This Week in State Tax

The Arkansas Supreme Court recently held in favor of the taxpayer that interest expenses incurred by the acquired company as part of a leveraged buyout were allocable to Arkansas. Murphy, an Arkansas-domiciled retail fuel seller, was spun-off from its original parent company, Murphy Oil Corporation, to Murphy USA, Inc. To fund this spin-off, Murphy issued $650 million in notes and credit agreements to be paid to Murphy USA. The taxpayer initially apportioned and deducted the interest payments associated with that debt from its corporate income in all states in which it was conducting business. Murphy later amended its Arkansas returns to treat the interest payments as nonbusiness expenses and fully allocated the interest expense to Arkansas, thereby reducing its Arkansas taxable income. After the Department of Finance and Administration (DFA) denied the requested refund, a circuit court granted summary judgement for the taxpayer.

On appeal, the state supreme court first ruled that under the Uniform Definition of Income for Tax Purposes Act (UDITPA) definitions of business and nonbusiness (which Arkansas had adopted), the interest was a deductible nonbusiness expense, as it did not arise from transactions and activity in the regular course of the taxpayer’s trade or business. The court focused on the isolated nature of the transaction, distinguishing between the taxpayer’s previous borrowing—which was used to fund expansions of its business—from the singular instance of taking on debt to finance a leveraged buyout. Because the latter activity occurred only once, it could not be considered part of the taxpayer’s regular trade or business.

An alternative argument raised by the DFA was that Arkansas law disallowed deductions for expenses allocable to nonbusiness income. Arkansas law provides that “no deduction shall be allowed for … [e]xpenses otherwise allocable as deduction which are allocable to nonbusiness income.” After determining that the text of the statute was ambiguous, the court interpreted the statute as applying only to nonbusiness income allocable to other states. Applying principles of statutory interpretation, the court held that the stated purpose of the above statute was to limit the deduction related to “tax exempt income,” and thus the statute did not apply to Murphy’s interest expense deduction.

Finally, the DFA argued that permitting the taxpayer to allocate the entire expense deduction to Arkansas when it had previously used it to reduce apportionable income in other states violated principles of fundamental fairness. The court rejected this argument, stating that its role was to interpret and apply Arkansas law, not to “adjust Arkansas tax returns based on unfairness to Tennessee, Mississippi, or other states.” Please contact Asad Markatia with questions about Hudson v. Murphy Oil USA, Inc.

Earlier this year, the Illinois legislature enacted several significant changes in the state sales and use tax that become effective on January 1. In addition, just before things began to wind down for the holidays, the City of Chicago pieced together a 2026 budget that contained several increases in City taxes that also become effective on New Year’s Day.

At the Illinois state level, the noteworthy changes include:

• HB 4951 changes the taxation, exemptions, and sourcing of tangible personal property leases from a regime requiring the payment of tax by the lessor “upfront” on the item to be purchased to collecting tax the tax on the stream of lease payments from the lessee. The changes do not apply to leases of motor vehicles, watercraft, aircraft, and semitrailers that are required to be registered. The new law also does not apply to leases subject to the Chicago Personal Property Lease Transaction Tax.
• SB 3362 requires retailers having some physical presence in Illinois making a sale to an Illinois customer from a location outside Illinois, must beginning January 1 collect the state and local Retailers’ Occupation Tax (ROT) based on destination of the goods in Illinois, i.e., Illinois customer location. Prior to the change, such sales were subject to only Illinois use tax of 6.25 percent. 
• SB 3362 mandates that each Illinois direct pay permit holder must, by March 31, 2025, and annually thereafter by March 31, review its purchase activity for the prior calendar year to verify that purchases made during that period were correctly sourced and taxed at the appropriate rate. If the discrepancy in tax collected compared to tax owed is greater than five percent, the permit holder is subject to a $6,000 penalty.

