This Week in State Tax

The California Franchise Tax Board has submitted proposed amendments to the sourcing rules for sales of services and intangibles for final approval, culminating a project begun in 2017. On July 25, 2025, the FTB submitted a final version of the proposed rule to the California Office of Administrative Law, which has 30 working days to approve or deny the proposed amendments.

If approved, the amendments would be applied to tax years beginning on or after January 1, 2026. The goal of the proposed amendments is to provide clarity and simplicity for the market-based sourcing of various types of receipts, including adding specific provisions for providers of asset management and professional services. In the most recent version, the FTB adopted consistent language throughout the amendments and reordered various subsections and paragraphs. Previous iterations of the proposed amended included presumptions to indicate that the benefit of service is in the state if the services involve real property located in the state, tangible personal property located in the state, intangible property used in the state, or individuals physically present in the state. The most recent amendment clarifies the service provider must maintain books and records in the normal course of business to substantiate the sourcing. Should the benefit of the service not be capable of substantiation by the company’s books and records, then methods for reasonable approximation have also been provided.

Other notable proposed amendments include: (1) allowing professional service providers that sell a given service to over 250 customers to use customer billing addresses to source the receipts, with an exception for large volume customers; and (2) allowing the assignment of receipts from sales of asset management services to California proportionate to the average value of interest in the assets belonging to investors and owners domiciled in California. Contact Candace Axline or Geoffrey Way with questions about the Proposed Amendments to Cal. Code Regs. tit. 18 § 25136-2.

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Recently, the Delaware State Escheator, administrator of the state unclaimed property law, issued guidance on reporting “illicit property”.  The new policy applies in situations in which a business (holder) reasonably believes that an owner has provided a false name, identity, or address, and  the holder has a reasonable belief (more than just a suspicion) that fraud or illegal activity concerning the property has occurred. The guidance may affect the compliance and reporting processes of businesses in possession of such property. 

The guidelines indicate that if a holder has identified property as “illicit,” its first step should be to contact the appropriate law enforcement agency and attempt to turn the property over to them, or if appropriate, attempt to return the property to the source. If neither of those courses is successful, and the holder has determined that the property is escheatable to Delaware under state and law and U.S. Supreme Court priority, the policy requires that, once the applicable dormancy period has run (usually 5 years without owner-generated activity in Delaware), the holder should file an “Illicit Property” unclaimed property report. The following procedures are to be used for the “Illicit Property” report:

• The “Illicit Property” report must contain only information about items that are considered illicit and should not be commingled with other reportable items.
• The holder must send an email to escheat.holderquestions@delaware.gov with “Report of Illicit Property” in the subject line.  The email must include specific information about the holder and disclose the basis on which the holder reasonably believes a false identity, or fraudulent or illegal activity has occurred.
• The Escheator may decline to accept such property; if this occurs, the Escheator must notify the holder in writing within 90 days, reject the report, and return any Illicit Property. The guidance states that the Delaware unclaimed property office will not post to the unclaimed property search website or perform public outreach on Illicit Property that has been reported.
• Holders are specifically directed in the policy not to alter or delete the owner name and address information (even if there are legitimacy concerns) for the property to be considered reportable to Delaware under the first or second priority rules. The guidance further states that holders should not take actions to induce reporting the funds to Delaware (such as transferring obligations between legal entities).
• Holders that fail to comply with the policy may be determined not to have reported in good faith and may be subject to liability for which Delaware will not indemnify the holder.

For more information on the Delaware Illicit Property Reporting Guidelines, please contact a member of the KPMG National Unclaimed Property team: Will King, Marion Acord, Ryan Hagerty, Keela Ross, Karen Anderson, or Quin Moore.

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The U.S. Court of Appeals for the Fourth Circuit recently ruled the pass-through provision of the Maryland Digital Advertising Gross Revenues Tax was unconstitutional on the basis that it violates the First Amendment of the U.S. Constitution.

Recall, the pass-through provision of the digital advertising tax states:

A person who derives gross revenues from digital advertising services in the State may not directly pass on the cost of the tax imposed under this section to a customer who purchases the digital advertising services by means of a separate fee, surcharge, or line-item. Md. Code Ann. Tax-Gen. § 7.5-102(c).

