2015-Issue 25—State legislatures are working hard to make changes to their tax systems in an attempt to stay competitive with their neighboring states and broaden their tax base. As state legislative sessions adjourn, we see a trend of numerous states moving towards mandatory combined filings, single sales factor apportionment, and market sourcing methods of apportionment for sales of other than tangible personal property. As compliance season approaches for most taxpayers, it is important to take a moment and see what changes states have enacted.
Louisiana — Temporary Limitation of Certain Deductions
On June 19, 2015, the Louisiana governor signed various tax bills. Most notably, Louisiana House Bill No. 218 provides a temporary 28 percent reduction of certain deductions, exclusions and credits applicable from July 1, 2015, through June 30, 2018. The temporary reduction applies to net operating loss deductions, dividend income exclusions, IRC 280C expenses, Louisiana corporation income tax refunds, depreciation allowances, public transportation fund exclusions and hurricane benefits.
This new law will impact all taxpayers who did not file their Louisiana 2014 income tax returns before July 1, 2015. Those taxpayers will be subject to the deduction limitations under the new law. However, the benefit of the deduction should not be lost as the law provides for one-third of the disallowed portion of the exclusion or deduction on the taxpayer’s return for each of the taxable years beginning during calendar years 2017, 2018 and 2019.
In addition to the temporary limitation, other bills signed by the governor increased the NOL carryforward from 15 to 20 years and eliminated the NOL carryback; converted the excess research and development credit from a refundable item to a carryover credit good for five years; converted the excess credit for taxpayers with total local property taxes exceeding $10,000 into a partially refundable credit; precluded businesses under NAICS codes 44, 45 or 722 (retail, restaurants and drinking places) from Enterprise Zone benefits; and temporarily reduced certain Quality Jobs program benefits.
Law Changes in Effect for 2015
New York State — Tax Reform Bill Enacted in 2014
The New York State 2014-2015 Budget bill enacted on March 31, 2014, contained the most significant reforms to New York State’s corporate tax system in decades. For tax years beginning on or after January 1, 2015, New York State eliminated the Bank Tax and now imposes the revised corporate franchise tax on all taxpayers. Also, the net income base is replaced with a tax based on business income, defined as entire net income minus investment income and other exempt income.
Other important changes include establishing economic nexus standards that define taxable corporations as those that derive more than $1 million of New York gross receipts, adopting a unitary combined reporting system, providing an effectively connected starting point for foreign corporations, revising provisions from pre- to post-apportionment net operating losses, providing tax breaks to manufacturers, and reducing the income tax base rate to 6.5 percent starting with tax years beginning January 1, 2016.
Additionally, the 2015-2016 Executive Budget bill signed on April 14, 2015, contained significant technical corrections to the state’s revised corporate franchise. Important for taxpayers, the changes made in the current executive budget have a retroactive impact and will be applicable to tax years beginning on or after January 1, 2015. Among other provisions and technical corrections, the bill placed a limit on the amount of income that can be classified as exempt investment income, redefined the definition of qualified financial instruments, provided sourcing rules for mark-to-market net gains, and limited the financial services investment credit. Also, the net operating loss conversion subtraction election became revocable, and it can only be claimed until the pool is exhausted.
New York City — Following New York State’s Lead
On April 13, 2015, the New York governor signed legislation for New York City that aligns the city’s tax structure along the newly adopted New York State tax regime. Effective for tax years beginning on or after January 1, 2015, New York City will subject general business corporations and banks to the same tax provisions and institute unitary combined reporting, market-based sourcing and other revisions similar to those made by New York State.
Despite the increased conformity with New York State, there are a few features of the New York State reform that were not included in the final New York City enactment that could substantially impact taxpayers. Some excluded provisions consisted of establishing the $1-million receipts threshold for New York City regarding economic nexus, retaining the existing phase-in of a single sales factor by 2018, the continued application of the capital tax, and differences in rate reductions for manufacturers.
Although the legislation is a big change for C corporations, other entities such as S corporations, qualified S corporation subsidiaries, partnerships and other unincorporated businesses will remain subject to the existing general corporation tax and unincorporated business tax.
Nevada — New Commerce Tax
As part of an estimated $1.5-billion omnibus tax plan intended to bolster and fund the state’s education system, Nevada enacted a new commerce tax effective July 1, 2015. The legislation imposes an annual commerce tax on each business entity engaged in business in Nevada. Generally, the commerce tax will be imposed on all business entities whose Nevada gross revenue in a taxable year exceeds $4 million. The tax rate varies depending on the industry from 0.051 percent to 0.331 percent. Gross revenue does not allow for any deductions for cost of good sold or other expenses incurred, but provides certain exclusions.
The commerce tax will be imposed annually on a separate entity basis, with the year matching Nevada’s fiscal year (July 1 through June 30). Reports are due on or before the 45th day following June 30 with the option to request a 30-day extension to pay tax with no penalty, only interest. The first commerce tax report will be due 45 days after June 30, 2016.
District of Columbia — Changes to the Franchise Tax Structure
Effective February 26, 2015, the District of Columbia enacted the Permanent Budget Act. This Act provides substantial changes to the District of Columbia tax structure, such as a reduction of the franchise tax from 9.975 percent to 9.4 percent, and promises to further reduce the rate if and when the District revenue collections exceed certain amounts.
