Little guidance has been released for individuals working remotely in Oregon. However, that does not mean that employees should ignore the effects of their new working arrangements. For example, a taxpayer’s resident state usually taxes all their income, regardless of where it is earned. When a taxpayer works in more than one state during the year, the taxpayer must allocate their income to the respective state in which it was earned. The taxpayer will be entitled to claim a tax credit for income tax paid to another state, which reduces their taxes payable on their resident state return. Thus, if a taxpayer normally works in a different state than their resident state, they could incur penalties for not making sufficient tax payments in their home state because they will no longer be receiving a state income tax credit from the state where they normally work. Taxpayers should make sure they have changed their withholding requirements to ensure they do not incur penalties.
Corporate Activity Tax
- Insufficient funds due to COVID-19 that caused the business to not be able to pay a full quarterly installment.
- The impact of COVID-19 made it so the business could not reasonably calculate a quarterly payment.
- The taxpayer could not determine whether it will have a CAT liability in 2020.
- The taxpayer made a reasonable estimate based on information available at the time.
- The taxpayer relied on information that was contained in a proposed administrative rule.
Business & Occupation (B&O) Tax
The Washington Department of Revenue has offered favorable guidance for businesses that received federal financial assistance. Businesses that received any federal assistance (including the federal Paycheck Protection Program (PPP)) should not report the assistance as gross receipts for B&O tax purposes for now. However, this is not a final decision, and the Department of Revenue indicated that it would continue to analyze the various programs more thoroughly. It will issue a final decision once the Legislature has had an opportunity to act, so businesses should be mindful that this is not a final ruling.
Washington has not released any guidance regarding the “physical presence” threshold for its B&O tax. In Washington, a business must pay B&O tax if it (1) has physical presence nexus in Washington; (2) has more than $100,000 in combined gross receipts sourced to Washington; or (3) is organized or commercially domiciled in Washington. The Washington Administrative Code says that even the “slightest presence” of a single employee may trigger the physical presence nexus. Thus, a remote worker could trigger nexus and an additional filing requirement for a company even if they do not normally meet the $100,000 threshold.
Earlier this summer, Apple won a $15 billion State Aid case related to its Irish operations. This decision was rendered by the EU’s lower court. In late September, the European Commission decided to appeal the outcome. Now that the appeal has been filed, it could take the European Court of Justice up to two years to issue a ruling. Meanwhile, EU efforts to redistribute the tax obligations of American technology companies on several other fronts are likely to advance well before the case is decided.
Apple is being sued for allegedly receiving two preferential tax rulings from the Irish government. Those rulings allowed two Apple units in Ireland to attribute a small percentage of some $130 billion in profit to Ireland over an 11-year period. The EC argued that all of the profit should be taxed in Ireland. But Apple and the Irish government pointed to the fact that virtually all of the Apple intellectual property is developed in the U.S. as justification for the allocation. Further, Ireland claimed that the rulings did not provided preferential incentives to Apple but were merely an expression of Irish law as applied generally.
EU Commission Executive Vice President, Margrethe Vestager, has been using the EU State Aid laws designed to crack down on tax deals that give companies an unfair advantage against other member states in a series of challenges against U.S.-based multinationals such as Starbucks, Nike, and Amazon. The results have been mixed at best, emboldening tax activists who say that the result reinforce their calls for new, more effective rules.
The judgement of the EU’s second-highest court was clearly in favor of Apple and Ireland. When the Commissioner appealed the decision, she stated that the court made “a number of errors of law.” Legal errors are the only basis for an appeal of the decision. However, the lower-court stated that the Commissioner misinterpreted the facts of the case, and, on that basis, she was mistaken as to how much profit should have been allocated and taxed in Ireland. Given the court’s assertion of matters of fact, rather than law, the Commissioner will seemingly face an uphill battle in overturning the decision.
The Commission has repeatedly stated that it will continue to fight against aggressive tax planning by multinational companies. The U.S. government views the EC’s ongoing State Aid challenges to be just one front in an ongoing money grab of U.S. tax revenues for their own coffers.
Convinced by the Apple decision of the deficiencies of the existing State Aid statutes as an effective weapon against the alleged exploitation of European markets by American companies, the Commission has stated that it will explore EU reform that would “allow taxation proposals to be adopted by qualified majority rather than unanimity” to ensure that member states are not abusing state-aid principles. Meanwhile, EC efforts at a comprehensive, multilateral overhaul of international tax standards through the initiative known as “BEPS 2.0” is stalled due to U.S. opposition. The “nuclear” option led by France and in various stages of enactment, development or consideration by many nations is imposing digital service taxes. “DSTs” serve as a blunt instrument to impose gross receipts excise taxes on technology companies who have no presence in a jurisdiction other than revenues. Given the slog through the courts, the complexity of reaching consensus on an ambitious global framework such as BEPS and the ravages of COVID-19 on the fiscal health of most national governments, unilateral DSTs and trade retaliation by the U.S. may define the future of international taxation.Read More
The Financial Accounting Standards Board (FASB) establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP). The FASB is recognized by the Securities and Exchange Commission as the designated accounting standard setter for public companies. FASB standards are recognized as authoritative by many other organizations, including state Boards of Accountancy and the American Institute of CPAs (AICPA).
The FASB issues an Accounting Standards Update (“ASU”) to communicate changes to the FASB Codification, including changes to non-authoritative SEC content. Since September 2009, the FASB has issued various ASU’s that have a direct impact to Accounting Standards Codification (“ASC”) 740 Income Taxes. This is the first in a series of KBF Technical Alerts that discusses the various ASUs issued by the FASB since 2009 related to ASC 740.
Accounting for Uncertain Tax Positions – Background
The rules for the accounting for uncertain tax positions (“UTPs”) are found in ASC 740. The rules clarify the accounting for uncertainty in income taxes recognized in an entity’s financial statements. They establish rules for recognizing and measuring tax positions taken in an income tax return.
The UTP rules mandate that companies evaluate all material income tax positions for periods that remain open under applicable statutes of limitation, as well as positions expected to be taken in future returns. The UTP rules then impose a recognition threshold on each tax position. A company can recognize an income tax benefit only if the position has a “more likely than not” (i.e., more than 50 percent) chance of being sustained on the technical merits. In making this determination, the possibility that the company will not be audited, or the position will escape an auditor’s notice, cannot be taken into account.
If a tax position does not meet the “more likely than not” recognition threshold in the first tax period, the benefits cannot be recognized. However, they may be recognized later if: (1) the threshold is met in a later period; (2) the matter is resolved with the appropriate taxing authority; or (3) the statute of limitations expires. The UTP rules call for derecognition of a previously recognized position in the first tax period in which it is no longer “more likely than not” that the position would be sustained on its technical merits.
If a position passes the recognition threshold, then as a second step, the UTP rules require that the position be measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement.
Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in (1) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable; (2) a reduction in a deferred tax asset or an increase in a deferred tax liability; or (3) both (1) and (2).
The UTP rules also provide guidance on interest and penalties, accounting in interim periods, disclosure, and transition.
The UTP rules apply to all entities that prepare GAAP financial statements.
 Accounting for Uncertain Tax Positions (FIN 48) Manager, Wolters Kluwer
ASC 740-10-50-15 and ASC 740-10-50-19 provides unrecognized tax benefit related disclosure guidance.