Several trade associations brought this case in the U.S. District Court of Maryland, arguing that the provision abridges their freedom to speak and explain the tax to their customers. The District Court initially dismissed the plaintiffs’ lawsuit on jurisdictional grounds under the Tax Injunction Act, but that decision was reversed by the Fourth Circuit. On remand, the District Court once again ruled against the plaintiffs, holding that although the pass-through provision regulates speech, it survives the intermediate scrutiny standard of review. Specifically, the District Court held that the provision directly advances a substantial government interest and imposes a burden on speech no more extensive than necessary. The original action by the trade associations challenged the tax on other grounds as well, but the First Amendment argument is the only one to have survived the jurisdictional challenge.

In this appeal, the Fourth Circuit again reversed the District Court. The court found that the pass-through provision failed both strict scrutiny and intermediate scrutiny as its only purpose was to restrict companies from communicating the cost of the tax to their customers, thereby insulating Maryland from potential political criticism. The court emphasized that the ability to criticize government actions, including taxation, is a fundamental aspect of free speech protected under the First Amendment, invoking the colonial protests of the Stamp Tax Act in 1765 as vivid evidence that “complaining about taxes is a grand American political tradition.”

Having found that the provision was unconstitutional, the court turned to the appropriate remedy. The plaintiffs had sought a universal injunction permanently enjoining the state from enforcing the provision, but the Fourth Circuit noted that the authority of federal courts to impose such injunctions has been circumscribed under a recent Supreme Court decision. Therefore, it remanded the case to the District Court to determine the appropriate remedy for the plaintiffs.

In separate state court litigation, additional challenges to the digital advertising tax, including under the Internet Tax Freedom Act, are currently being considered by the Maryland Tax Court. KPMG will continue to monitor the developments surrounding the tax. For additional information, please contact Jeremy Jester with questions regarding U.S. Chamber of Commerce v. Lierman.

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The New York Division of Tax Appeals (DTA) held that T-Mobile Northeast LLC’s (T-Mobile) recovery of Federal Universal Service Fund (FUSF) fees from customers, when tied to bundled mobile telecommunications services, was subject to sales and use tax.

T-Mobile offered service plans that included commercial mobile radio service (CMRS), instant text messaging (SMS/MMS), and internet access, sold for a single fixed periodic charge. The facts show that T-Mobile did provide the price for each of these individual services in its billing system and books. In addition to these bundled plans, T-Mobile also offered the ability to add-on interstate and international calling minutes for which it separately stated a FUSF fee on customer invoices to offset its mandatory contributions to the FUSF under federal law. Following an audit, the New York Division of Taxation (Division) assessed T-Mobile for sales and use tax due on the portion of T-Mobile’s charges attributable to the recovered FUSF Fees.

On appeal, T-Mobile argued that the FUSF fees were not “charges for mobile telecommunications services” under Tax Law § 1111(l)(1) and, therefore, not subject to sales tax. T-Mobile contended that the statutory definition of such charges was derived from the Mobile Telecommunications Sourcing Act (MTSA), which does not include FUSF obligations in its scope, thus excluding FUSF fees from the definition. The DTA rejected this argument, however, agreeing with the Division of Taxation that the separately stated FUSF fees on T-Mobile’s customer invoices are a component of the “whole service” provided by T-Mobile. The DTA determined that T-Mobile’s charges at issue were taxable under § 1105(b)(2).

In contrast, in the Matter of Time Warner Cable (Time Warner), the New York Tax Appeals Tribunal (Tribunal) found that the service provider’s FUSF fees were not taxable because they were tied to nontaxable interstate and international wireline VoIP services under § 1105(b)(1). Here, the DTA differentiated T-Mobile’s services from that of the provider in Matter of Time Warner Cable and instead relied upon the Tribunal’s analysis in Matter of Helio, LLC. In Helio, the Tribunal affirmed without discussion that FUSF fees included on an invoice with bundled mobile telecommunications service plans were taxable in their entirety under § 1105(b)(2) and may not be unbundled. As such, the DTA sustained the assessment, concluding that T-Mobile’s FUSF fees were taxable even though they were separately stated. Please contact Audra Mitchell with questions regarding in Matter of T-Mobile Northeast LLC. 

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