This Week in State Tax

The Supreme Court of Arizona recently held that a taxpayer’s machinery and equipment used in sanitizing healthcare textiles is exempt from Arizona use tax. The taxpayer rented reusable healthcare textiles to hospitals, outpatient facilities, and long-term care centers within Arizona. As part of its operations, the taxpayer collected, cleaned, and disinfected the textiles for reuse by its customers. From 2014 to 2018, the taxpayer purchased equipment to be used in the disinfecting process and remitted use tax to Arizona and the City of Phoenix on the purchases. The taxpayer later filed a refund claim on the grounds that such equipment qualified as machinery and equipment used directly in manufacturing or processing operations, and as such was exempt under state law. The Department of Revenue denied the refund claim; the Arizona Tax Court and the Court of Appeals affirmed the denial on appeal, and the taxpayer sought review by the state supreme court.

In its analysis, the supreme court focused on the meaning of “processing operations,” which was not a defined term in the exemption statute. The court synthesized various dictionary definitions and Arizona case law into a single operative definition: a “processing operation” is a “series of integrated actions or methods that prepares a product for the market or converts a product into marketable form.” In addition, only machinery or equipment that touches, manipulates, affects, or adds value to a product will qualify for the exemption. Applying this framework to the taxpayer’s operations, the court found that the taxpayer’s textile laundering and disinfecting process involved a series of actions that transformed the healthcare textiles into a marketable form. The textiles were not marketable for their intended use prior to the taxpayer’s operations (i.e., the cleaning and sanitizing), and the court disregarded whether the textiles acquired by the taxpayer could have been marketable for some other purpose prior to the taxpayer processing them to be used in the healthcare field. Therefore, the taxpayer’s machinery and equipment that touched, affected, or added value to the textiles qualified for the exemption. 

The court also addressed two other issues: (a) whether the taxpayer’s “downstream transactions”, i.e., whether a taxpayer rents or sells a product were important to the analysis; and (b) whether the activities of the business as a whole must be viewed in determining eligibility for the exemption. The court held the determination of whether a taxpayer is eligible for the “processing operation” use tax exemption is based solely on “distinct operations within the entire business,” such as the taxpayer’s sanitization process, and does not require that taxpayers sell products instead of leasing them, only that they be made marketable. Please contact Eric Gee and Brian Phillips with questions about 9W Halo Opco LP v. Arizona Department of Revenue. 

Governor Brian Kemp recently signed a bill [House Bill 1199] updating the state fixed date conformity to the Internal Revenue Code (IRC). For tax years beginning on or after January 1, 2025, Georgia will conform to the IRC “as provided for in federal law enacted on or before January 1, 2026,” with certain exceptions. New exceptions to the general rule of conformity addressing provisions in the One Big Beautiful Bill Act (OB3) (P.L. 119-21) include decoupling from IRC section 174A (full expensing of domestic research & experimental expenditures), and section 179(e) (definition of qualified real property for certain taxpayers). Georgia had previously decoupled from the provisions of IRC section 168(k) (bonus depreciation) and IRC section 168(n) (depreciation for qualified production property); the bill continues that decoupling. The new law also decouples from the personal income tax deductions for qualified car loan interest, certain tip income and qualified overtime pay contained on OB3.

In the same bill, Georgia enacted a temporary 60-day suspension of its excise tax imposed upon distributors selling or using motor fuel, other than diesel fuel. The temporary suspension on the motor fuel tax became effective upon the governor’s approval, which occurred on March 20, 2026. A separate measure [House Bill 1000], also signed by Governor Kemp recently, created a one-time tax refund available to qualified individual income taxpayers filing a 2025 Georgia tax return. Please contact Greg Aughenbaugh, Trent Kool, and Alison Tilson with questions on these measures.

The Texas Comptroller of Public Accounts has proposed amendments to the Cost of Goods Sold (COGS) deduction for the Texas Franchise Tax. The amendments reflect an earlier determination of the Comptroller that certain elements of franchise tax, including depreciation under the COGS deduction, should be based on the current version of the Internal Revenue Code (IRC). The proposed amendments are expected to be published in the Texas State Register on April 3, 2026, and the public comment period is open until May 3, 2026.

