As 2020 comes to a close, uncertainty remains. Employers and schools balance between in-person and remote participation. While unemployment numbers declined through the summer, new jobless claims appear to be steadily rising again. Businesses running out of federal stimulus money may now be forced to lay off employees, which would drive more people to state unemployment lines. What does this mean for states? Without federal relief and with no other way to replace revenue lost to pandemic-related shutdowns, budgets have been slashed, employees have been laid off or furloughed and legislators are looking at other avenues to refill their coffers.
We begin this article where we left off this past summer.
In July, we reported New York’s Assembly and Senate have nearly identical bills to increase state tax rates for individuals, and Illinois’ ballot imposes a question regarding a constitutional amendment to adopt graduated rates thus increasing taxes for individual and corporate citizens. The New York bills are still pending, and the Illinois voters will have decided the fate of the amendment in November.
Two new states worth mentioning are New Jersey and California.
On Sept. 30, the New Jersey governor signed a nine-month budget for the remainder of fiscal year 2021. The budget contains corporate and individual tax increases and a potential rebate for New Jersey families. However, the millionaire’s tax is grabbing all the attention. The top tax rate of 10.75% will apply to taxable incomes of $1 million retroactive to tax years beginning on or after Jan. 1, 2020.
California has bill AB 2088 “in committee process.” The bill intends to impose a tax of 0.4% on worldwide net worth of residents in excess $15 million for married filing separately and $30 million for married filing jointly. Worldwide net worth is calculated in a similar manner to Internal Revenue Code (IRC) for estate taxes under Chapter 11 as of June 15, 2020. The bill lists the assets to include (list is not limited) and exclude (real property directly held, mortgages and other liabilities associated with realty). The tax would be assessed on the value as of Dec. 31. The bill contains rules for part-year and temporary residents as well as residents who generated their wealth prior to moving into California. If the bill passes, it is effective immediately. However, the state has much to consider if this bill is to become law, as the bill requires additional rules not yet written.
Change of residency
In recent weeks, the inquiries from clients about moving from high-tax states has increased. While this is nothing new, there appears to be a resurging interest. The pandemic has certainly proven we can work remotely which may be prompting one to ponder where they live and work since, for right now, it is one and the same for so many of us.
Moving from high-tax states, like California, New Jersey, New York and even Minnesota and Wisconsin, pose residency audit risks. The taxpayer’s former residency must be considered abandoned in order for the challenging state to recognize new residency. Advanced planning is key to managing this risk. Careful considerations to each individual’s facts, circumstances and intent are critical as well as researching a state’s specific residency and domiciliary laws, regulations and cases.
States response to the Coronavirus Aid, Relief, and Economic Security (CARES) Act
Back when we reported in July, 21 states and the District of Columbia had not yet adjourned their 2020 legislative sessions. By early October 2020, that number increased to 32. Sixteen states are either still in session or in special session, leaving three that have not yet convened. Therefore, there is still likelihood of a state adopting in full or in part or decoupling in full or in part the CARES Act.
Taxpayers are expressing most concern with whether states will follow the forgiveness of loans (Section 1106 of the CARES Act) similar for federal income tax purposes if qualifications of the program are met. States with rolling conformity to the IRC will automatically conform to the CARES Act unless the state decouples as New York did. Other jurisdictions with rolling conformity that have not decoupled from the CARES Act include Alabama, Colorado, District of Columbia, Illinois, Maryland, New Jersey, Pennsylvania and Tennessee (this list is not all inclusive). Any state with a conformity date prior to March 27, 2020, will need to either (1) adopt in full or in part, (2) decouple in full or in part from the IRC or (3) do nothing. Wisconsin adopted only specific sections of the CARES Act and New York, as noted above, decoupled in full. Caution should be made even if a state has not yet adopted Section 1106 as a state-specific statute may provide relief.
The majority of states adopted the business interest limitation provisions under the Tax Cuts and Jobs Act (TCJA). However, as noted above, unless the state has rolling conformity, the new provisions under the CARES Act will not apply. Therefore, those states conforming to section 163(j) will need to follow TCJA provisions to determine allowed interest deduction.
Aggressive enforcement of nexus laws
States have not slowed down their attempts to find the nonresident, nonvoting taxpayer. Nexus remains an important element of managing a business’s overall state tax risk. With the budget shortfalls expected through 2022 as indicated by the Center for Budget and Policy Priorities, we should continue to expect taxpayers to receive nexus inquiries from state and local taxing authorities.
Back in July, we reminded clients of the Wayfair decision. Given the broad implications for companies beyond remote sellers, it bears repeating and a bit of expansion to include prior cases.
Prior to the Wayfair decision, states were looking to the Geoffrey, Inc v South Carolina Tax Commission decision for inspiration to impose income taxes based on the economic realities of using intangibles in the state. In 1993, post the certiorari denial to hear Geoffrey, states began to enact what was dubbed “Geoffrey’s nexus” laws. Hence, the beginning of economic nexus for income tax purposes. Additionally, numerous states’ “doing business” statutes contain language or equivalent language “deriving income from sources within state.” Therefore, unless a taxpayer qualifies for Federal Public Law 86-272 (P.L. 86-272) protection from income taxation, it may very well have nexus and therefore a legal requirement to file and pay income taxes. P.L. 86-272 is available only to sellers of tangible personal property. With respect to orders placed from outside of state and that ship goods from outside of state, some states require the seller to use third-party common carriers while others may permit delivery in own vehicles.
As a reminder, for those employers considering allowing employees to continue teleworking post the state of emergency or stay-at-home orders, they need to understand the nexus implications not only for income, non-income and sales taxes, but also payroll withholding and unemployment insurance.
Both physical presence and economic standards must be analyzed for all state taxes when performing a nexus study. Proactive understanding of an organization’s nexus footprint is the ultimate strategy to begin managing risk.
Increase in state audit activity
Unfortunately, in the last several months, clients continued to receive letters notifying them of state’s intention to audit. These, like nexus questionnaires and notices, should be taken seriously. Notices, especially if there is an adjustment to tax, may require a response within a certain time frame. Otherwise, opportunity to object could be lost. Therefore, when in doubt, engage the services of a tax professional or attorney to handle these situations.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.