This Week in State Tax

The D.C Court of Appeals recently upheld a Superior Court decision regarding a real estate transaction involving a sale and leaseback arrangement. The appellate court addressed two questions: (1) Is the retention of a leasehold interest on the sale of real property different from the creation of a leasehold interest such that transfer and recordation taxes are not due on the leasehold retention; and (2) Does the statute of limitations bar recovery of taxes due on the leasehold transfer when the recorded deed referenced is absent any details. Affirming the lower court ruling, the appellate court determined that a “retention” of a leasehold interest does not differ from the creation of a leasehold, as the leaseback can only occur after the sale of the real estate, which is a separate transfer. The appellate court further held that recovery of transfer taxes was not barred as the statute of limitations was not triggered by a single tax filing related to the deed transfer; instead, there were two transfers, a sale and a leaseback, subject to separate filings and taxes. The deed filing contained no lease term information and was insufficient to trigger the statute of limitations for taxation of the lease.

This case involved the sale of five condominium units by Party A to Party B for $39 million under a "Bargain and Sale Deed.” This deed transferred the property title to Party B, while purporting to reserve a leasehold interest of undefined length for Party A. On the same day, a separate "Ground Master Lease" was executed, in which Party B leased the property back to Party A for a term of 30 years with options to extend up to 117 years. The Ground Master Lease was not separately recorded. However, Party A executed a Leasehold Deed of Trust with Party C; this Leasehold Deed was recorded as a financial transaction for which no taxes were due.

In February 2019, Party C’s successor-in-interest foreclosed on the Leasehold Deed of Trust. The title insurance company, acting on behalf of the new leasehold owner, encountered complications when the Recorder of Deeds refused to accept the Leasehold Deed of Foreclosure for recordation, due to fact that no recordation and transfer taxes had been paid on the creation of the Ground Master Lease, which had a term of over thirty years. The overdue taxes were paid under protest to record the Leasehold Deed of Foreclosure, and an administrative refund action was filed based on the claim that the Master Ground Lease was the retention of a leasehold interest, not the creation of a leasehold interest subject to tax. The action further claimed that the three-year statute of limitations had run since the initial event took place in 2013.

The Court of Appeals decision centered on two issues. First, it confirmed that two separate transactions occurred during the sale and leaseback arrangement, each requiring separate tax filings. The first transaction was the sale of the property to Party B, and the second was the leaseback of the property to Party A. Second, the court found that the statute of limitations for tax collection had not begun because no tax return for the leaseback was filed until 2019. Therefore, the situation was not time-barred, and taxes were still owed on the leaseback transaction. For any questions regarding real estate transfer taxes or Commonwealth Land Title Ins. Co. v. District of Columbia, please contact Michelle Dohra.

Governor Gretchen Whitmer recently signed the FY 2026 state budget which included legislation to specifically decouple from various provisions of the federal One Big Beautiful Bill Act (OB3). Recall, Michigan is generally a fixed conformity state, with the Internal Code defined to mean the IRC in effect on January 1, 2018 (updated to January 1, 2025, in the enacted bill). Most taxpayers, however, avail themselves of an election to use the IRC in effect for the current tax year (i.e., rolling conformity).

The new law provides that for tax years beginning after December 31, 2024, Michigan taxable income of a corporation is to be computed as if IRC section 168(k) (bonus depreciation for certain business assets), IRC section 168(n) (bonus depreciation for qualified production property), and IRC section 174A (research and experimental expense deductions) were not in effect. Additionally, the bill provides that IRC sections 163(j) (business interest deduction limitation), 174 (research and experimental expense treatment), and 179 (expensing of certain assets) must be applied as those provisions existed on December 31, 2024. Further, the bill also decouples from the transitional rules related to the treatment of research and experimental expenses included in OB3.

As it relates to individual income taxpayers, new law will allow individual taxpayers to deduct qualified tips and qualified overtime compensation for tax years beginning after December 31, 2025. These provisions are effective for tax year 2025 at the federal level. Contact Dan De Jong and Arthur Orzame with questions about H.B. 4961.