Specifically, ASC 740-10-50-15 provides that all entities shall disclose all of the following at the end of each annual reporting period presented:
- The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position
- For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:
- The nature of the uncertainty
- The nature of the event that could occur in the next 12 months that would cause the change
- An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made
- A description of tax years that remain subject to examination by major tax jurisdictions
In addition to the above, and prior to the issuance of ASU 2009-06, ASC 740-10-50(a) & (b) required that an entity would have to disclose all of the following at the end of each annual reporting period presented:
a. A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:
- The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period
- The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
- The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
 Accounting for Uncertain Tax Positions (FIN 48) Manager, Wolters Kluwer
* For a downloadable and printable version of this article please click here.Read More
On August 9, 2020, President Trump signed an executive order that allows for the deferral of withholding, deposits, and payments of the employee portion of Social Security tax from September 1 to December 31, 2020. Further to this, on August 28, 2020 the Treasury issued Notice 2020-65 providing guidance on the implementation of President Trump’s executive order.
The deferral is only available to employees whose biweekly compensation is less than $4,000, or $104,000 per year. The $4,000 is evaluated on a per payroll period basis. Additionally, only the employee portion of the Social Security tax is deferred. The employee portion of the Medicare tax is not impacted by the executive order. The executive order came into effect on September 1 and will end on December 31, 2020. Employers are not required to defer the withholding or deposit of Social Security tax. Notice 2020-65 provides only that no interest and penalties will be imposed if the employer does not deposit the tax.
The deferred taxes must be “repaid” because they are currently only deferred per the guidance released, and not forgiven. Under existing tax law, an employer is liable for payroll taxes, including the employee portion of Social Security taxes, even if it is not withheld from an employee. Nothing in the Treasury guidance or the Presidential Memorandum changes that principle.
The Notice explains that an employer must repay the deferred tax by withholding extra social security taxes ratably from wages paid to employees whose Social Security tax was deferred between January 1, 2021, and April 30, 2021 (resulting in lower employee net pay during that period). If an employer fails to “repay” the deferred taxes, interest and penalties will be imposed on the employer with respect to the unpaid or underpaid amount beginning May 1, 2021.
This is not the first time that Social Security tax relief has been given to taxpayers. In 2009 and 2010, a tax credit of $400 was given to individuals and $800 to families during the Obama administration. However, this was done through legislation, not through an executive order. When it comes to the collection of deferred tax in 2021, the Payroll Tax Deferral program leaves many questions unanswered, including whether state laws even allow deduction of deferred taxes from future earnings.Read More
Please join us in welcoming Priyanka Shah to KBF.
We are excited to announce the addition of Priyanka Shah, Tax Manager, to KBF in the Seattle Corporate Tax Services group. Priyanka will be working from her home office in Dallas, TX.
Priyanka started her career with Deloitte Tax in New York in 2012 and moved to EY in 2014. She has more than 7 years of public accounting experience with both publicly and privately held companies. Most recently, Priyanka worked at SCOA (Sumitomo Corporation of America) where she managed the tax provision and tax compliance. Priyanka’s experience and skills fit squarely in KBF’s core services to our corporate tax clients and will contribute greatly to our growing Pacific Northwest practice.Read More
Supreme Court Denies Review of Tax Breaks for Big Tech Companies in Altera but the Controversy Continues
The Supreme Court denied a petition of certiorari in Altera v. Commissioner on June 22, 2020, a closely followed case from the Ninth Circuit concerning the validity of a 2003 Treasury regulation requiring participants to include stock-based compensation (SBC) as intangible development costs (IDCs) in cost-sharing arrangements (CSAs). Altera argued that Treasury violated the Administrative Procedure Act (APA) by concluding that their final rule was consistent with the arm’s-length standard notwithstanding contrary evidence presented that unrelated parties would never agree to share each other’s SBCs. Despite a rare unanimous 15-0 Tax Court opinion in favor of Altera, the Ninth Circuit reversed in a 2-1 June 2019 decision which held that the Government had adequately supported its position in the record and that the position on the underlying issue did not constitute a policy change.
Despite this multi-billion dollar win for the Treasury at the court of last resort, the holding is only binding on companies in the Ninth Circuit, so this is not the end of the Altera issue. Meanwhile, technology companies must evaluate how to respond in their tax filings, on their financial statements and to contractual clauses that may have just been triggered in their CSAs.
Stock-Based Compensation and Cost Sharing Arrangements
The regulations that Altera contested required it to include SBC as a component of its IDCs shared with its foreign subsidiaries in order to develop technology benefiting domestic and foreign markets. Like many other tech companies, Altera established a foreign subsidiary in a low tax rate jurisdiction, transferred the non-U.S. rights to intangible property to it, and then shared the costs to develop the core technology pursuant to a CSA.
In the relatively high U.S. tax rate climate that prevailed until tax reform became effective in 2018, U.S. companies optimized the value of the tax deductions arising from these CSAs by allocating more costs to the U.S. and by limiting the costs in the base that were required to be allocated in the first place. Whether measured in terms of the tax deductions they produce or the financial statement expenses recorded for them, including SBC in a CSA results in an enormous shift of tax liability to the U.S. and a significant increase on the global tax burden due to the resulting adverse tax rate arbitrage.
After the Ninth Circuit reversal, Altera, which is now owned by Intel, and other tech companies based in the Ninth Circuit reportedly faced billions of dollars in cash payments and financial statement charges. Those that waited for the Supreme Court outcome will face those consequences in the quarter just concluded. Further, many companies stopped cost sharing of SBC and inserted a “reverse clawback” clause in their CSAs after the 2015 invalidation of the Treasury regulations by the Tax Court. This clause provides that if the regulations were ultimately upheld, the U.S. company would be required to charge out to the foreign CSA participants the quantum of costs that should have been shared in the intervening years.
The Supreme Court’s action is likely a triggering event for many of these reverse clawback charges which presents a myriad of issues and implications. For example, some taxpayers may want to report the payments all in the current year rather than amending prior year returns. On the surface this seems advantageous given the favorable rate arbitrage of 21% today versus the 35% rate in pre-TCJA years and the commensurate reduction in foreign earnings and profits subjected to the Section 965 transition tax. However, the IRS might contest such an application of these contractual clauses. CARES Act NOL carrybacks complicate the analysis. Foreign governments may well object to a deduction for the payments which could be material since many companies migrated their offshore intangibles from tax havens to locations with “DEMPE” such as Ireland or the Netherlands in response to the OECD’s BEPS initiative. Statute of limitations issues complicated by an overlay of transfer pricing rules are implicated as well, potentially exposing taxpayers to a whipsaw where income could be double taxed through an IRS assessment for inclusion of the chargeback in the prior years while denying a compensating adjustment to remove it in the current year once reported on an original return.
In order to avoid penalties when taking a position on a U.S. tax return, a company must be able to muster sufficient precedential support constituting “substantial authority” or, alternatively, a “reasonable basis” with adequate disclosure of the position to the IRS. Practitioners typically measure substantial authority, as a position that has a 40-45% chance of success and reasonable basis at a 20-25% chance of success. The authorities that companies can rely on in making this highly judgmental assessment include the Internal Revenue Code; Treasury regulations, both final and proposed; revenue rulings; legislative committee reports; and court cases.
Obviously, a Supreme Court decision or refusal to hear a case ranks among the highest authorities. By denying certiorari, the Ninth Circuit’s reversal of the Tax Court’s decision is binding on all companies in that circuit. Since many large tech companies with this issue are headquartered in the Ninth Circuit, Treasury has essentially won the Altera issue for the time being. However, the Tax Court has nationwide jurisdiction, so companies outside the Ninth Circuit can still rely on the Tax Court’s unanimous decision. Large tech companies would welcome a decision by another circuit court affirming the Tax Court’s decision because the Supreme Court would be much more likely to take certiorari if there is a split decision amongst the circuits. However, the Altera issue took seventeen years to work through the court system, so it is unlikely that any new developments will produce clarity, much less relief, any time soon. Therefore, the Altera issue will likely persist and create controversy for some time to come even though the ruling is unlikely to affect current corporate tax strategies because of changes made in the 2017 tax reform law.