Switching to the City of Chicago, home of the Bears, the City Council, on December 16, passed the 2026 City Budget just two weeks before the budget year begins on January 1. While the adopted budget did not contain a property tax increase, which Mayor Johnson recommended, it did include an increase in several other taxes that the City imposes and administers under its home rule authority, including:

• The Personal Property Lease Transaction Tax (PPLTT) rate is increased from 9 percent to 11 percent, effective January 1, 2025. The PPLTT is imposed on the lease or rental in the city of personal property, or the privilege of using in the city personal property that is leased or rented outside the city. In addition to items such as vehicles or copiers, it also includes “nonpossessory computer leases,” which is interpreted to include software as a service and certain other cloud services and software transactions.
• The Amusement Tax as applied to paid television and electronically delivered amusements, such as video streaming, audio streaming, and on-line games, increases from 9 percent to 10.25 percent, according to a release from the Chicago Department of Revenue. The increase is also effective with the New Year.

There were also increases in the rates for the Chicago Parking Tax and Bag Tax. For more information on Senate Bill 3362, House Bill 4951, and Chicago Tax Rate Changes, contact Drew Olson. 

The Washington State Supreme Court determined that Envolve Pharmacy Solutions (Envolve), an affiliate of Coordinated Care (CC)—both subsidiaries of Centene Corporation—is entitled to an exemption from Washington Business & Occupation (“B&O”) tax on receipts earned from providing services to CC. The B&O tax exempts the receipts of “any person in respect to insurance business upon which a tax based on gross premiums is paid to the state,” known locally as the insurance business exemption.  CC contracts with the Washington State Health Care Authority to administer health insurance benefits to Washington residents; CC further subcontracts with Envolve to provide pharmacy benefit management and services. CC pays the annual state premiums tax on premiums received from customers. The question that eventually found its way to the state high court was whether Envolve, as an affiliate of an entity that paid gross premiums tax, qualified for the insurance business exemption on the amounts received from CC for the services it performed.

The Washington Department of Revenue (Department) has historically interpreted the insurance exemption to apply to a corporate affiliate that contracts with another corporate affiliate provided that the primary corporate affiliate pays the premiums tax.  In 2013, Envolve received a letter ruling from the Department stating that an affiliate of CC, it did not have to pay B&O tax on any activity that was “functionally related” to CC’s insurance business, providing CC paid the premiums tax. Subsequently, Envolve filed a refund claim for B&O tax previously paid on activities that Envolve considered functionally related to CC’s insurance business. The Department denied the refund claim, opened an audit of Envolve, and assessed $3 million in unpaid B&O taxes plus interest and penalties, for years dating back to 2010.  Envolve filed an appeal, and the matter eventually made its way to the state supreme court. The Department’s position on appeal was that the insurance business exemption was available only to taxpayers who themselves had paid the premiums tax. It further argued that some of Envolve’s services were health care services, not services functionally related to insurance business.

Affirming the Court of Appeals, the supreme court rejected the Department’s arguments. First, the court found that the plain language of the exemption statute did not require the taxpayer seeking the exemption to be the entity that paid the premiums tax.  The legislature had used the passive voice to state that the exemption was available when the premiums tax had been paid on insurance business – without describing by whom the tax was paid. 

Second, the court determined that the services provided by Envolve (including establishing and maintaining provider networks, benefit management, claims processing, and subscriber and provider reimbursement, among others) were not actual health care services but were all administrative and central to the insurance function, noting that none of Envolve’s activities met the statutory definitions of “health care and related terms.  In fact, “everything Envolve does is functionally related” to CC’s insurance business.” Therefore, the court held that Envolve was exempt from the B&O tax on receipts from all its activities. Four justices dissented on the basis that the interpretation of the majority both on qualifying entities and the services covered was too broad in scope and subverted the intent of the B&O tax. For questions regarding Envolve Pharmacy Solutions v. Dept. of Revenue, please contact Patrick Lee or Michele Baisler.