This Week in State Tax

District of Columbia: Congress reverses OB3 decoupling legislation

The U.S. Congress recently approved a joint resolution that would repeal legislation in the District of Columbia which severed the District from a number of provisions included in the One Big Beautiful Bill Act (OB3). Items from which D.C. decoupled include Internal Revenue Code (IRC) § 168(k) (bonus depreciation), IRC § 168(n) (bonus depreciation for qualified production property), IRC § 174A (full expensing of domestic Research & Experimental expenditures), and the amendments to IRC § 163(j) (interest expense disallowance) as well as most individual income provisions. Recall, D.C. conforms to provisions of the IRC on a rolling basis, so any changes made to the IRC automatically become law in the District unless it acts to decouple. In November 2025, the District passed two bills decoupling from OB3, one a 90-day temporary measure and another to make the decoupling permanent following approval from the Mayor Bowser and a subsequent 30-day review period in which Congress may overturn the legislation. [For details on Bill B26-0457 and Bill B26-0458, see our TWIST of November 10, 2025]. If the President signs the recently approved joint resolution, the District decoupling from OB3 would be nullified, and D.C. would conform to all the provisions set forth in OB3.

The D.C. City Council has expressed concern over whether the Senate action on the resolution on February 12, 2026, was within the permitted 30-day review period during which Congress may disapprove legislation approved by the Council. The Council contends the 30-day review period began in late December 2025 when the D.C. legislation was transmitted to Congress; the Senate takes the position that the 30-day period began when it published its notice of the law being passed in the Congressional record on January 7, 2026. The resolution is currently awaiting a signature from President Trump.

The D.C. Chief Financial Officer estimates that approval of the resolution will reduce city revenues by about $650 million in FY 2026 and require the income tax filing season to be halted while new forms, systems and software are developed to accommodate the changes. Please contact Tom Dexter-Rice with questions about House Joint Resolution 142.

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New York: Appellate court holds sales tax refunds due on certain leases

In a recent decision, the New York Supreme Court, Appellate Division considered the sales tax implications for motor vehicle leases containing terminal rental adjustment clauses (TRACs). These leases require lessees to make provisional monthly payments based on estimated residual values at the end of the lease, with the final payment amount adjusted at lease-end to reflect the vehicle’s actual value. The taxpayer, the lessor in this case, collected and remitted sales tax at the outset for the first 32 months of the lease, based on the estimated rental value for that period. If the lease extended beyond 32 months, the taxpayer would collect rent until the termination of the lease at which time the taxpayer would adjust the rent value up or down, based on the actual condition of the vehicle. If the rent value was adjusted upward, the lessee would pay additional rent and tax; if adjusted downward, the lessee received a refund. The taxpayer claimed credits on its sales tax returns for instances in which the value was adjusted downward, and a refund was made to the lessee at lease termination.

Following an audit, the Department of Taxation and Finance concluded that the taxpayer was not entitled to these credits and that the initial estimated receipts constituted the taxable base. The taxpayer appealed. An Administrative Law Judge (ALJ) upheld the Department on the basis that tax was due at the outset of the lease and there was no provision for a credit such as that sought by the taxpayer. The New York Tax Appeals Tribunal affirmed the ALJ holding that tax was due at the inception of the lease and adjustments at the termination of the lease did not alter the taxable value. The taxpayer sought review by the appellate court.

The appellate court’s analysis centered on the interpretation of the law governing leases, specifically the statutory phrase that tax is due on the “consideration…contracted to be given.” The court reasoned that TRAC payments are inherently provisional and subject to final reconciliation, meaning that amounts refunded at the end of the lease were never truly part of the final consideration “given” under the lease agreement. The court emphasized that adoption of the taxing authority’s interpretation would ignore the conditional nature of the TRAC payments, create a tax that is incapable of precise measurement, and tax consideration that the taxpayer was legally obligated to return. Ultimately, the court concluded that the lease payments required to be paid at lease inception were provisional estimates, but only the net amount actually owed following the lease-end reconciliation constituted the consideration for the transaction. The taxpayer was entitled to recover overpaid sales tax on amounts that were ultimately refunded to lessees. For any questions regarding Gelco Corp. v. New York Tax Appeals Tribunal, please contact Judy Cheng or Jenn White.

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Rhode Island: Division of Taxation finds broad scope for vendor hosted software

In a recent administrative hearing, the Rhode Island Division of Taxation addressed whether sales of online subscriptions to databases of various information and publications constituted taxable sales of vendor-hosted prewritten computer software. The taxpayer sells subscriptions to online databases of legal resources, news, business, published content, and other records. During an audit covering tax years 2017-2019, the Division classified the taxpayer’s subscription receipts occurring after 2018 as emanating from taxable vendor-hosted prewritten computer software and assessed sales tax. The taxpayer attempted to distinguish between its “content” subscriptions (which it characterized as information services) and separately sold software-as-a-service (SaaS) products for which the taxpayer had charged sales tax beginning in October 2018.