ASC 740 Considerations
Companies in the Ninth Circuit that already accounted for the adverse outcome in Altera last year when the Circuit Court issued its opinion will not face extreme financial statement consequences for the quarter just concluded. However, if a company in the Ninth Circuit has not recorded any uncertain tax positions, its quarterly financial statements will likely reflect a substantial tax expense from the Altera issue.
Companies outside of the Ninth Circuit most likely will not report any change for Altera regardless of their position on the underlying substantive position of inclusion of SBC compensation in a CSA. Most will likely have followed the Tax Court’s favorable decision. The Altera decision was procedural so it has no direct impact on the substantive issue. As noted above, these companies can rely on the Tax Court’s decision for the procedural issue. Such taxpayers should have previously concluded on the more-likely-than-not threshold for recognition on the substantive issue based on other relevant authorities. The only avenue for an adjustment in reserves by such companies based on the Alteradevelopments would be a change in judgment regarding the measurement standard based on “new information” regarding an emboldened IRS that would be very unlikely to negotiate the issue at this point. However, that change likely already occurred in July 2019 when the IRS very publicly instructed its agents to once again pursue enforcement of the contested regulation shortly after the Ninth Circuit reversal.
Please join us in welcoming Jie Shao to KBF.
Jie Shao is joining KBF as an International Tax Director, where she will be focused on growing and developing our Corporate Tax Services practice. Jie is a firmwide resource and will be assisting clients in all of the markets KBF serves.
Jie has 17-years of public accounting experience in U.S. corporate income tax accounting, compliance, and consulting services, with a focus in the international tax area. Her experience includes significant work in U.S. international tax reporting, strategic planning, U.S. tax reform planning and modeling surrounding GILTI, subpart F, FTC, FDII, and BEAT, and assessment of relevant income tax accounting implications.
Jie started her career with Deloitte Tax LLP in 2003, later spent five years in the Deloitte China practice in Shanghai, China. Jie returned to the U.S. in late 2017 and joined PricewaterhouseCoopers. Jie has broad experience in advising both publicly and privately held multinational companies in a variety of industries, including manufacturing, consumer products, pharmaceutical research, information technology, chemical, construction, investment banking, etc.Read More
As amended by the Tax Cuts and Jobs Act (TCJA), Internal Revenue Code (“IRC”) Section (“Sec.”) 274(a)(4) disallows deductions for the expense of any qualified transportation fringe (QTF) as defined in IRC Sec. 132(f) provided to an employee of the taxpayer for amounts paid or incurred after December 31, 2017. The value of a qualified transportation fringe benefit provided by an employer to an employee is excluded from the employee’s income, subject to monthly limits. Under pre-TCJA law, a deduction was not barred for the expenses of providing qualified transportation fringe benefits or other transportation or commuting benefits to an employee.
Although the TCJA denies the employer a deduction for the qualified transportation fringe benefit, it does not change the employee’s exclusion of the benefit from income under IRC Sec. 132, except in the case of qualified bicycle commuting reimbursements.
Employees are allowed to exclude, from their gross income, up to $270 per month as a QTF benefit pursuant to IRC Sec. 132(f)(2). The monthly limit is adjusted annually for inflation. Amounts paid in excess of $270 per month are considered taxable income to the employees and deductible by the employer. As mentioned previously, amended IRC Sec. 274(a)(4) provides that no deduction is allowed for the expense of any QTF provided to an employee of the taxpayer.
It should be noted that the rules that disallow the deduction for QTF benefits are subject to three important exceptions which include amounts paid by the employer that are includible in the employees taxable income; amounts paid for goods, services, and facilities made available by the taxpayer to the general public; and finally, amounts paid for goods or services (including the use of facilities) that are sold by the employer in a bona fide transaction for an adequate and full consideration in money or money’s worth.
Notice 2018-99 provided interim guidance for taxpayers to determine the amount of parking expenses for qualified QTFs that is nondeductible under IRC Sec. 274(a)(4). That Notice had a four-step method for making that determination where the taxpayer owned or leased the parking facilities. Those four steps are summarized as:
Step 1. Calculate the disallowance for reserved employee spots.
Step 2. Determine the primary use of remaining spots (the “primary use test”).
Step 3. Calculate the allowance for reserved nonemployee spots.
Step 4. Determine remaining use and allocable expenses.
The IRS recently released proposed regulations (REG-119307-19) clarifying how to determine the amount of QTF expenses that are nondeductible. Until final regulations are issued, taxpayers may rely on the proposed regulations or the guidance in Notice 2018-99. The proposed regulations would create Regulation (“Reg.”) Sec. 1.274-13 which addresses QTF parking expenses paid or incurred by an employer (along with certain exceptions in IRC Sec. 274(e)) and Reg. Sec. 1.274-14 to address expenses incurred to provide any transportation, or any payment or reimbursement, to an employee in connection with travel between the employee’s residence and place of employment, except as necessary for ensuring the safety of the employee.
Parking Guidance (Reg. Sec. 1.274-13)
The proposed regulations delineate between situations where the employer pays a third party for its employee’s QTF and situations where the employer owns or leases the parking facility.
Where Taxpayer Pays a Third Party – The proposed regulations provide that if the taxpayer pays a third party for its employee’s QTF, the IRC Sec. 274(a)(4) disallowance is generally calculated as the taxpayer’s total annual cost of the QTF paid to the third party.
Where the Taxpayer Owns or Leases the Parking Facility – With regard to QTF parking expenses, the proposed regs provide that if the taxpayer owns or leases all or a portion of one or more parking facilities, the Code Sec. 274(a)(4) disallowance may be calculated using a general rule or any one of three simplified methodologies. These methodologies are an annual election that are made on a facility by facility basis.
- General rule
- Qualified Parking Limit Method
- Primary Use Method
- Cost per Space Method
General Rule: The taxpayer can use a reasonable interpretation to calculate its QTF expenses, which is limited in three ways: (1) the expense cannot be calculated based on the value of the employee parking; (2) the taxpayer cannot deduct expenses related to spaces reserved for employees; and (3) the taxpayer cannot improperly apply the exception for qualified parking made available to the public. Regarding the third limitation, the employer cannot treat a parking facility regularly used by employees as available to the general public simply because the general public has access to the parking facility.
Qualified Limit Methodology: The taxpayer can determine the monthly qualified limit disallowance of deductions by multiplying the total number of spaces used by employees during the peak demand period, or the total number of taxpayer’s employees, by the monthly per employee limitation on exclusion ($270 in 2020). This methodology may be used only if the taxpayer includes the value of the qualified transportation fringe in excess of the sum of the amount, if any, paid by the employee for the qualified transportation fringe and the applicable statutory monthly on the taxpayer’s Federal income tax return as originally filed as compensation paid to the employee and as wages to the employee for purposes of withholding under chapter 24 of the Code (relating to collection of Federal income tax at source on wages).
Primary-Use Methodology: The taxpayer may use the primary-use methodology to determine its QTF expense by using the following four-step approach to calculate the disallowance of deductions for each parking facility:
- Step 1. Calculate the disallowance for reserved employee spots.
- Step 2. Determine the primary use of remaining spots (the “primary-use test”).
- Step 3. Calculate the allowance for reserved nonemployee spots.
- Step 4. Determine remaining use and allocable expenses.
Cost Per Space Methodology: The taxpayer can calculate the disallowance of deductions for QTF parking expenses by multiplying the cost-per-space by the total number of available parking spaces used by employees during the peak demand period. The product of that amount is the deduction for total parking expenses that are disallowed. The term peak demand period is defined as the period in a typical business day when the greatest number of the taxpayer’s employees are using parking spaces in the taxpayer’s facility.
