This Week in State Tax

Governor Josh Shapiro recently signed a revision of the state tax appeals process (Senate Bill 1051) into law. Most notably, the new law authorizes the Board of Finance and Revenue (Board) to engage in a settlement conference process with a taxpayer appealing an adverse decision made by the Department of Revenue. A settlement conference may be requested in writing by the taxpayer or by the Department of Revenue, or initiated at the direction of the Board, within 30 days of the petition for review being filed. Note that a petition for review by the Board must be filed within 60 days after the Department’s Notice of Decision and Order on a Petition. If a settlement conference is requested by a party, the Board has five business days to decide whether to initiate a conference.

Once initiated, an opening settlement conference must be held within 60 days. The Board may defer consideration of the petition for review until the conference is concluded; if the parties fail to settle the matter, the Board will be required to issue a decision within 60 days of termination of the process (including by refusal of a party to participate). A conference will terminate without an agreement when the settlement officer declares that further efforts would not contribute to a resolution of the dispute, the parties agree to terminate the conference, or one or both parties fail to communicate with the settlement officer for 21 days following the conclusion of the conference.

The conference will be managed by an impartial settlement officer appointed by the Board. A party may attend the conference through a representative of its choosing. The settlement officer is not authorized to impose a settlement on the parties but may recommend a potential settlement. An agreement reached through the conference will be approved by the Board unless contrary to law. An approved settlement is final and binding without a showing of fraud, malfeasance, or misrepresentation or material fact; however, settlement agreements are not precedential on separate matters.

The bill also extends the due date for the filing of a petition for review with the Board on a personal income tax matter from 60 days to 90 days after mailing of the notice (with the possibility of an additional 30 days for cause.) Please contact Mark Achord with questions about S.B. 1051. 

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The Virginia Tax Commissioner (Commissioner) ruled that a taxpayer that fabricated property for both retail sales and its own use and consumption as a real property contractor was a dual operator primarily fabricating products for its own use. Consequently, the taxpayer, that had considered itself to be a retailer of fabricated products, had erroneously collected and remitted sales tax from customers on transactions involving real property improvements for which the taxpayer should have instead either paid sales tax to its suppliers or accrued use tax on its purchases.

The taxpayer fabricated vinyl fencing, decking, pergolas, screen porches, and outdoor furniture. It sold these products to construction contractors, lumberyards, and other retailers; the taxpayer also sold and installed the products for its own customers. The issue in the audit centered around the taxpayer having treated itself as a retailer. On audit, the Department of Taxation reclassified the taxpayer from a retailer to a fabricator of tangible personal property for its own use and assessed use tax on untaxed purchases of tangible personal property. The taxpayer challenged the assessment arguing it was properly classified as a retailer; alternatively, it contended it should receive a credit allowed under newly amended legislation for sales tax collected and remitted.

Virginia law states that real property contractors are deemed to have purchased tangible personal property for use or consumption, and the subsequent sale of tangible personal property is not a resale. Based on the taxpayer’s activities, the Commissioner determined that the taxpayer was fabricating property for both retail sale and its own use as a consuming contractor, thus classifying it as a dual operator.

In Virginia, dual operators are required to follow the primary purpose rule based on gross receipts to determine the application of sales and use tax. If a majority of gross receipts are from retail sales to customers, a taxpayer should purchase materials tax-exempt and collect sales tax from the customers; for projects involving real property contracts, the taxpayer should remit use tax on inventory used in the contracts. Alternatively, if a majority of the receipts are from fabricating products for its own use in real property contracts, a taxpayer should pay sales tax on all materials at the time of purchase. If the taxpayer cannot determine how the materials it purchases will be used, the taxpayer may apply for a direct pay permit.

Here, the audit revealed that most of the taxpayer's gross receipts were from its role as a real property contractor for its customers. Therefore, the taxpayer, by treating transactions as retail sales had erroneously charged, collected, and remitted sales tax from its customers. The taxpayer’s alternative claim for a credit was based on the assertion that it had already collected and remitted sales tax exceeding the use tax assessed. Effective July 1, 2024, Virginia allows a one-time credit for erroneously collected sales tax against a use tax assessment for contractors. The credit is limited to the amount of use tax assessed on a contractor’s purchases of tangible personal property and is allowed for first offenses only. Accordingly, the Commissioner returned the matter to audit for a determination of the taxpayer’s eligibility for the credit. For more information on Virginia Public Document Ruling No. 24-87, contact David B. Meyer.  

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State tax revenue growth continues to grow slowly, if at all, according to recent reports. The most comprehensive look in the State Tax and Economic Review by Lucy Dadayan at the Tax Policy Center indicates that for the 12 months ending March 31, 2024 (three-fourths of FY 2024 for most states), state revenues increased by only 2.2 percent in nominal terms and declined by 0.6 percent after adjustment for inflation. This rather tepid growth continued through the 2^nd quarter of 2024 with the median state growth in all taxes coming in a 1.0 percent in nominal terms. This trend of moderating to negative real growth first began to appear in late 2022 after two years of double-digit increases in state tax increases.

Further complicating state budget-making in some states, federal assistance to states and localities provided by the American Rescue Plan to offset the budgetary impacts of the pandemic is no longer available.  In total, state and local governments received about $350 billion under the plan, some portion of which (as much as one-third in the early years) was used to offset the impact of reduced revenues on current government services. Additionally, over one-half of the states enacted significant state reductions from 2021-2023, with most states focusing on personal and corporate income rate reductions, according to the Tax Foundation.

These pressures are surfacing in some states as they prepare the FY 2026 budget for consideration by state legislatures in January. Rhode Island, for example, is requiring state agencies to submit budget requests at two different levels and are looking at a $400 million structural budget deficit in FY 2026, a figure expected to increase in future years. Additionally, Iowa recently deferred a corporate tax rate reduction as FY 2024 corporate income tax revenues fell short of the required $700 million level needed to trigger a rate reduction for 2025 as specified in legislation passed earlier. On a broader basis, the Pew Trusts examined long-term budget estimates (extending to at least FY 2028) produced in a dozen states. It found that at least seven states were expecting structural deficits over the period. There were a variety of contributing factors, including slowing revenue growth, enacted tax cuts, and various budget pressures such as the aging population, transportation needs, and Medicaid costs. On the bright side, state rainy day funds and other available budget balances remain near all-time highs and can provide some near term relief if a state so chooses. Stay tuned to TWIST for further updates on state fiscal conditions.

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