This Week in State Tax

Wayfair, a Massachusetts-based internet retailer, recently reached a settlement in a local sales tax dispute with the City of Lakewood, Colorado, one of about 70 home rule jurisdictions in the state.  The retailer had challenged a City sales tax assessment for periods in 2018 to 2021, claiming that the City sales tax unduly burdened and discriminated against interstate commerce.  The case drew widespread interest because it may have addressed the Commerce Clause limits of home rule jurisdictions to impose sales tax collection requirements on out-of-state retailers, in light of the 2018 U.S. Supreme Court in Wayfair that overturned the longstanding physical presence nexus standard for sales and use tax collection.

In its complaint, Wayfair alleged the City sales tax imposed an undue burden on the taxpayer because neither Lakewood nor the state provided a statewide sales tax filing system or other simplifications, a matter compounded for interstate sellers by other home rule jurisdictions imposing similar requirements. It also contended the City system discriminated against interstate commerce by imposing different sourcing requirements than on in-state sellers and allowing retailers physically located in a special district in the City to charge a lower rate of tax than retailers located outside of the district.  Wayfair also raised arguments that it lacked substantial nexus with the City during the period at issue.  For questions regarding the case, please contact Steve Metz.

Effective July 11, 2024, the Illinois Department of Revenue adopted changes to its Investment Partnership classification regulation in Ill. Admin. Code tit. 86, § 100.9730 and has adopted a new regulation with guidance on Investment Partnership nonresident withholding in Ill. Admin. Code tit. 86, § 100.7034. These regulations relate to statutory changes enacted in June 2023 in Senate Bill 1963; the law changes are effective for tax years ending on or after December 31, 2023. Please see KPMG’s TWIST from June 12, 2023 for a detailed description of the statutory changes. The text of the adopted regulation is available in the July 26, 2024, Illinois Register (pp. 10846-10876).

The changes regarding Investment Partnership classification are consistent with the statutory changes. For tax years ending on or after December 31, 2023, prior guidance on applying the “asset test” and “income test” computations has been retained. For the “income test,” the rule considering lower-tier partnership income in the test is limited only to tax years ending before December 31, 2023, to reflect that the income test now includes the distributive share of partnership income from lower-tier partnerships classified as a security under subsection (a)(1) of Subchapter 77b of Chapter 2A of Title 15 of the United States Code.

The regulation provides several clarifications to the new nonresident withholding requirement. The base for the withholding is the sum of two elements. The first element is the Investment Partnership’s distributable share of business income from other partnerships that would be apportioned to Illinois. The second element is Investment Partnership’s distributable share, considering IRC sections 702 and 704, of nonbusiness income from other partnerships that would be allocated to Illinois excluding the types of nonbusiness income that are allocated based on commercial domicile (e.g., interest, dividends, capital gains, and losses from sales or exchanges of intangible personal property). When the Investment Partnership holds interests in multiple partnerships, the income and losses from those partnerships may be netted in determining the nonresident withholding base, but losses from other types of investments held by the Investment Partnership may not be netted against income in computing the nonresident withholding base.

In general, a nonresident partner is not permitted to claim the amount withheld by an Illinois Investment Partnership as a reduction to the nonresident partner’s taxes due. However, the regulation indicates specific instances when a nonresident partner will be permitted to claim the withheld amount. While a nonresident partner would generally treat distributive share income from the Illinois Investment Partnership as nonbusiness income, if the nonresident partner elects or is required to treat its share as business income, then such partner is permitted to claim the Investment Partnership withholding. An upper-tier Illinois Investment Partnership is permitted to claim the withholding from a lower-tier Illinois Investment Partnership to reduce the upper-tier Illinois Investment Partnership’s amount of nonresident withholding on its partners. If Illinois residents are partners in an upper-tier partnership which is reported Illinois Investment Partnership withholding by a lower-tier partnership, the distributive share of any withholding remaining after satisfying any amounts owed to Illinois by the upper-tier partnership, can be claimed by the Illinois resident partners. A nonresident partner, other than an individual, that is commercially domiciled in Illinois is allowed to claim the Investment Partnership withholding related to its income from the Investment Partnership. An Illinois Investment Partnership that overpays its withholding for the tax year is generally entitled to a refund of that overpayment. However, if the withholding relates to a partner that will be able to claim that withholding under the preceding rules, the Investment Partnership is not permitted to claim a refund for the withholding overpaid. In that situation, the prescribed remedy is for the partner to report the withholding and claim a refund for any amount that exceeds the partner’s tax due.