The New York Tax Appeals Tribunal upheld an administrative law judge holding that subscription fees charged by two related taxpayers for facilities management services constituted bundled transactions which included prewritten software and were thus taxable. The taxpayers provided integrated facilities management to large retail clients, offering a suite of services that included 24/7 call center support, work order management, vendor coordination, electronic invoicing, and data analytics, all facilitated through their proprietary software platform. Clients entered into management agreements and paid subscription fees for access to the platform and taxpayers’ services for a single, non-itemized.

On audit, the Department of Taxation and Finance concluded that the taxpayers’ facilities management service package included access to the software platform. The Department determined that the subscription fees for the facilities management service package constituted taxable sales of prewritten software bundled with services and therefore assessed sales and use tax on those fees. The taxpayers contested the assessments through the administrative appeal process, ultimately bringing the matter before the Tax Appeals Tribunal.

On appeal, the taxpayers argued that the primary function of their offering was integrated facilities management, rather than the sale or licensing of software. The taxpayers asserted that the software platform was simply a communication tool used to facilitate their services, and not a separately sold product. The Tribunal disagreed and found that the taxpayers’ management agreements explicitly licensed the software platform to customers and that the software was integral to the service package. The entire subscription fee was taxable because it included prewritten software with no further itemization. Further, the primary function test did not apply because the transaction involved a bundle of tangible personal property and services, and not a bundle of all services for which the primary function test could be used to determine taxability.

The taxpayers also contended that the software platform should not be considered taxable prewritten software because customers could perform only limited actions in the software to request services, and the software was not sold or licensed independently. The Tribunal rejected this position, concluding that the subscription fees granted customers a license to use prewritten software, which was central to the service bundle and not incidental.

The Department had also contended that services were taxable information services. The taxpayer argued that the reports and data generated through the platform were tailored to each customer’s unique needs and were excluded from tax as being “personal or individual in nature” and not substantially incorporated into reports to others. The Tribunal found this argument unpersuasive, noting that the reports incorporated aggregated anonymous data for benchmarking, comparing each customer’s metrics to those of other customers. As the information was substantially incorporated into reports furnished to other persons, the Tribunal concluded that a statutory exclusion did not apply. Please contact Judy Cheng for more information on In Matter of FacilitySource LLC. 

The Rhode Island Division of Taxation this week released guidance on the state treatment of various individual and corporate tax changes taking effect for tax year 2025 under the recent federal One Big Beautiful Bill Act (OB3). Recall, the FY 2026 Rhode Island budget provided that for tax years beginning on or before January 1, 2025, Rhode Island will require taxpayers to add to their taxable income for corporate taxpayers and adjusted gross income for individual taxpayers “any amount of income, deduction or allowance” that would be subject to federal income tax but for the enactment of OB3.

For corporation income tax purposes, the notice indicates that Rhode Island will not follow the OB3 changes to the deductions related to business interest expenses (IRC Sec. 163(j)), research and development expensing (IRC Sec. 174), the increased cap for depreciation of certain business assets (IRC Sec. 179), the deduction for qualified sound recording equipment (IRC Sec. 181), and qualified opportunity zone designations. Rhode Island will require taxpayers to make addition modifications to their state taxable income if such deductions were taken federally on their 2025 return. The Division has created RI Schedule HR1-Entity to calculate the taxpayer’s addition modifications. The schedule must accompany the Rhode Island return regardless of whether it is electronically or paper filed.

From an individual tax perspective, Rhode Island conforms to federal adjusted gross income, meaning that certain provisions in OB3, such as no tax on certain tip income, overtime pay, and car loan interest will not be incorporated into state income tax calculations. The guidance, however, notes that to the extent an individual return reflects amounts for items outlined above that are part of the calculation of adjusted gross income, those amounts will be required to be added back for Rhode Island purposes. Schedule HR1-Individual will be used for these addback modifications.

The Division had earlier issued an advisory providing information on decoupling from those portions of IRC Section 174A changes in OB3 that in some cases can be applied retroactively to tax year 2022. [For details on Advisory Notice 2025-18, see our TWIST of September 22, 2025.] Contact Jamie Posterro with questions about Advisory Notice 2025-20, and other Rhode Island income tax matters.