This Week in State Tax

Multiple companies have filed challenges to the digital advertising tax in the Maryland Tax Court, claiming it violates the U.S. Constitution and the Internet Tax Freedom Act (ITFA). Recall, the digital advertising tax is a graduated gross receipts tax imposed on digital advertising services in Maryland, and ITFA prohibits states from imposing discriminatory taxes on electronic commerce, meaning generally taxes that are not also imposed on transactions involving similar property or services accomplished through other means.

The Tax Court held hearings last year in cases involving four high-profile taxpayers that had submitted motions for summary judgment based on the various claims.  At the hearings, the Maryland Comptroller argued that the state should be allowed to conduct extensive discovery to determine whether the taxpayers’ digital advertising methods are, in fact, similar to traditional advertising for purposes of ITFA. Recently, the Tax Court entered a scheduling order allowing six months of discovery in the four cases, up through June 20, 2025.  Evidentiary hearings are now scheduled for July 21 through August 1, 2025. For questions, please contact Jeremy Jester.

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The New Jersey Tax Court recently held that, for the purposes of the Gross Income Tax (GIT, the New Jersey tax on personal income), “gross income” does not include deemed repatriation amounts included in federal income under the one-time tax imposed by Internal Revenue Code section 965 (“IRC 965 income”), as part of the Tax Cuts and Jobs Act (TCJA). Recall, unlike many states, the New Jersey GIT does not conform to the federal definition of gross income; instead, “gross income” is the sum of specific categories of income, including “dividends”.  Dividends are defined in New Jersey law as “any distribution in cash or property made by a corporation … (1) out of accumulated earnings and profits, or (2) out of earnings and profits of the year in which such dividend is paid.” In a notice issued shortly after the passage of the TCJA, the Division of Taxation (Division) stated that IRC 965 income was a “deemed repatriation dividend” and should be included in gross income for GIT purposes. The taxpayers did not include any portion of the IRC 965 income reported on their federal return on their New Jersey GIT return. On audit, the Division issued a notice of deficiency assessing GIT, penalties, and interest. The taxpayers appealed to the Tax Court arguing that IRC 965 income was not a dividend under New Jersey law because the statutory definition requires an actual distribution or payment to be made. It also argued that, even if IRC 965 income could be categorized as a dividend, the Division did not follow proper administrative procedure in promulgating its notice.

The Tax Court ruled in favor of the taxpayers, finding that IRC 965 income was not included within the statutory definition of “dividend”. In the court’s view, the statutory reference to “distribution” means that an actual payment or transfer of money or property is a required element of a “dividend”, and that no such transfer occurred here. Although the Division argued this interpretation unduly emphasized the meaning of a single word in a way that caused disharmony with the principles of the GIT, the Tax Court held that the statute was clear and unambiguous on this point, meaning application of the principle of avoiding undue emphasis was unwarranted. The court further noted that the legislature explicitly included “deemed” payments as part of gross income in other sections of the GIT statute, and it could have done the same to include undistributed corporate earnings and profits within the definition of dividends. Finally, although the legislature had amended the Corporate Business Tax Act to address IRC 965 income, it had not made similar amendments to the GIT Act. Having found that IRC 965 income was not included within the statutory definition of dividends, the court did not consider the taxpayers’ procedural argument. Contact James Venere with questions about Amin v. Director, Division of Taxation.

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The New York Tax Tribunal recently ruled that deferred fees earned by a hedge fund should be apportioned to New York using the Business Allocation Percentage (BAP) of the year in which the fees were earned, rather than the year in which they were included in income. The taxpayers were partners in an investment management partnership. The partnership voluntarily deferred a portion of the management and performance fees that it earned for services provided from 1998-2003, a period in which the partnership operated exclusively from a New York office. For federal purposes, most of the deferred fees and related appreciation (from reinvestment of the deferred fees) were recognized in the income of the partnership in Tax Year 2017. (The partnership had recognized portions of the deferred fees and appreciation in prior tax years.)

In April 2018, the Department of Taxation and Finance (Department) issued a Technical Memorandum (TSB-M-18(2)C, (3)I) providing guidance on the state treatment of nonqualified deferred compensation and its inclusion in New York income. In the Technical Memorandum, the Department stated that nonqualified deferred compensation (and any earnings thereon) for services performed prior to January 1, 2009, must be included in New York-source income when the business was conducted only in New York. In filing its 2017 New York returns, the partnership included the full value of deferred fees and appreciation as New York-source income when computing its 2017 BAP (i.e., included the full value in the numerator and denominator of the sales factor). The deferred fees and appreciation flowed through to the taxpayers based on their proportionate share of the partnership income. On audit, the Division rejected use of 2017 BAP (a three-factor formula which was less than 100 percent, due to having added a Connecticut office location) to apportion the fees and allocated the entire amount to New York based on the partnership’s BAP in tax years 1998 through 2003 – the years the services were performed. The taxpayers challenged their proportionate share of the audit adjustment. An ALJ ultimately found in favor of the Department, and the taxpayers appealed.

