This Week in State Tax

A special session of the Colorado legislature has passed, and Governor Polis has signed, several measures to address an estimated $800 million budget deficit for FY 2026 attributable in significant part to the One Big Beautiful Bill (OB3) signed by President Trump on July 4, 2025. The measures enacted include:

• House Bill 1001 makes permanent the existing addback for the federal qualified business income (QBI) deduction provided for owners of certain passthrough entities. Under current Colorado law, the addback was set to expire for income tax years before January 1, 2026.
• House Bill 1002 requires an addback to federal taxable income for foreign-derived deduction eligible income (FDDEI) under IRC Section 250. In addition, it expands the list of foreign jurisdictions for which there is a rebuttable presumption that an entity incorporated in such a “listed jurisdiction” is for tax avoidance purposes. Specifically, these countries to the roster of “listed jurisdiction:” Hong Kong, Ireland, Liechtenstein, Netherlands, and Singapore. Finally, the bill amends the subtraction modification for Section 78 dividends by doing away with the exclusion for Section 78 dividends from a corporation incorporated in a listed jurisdiction. The bill applies to tax years beginning on or after January 1, 2026.
• House Bill 1004 authorizes the Department of Treasury (Department) to sell insurance premium tax credits and corporate income tax credits to qualified taxpayers. Specifically, the Department may issue tax credit certificates up to the lesser of a total face value of up to $125 million or total sales proceeds of up to $100 million for both premium taxes and corporate income taxes. The credit certificates may then be used by qualified taxpayers to offset their premium income tax liabilities in subsequent years. A bidding process will be used to accept offers for the purchase of tax credit certificates. If payment is not made within the specified time, a penalty of 10 percent of the remaining purchase price unpaid will be due within 30 days unless the certificate is transferred to a new or existing qualified taxpayer. For certificates issued in Fiscal Year 2025-2026, the Department may determine the tax years in which the certificates may be applied against a tax liability. Credits in excess of liabilities are nonrefundable and may be carryforward and applied through tax years 2033. The effect of the measure is to accelerate receipts to FY 2026 at a discounted rate.
• HB 1005 repeals the vendor allowance previously accorded to certain retail sales taxpayers. Vendors with less than $1 million in retail sales per period were previously allowed to retain an allowance of up to $1,000. The measure is effective for sales made on or after January 1, 2026.

For information or questions on the Colorado legislation, please contact Amanda Bennett.

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The Indiana Department of State Revenue (Department) recently issued Revenue Ruling #2025-02-RST, concluding that a company’s artificial intelligence (AI) chatbot services accessed via a web interface or application programming interface (API) are not subject to Indiana sales or use tax. The Department determined the offering would be considered a type of service, rather than prewritten software or a specified digital product.

The company’s primary service is an AI chatbot that is hosted on third-party cloud infrastructure, and customers cannot download the chatbot onto their computers. The chatbot can perform various functions and communicate with the user in a human-like manner. In addition, customers can utilize the chatbot’s API to integrate its capabilities into their own applications. The company does not deliver any software to its customers.

Indiana imposes tax on retail transactions that involve the sale of tangible personal property and certain enumerated services. Software-as-a-Service is not a taxable service in Indiana, nor are charges for accessing prewritten computer software over the internet. Certain specified digital products are taxable only when electronically transferred for permanent use and limited to defined categories such as digital audio works, digital audiovisual works, or digital books. The Department ruled that because the AI chatbot is accessed over the internet and does not grant the user permanent ownership, the service is not considered taxable in Indiana. For additional information on this ruling and further questions regarding taxability in Indiana, please contact Dave Perry or Reid Okimoto.

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The Minnesota Supreme Court recently addressed whether the Commissioner of Revenue (Commissioner) correctly applied an alternative apportionment method for a taxpayer’s receipts from forward exchange contracts (FECs), which were a hedging technique used by the taxpayer to protect outstanding balances from foreign currency exchange risks.

The taxpayer was a multinational company conducting business in various foreign countries, as well as in Minnesota. While most of the taxpayer’s sales were generated outside the U.S., all operations of the taxpayer were unitary. Due to its foreign operations, the taxpayer regularly had balances on its books that were denominated in foreign currencies that ultimately needed to be converted into U.S. dollars. These outstanding balances were subject to foreign currency fluctuation risks based on the volatility of the foreign currency exchange market. To mitigate that risk, the taxpayer engaged in FEC transactions, which were legally binding contracts whereby one party agreed to sell a currency in exchange for a different currency at an agreed future date at a fixed, negotiated exchange rate. On the date the FEC expired, the taxpayer paid the other party a set amount of currency in exchange for a set amount of dollars according to the contracted exchange rate. To satisfy the FEC, the taxpayer bought the foreign currency it owed from a third party at the daily market rate, which can result in either a loss or a gain for any particular transaction.

