio
• Tennessee
• Texas
• Utah
• Wisconsin

California

Corporate, personal income taxes: Gain on sale was apportionable business income

An S corporation and a limited liability company (LLC) were engaged in the same unitary business, so gain on the sale of the S corporation’s interest in the LLC-generated business income subject to apportionment for California income tax purposes. The S corporation didn’t have California apportionment factors of its own, but it would have a portion of the LLC’s California factors attributed to it if it was unitary with the LLC.

The S corporation and another company, the two largest independent contact lens distribution companies in the United States, had contributed substantially all of their operating assets to the LLC in return for interests in the LLC. The S corporation’s CEO and COO became the LLC’s CEO and COO. In turn, the LLC distributed profits to the S corporation.

Unitary business

A unitary relationship existed between the businesses, as evidenced by functional integration, centralized management, and economies of scale. In addition, mutual interdependence and flows of value existed, as the LLC was dependent on the S corporation’s assets and executive know-how as much as the S corporation was dependent on the LLC’s revenue stream after contributing all of its operating assets to the LLC.

Business income

Gain from the S corporation’s sale of its interest in the LLC-generated business income under the functional test, because the S corporation’s acquisition, control, and use of its interest in the LLC contributed materially to its production of business income.

Flow-through to shareholders

Further, because the S corporation’s sale of its interest in the LLC-generated business income, nonresident shareholders were subject to California personal income tax on their pro rata share of the S corporations unitary business income that was apportioned to California. The S corporation and shareholders had argued that the sale was a sale of an intangible asset that generated income that was allocable as nonbusiness income. However, the sale generated business income under the functional test.

Alvarado Trading Company, Inc., California Office of Tax Appeals, Nos. 220410259, 220410261, 220410262, 220410263, 2024-OTA-142, Jan. 23, 2024 (released April 2024).

Corporate income tax: Qualifying dividends deducted from income were includable in sales factor

Repatriated dividends received by a taxpayer and partially deducted from income were includable in the sales factor of the apportionment formula used to calculate the taxpayer’s taxable income in California. In a nonprecedential opinion, the Office of Tax Appeals (OTA) directed the Franchise Tax Board (FTB) to recompute the taxpayer’s sales factor, which entitled the taxpayer to an almost $94 million tax refund. The OTA also denied the FTB’s petition for rehearing.

The taxpayer was a Washington corporation that, together with its subsidiaries, operated a worldwide unitary business. The taxpayer elected to file a water’s-edge combined report with certain affiliated entities. Controlled foreign corporations (CFCs) with which the taxpayer was unitary were excluded from the water’s-edge group. The taxpayer received repatriated dividends from the CFCs and, under California law, deducted 75% of the qualifying dividends received.

Dispute was over amount includable in sales factor

The taxpayer asserted that the qualifying dividends should be included in its sales factor denominator without a reduction for the deducted amount. The FTB contended that only the net dividends after applying the deduction, or 25% of the dividends, should be included in the sales factor denominator.

Total dividends were includable in sales factor denominator

The OTA noted that the apportionment statute referred to gross (rather than net) amounts realized. The FTB argued that the deduction should be treated like eliminated intercompany dividends, which aren’t included in the sales factor. However, eliminated dividends aren’t considered in determining the tax of any member of a unitary group, and they are expressly excluded from the sales factor by statute and regulation. There is no similar language applicable to the qualifying dividends deduction. Thus, the OTA concluded that the taxpayer’s total qualifying dividends were includable in the sales factor denominator.

Dividends not excluded from sales factor as substantial and occasional sale

The FTB also argued that the distribution of dividends qualified as a sale under a California regulation and, therefore, the gross receipts from the qualifying dividends should be excluded from the sales factor as arising from a substantial and occasional sale. However, while the apportionment statute defined “gross receipts” as expressly including dividends, the definition of a “sale” in the regulation was more limited in scope. The regulation didn’t apply to exclude qualifying dividends from the sales factor.