Historically, the franchise tax has been tied to the IRC as in effect for the tax year beginning on January 1, 2007, and items on the franchise tax report taken from the federal return were to be computed under the IRC of 2007. In December 2025, the Comptroller determined that certain aspects of the franchise tax reports should be based on the current federal law. As detailed in a Policy Memo, beginning with the 2026 franchise tax report, a taxable entity will determine amounts taken from the federal tax return under the current year federal tax law, unless the franchise tax statute or rule specifically references the IRC, in which case those amounts must be determined under the IRC in effect on January 1, 2007.

For franchise tax purposes, a taxable entity may include in its COGS deduction the depreciation or amortization it claims for federal tax purposes, to the extent those assets are “associated with and necessary for the production of the goods.” The proposed rule provides that beginning with the 2026 franchise tax report, a taxable entity shall use the current federal tax law instead of the IRC of 2007 when determining the includible depreciation, including amounts for depreciable assets which the taxable entity elected to expense. The draft specifically calls out that any deduction for amortization of goodwill or other intangibles under IRC section 197 must be determined under the IRC rules of 2007 as statute authorizing such recovery specifically references the IRC. The proposed amendment also deletes a reference to IRC section 179 in the current rule, meaning any depreciation under IRC section 179 on the 2026 report will be based on current rules.

The proposed rule allows a “one-time net depreciation adjustment” on the entity’s 2026 report for each asset placed in service prior to the beginning of the accounting period on which the 2026 report is based, if the asset has not been disposed of. The adjustment for each asset is the difference between the depreciation claimed on the federal return and that claimed for franchise tax purposes each year. The total adjustment allowed on the 2026 report is the sum of the annual adjustments for each property, but the adjustment may not be less than zero and may not reduce the taxable margin of the entity below zero. Any unused adjustment may be carried forward to successive years.

This discussion is based on a draft of the proposed amendments. Changes may occur before final promulgation. For further information, please contact Jeffrey Benson or Karey Barton. Also, KPMG will publish a SALT Alert on the proposed rule this week.

Utah Governor Cox recently signed a Senate Bill 60 that will reduce the state corporate income, corporate franchise, and individual income tax rate from 4.5 percent to 4.45 percent for taxable years beginning on or after January 1, 2026.

Governor Cox also signed into law House Bill 519, which amends the state’s unclaimed property statute to define “digital assets” and establish the manner in which such assets should be treated when presumed abandoned. Under the new law, digital assets are subject to a three-year dormancy period measured from the owner’s last indication of interest in the asset, unless the holder, in the regular course of business, sends physical correspondence to the owner of a digital asset associated with the holder’s digital asset account. In that case, the dormancy period is measured from the date the physical correspondence is returned to the holder as undeliverable.

If the holder can transfer the digital asset, it must report the property and transfer it in its “native form” to the state via the state’s custodian. However, if the holder does not have the private key or other authority needed to transfer the digital asset, the holder must report the asset to the state, maintain the asset until it has the ability to transfer it, and annually review whether it has obtained the ability to transfer the asset. The state may not sell a reported digital asset until three years after the state’s custodian receives the asset and the state has provided notice to the owner that it holds the property. The bill takes effect May 6, 2026.

Finally, Governor Cox signed Senate Bill 73, which imposes an excise tax equal to 2 percent of the sales price on certain entities that provide content harmful to minors. The new law is effective October 1, 2026. Please contact Timothy Lau with questions on Senate Bill 60, Mike Larkin with questions on Senate Bill 73, and Will King or Karen Anderson with questions on House Bill 519.

In response to the federal phase-out of the penny, states are continuing to provide guidance for taxpayers on handling the application of sales tax to transactions that require rounding because of the inability to make exact change. We will continue to track these through TWIST, providing a list of the states as well as links to where you can find the direct guidance.