In filing its returns, the taxpayer included the gross receipts from all FEC transactions in the sales factor for apportionment purposes. The taxpayer was audited and assessed tax as the result of an adjustment in which the Commissioner used an alternative apportionment formula that included only the net receipts, rather than the gross receipts, from the FEC transactions in the sales factor. The taxpayer appealed to the Minnesota Tax Court, which affirmed the use of the alternative apportionment method. The taxpayer then appealed to the Minnesota Supreme Court.

Minnesota applies a singles sales factor apportionment method; the sales factor includes “all sales, gross earnings, or receipts received in the ordinary course of the business” with certain enumerated exceptions. Minnesota law permits the Commissioner to deviate (or for the taxpayer to request to deviate) from the general apportionment method if it does not “fairly reflect all or any part of taxable net income allocable to this state.” The court noted that even though the FEC transaction receipts were earned in the ordinary course of the taxpayer’s business, the FEC transactions and the taxpayer’s other business activities were qualitatively different from each other. In the court’s view, the FEC transactions supported the taxpayer’s access to foreign markets in which it conducted its primary science, technology and related businesses. The taxpayer was not a hedge fund or financial institution, and receipts from FECs were qualitatively different from those arising from its principal businesses. Additionally, the court held that the Commissioner met his burden of proof in applying alternative apportionment. Here, the court focused on the fact that if the taxpayer included all gross receipts in the denominator of the sales factor, as the taxpayer had filed, it would result in an “…extraordinary volume of gross receipts from FEC transactions in the Everywhere Sales denominator…” which would produce a “quantitative distortion.” The FEC transactions often amounted to more than 70 percent of the taxpayer’s gross receipts but less than five percent of its profits. Finding that the inclusion of the gross receipts from FEC transactions diluted the taxpayer’s Minnesota tax liability and did not show the full extent to which the taxpayer operated within the state, the Supreme Court affirmed the Tax Court decision in favor of the Commissioner. Contact Dale Busacker with questions about E. I. duPont de Nemours & Co. v. Commissioner of Revenue.

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The North Carolina Supreme Court has ruled that the state Office of Administrative Hearings (OAH) lacks subject-matter jurisdiction over constitutional “as-applied” challenges. The underlying dispute in this case was the constitutionality of a law that allowed a deduction from the corporate franchise tax base only for receivables owed to the taxpayer by related corporations doing business in North Carolina. The effect of the law was to require an addback of receivables to the franchise tax base when the debtor affiliate was not doing business in North Carolina and was not subject to franchise tax. The taxpayer alleged that denying a deduction for receivables from affiliates not doing business in North Carolina discriminated against interstate commerce in violation of the dormant Commerce Clause. The OAH held in favor of the taxpayer. The Department of Revenue then appealed to the North Carolina Business Court which held that the OAH did not have jurisdiction to determine U.S. Constitutional matters. The substantive arguments were not addressed. The taxpayer appealed Business Court decision on jurisdiction to the North Carolina Supreme Court.

The primary question before the court was the interpretation of N.C.G.S. § 105-241.17(2)-(3), which states that a civil claim can be filed only after the taxpayer commences a case before the OAH and the OAH dismisses the case “for lack of jurisdiction because the sole issue is the constitutionality of the statute and not the application of a statute.” Further, N.C.G.S. § 1-267.1, provides that “[a]ny action that is a facial challenge to the validity of an act of the General Assembly shall be” heard by a three-judge panel of the Superior Court of Wake County. In its initial decision, the OAH had interpreted these provisions as prohibiting the OAH from hearing facial constitutional challenges (i.e., alleging a statute can never be applied constitutionally) but not as-applied challenges (i.e., asserting a statute cannot be constitutionally applied to the party disputing its validity). The Supreme Court rejected this reasoning, holding that “both facial and as-applied challenges are mechanisms for disputing the constitutionality of legislation.” The court also noted that the use of the term “facial challenge” in N.C.G.S. § 1-267.1, “suggests that lawmakers did not intend to restrict N.C.G.S. § 105-241.17 to facial challenges.” The court further held that allowing the OAH to consider as-applied constitutional challenges would ignore “foundational principles of administrative law” and would raise serious separation-of-powers concerns under the North Carolina constitution.

Taxpayers should note that, although the OAH is prohibited from hearing constitutional challenges to tax statutes, a taxpayer is still required to file the challenge with the OAH. Under the scheme laid out in N.C.G.S. § 105-241.17, a constitutional challenge is ripe for adjudication only after the matter has been both filed with and dismissed by the OAH. Please contact Nikki Emanuel Jarrell with questions about N.C. Dep’t of Revenue v. Philip Morris USA, Inc.

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