FTB didn’t show that alternative apportionment method was warranted

Finally, the FTB argued that inclusion of total qualifying dividends in the sales factor denominator resulted in distortion similar to a substantial and occasional sale. The FTB proposed an alternative apportionment method. However, the FTB didn’t show that the activities generating the dividends were qualitatively different from the taxpayer’s main line of business. Nor did the FTB show that inclusion of the repatriated dividends in the sales factor resulted in quantitative distortion. Thus, the FTB failed to show that the standard apportionment formula didn’t clearly represent the taxpayer’s activity in California and that use of an alternative method was warranted.

Microsoft Corporation & Subsidiaries, California Office of Tax Appeals, No. 21037336, 2024-OTA-130, July 27, 2023, petition for rehearing denied, 2024-OTA-131, Feb. 14, 2024 (released April 2024).

Colorado

Corporate, personal income taxes: SALT Parity Act guidance updated 

Colorado has issued updated guidance on the state’s SALT Parity Act, which allows electing pass-through entities (PTEs) to pay Colorado income tax at the entity level. The guidance has been updated to include information on:

• State income tax addbacks.
• PTE owner credits for elective PTE tax paid in instances involving tiered partnerships.

State income tax addbacks

Partners and shareholders must make an addition on their Colorado income tax returns for their distributive share of state income deducted tax by the partnership or S corporation on its federal return.

PTE owner tax credits

If a partnership is a partner in another partnership that made a SALT Parity Act election, the credit allowed to the upper-tier partnership for tax paid by the lower-tier partnership passes through to the upper-tier partnership’s partners. The upper-tier partnership must report each partner’s share of the credit on line 22 of the partner’s Colorado K-1 (DR 0106K). Each partner may claim their share of the credit on their own Colorado income tax return.

Income Tax Topics: SALT Parity Act, Colorado Department of Revenue, February 2024.

Personal income tax: Addback and subtraction rules adopted

The Colorado Department of Revenue has adopted the following new individual income tax rules:

• Rule 39-22-104(3)(d), relating to the addback for state income taxes deducted in determining federal taxable income.
• Rule 39-22-104(3)(p), relating to the addback for itemized deductions.
• Rule 39-22-104(3)(p.5), relating to the addback for itemized or standard deductions.
• Rule 39-22-104(2)–1, relating to the subtraction for family and medical leave insurance (FAMLI) benefits.

State income taxes addback

Generally, for Colorado income tax purposes, an individual, estate, or trust must add to federal taxable income any state income taxes deducted by the individual, estate, or trust or by a partnership or S corporation in which the individual, estate, or trust is a partner or shareholder. The addback also applies to any premiums withheld from an individual’s wages under the Paid Family and Medical Leave Act and deducted by the individual as state income taxes in computing federal taxable income. The addback for state income taxes deducted by an individual, estate, or trust is limited to the amount required to reduce the federal itemized deductions amount computed for the individual, estate, or trust to the federal standard deduction amount allowed to the individual, estate, or trust. The limitation doesn’t apply to any addition required for an individual’s, estate’s, or trust’s share of a deduction claimed by a partnership or S corporation for state income taxes, because that deduction isn’t included in the federal itemized deductions amount computed for the individual, estate, or trust.

For a partner in a partnership or a resident shareholder of an S corporation, the addition applies to the partner’s or shareholder’s share of any state income tax deducted by the partnership or S corporation for federal tax purposes, regardless of the state to which the income tax was paid. For a nonresident shareholder of an S corporation, the addition applies to the shareholder’s share of any Colorado income tax deducted by the S corporation for federal tax purposes.

Itemized deductions addback

An individual whose adjusted gross income (AGI) and federal itemized deductions exceed certain limits for tax years beginning on or after Jan. 1, 2022, and before Jan. 1, 2023, must add back a portion of the itemized deductions when determining Colorado taxable income. An individual who files as married filing separately or head of household for federal tax purposes is considered a single filer for purposes of this addback. The new rule provides guidance for coordinating this addback with other addbacks required under state law.

Itemized or standard deductions addback

An individual whose AGI and federal itemized or standard deductions exceed certain limits for tax years beginning on or after Jan. 1, 2023, must add back a portion of the itemized or standard deductions when determining Colorado taxable income. An individual who files as married filing separately or head of household for federal tax purposes is considered a single filer for purposes of this addback. The new rule provides guidance for coordinating this addback with other addbacks required under state law.