Additional Guidance in the Proposed Regulations
Typically, an employer that owns its parking facility will have a variety of expenses associated with the facility that makes it difficult to identify the parking portion of the expenses. If the employer elects to use the primary-use methodology or the cost-per-space methodology, the proposed regulations allow the employer to allocate the “mixed parking expenses” using any reasonable methodology, with a 5% safe harbor. This means that the IRS will not question a taxpayer’s return if it takes a deduction of 5% of the total mixed parking expenses. Mixed parking expenses include any rental agreement expenses, property taxes, interest expense, and expenses for utilities and insurance.
The proposed regulations also broaden the applicability of the aggregation rule for parking spaces in the same geographic location. The aggregation rule allows a taxpayer to combine spaces together that are located in the same geographic region. The proposed regulations would allow taxpayers to apply the aggregation rule when calculating the QTF expenses using the general rule and the cost-per-space methodology.
Expenses for transportation in a commuter highway vehicle or transit pass (Reg. Sec. 1.274-14)
The proposed regulations clarify that, unless the expenses are incurred for the safety of the employee, no deduction is allowed for any expense incurred for providing any transportation, or any payment or reimbursement, to an employee of the taxpayer in connection with travel between the employee’s residence and place of employment. Travel between the employee’s residence and place of employment includes travel that originates at a transportation hub near the employee’s residence or place of employment. For example, an employee who commutes to work by airplane from an airport near the employee’s residence to an airport near the employee’s place of employment is traveling between the residence and place of employment.
The proposed regulations provide much needed guidance to assist taxpayers in determining the amount expenses related to QTF benefits that are or are not deductible. By making the expense allocations both an annual election and one that is made on a facility by facility basis, the IRS is providing the taxpayers with the flexibility to determine the optimal methodology or methodologies which will result in the least amount of disallowed expenses.
California has at times either restricted the ability of individuals and corporations to utilize the full carryover amount of net operating losses (“NOLs”) or completely suspended net operating loss deductions for business entities and individuals with business income in response to facing budgetary constraints. For example, in response to the global mortgage crisis that began in 2008 and the severe recession that followed and triggered a state budget crisis, California suspended NOL deductions for years from 2008 through 2011.
CA Assembly Bill 85
With the COVID-19 pandemic an omnipresent influence on daily life, state governments are trying to recoup lost funds through tax law changes. As a result of the coronavirus pandemic, California has a projected budget deficit of around $54 billion. To mitigate the effects of lost general fund revenues and increased health and human services costs, on June 29, 2020, Governor Gavin Newsom signed into law Assembly Bill 85 (“AB 85”). Two of the main provisions of AB 85 mirror the state’s historical efforts to regain lost revenues by suspending NOL deductions and limiting business incentive tax credits. The projected revenues for these two provisions of AB 85 total $9.2 billion: $4.4 billion in 2020-2021, $3.3 billion in 2021-2022, and $1.5 billion in 2022-2023.
Suspension of Net Operating Loss Utilization
NOL usage for California taxpayers with net business income of $1 million or more will be suspended for tax years beginning on or after January 1, 2020 and before January 1, 2023. As with similar provisions previously enacted, the carryover period for suspended NOLs has been extended. For losses incurred in taxable years beginning on or after January 1, 2021, and before January 1, 2022, the carryover period has been extended one year. For losses incurred in taxable years beginning on or after January 1, 2020, and before January 1, 2021, the carryover period has been extended two years. For losses incurred in taxable years beginning before January 1, 2020, the carryover period has been extended three years. However, under Legal Ruling 2011-4, the California Franchise Tax Board (“FTB”) takes the position that unless a taxpayer could utilize at least $1 of NOL during a suspension year, the taxpayer is not entitled to the extended carryover periods.
Limitation of business incentive credits
AB 85 also limits the use of business incentive tax credits for taxable years 2020, 2021, and 2022 by requiring that credits not reduce the applicable tax by more than $5 million. This limitation is applied on a combined group basis. Similar to the suspended NOLs, credit carryforward periods have been extended by an additional year for each year the credit is impacted by the limitation. The limitation on the utilization of credits extends to the California research and development (“R&D”) credit, jobs tax credit, motion picture production credits, and California competes credit and impacts both corporate and personal income taxpayers. Certain credits, however, including the low-income housing tax credit and earned income tax credit, among others, are excluded from this limitation.
Implications and Tax Planning
As this assembly bill was passed prior to the close of calendar year entities’ quarter 2 close, it is necessary to evaluate the implications as part of any Q2 2020 filings and disclosures. Companies should consider whether or not it makes sense to implement tax planning strategies to increase taxable income in 2019 to utilize unrestricted NOLs and/or to reduce taxable income below $1 million for years 2020, 2021 and 2022 to the extent possible, such as, among many planning ideas, accelerating deductions, adopting accounting method changes, and making California 59(e) elections on 2019 tax returns to push deductions to years when the NOL is suspended. In addition, based on the methodology applied by the FTB under Legal Ruling 2011-8, depending on the value of the NOL available by year, under a cost versus benefit analysis, it may be advantageous for a taxpayer to increase taxable income above $1 million during one or more of the suspension years in order to obtain the additional carryover periods for certain prior year net operating loss carryforwards.
While this tax law change is inconvenient for many business entities, it is not a new method for states, particularly California, to employ to regain lost revenues. There is historical precedent for similar revenue generating measures instituted by California dating back many years. While COVID-19 continues to present ongoing business, economic, personnel, and planning challenges, ways to mitigate the impact of the California NOL suspension and the business incentive credit limitation should be highlighted and investigated.Read More
Multnomah County Reviewing Two Tuition-Free Preschool Measures for November Ballot – Both Seek to Tax High-Earners
Multnomah County has two tuition-free preschool measures that may go to the ballot this November. The first campaign, Universal Preschool Now, has received enough signatures to be considered by the Multnomah County Board of Commissioners. This campaign has been developed by an independent task-force group. The other campaign, Preschool For All, is developed by a county-based task force. The Preschool For All measure is spearheaded by County Commissioner Jessica Vega Pederson, and since it is backed by the county, it will not need to collect signatures before being referred to the ballot this fall.
The Universal Preschool Now has collected enough signatures to send it to the Multnomah County Board of Commissioners for consideration. The Board of Commissioners has until September 3 to decide what it will do with the measure. It can either send the measure to the ballot for voter approval this November, or it can adopt the measure and have it become an ordinance of Multnomah County. If the Board of Commissioners elects to adopt the measure, it will still have the ability to take action and amend the measure as it sees fit. The Preschool For All campaign is still being developed by a county-based task force, but it will likely be put on the ballot as well this fall.
Universal Preschool Now
The Universal Preschool Now measure is the more aggressive tax of the two tuition-free preschool measures. If voters pass the measure in November, Multnomah County residents will be subject to a 3.9% tax on personal Oregon taxable incomes over $165,000 and joint incomes over $190,000. A taxpayer is considered a Multnomah County resident if they are domiciled in Multnomah County for any portion of the taxable year. If passed, the tax will begin on or after January 1, 2021. Multnomah County single-filing residents would be subject to a 14.8% (4.9% Local + 9.9% State) incremental state and local tax rate on income over $165,000. This new tax, coupled with the recent 1% tax to fund housing services for homeless people in the metro area would cause Multnomah County taxpayers to pay some of the highest taxes in the country.
The County Attorney, Jenny Madkour, stated that since the measure was not born in Multnomah County, it would likely need to be right-sized, reviewed, and revised to make sure it fits within the County’s administrative functions and processes. She did state that the measure is “tax legal” and is going through the proper process, so it would withstand legal scrutiny.