The Act also made certain changes to the apportionment provisions, including the use of single sales factor apportionment and market-based sourcing for years beginning after December 31, 2014. Additionally, a throw-out rule was enacted excluding receipts from the sales factor denominator if sales are sourced to a state in which the taxpayer is not subject to tax.
North Dakota — Election to Use Single-Sales Factor
Historically, North Dakota had an equally weighted three-factor apportionment formula consisting of sales, property and payroll. Effective for taxable years beginning after December 31, 2014, North Dakota permits taxpayers to elect to apportion business income with a phased-in single sales factor. If elected by an eligible taxpayer, the single sales factor will phase in over a five-year period and will apply to all companies in a unitary group or filing a consolidated North Dakota return. An eligible taxpayer may not be a pass-through entity.
The single sales factor election must be made on an originally filed return and is binding for five consecutive taxable years, at which time the election lapses. If the taxpayer does not make another alternative apportionment election on the original return for the taxable year immediately following the final year of the election, then the taxpayer is required to apportion business income using the equally weighted three-factor formula for a period of three taxable years before the taxpayer may make another election.
Rhode Island — Changes to the Corporate Tax Structure
Rhode Island enacted various changes that will take effect for the taxable year beginning on or after January 1, 2015. Rhode Island’s business corporation tax rate will decrease from 9 percent to 7 percent. Like many of the other states, Rhode Island is moving to a single sales factor apportionment method with market-based sourcing for its sales factor. Additionally, the franchise tax has been repealed, and S corporations will be subject to the $500 minimum tax.
Lastly, the new law provides mandatory combination for each C corporation that is part of a unitary combined group, including non-U.S. corporations with sales of 20 percent or more inside the United States. Rhode Island incorporates a tax haven definition similar to other states. However, the Rhode Island treatment of tax havens is unique. Unlike other states, a non-U.S. entity is not included in a combined group just because it is incorporated in a tax haven. The tax haven rule is applicable only when the non-U.S. entity has sales of 20 percent or more and is considered part of the unitary combined group.
Looking Forward: 2016 and Beyond
Connecticut — Mandatory Combined Reporting
On June 30, 2015, Governor Dannel Malloy signed a budget bill that provides significant corporate income tax changes, effective for tax years beginning on or after January 1, 2016. The legislation replaces the current combined reporting provisions with mandatory water’s-edge combined reporting for entities engaged in a unitary business, including entities incorporated in tax haven jurisdictions. Additionally, a combined group of entities has the option to make an election to file on a worldwide or affiliated group basis. The worldwide or affiliated group election must be made on a timely filed return and is binding for the income year in which it was made and the 10 immediately succeeding tax years.
As of January 1, 2015, the legislation will limit the deduction of NOL carryovers to the lesser of (1) 50 percent of net income or, for companies with taxable income in other states, 50 percent of the net income apportioned to Connecticut; or (2) the excess, if any, of such NOL over the NOL deductions allowable with respect to such operating loss for each of any prior income years following the loss year. Other corporate income tax changes in the budget bill included the extension of the temporary 20 percent corporate income tax surcharge to 2016 and 2017 income years and limitation of the allowable tax credits to 50.01 percent (previously 70 percent) of a taxpayer’s tax liability.
Tennessee — Economic/Bright-Line Presence Test
Tennessee recently enacted the Revenue Modernization Act, which will be effective for tax years beginning on or after January 1, 2016. The Act expands substantial nexus in the state, which would now mean any direct or indirect connection of the taxpayer to the state so that the taxpayer can be constitutionally required to pay the tax. The Act also included language for a bright-line presence test stating that a taxpayer is considered to have nexus if any of the following apply: $500,000 of state receipts or 25 percent of the total receipts from everywhere; average value of real and tangible personal property owned or rented and used in the state exceeds the lesser of $50,000 or 25 percent of the average value of all the taxpayer’s real and tangible personal property; or compensation exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the taxpayer.
For tax years beginning on or after July 1, 2016, a taxpayer will be required to use market-based sourcing to determine the Tennessee sales factor. A taxpayer may make an annual election to use the cost-of-performance method (i.e., Tennessee’s prior sourcing methodology) if that method will result in a higher overall apportionment factor for the applicable tax year. A taxpayer, however, is not able to make this election if it is in a loss position.
2015 Tax Rate Changes
As noted above, recent and past state tax legislation has revised applicable state income tax rates that will apply to your 2015 corporate state income tax returns. For a quick reference, please see the chart below that highlights some income tax rate changes.
(*) 7.5% after June 30, 2013, and before July 1, 2014; 7.0% after June 30, 2014, and before July 1, 2015; 6.5% June 30, 2015, and before July 1, 2016.
(**) 0.475%/0.950% for reports due after January 1, 2015; 0.375%/0.750% for reports due after January 1, 2016. Lower rate generally applicable to taxable entities primarily engaged in retail or wholesale trade.
Alvarez & Marsal Taxand Says:
It is imperative for taxpayers to be aware of the tax law changes to accurately comply with their state tax filing obligations. States that continue to clarify and broaden their nexus standards include New York and Tennessee. These new standards may trigger new state income tax obligations for many. Taxpayers should stay current with these recent enactments to avoid pitfalls along the way.
As more states jump on the bandwagon to enact tax reform, it will be interesting to see the changes implemented, as states are in a tough position to balance their budgets but are simultaneously being persuaded by neighboring states to enact taxpayer-friendly legislation in an attempt to stay competitive.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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