FAMLI benefits subtraction

To the extent included in federal taxable income, the amount of any FAMLI benefits received by an individual may be subtracted from federal taxable income for Colorado income tax purposes. This applies to taxable years beginning on or after Jan. 1, 2024.

Rules 39-22-104(2)–1, 39-22-104(3)(d), 39-22-104(3)(p), and 39-22-104(3)(p.5), Colorado Department of Revenue, effective April 30, 2024.

Illinois

Corporate, personal income taxes: Partnership replacement tax return instructions updated 

The Illinois Department of Revenue updated the 2023 partnership replacement tax return instructions to:

• Cover new requirements that investment partnerships withhold income tax for nonresident partners.
• Explain how to calculate and report the withholding tax.

News, Illinois Department of Revenue, April 8, 2024.

Indiana

Sales and use tax: Updated guidance issued for remote sellers and marketplace facilitators

Indiana has issued updated guidance regarding sales and use tax registration, collection, and remittance requirements for remote sellers and marketplace facilitators. The guidance includes a discussion of the elimination of the 200 transaction economic threshold pursuant to recently enacted legislation.

Information Bulletin #89, Indiana Department of Revenue, April 2024.

Minnesota

Corporate income tax: Effective date for net operating loss limit change retroactively modified 

For tax years beginning after Dec. 31, 2023, the Minnesota corporate net operating loss (NOL) deduction limit is 70% of a corporation’s taxable income. For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2024, the limit is 80% of a corporation’s taxable income.

Legislation enacted in 2023 (H.F. 1938) had reduced the corporate NOL deduction limit from 80 to 70% of a corporation’s taxable income, effective for tax years beginning after Dec. 31, 2022. But, legislation signed into law on April 8, 2024, retroactively modified the effective date for the change. Taxpayers that filed 2023 tax year returns before enactment of the retroactive legislation may need to file amended returns.

Ch. 82 (H.F. 3769), Laws 2024, effective as noted.

New Jersey

Corporate income tax, practice and procedure: Partnership audit regime guidance released

New Jersey had released guidance regarding its adoption of the federal partnership tax audit regime. The adoption of laws regarding the federal centralized partnership audit regime applies to any adjustments to a taxpayer’s federal taxable income on or after Jan. 1, 2020.

The guidance discusses:

• Partnerships subject to final federal adjustment.
• The two ways to pay.
• The federal adjustments report. 
• The state partnership representative.

New Jersey Adoption of the Federal Partnership Tax Audit Regime, New Jersey Division of Taxation, April 5, 2024.

Ohio

Corporate income tax: Guidance on net operating loss deductions issued

The Ohio Department of Taxation has reminded taxpayers that have made an election to have the state administer the municipal net profit tax, that they may use 100% of the remaining balance of unexpired net operating loss (NOL) deductions, up to the amount necessary to reduce their municipal taxable income to zero. Except for NOLs incurred prior to taxable year 2017, NOL deductions reduce municipal taxable income on a pre-apportionment basis and have a standard five-year carryforward period.

Municipal Net Profit Tax Information Release MNP 2024-02, Ohio Department of Taxation, April 2, 2024.

Tennessee

Franchise tax: Bill to revise tax calculation passed by Senate

The Tennessee Senate has passed a bill that would, if enacted, modify the franchise tax calculation by removing the alternative minimum measure based on the actual value of real or tangible personal property owned or used in the state.

The bill would require the tax to be calculated using only net worth, and certain refunds would be authorized for franchise tax previously paid under the alternative minimum base. A corresponding bill (H.B. 1893) is being considered by the Tennessee House.

S.B. 2103, as passed by the Tennessee Senate on March 21, 2024.

Texas

Corporate income tax: Limitations period when extension filed

The Texas Comptroller has issued guidance as to the limitations period for assessments and refunds of franchise tax when a taxpayer requests an extension of the deadline to file and pay any tax due on a Texas franchise tax report. In general, the limitations period is four years from the date a tax becomes due and payable. The Comptroller’s guidance explains that Texas franchise tax becomes due and payable on the due date for the Texas franchise tax report for that report year, which is typically May 15.