Preschool For All
The Preschool For All measure targets a broader range of taxpayers, at lower rates. If this measure passes in November, single filers with incomes over $125,000 and joint incomes over $200,000 will be subject to a 1.5% tax. Single filers with incomes over $250,000 and joint incomes over $400,000 will be subject to an additional 1.5% tax (3% total). Both taxes will get an automatic bump of 0.8% in January 2026, which would raise the rates to 2.3% for the lower-income level, and 3.8% for the higher-income level. The tax would be imposed on both resident and non-resident incomes that are earned in Multnomah County. The Preschool For All measure will also go into effect on or after January 1, 2021.
With potentially two tuition-free preschool measures on the ballot this fall, there is a chance that both measures will pass. If this happens, both would be a part of the Multnomah County ordinance structure. The Board would then have the authority to change, alter, or amend these ordinances, as long as it is lawful. The Universal Preschool Now measure needed 23,000 signatures in order to be referred to the Multnomah County Board of Commissioners, and it collected over 32,000 signatures, which is a strong indication that one of these measures may pass if it goes to the ballot this fall. This measure is also similar to the education levy passed by Seattle voters in 2018, which passed by a wide margin. If either measure is passed, high-earners in Multnomah County can expect to pay some of the highest incremental tax rates in the country.Read More
Seattle’s City Council Passes ‘JumpStart Seattle’ Payroll Tax on Big Businesses – Mayor Returns Bill Unsigned with New Proposals
Seattle’s City Council recently passed a 20-year tiered payroll tax on businesses with payrolls greater than $7 million. Mayor Jenny Durkan returned the bill to the City Council on July 17, 2020 unsigned, understanding it will become law. The city estimates that about 800 corporations will be subject to the tax, and it expects to raise about $214 million per year. The new funds will go towards economic relief programs like affordable housing, homeless service providers, grocery vouchers, and cash assistance to small businesses. The tax is scheduled to go into effect January 1, 2021, and will remain in effect through December 31, 2040.
Tiered Payroll Tax Rates
Companies are taxed on all compensation paid to “employees” that perform work, labor, or personal services of any nature for compensation paid by the business. The scope of the tax includes compensation paid to members of LLCs or PLLCs, partners, other owners of pass-through entities, and sole proprietors. Compensation that is paid to owners of a pass-through entity that are not earned for services rendered, such as return of capital, are not included in the payroll tax base.
Businesses with total annual payrolls from $7 million to under $100 million would be subject to a 0.7% tax on total annual Seattle-based employee salaries between $150,000-$399,999, and a 1.7% on total annual Seattle-based employee salaries over $400,000. Companies with payrolls between $100 million and $1 billion are subject to a 0.7% tax on total annual Seattle-based employee salaries between $150,000-$399,000, and a 1.9% payroll tax on total annual Seattle-based employee salaries over $400,000. For the largest companies in Seattle with payrolls over $1 billion, Seattle-based employees with annual salaries between $150,000 and $399,999 will be subject to a 1.4% tax. These large employers will also be subject to a 2.4% payroll tax on total annual Seattle-based employee salaries over $400,000.
Companies are exempt from paying the payroll tax if they engage in certain business operations. Seattle grocery businesses are exempt from the tax. Other businesses that Seattle does not have the authority to tax because of federal or state statutes are also exempt from the payroll tax. These businesses include insurance businesses and their agents; businesses that only sell, manufacture, or distribute motor vehicle fuel; businesses that only distribute or sell liquor; and federal and state governmental agencies. Nonprofit healthcare organizations are also exempt from the tax on employee compensation between $150,000 and $400,000 for the first three years after the tax goes into effect. Any individual who is an independent contractor for purposes of the Seattle business license tax and whose compensation is not included in the payroll expense of another business is exempt from the payroll tax. Additionally, stock options are not included in the annual employee compensations, but stock grants are subject to inclusion. No clarification is provided regarding RSUs, phantom stock, or the many other forms of equity-based compensation. Presumably, stock grants are included in the payroll tax base when they are reported as taxable compensation to the employee but there is no clarity on this timing point either.
Remote Workers and Assigned Payroll
The payroll tax only targets companies that have employees that are primarily assigned to work within the city of Seattle. An employee is not primarily assigned to Seattle if 50% or more of the employee’s service is performed outside of Seattle. Because of this, employees that are working remotely outside of the city limits for more than half of their time will not be subject to the tax.
The COVID-19 pandemic has caused many employees to work remotely, and the new tax will provide one more incentive for companies to continue to have their high-earning employees work from home. The Director of Finance and Administration may adopt a procedure to allow taxpayers who have payroll expenses consisting of work done and services provided within and outside Seattle to use a representative test period or conduct a survey based on factual data to arrive at a formula to calculate the percentage of payroll expense attributable to Seattle.
On July 17, 2020, Mayor Jenny Durkan returned the bill to the City Council unsigned, knowing that it will become law because it was passed with a 7-2 veto-proof majority. In a letter to the City Clerk, Mayor Durkan stated that the bill would cost affected companies an average of $2,700 per job, and that this would not help Seattle rebuild its economy. The Mayor also stated that she could not support this bill because it targets employers that already account for the majority of tax revenue in Seattle. She also voiced her concerns about the current bill because no tax would be collected until 2022, so this measure would not help Seattle out of its current financial hardships. Instead, the Mayor proposed a citywide income tax, a reduction of other regressive city taxes, and a regional payroll tax.
The likelihood that the tax will ever actually take effect is still uncertain. In 2018, the council repealed a similar per-employee “head tax” on corporations after pressure from Amazon and other large businesses. With massive deficits in Seattle’s budget due to the economic effects of COVID-19 and more precise targeting of the largest employers, however, this measure is more likely to survive. But it may go through substantial changes before taking effect next year.
Although Washington’s constitution restricts the scope of taxation options available to its state and city governments to fund their operations compared to its neighbor to the south, the measure comes in the wake of a payroll tax being considered by the Portland Metro Council to fund its $7 billion transportation initiative. Multnomah County is also sending an income tax measure to the ballot in November that would impose a 3.9% tax on personal incomes more than $165,000 and joint incomes over $190,000. Those developments come on the heels of a recently passed 1% tax on businesses called the Oregon Metro Area Homeless Housing Tax to fund housing services for homeless people in the metro area that is slated to begin in 2021. That, in turn, followed the recent enactment of the Oregon Corporate Activity Tax (CAT) on businesses in a region where individuals and businesses were already subject to Multnomah County Business Income Tax; Oregon Corporate Income/Excise Tax; City of Portland Business Income Tax; City of Portland Clean Energy Surcharge; and the City of Portland Pay Ratio Surcharge. With economic pressures mounting, could Seattle’s payroll tax proposal just be the tip of the taxation iceberg for resident individuals and businesses in the city and the state?Read More
Oregon Legislature Makes Changes to Corporate Activity Tax (CAT); Second Payment Deadline on July 31, 2020 Remains for Taxpayers
The Oregon Corporate Activity Tax (CAT) is imposed on taxpayers that have commercial activity of more than $1 million. Although many Oregon taxpayers have asked for significant changes to the CAT due to the economic downturn from COVID-19, the legislature only made changes that affect a small subset of taxpayers. The new legislation is beneficial to farmers and provides clarity to taxpayers. The new legislation becomes effective on September 25, 2020.
Corporate Activity Exclusions
Insurance Proceeds: CAT usually excludes insurance proceeds when calculating commercial activity, unless those proceeds represent compensation for a loss of business revenue. The new legislation now exempts crop insurance proceeds, which are usually paid out due to the loss of business, from being included in commercial activity.