The central question was whether website subscriptions that provide searchable access to content fall under Rhode Island’s statutory definitions of computer software, prewritten computer software, and vendor-hosted prewritten computer software. In 2018, Rhode Island amended its law to explicitly include the retail sale of vendor-hosted prewritten computer software as taxable, defining it to include software accessed online or via a vendor-hosted server, regardless of whether customers download or permanently retain the software. The taxpayer argued that its content subscriptions should be exempt as information services or data processing services. The Division disagreed and treated all subscription receipts as taxable vendor-hosted prewritten computer software.

The hearing officer focused on the functionality of the taxpayer’s websites and found that the search, retrieval, and interactive features met the statutory definitions of taxable software. Customers paid not only for access to data or information, but also for the software’s functionality, which allowed them to search and save information from the database. The hearing officer emphasized that the vendor hosted the software and users accessed it online, rather than through custom-developed or locally installed software. The decision stated that the information service and data processing service exemptions cited by the taxpayer apply only in the context of telecommunications taxes and do not provide a general exemption for such products from Rhode Island sales tax. As a result, the hearing officer deemed the subscriptions taxable as payments for vendor-hosted prewritten computer software. For further questions regarding this administrative hearing decision, please contact Ryanne Tannenbaum.

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Washington: Interchange fees not included in B&O tax base

A Washington State appeals court recently ruled that a credit card processing company should not include interchange fees in its gross income calculation for Washington Business & Occupation (B&O) tax purposes. The taxpayer is a processor of credit card transactions. Its business focuses on entering into agreements with a merchant’s bank (called the acquiring bank) to perform “acquiring services” on their behalf, including the collection of electronic data from the merchant to submit to the various credit card networks. Processors such as the taxpayer then enter into contracts with merchants to enable the merchants to access network funding services. An interchange fee is the amount that networks permit an issuing bank (i.e., the bank issuing the card to the consumer) to charge for funding approved credit card transactions, among other things. Once the transaction is approved, the issuing bank receives the relevant merchant information and funds the transaction, less the permitted interchange fee. During the processing of the transaction, the interchange fees are not distributed to the processor but instead are retained by the issuing bank when it funds the transaction.

The Washington Department of Revenue had issued an advisory stating that consideration accrued by processors is gross income for B&O purposes even if fees charged by other parties in the transaction are netted out prior to the processor receiving payment. Based on this guidance, the taxpayer originally included the interchange fees as gross income on its 2018 B&O return but later sought a refund for the portion of tax attributable to the interchange fees. Under Washington law, gross revenue for B&O tax purposes includes the “value proceeding or accruing” from all a taxpayer’s services without deduction for any expenses. The “value proceeding or accruing” is defined as “consideration actually received or accrued.” A trial court ruled in favor of the taxpayer, finding that the interchange fees were not “actually received” by the taxpayer; neither did the taxpayer “actually accrue” the interchange fees such that they should be included in gross revenue. The department then sought review by the appellate court.

On appeal, the court examined the trial court findings related only to whether the taxpayer “actually accrued” the interchange fees since the parties agreed the fees were not actually received by the taxpayer. The court stated that when determining the “consideration actually … accrued,” for purposes of the B&O tax, the term should be applied according to the method of accounting regularly employed by the taxpayer. The taxpayer utilized Generally Accepted Accounting Principles, and applying this accounting method, interchange fees are not considered part of the taxpayer’s revenue or gross income. The Department countered that its published guidance provides that value can be said to accrue for a taxpayer when the taxpayer becomes legally entitled to receive consideration, but because the statute requires that value actually accrue, the court turned to whether the taxpayer was actually entitled to receive interchange fees. The court noted that the interchange fees are deducted by the issuing bank prior to the taxpayer receiving the funds from the issuing bank and transferring those funds to the merchants. Accordingly, the appeals court affirmed the judgment of the lower court, finding that the taxpayer was entitled to a refund of the B&O tax paid on interchange fees. Please contact Michele Baisler for questions about First Data Merchant Services LLC v. State of Washington Department of Revenue, case number 40584-2-111.

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This Week in State Tax (TWIST) is a series providing the latest updates on the ever-changing state and local tax environment.

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What’s included: Discussion on noteworthy developments with broad applicability to taxpayers across the country. Brought to you by: KPMG Washington National Tax – State and Local Tax practice.

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State and Local Tax developments for the week of February 16, 2026

District of Columbia: Congress reverses OB3 decoupling legislation

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New York: Appellate court holds sales tax refunds due on certain leases

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Rhode Island: Division of Taxation finds broad scope for vendor hosted software

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Washington: Interchange fees not included in B&O tax base

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