At issue was whether the deferred fees and appreciation should be allocated as New York source income based on the 2017 BAP, or whether the income should be allocated to New York using the BAP for the years when the services were performed. The Tax Tribunal ruled that the statute clearly requires that the deferred fees and appreciation received by a nonresident related to a business previously carried on within or partially within New York be treated as ordinary income and would require you to look to the BAP in the year the income was earned (i.e., 1998 through 2003) in allocating to New York. Because the taxpayers’ business was carried on entirely within New York during the years in which the fees were earned, the Tax Tribunal determined that the fees must be entirely allocated to New York once included in income. The Tax Tribunal rejected the taxpayers’ position that “taxable year” must mean the year in which the fees were reported. Having found that the law was clear on this matter, and that the Technical Memorandum did not articulate new rules of interpretation, the Tax Tribunal found the memorandum constituted proper technical guidance. Finally, the Tax Tribunal upheld the assessment of penalties even though they acted under written tax advice from advisers; in the Tribunal’s opinion, the taxpayers’ position was contrary to New York law, making penalties appropriate. The taxpayer has four months from the date of the Tribunal decision (December 12, 2024) to appeal the case to the New York intermediate appellate court. If no appeal is taken, or is taken but unsuccessful, the Tribunal would become binding precedent. Contact Russell Levitt with questions about Matter of Techar and Matter of Frascella.

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Last year, New York State enacted a law governing the regulation and taxation of short-term residential rentals in the state. As defined, short-term residential rental generally means the offering for rent of all or part of a dwelling for occupancy for less than 30 consecutive days by the owner or person in lawful possession of the dwelling (termed the short-term rental host).

On the tax side, the new law broadens the definition of “hotel” for purposes of the hotel occupancy tax to include short-term residential rentals, effective April 1, 2025. The law also adds the term “booking service,” defined generally as an entity that operates an online system that can be used directly or indirectly to list or advertise offers for short-term rentals, accept offers or reserve or pay for such rentals, and charges a fee to facilitate the transaction, excluding an entity that solely lists or advertises offers for short-term residential rentals. Under the law, booking services are required to collect and remit the hotel occupancy tax on short-term rental transactions they facilitate. In addition, the new provisions amend current law to allow booking services to collect the occupancy tax on hotel rooms in lieu of the hotel operator if they present the operator with valid documentation. Finally, the law makes clear that booking services and short-term rental hosts are liable for other provisions of the state sales and use tax. The new regime does not address the administration of local government occupancy taxes.

On the regulatory side, the new law establishes standards for what may and may not be used as a short-term residential rental as well as the standards that must be maintained in operating such rentals. In addition, short-term rental hosts are required to register and receive a business license to operate. Hosts are required to maintain records with comprehensive information on each rental and to provide such information annually to the Secretary of State. It also imposes certain reporting obligations on booking services facilitation short-term residential rentals. The new regulatory system does not apply in municipalities with a comparable existing regulatory system for short-term residential rentals. For questions regarding Senate Bill 885 (2024 Legislature),  please contact Judy Cheng.  

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The Texas Comptroller of Public Accounts recently issued a private letter ruling clarifying that a taxpayer’s purchase of cloud computing services to host and operate its online transportation logistics system did not qualify for a resale exemption. The taxpayer provided a web-based software system with several modules offering transportation logistics solutions to its customers. Each customer had a database of its activities and data on the system that populated the various modules to meet their logistics needs, such as individual shipping, shipment tracking, freight payment, fleet accounting, and supply chain management. The taxpayer charged its customers a single monthly fee. To provide its service, the taxpayer purchased certain cloud services (e.g., access to virtual servers, data base software, data storage, and security) from a cloud service provider that invoiced the taxpayer monthly for each service. The taxpayer paid sales and use tax on the services as data processing services. The taxpayer claimed the itemized charges from its cloud provider were based on the use of the services by its customers, and the taxpayer requested guidance from the Comptroller on whether its purchase of cloud computing services qualified for the resale exemption.

In Texas, data processing services are included in the list of taxable services. Taxable items purchased for resale are exempt from sales and use tax if purchased for the purpose of reselling to a customer and not to perform a contract. The Comptroller determined that the taxpayer’s purchase of cloud services did not qualify for a resale exemption because the taxpayer purchased the cloud services for its own use to provide its logistics services. The Comptroller emphasized that merely purchasing a taxable item to perform a contract with a customer does qualify as being purchased for purposes of reselling. Further, the taxpayer failed to provide sufficient information from the cloud service provider to establish that its customers’ use was the basis of the charges for the cloud services. Consequently, the taxpayer’s purchase for the cloud service did not qualify for the resale exemption. For more information on Private Letter Ruling No. 20210226061035, contact Carolyn Owens.            

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