Tax Refunds: The original CAT statute stated that “tax refunds, other benefit recoveries, and reimbursements for the tax” were excluded from corporate activity. The new provision now clarifies that “tax refunds from any tax program” can be excluded from corporate activity, not just CAT refunds.
Vehicle Dealer Registration Fees: Under the initial CAT statute, registration fees for in-state vehicle dealers were exempt from commercial activity. Now, out-of-state vehicle dealers also receive the commercial activity exclusion for registration fees or taxes collected.
Milk Sales by Farmers: The new legislation excludes “receipts from the sale of fluid milk by dairy farmers that are not members of an agricultural cooperative” from commercial activity. Now, farmers that sell milk to agricultural cooperatives are treated the same as those who sell to non-agricultural cooperatives. The exclusion is not applicable to farmers that sell non-milk products that must be processed by non-agricultural cooperatives and those who resell the product out of state.
One-Time CAT Registration: Taxpayers now no longer need to re-register each year for CAT. Once a taxpayer exceeds $750,000 in commercial activity, the taxpayer must only register once, and it will roll over from year-to-year. Taxpayers may need to re-register after a merger or reorganization.
Alternate Cost Inputs for Farmers: Under the CAT statute, taxpayers can subtract from commercial activity sourced to Oregon 35% of the greater of cost inputs or labor costs in arriving at taxable commercial activity. Cost inputs were traditionally defined as cost of goods sold. The new legislation provides clarity for farming operations that do not report cost of goods sold for federal purposes. It allows those taxpayers to calculate cost inputs as “the taxpayer’s operating expenses excluding labor costs.”
Exclusion of Manufactured Dwelling Park Nonprofit Cooperative: The new CAT legislation excludes entities that are “manufactured dwelling park nonprofit cooperatives organized under ORS chapter 62.”
Election to Exclude Foreign Members from Unitary Group: Unitary groups must register, file, and pay CAT as a single taxpayer, and receipts attributable to intergroup transactions are excluded from CAT. The new legislation allows taxpayers to exclude from unitary group membership all foreign members that do not have commercial activity or amounts realized but that are excluded from commercial activity that is sourced in Oregon.
Returns and Allowances: The new legislation allows taxpayers to offset against commercial activity any returns or allowances that are made in the calendar year.
Subtraction Revisions: The new legislation expands the apportionment provisions and directs taxpayers to apportion cost inputs or labor costs (1) as provided in ORS 314.650 and 314.665; (2) by using the alternative apportionment method under ORS chapter 314; or (3) as provided for by the DOR by rule. The new subtraction election must be timely filed with the original return and is irrevocable.
For unitary groups with members subject to more than one of the apportionment cost methods, they must apportion costs as provided by DOR by rule. Unitary groups must also include all members of the group when determining the group’s subtraction amount and apportionment ratio.
Farmer Election for Out-of-State Wholesale Exclusion: The new legislation gives taxpayers that are engaged in a farming operation that sell agricultural commodities to a wholesaler or broker an opportunity to demonstrate that the percentage of the taxpayer’s goods sold in Oregon compared to outside of the state, for purposes of determining commercial activity can be calculated by (1) obtaining a certificate, from a wholesaler or broker, stating the percentage; or (2) using an industry average percentage that is based on the most recent information from the USDA National Agricultural Statistics Service.
Changes to Interest and Penalties: Multiple changes were made to the interest and penalties provisions when calculating commercial activity. All the amendments are retroactive to tax years beginning on or after January 1, 2020. First, “penalty” has been removed from each reference to ORS 317A.161(1), and now that section only applies to interest. Additionally, the penalty for failure to pay at least 80% of estimated payments has been clarified to apply to any quarter in which the threshold is not met, and the penalty is 5% of the underpayment amount. The DOR is now prohibited from imposing a penalty for any quarter for which the taxpayer paid an amount at least equal to the previous year’s required installment payment. Finally, ORS 314.400(1) and (2) do not apply to taxpayers that do not file an annual return, or that do not pay the CAT by the due date of such return.
The new legislation also amends ORS 317A.161, which disallows the DOR from imposing interest on underpayments or underreporting in such years, and the 80% threshold has been changed to 90%.
Second Payment Deadline
Taxpayers in Oregon must make their second CAT payment by July 31, 2020. Companies with “substantial nexus” in Oregon and those with an annual CAT tax liability greater than $10,000 must make a payment of at least 25% of their 2020 calendar year CAT liability. Commercial activity includes a person’s or entity’s gross amount realized from its activities and transactions that occur in its regular course of business before expenses are deducted. Although the new legislative guidance exempts certain commercial activities after September 25, 2020, Oregon commercial activity market-based sourcing rules still generally include the (1) sale of a service or tangible personal property delivered to a purchaser in Oregon; (2) sale, rental, lease, or license of intangible or real property used or located in Oregon; or (3) rental, lease, or license of tangible personal property located in Oregon. A company has “substantial nexus” in Oregon if it has one or more of the following in Oregon during a calendar year:
- $50,000 in property
- $50,000 in payroll
- $750,000 in commercial activity
- At least 25% of its total property, payroll, or commercial activity or
- Other nexus with the state that would trigger a CAT tax liability under the US Constitution
Although Oregon has extended some of its tax filing and payment deadlines due to COVID-19, the due date for estimated quarterly CAT payments for 2020 has not been extended. Taxpayers can either make payments through the Oregon DOR website or by mailing a check or money order to the DOR. Taxpayers that underestimate their estimated tax payments by more than 20% or that fail to make a timely estimated tax payment will be subject to a 20% penalty. If a company fails to pay or if the underpayment exceeds one month, they will also be assessed a 20% penalty of the required payment. However, taxpayers that show a good faith attempt to accurately estimate and pay their quarterly CAT payment will not be subject to a penalty this year.
As soon as taxpayers exceed $750,000 of commercial activity in Oregon, they must register with the DOR within thirty days. Taxpayers that fail to timely register will be subject to a $100 penalty per month, not to exceed $1,000 in a calendar year.
On July 16, 2020, the Portland Metro Council unanimously voted to send a $7 billion transportation plan to the November ballot. This tax will impose a payroll tax on employers for individuals who perform services in the Metro Area. The rate will not exceed 0.75% of wages paid by the employer, and employers with 25 or fewer total employees are exempt from paying the tax.
If the Metro area voters pass the payroll tax in the November election, it will commence at the beginning of 2022. The Metro Council amended the original proposal by exempting state and local governments from paying the tax due to the COVID-19 economic impact. The Metro Council still has not solidified its plan on how the payroll tax will be imposed on local businesses. In the initial draft plan, five of the seven council members advocated for an aggressive payroll tax approach, which would impose a 0.75% payroll tax on employers in the Portland metro area immediately. Other council members support a gradual increase in payroll tax with rates starting at 0.1% that would increase to 0.6% by 2028. In the coming months before the November election, the Portland Metro Council will release its more detailed plan.
Future Uncertainty and Implications
There is controversy surrounding the new payroll tax that will be imposed on Portland businesses. The Portland Business Alliance, along with other business groups in the metro area have expressed their concerns about the tax. Those groups have suggested that the Metro Council delay the referral measure to the ballot until a later date for businesses that are struggling due to the COVID-19 pandemic. Other areas in the Portland metro, like Clackamas County, do not benefit as much from the transportation plan, and the Clackamas County Commissioner has voiced his concerns about the measure. The new payroll tax also comes in the wake of the recently passed 1% tax on businesses to fund housing services for homeless people in the metro area that is slated to begin in 2021. This tax will cause further hardship to Portland businesses already facing multiple state and local taxes, including the Multnomah County Business Income Tax; Oregon Corporate Income/Excise Tax; Oregon CAT; City of Portland Business Income Tax; City of Portland Clean Energy Surcharge; and the City of Portland Pay Ratio Surcharge.