The regulation also provides guidance on the interaction of the Illinois Investment Partnership nonresident withholding requirement and the elective Illinois Pass-through Entity Tax (IL PTET). The regulation indicates that an Investment Partnership that elects IL PTET remains subject to the Illinois Investment Partnership withholding requirement. If the Investment Partnership is invested in another partnership that elects IL PTET, the Investment Partnership may use its share of IL PTET Credit that relates to its nonresident partners to reduce the amount of withholding tax it would otherwise owe. If the Investment Partnership itself elects IL PTET, it may elect to reduce its IL PTET base by the amount of income that will be included in its base for Illinois Investment Partnerships nonresident withholding.

The new regulation includes numerous examples that apply the withholding requirement to various structures under different facts. Please contact Brad Wilhelmson with questions.

The Secretary of State has certified that Initiative Petition 17 to increase the minimum tax on corporations has received sufficient signatures to be placed the November 2024 ballot. Under current law, corporations pay the higher of either a tax on their “taxable income” or a business minimum tax. The minimum tax is a graduated levy against total Oregon sales and is capped at $100,000 for taxpayers with $100 million or more in Oregon sales.  If approved by the voters, Initiative Petition 17 would impose a minimum tax on corporations with Oregon sales exceeding $25 million. The tax would be equal to the current minimum tax for the applicable bracket, plus three percent of the excess over $25 million. For example, a corporation with Oregon sales of $50 million would have a minimum tax liability of $750,000 plus the current $50,000 obligation. The new minimum tax rate would be applicable to tax years beginning on or January 1, 2025, and would have no cap. The bill would apply the same minimum tax to S Corporations with Oregon sales over $25 million. Currently, such entities pay a $150 minimum tax only. Revenue from the increased minimum tax will be used to provide rebates for individuals. Please contact Nisha Mathew with questions on Initiative Petition 17. 

In recent weeks, the South Carolina Administrative Law Court and the Court of Appeals have issued decisions regarding the state Bank Tax Act that were averse to taxpayers. In the first matter, the Administrative Law Court (ALC) affirmed a Department of Revenue (Department) Determination that a national bank must source its mortgage loan interest, credit card interest and fees, and credit card interchange fees based on the location of the borrower for purposes of the Bank Tax.

For income relating to mortgages, the ALC first found that mortgages should be classified as intangible property because they are “evidence of debt” and statutorily excluded from the definition of tangible personal property. Under South Carolina law, income from intangible property is sourced to the location where the property is “used,” which, according to ALC, was the location of the real estate. Further, the ALC noted the Department had a “longstanding administrative practice” of using location of the borrower as a proxy for location of the real estate. The taxpayer had argued that its mortgage activities constituted service income and should be sourced based on the income producing activities regarding the issuance, approval and servicing of the mortgage, which occurred primarily outside of South Carolina. While the ALC rejected this framing, it noted that, even if the activities constituted a service, the true income-producing activity is the issuance of mortgage loans to South Carolina borrowers, as without the mortgage, the taxpayer would have received no income. The ALC analogized to the state supreme court decision in DIRECTV, holding that receipts from digital television subscriptions should be sourced to the location of the subscriber.

For fees related to the issuance of credit cards, the ALC held that the extension of credit to cardholders created accounts receivable and fell within the definition of intangible property. Thus, interest, late fees, and annual fees associated with the cards should be sourced based on the borrower’s location. Even if the issuance was treated as a service, the income was sourced to the South Carolina borrower because the customer is paying for the ability to spend money on credit. The ALC did agree that interchange and merchant fees received by the taxpayer were service income. It found, however, that the true income producing activity occurred where the credit card transaction was initiated because the transaction could not be concluded (and income received) without the approval or denial decision being transmitted to that location.

In the second case, the Court of Appeals affirmed an ALC decision holding that the bank tax does not permit certain deductions allowed by the federal income tax, specifically the federal net operating loss carryforward. The South Carolina bank tax is imposed on the entire net income of a bank.  In reaching its decision, the court relied on the general rule that a deduction statute should be construed against the taxpayer. The court first noted that unlike the bank tax, the South Carolina corporate income tax explicitly authorizes a net operating loss deduction from entire net income, rather than including them as part of the computation of entire net income. While the state corporate income tax also was imposed previously on entire net income, the legislature had specifically authorized a deduction for federal net operating losses in 1955. As such, net operating loss carryforwards are not an inherent part of entire net income and must be statutorily authorized as deductions, and there is no such deduction under the bank tax. Moreover, the court rejected the taxpayer’s argument that the bank tax base was to be identical to the corporate income tax base. Based on legislative history and established practice, the court determined that the bank tax was a franchise tax (not an income tax) and was not intended to conform to the state corporate tax, except for certain specified elements such as administration, enforcement, and enforcement. For more information on U.S. Bank National Association v. South Carolina Department of Revenue or Synovus Bank v. South Carolina Department of Revenue, please contact Jeana Parker.