However, if a taxpayer properly requests an extension on or before May 15 and makes the required extension payment with its request (either 100% of tax due in the prior report year or 90% of the tax that ends up being due in the current year), the date that the tax becomes due and payable becomes the extended deadline. As a result, the beginning of the limitations period is the extended deadline, not the original deadline of May 15. But, if the taxpayer doesn’t make the required extension payment or otherwise doesn’t meet the legal requirements for an extension, the limitations period will begin on the original deadline of May 15.

Letter No. 202404001L, Texas Comptroller of Public Accounts, April 12, 2024.

Utah

Unclaimed property: Guidance on reporting requirements of holders of unclaimed property revised

Utah has revised guidance it provides on reporting instructions for holders of unclaimed property. The revised guidance discusses Utah’s 2024 unclaimed property laws concerning the reporting requirements of holders of unclaimed property and the important reporting changes that have occurred with the state’s unclaimed property. Reports and payments are due Nov. 1, 2024. Due diligence notice must not be more than 180 days (May 5, 2024), nor less than 60 days (Sept. 5, 2024), prior to report submission. Additional topics discussed in the guidance include general information; due diligence requirements; securities registration and deposit instructions; holder reporting requirements and considerations; holder reporting methods; remitting safe deposit box contents; owner relations codes and definitions; voluntary disclosure agreement; and holder reimbursement request form.

2024 Reporting Instructions, Utah State Treasury Department, April 2024.

Corporate, personal income taxes: Pass-through entity tax paid to Utah due to clerical error was refundable

A pass-through entity (PTE) tax payment made to the State of Utah instead of another state due to a clerical error was refundable.

The taxpayer’s accountant had prepared a spreadsheet for all of the PTE tax payments due for his S corporation and partnership clients, so that an employee in his office could send the payments while he was on medical leave. He had concluded for the taxpayer that payment needed to be made to a state other than Utah. However, an employee sent the taxpayer’s payment in error to Utah. Upon receiving confirmation of the payment, the taxpayer immediately contacted his accountant. The accountant immediately contacted the State Tax Commission asking to cancel the payment prior to the payment being received by the Commission. However, the Commission proceeded to process the payment, taking the position that Utah PTE tax elections are irrevocable, and the payments are nonrefundable.

The taxpayer argued that asking to cancel a payment made in error was not the same thing as asking for a refund. The taxpayer’s accountant understood from his initial conversations with a Commission employee that the Commission would cancel the payment. The accountant relied on that information to his detriment, which contributed to him not taking other actions that could have canceled or stopped the payment. On the limited basis of these facts and circumstances, the Commission was ordered to issue the requested refund.

Commission Decision, Appeal No. 23-56, Utah State Tax Commission, Nov. 28, 2023 (released March 2024).

Wisconsin

Corporate, personal income taxes: Business development and enterprise zone jobs credits revised

Wisconsin has made various revisions to the business development credit and the enterprise zone jobs credit, generally applicable to taxable years beginning after 2023.

The law revises the business development credit to allow eligibility if a person (1) creates new jobs or retains existing jobs and makes a capital investment in the business, and (2) does not decrease net employment in the state in the person’s business below the net employment in the state in the person’s business during the year before certification. Additional claims are authorized for investments in workforce housing and establishing employee childcare programs, up to 15% of the investment amounts. The law also specifies that the Wisconsin Economic Development Corporation (WEDC) must approve or deny an application for certification within 90 days after receiving it. Further, for credits awarded for property investment, the law reduces the capital investment threshold from $1 million to $250,000.

The law includes a new definition of “full-time job,” meaning a nonseasonal job for which the annual pay is more than 2,080 multiplied by 150% of the federal minimum wage, and for which retirement, health, and other benefits are offered. The definition of “zone payroll” is amended to mean amounts attributable to full-time employees “based in” an enterprise zone; previously, services had to be “performed in” the zone. A new 12-month period “base year” is created, and the WEDC’s authority to require repayment of certain credits is revised to provide that repayment may be required for general failure to comply with an agreement entered into between a business and the WEDC.

Act 143 (A.B. 627), Laws 2024, effective March 23, 2024, applicable as noted.