The State of Wayfair in 2020: State and Local Income Tax Implications Two Years After the Wayfair Decision
In 2018, the U.S. Supreme Court overturned the long-standing physical presence standard for sales-and-use tax nexus in South Dakota v. Wayfair (“Wayfair”). Since then, nearly all states that impose sales and use tax have adopted economic nexus standards. Several states have started extending the economic nexus standard beyond sales tax regimes, adopting economic nexus provisions for corporate income taxes. Many states have adopted the economic nexus standards through the legislative process. Other states have acted through their revenue departments, either promulgating regulations under existing statutes or issuing administrative pronouncements.
Before Wayfair, states had to rely on the Quill (Quill Corp. v. North Dakota) doctrine that required physical presence to subject a business to tax. In Wayfair, the Court replaced the previous physical presence standard established by Quill and found that simply having a certain amount of sales or transactions within the state was sufficient to create an obligation to collect sales tax. Most states have followed the precedent established by the Wayfair decision and have begun to require remote sellers to register and collect sales tax based on factor presence nexus standards, measured by the amount of sales or volume of transactions that a seller has in the state. Income tax filing requirements based on this standard are currently being considered in many states and some states have already enacted such standards in the wake of the Wayfair decision.
Pre-Wayfair State Income Tax
A few states had already adopted an economic nexus standard for their income tax or gross receipts tax regimes before Wayfair was decided in 2018. The previous economic presence nexus standards were often quite ambiguous, as economic presence may have been deemed to occur based on an arbitrary amount of economic activity in a state considered sufficient to impact a state’s economy. Prior to Wayfair, Alabama, Colorado, California, Connecticut, Michigan, New York, Ohio, Oklahoma, Tennessee, Washington, and Virginia all had implemented a form of economic presence nexus, similar to what was approved in the Wayfair case.
Factor presence nexus refers to the concept that nexus is created when factors exceed certain thresholds with respect to property, payroll, or sales. Of these factors, the property and payroll factors would generally represent physical presence and trigger nexus regardless. As such, the most important and most controversial factor is the sales factor, as a seller could exceed the sales factor threshold without any other physical presence in the state. This sales factor presence deviates from the physical presence standard to create nexus established by Quill. However, there was no historical standard or case law precedent to require physical presence to create nexus for business activity taxes such as an income tax, a franchise tax, or a gross receipts tax, though many states relied on the Quill standard to impose these taxes. For example, for those states not listed above, income tax regulations for economic presence had not been enacted prior to the Wayfair decision and those states took a position for income taxes that was analogous to the sales tax nexus requirement in the Quill case that required physical presence in the state.
Post-Wayfair State Income Tax
In the Wayfair case, the issue was whether South Dakota could require a company, without a physical presence inside the state, to collect sales tax. Its statute required companies with at least $100,000 in sales or 200 transactions within the state to collect and remit sales tax. Although the issue was about sales tax in Wayfair, the dicta indicate that its holding could be applied to other tax regimes.
After Wayfair, states have almost completely moved away from the physical presence requirement for income tax. Most states that have strayed from the physical presence requirement have chosen to either maintain a pre-Wayfair economic presence standard or implement the post Wayfair factor presence type of test as outlined above as part of the economic nexus standard. Both approaches have complications when applied to an individual business in an individual state, and without guidance, taxpayers are struggling to understand whether they are subject to income tax in each respective state.
Economic Presence Standard
For states that already had their economic presence income tax regimes in place before Wayfair, the decision is welcome because it supports the constitutionality of these taxes under the Commerce Clause. This standard, however, is ambiguous in many states. Some state statutes require companies that conduct any business in or derive income from the state to file an income tax in return. This standard is difficult to apply because it does not mention whether a company is making any income in the state, or if there is a de minimis exception. Several states are taking the approach that if a company is subject to collecting sales and use tax in the state, it is also subject to income tax, even though different standards are applied. Other statutes require a company that has a “substantial economic presence” in the state to file an income tax return, without any further guidance.
With no uniformity, it is increasingly difficult for taxpayers to adhere to each state’s income tax regime. For example, in Minnesota, a taxpayer has nexus in the state if it sells products or services received by customers in Minnesota, even if the services are performed outside the state. This could cause a lot of uncertainty for taxpayers, especially in the financial services industry. For example, determining who the “ultimate customer” is can be difficult for banks and other financial institutions that operate large funds with a myriad of investors. As the economic threshold becomes broader, companies can expect to have increased filing requirements. Additionally, states will inevitably have to ramp up their state tax audit procedures.
Factor Presence Standard
As of right now, less than a dozen states have implemented some form of a factor presence standard. This standard was expressly approved in the Wayfair case for sales and use tax, and states are using this standard for their income tax regimes as well. Some states, like Alabama, are utilizing a multi-factor presence model. A company is subject to income tax in Alabama if its property, payroll, or sales exceeds any of the following thresholds during a tax period: (1) $50,000 of property; (2) $50,000 of payroll; (3) $500,000 of sales; or (4) 25% of total property, total payroll, or total sales. Other states, like Massachusetts, have a single-factor presence standard. Massachusetts requires businesses to file a state income tax return if its sales for the taxable year exceed $500,000. Although these bright-line rules can be easier to follow, they are not without complication, especially with transaction thresholds.
In Wayfair, the Court allowed South Dakota to require companies to collect and remit sales tax if it had more than 200 transactions or $100,000 in sales. Many states, like Hawaii, have adopted the same requirement for its income tax regime. Although this appears straightforward, it can be difficult to distinguish what one transaction is for certain businesses. For example, for a business that makes an installment sale, are the recurring collections each considered a separate transaction? States have offered little guidance on how to account for different types of reoccurring or subscription-like sales. Additionally, these transaction thresholds could violate the Commerce Clause. The Commerce Clause prohibits states from enacting statutes that are an “undue burden” on interstate commerce. For example, if a company has 200 one-dollar transactions, it would be subject to income tax in the state. The dicta in Wayfair indicates that this could create an undue burden on companies with minimal sales in the state and would, therefore, be unconstitutional under the Commerce Clause.
After the Wayfair decision, a number of states have decided to utilize the factor presence model instead of the more vague economic presence model. This factor presence model is easier to follow and adhere to because it gives taxpayers a bright-line requirement. Additionally, if states had already implemented a factor presence model for sales tax, implementing a similar model for income taxes eliminates any ambiguity caused by the economic presence standards. As states begin to implement and enforce their new income tax regimes relying on the Wayfair decision, companies should pay close attention to all economic activity that could trigger nexus in a state as well as any new legislation that adopts the factor presence model. Companies should also look for state guidance or authority that clarifies the ambiguity in the models. Although Wayfair to a large extent clarified most states’ sales and use tax regimes, there are still many unanswered questions for states regarding income tax in the fallout of the Wayfair decision.Read More
Even as regulatory guidance is still being issued by the U.S. Treasury, nearly 2-1/2 years after the enactment of sweeping changes to the international taxation of U.S.-based multinational enterprises (MNEs), the Organization for Economic Co-operation and Development (OECD) has been spearheading proposed changes to global taxation known as “BEPS 2.0” which would cause another seismic shift for MNEs. However, in a June 12 letter to his European counterparts, U.S. Treasury Secretary Mnuchin formalized the U.S. government’s concerns regarding a key provision of BEPS 2.0 and called for a “pause” in the negotiations.
