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This Week in State Tax

Read recent state tax developments including a notice clarifying retailer bad debt refunds in California, an Ohio update on sales tax treatment of services related to consumer banking and a reminder about annual reconciliation of B&O apportionable services in Washington.

State and local tax developments for the week of October 21, 2024

California: CDTFA Clarifies Retailer Bad Debt Refunds Continue in 2025

The California Department of Tax and Fee Administration recently issued a Special Notice on Senate Bill 167, budget-related legislation, containing numerous tax changes, which was signed by Governor Newsom earlier this year. 

Recall, California allows a bad debt deduction for sales and use taxes remitted to the state that relate to accounts that have been found to be worthless and charged off for income tax purposes or under GAAP. Lenders who purchase accounts from retailers are currently eligible to claim a bad debt deduction or refund under certain circumstances, and retailers are also able to assign their rights to claim a deduction or refund to an affiliated entity under certain circumstances.

In the Special Notice, the Department states that the provisions in SB 167 curtailing the availability of bad debt deductions apply only to lenders and affiliated entities of retailers.  Those parties may no longer take a bad debt deduction or file a refund claim for accounts found worthless on and after January 1, 2025. For accounts found worthless prior to that date, lenders and affiliated entities of retailers may still take a bad debt deduction and file a refund claim for up to three years from the date that the account was found worthless. The Special Notice specifically states that the provisions of SB 167 do not affect a retailer’s ability to take a bad debt deduction on and after January 1, 2025. For more information on SB 167, see our earlier TWIST, and contact Jim Kuhl with questions.

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Ohio: BTA Finds Debit Authorizations Not Taxable; Other Services Need Closer Examination by Commissioner

The Ohio Board of Tax Appeals (Board) recently issued a decision in a dispute over the sales tax treatment of services related to consumer banking. The taxpayer offered “debit authorization services”—jointly used by banks and ATM vendors to determine whether to authorize a customer’s request for a cash withdrawal—and “disbursement authorization services”—used by banks to determine whether to authorize a customer’s electronic payment. The crux of the dispute was whether the services were taxable automatic data processing services (ADP), electronic information services (EIS), or computer services; explicitly nontaxable services, such as personal or professional services or debt collection; or other (presumably nontaxable) non-enumerated services.

The taxpayer argued that its sales of debit authorization services should not be taxable because the true object of each transaction was a single yes-or-no answer. The Ohio Supreme Court had previously held in Marc Glassman v. Levin that the provision of such a “formulated” answer “in response to a routine request” was not a taxable ADP service. The taxpayer further argued that sales of disbursement authorization services should not be taxable because they were properly classified as personal or professional services or debt collection services. By contrast, the Tax Commissioner’s Final Determination took the position that the entire transaction should be deemed taxable because it consisted of a bundle of services that included some that fell squarely within the definition of ADP, and that the taxpayer should hold the burden of claiming an exemption for any separately stated items it felt should not be taxable. Before the Board, the Tax Commissioner took the narrower position that the true object of each line item should be separately considered, and that many of the individual line items constituted ADP. She further contended that the disbursement authorization services were properly characterized as ADP, not personal or professional services, because they involved processing other’s data.

The Board rejected both the taxpayer’s approach and the position taken by the Tax Commissioner as inconsistent with the Ohio Supreme Court’s ruling in Cincinnati Fed. S. & L. v. McClain. The Board interpreted that case as rejecting an “all-or-nothing approach” and instead requiring a “more refined analysis” that considers each separately stated item individually. The Board agreed that Marc Glassman controlled for the purpose of characterizing those services for which the true object is data authorization. Further, the Board did not agree that the disbursement services should be considered as exempt personal or professional services because of the level of automated activities involved. Beyond that, however,  it remanded the dispute to the Commissioner to analyze all other separately stated items in light of Cincinnati Fed. Please contact Dave Perry with questions about Checkfree Services v. Harris.

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Washington: Annual Reconciliation of B&O Apportionable Services Due October 31

Taxpayers reporting apportionable income on their Washington Business and Occupation Tax (B&O) returns are required to file an annual report reconciling the apportionable income reported on their B&O returns in the prior calendar year with actual apportionable income for that period and to pay any tax due on additional receipts. The report is due by October 31 each year, and failure to comply can result in the imposition of penalties as high as 29 percent on unpaid tax.

The B&O tax is a gross receipts levy in which the tax rate varies by type of business activity. Certain business classifications (e.g., services and royalties) are required to apportion their income according to various sourcing rules to determine the amount taxable in Washington. Taxpayers reporting apportionable income are allowed to calculate the receipts factor for the current tax year based on the most recent calendar year for which information is available for all twelve months, rather than computing the actual allocation for each reporting period. The annual reconciliation then adjusts the receipts reported under the prior year factor with the actual receipts computed upon completion of the year.

If a taxpayer fails to file the reconciliation and pay any tax due timely, it may result in imposition of penalties as high as 29 percent if the Department on audit or otherwise subsequently increases the taxpayer’s apportionable receipts. The penalty can be assessed even if a timely filed reconciliation would have resulted in a “no change” report. Likewise, if the Department reclassifies certain income to apportionable on audit, the penalty can be assessed even if the taxpayer did not report any apportionable receipts in the relevant tax year, and therefore felt it had no obligation to file the reconciliation.  For more information, contact Michele Baisler or Alexander Low.

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This Week in State Tax

This Week in State Tax (TWIST) is a series providing the latest updates on the ever-changing state and local tax environment.

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TWIST - This Week in State Tax

What’s included: Discussion on noteworthy developments with broad applicability to taxpayers across the country. Brought to you by: KPMG Washington National Tax – State and Local Tax practice.

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