Reaction was swift from the head of tax policy at the OECD and finance ministers in France, Spain, Italy and the UK who characterized the letter as a “provocation,” raising the specter that an impasse on U.S. participation in BEPS 2.0 would cause them and dozens of other countries to default to already enacted, pending, or proposed Digital Services Taxes (DSTs) imposed on the gross receipts of leading companies of the “digital economy.” They cite these taxes as a matter of tax equity and also a necessary expedient to address coffers emptied by COVID-19 stimulus and incentives. The U.S. has long complained that mandatory global conformity with aspects of BEPS 2.0 is just a “DST light” targeted at U.S. MNEs. It has also threatened retaliatory tariffs if the DSTs are not abandoned.
BEPS (Base Erosion and Profit Shifting) 2.0 is an outgrowth of the massive initiative that the OECD undertook beginning several years ago to address a variety of perceived international tax abuses. The first of the 15 BEPS “action items” was a proposal to create a separate system of taxation for “digital companies” or the “digital economy” based on the notion that existing taxing mechanisms are too antiquated to fairly tax its unique forms of valuation creation and delivery. The U.S. Treasury objected that this action item was a discriminatory effort targeted at Google, Microsoft, Apple, Amazon, Facebook, and other leading U.S. companies, and that you cannot ringfence one sector of the global economy and tax it differently than the rest if every sector is becoming digital in the “Internet of Everything.” As progress on this Action Item 1 stalled, many countries began to unilaterally enact or propose DSTs as an expedient means of taxing what they viewed as an exploitation of their markets and populace.
What is BEPS 2.0?
A so-called Inclusive Framework (IF), consisting of 137 participating jurisdictions, and sponsored by the OECD, has developed a Two-Pillar approach to address the taxation of digital services in the worldwide economy. Pillar One addresses new global standards for nexus and profit allocation. Pillar Two, also referred to as the “GloBE” proposal, seeks to develop a set of rules that allows jurisdictions to “tax back” income that has not been taxed by the primary taxing authority or is subject to low levels of taxation. In essence, it provides a minimum tax on global profits similar to the Global Intangible Low-Taxed Income (GILTI) provisions under the U.S Tax Cuts and Jobs Act of 2017.
Pillar One – Who Can Tax What?
Pillar One broadens the net of taxing nexus. For “automated digital services,” a minimum revenue threshold to be established based on the size of a market (with an absolute minimum threshold) will be the only factor necessary for nexus. This is an approach highly reminiscent of the “factor presence” standard for sales tax nexus in the U.S. after the Supreme Court’s 2018 Wayfair decision, essentially abandoning the need for physical presence. For other businesses, nexus will be more subjective, based on indicators of “significant and sustained” engagement with a market. These new nexus standards are exclusively applicable to the new taxing right described below as “Amount A.”
Pillar One attributes income to an identified nexus by distinguishing among three types of taxable profit which it identifies as Amount A, Amount B, and Amount C. Amount A is a share of the residual profits that is unique to digital businesses and attempts to capture the value created through the reach of the business into markets where the business has no physical presence, including the value of tracking the interactions with customers and among customers within the market. The IF admits that this concept is a departure from application of the traditional arm’s-length principle and even describes it as a “new taxing authority.” The allocation key could be a formulary approach similar to apportionment in U.S. state taxation which could produce results very different than those obtained under longstanding transfer pricing principles.
Amount B is a baseline measure of the routine returns on distribution or marketing functions that take place in the market. Amount C captures the value of any in-country functions that exceed the baseline activity compensated under Amount B. Amount A creates a new taxing right, but Amounts B and C do not create any new taxing rights and are based on existing nexus and transfer pricing profit allocation rules.
Scope of Businesses Affected
Two categories of businesses are within the scope of Amount A’s new taxing authority. The first category is those businesses that provide “automated digital services” on a standardized basis to global customers. These are businesses that provide digital services remotely to customers without any local infrastructure. These types of companies benefit from the data and content that the users contribute to the service in a particular jurisdiction and they can profit from that information without any physical presence. The list of these business models that are expected to be included in the scope of Amount A include:
- online search engines;
- social media platforms;
- online intermediation platforms, including the operation of online marketplaces, irrespective of whether used by businesses or consumers;
- digital content streaming;
- online gaming;
- cloud computing services; and
- online advertising services.
The second category consists of businesses that generate revenue from selling goods or services, whether directly or indirectly, to consumers. This includes businesses that license rights for trademarked consumer products or license a consumer brand and commercial know-how. This category would include, but is not limited to:
- personal computing products (e.g. software, home appliances, mobile phones);
- clothes, toiletries, cosmetics, luxury goods;
- branded foods and refreshments;
- franchise models, such as licensing arrangements involving the restaurant and hotel sector; and
The new taxing authority has thresholds in place to limit the number of MNEs that are affected by the new tax. Preliminary discussions have set the gross revenue threshold at €750 million. This threshold would significantly limit the scope of businesses and avoid burdensome compliance costs for smaller businesses. Another threshold being discussed is based on the amount of in-scope revenue that would otherwise be subject to tax. Finally, a third carve-out is being considered for companies whose Amount A profits do not exceed certain de minimis amounts. The OECD IF is currently looking at indicators to determine the threshold of significant and sustained engagement in the jurisdiction that would trigger the tax.
U.S Call for a “Pause” in Negotiations
U.S. Treasury Secretary Steven Mnuchin’s June 17 letter stated that the U.S. was concerned about Pillar One unfairly targeting U.S. multinational entities, and it wanted to pause negotiations on Pillar One during the global pandemic. The Secretary stated that the U.S. government’s most pressing issue was the economic issues resulting from COVID-19 and wanted to resume negotiations in 2021. Regarding Pillar Two of the IF, the U.S. has stated that it is “much closer to an agreement,” and wants to bring the negotiations to a successful conclusion by the end of the year.
OECD’s Response and the Outlook for BEPS 2.0
In response to the initial report that the U.S. was withdrawing from negotiations, the head of the tax policy center at the OECD stated that it was “a very bad message.” Regarding the COVID-19 pandemic, he stated that digital companies have actually benefited from the crisis creating more, not less, urgency in a global response to fixing an inequitable tax system. With countries taking on increased debt due to the worldwide pandemic, a better taxing mechanism for digital MNEs profiting during the pandemic would help replenish the coffers of countries experiencing record deficits created by the downturn in the world economy. The European finance ministers agreed, noting that the pandemic has “accelerated a fundamental transformation in consumption habits and increased the use of digital services, translating to revenue for digital-based businesses at the expense of others.”
The OECD has pushed back its targeted decision-making meetings on BEPS 2.0 by the IF to later this fall around the G20 Finance Minister’s meetings. With the U.S.’s current position regarding Pillar One, it is less likely that an agreement will be reached by the end of the year, as first targeted.
Consensus on BEPS 2.0 is certainly proving much more elusive than the original BEPS initiative. The initial BEPS effort was to increase the tax pie for everyone (i.e., every governmental taxing jurisdiction) by preventing tax planning that created “stateless income” not taxed anywhere. The national interests of governments worldwide were generally aligned in making sure that tax planning by sophisticated MNEs, and their advisors, did not result in substantial value escaping the global tax net. However, the 2.0 version is going beyond that to decide who gets a bigger piece of the pie by addressing tax rate arbitrage among jurisdictions. The implications of the initiative go far beyond the digital economy and U.S. MNEs. The changes contemplated by the proposal could lead to fundamental changes in the global international tax system under which all MNEs operate and could have significant consequences in terms of both the overall tax liabilities of businesses and the tax revenues of countries. If it fails, the alternative could be a global outbreak of punitive DSTs followed by retaliatory U.S. tariffs.Read More