This Week in State Tax

In the latest episode in a longstanding controversy, the 11th Circuit Court of Appeals recently held that Alabama’s imposition of a state tax on diesel fuel used by interstate railroads, but not on interstate water carriers, violated the Railroad Revitalization and Regulatory Reform Act (4R Act). Enacted in 1976, the 4R Act prohibits discrimination against interstate railroads with respect state and local property taxes, as well as “any other tax”.

Alabama law imposes a 4 percent state tax on diesel fuel used by interstate rail carriers; interstate motor carriers and water carriers are exempt from the levy. In 2008, CSX Transportation challenged this regime as violating the “any other tax” provision of the 4R Act. The litigation has involved two full decisions by the U.S. Supreme Court and three judgments by the 11th Circuit Court of Appeals. The merits of the matter as involving CSX Transportation were finalized in 2018 in CSX III when the 11th Circuit Court of Appeals held that “as long as the state retains the sales and use tax exemption for diesel fuel used by [interstate] water carriers, the 4R Act forbids it from imposing the sales and use tax on fuel used by [interstate] rail carriers.” The Supreme Court denied certiorari in June 2019 (Docket 18-612).

As the CSX litigation progressed, six other railroads filed similar claims in Alabama. With the finalization of CSX III, the railroads moved for judgment against the state. In defending the claims, the state had not contested that the railroads were engaged in interstate commerce and were subject to the diesel fuel tax which still exempted water carriers, but denied that water carriers were the principal competitors to these railroads (a point it had stipulated throughout the CSX litigation). The district court consolidated the cases and held for the railroads, holding that the state was judicially estopped from denying the water carriers were principal competitors to the railroads based on its stipulation in CSX. The lower court further emphasized the holding in CSX III that the tax on diesel fuel cannot be applied to interstate railroads if interstate water carriers are not subject to it. The state appealed to the 11th Circuit.

In its decision, the Court of Appeals focused on the judicial estoppel question. The court described judicial estoppel as an equitable doctrine “intended to prevent the perversion of the judicial process and protect its integrity by prohibiting parties from deliberately changing positions according to the exigencies of the moment.” The application of judicial estoppel in this matter involved two tests or elements in determining whether the doctrine should be applied: (a) whether the party resisting the estoppel (i.e., Alabama) took an inconsistent position under oath in a separate proceeding, and (b) whether these inconsistent position were calculated to make a mockery of the judicial system.

As to the first element, the Court of Appeals held that the district court “correctly concluded” that the state had taken inconsistent positions under oath when it stipulated clearly and unambiguously in the CSX litigation that “[t]he principal competitors to rail carriers … in interstate commerce in … Alabama are motor carriers … and carriers of property in interstate commerce by ships, barges and other vessels….” The state argued that its CSX stipulation should be considered a “qualified” or “case specific” stipulation applicable only to CSX and not all interstate railroads. The appellate court, based on the lack of qualifying terminology or ambiguity in the earlier stipulation, held that the district court did not abuse its discretion in rejecting the state’s position.

As to the second element, the appellate court also held that the district court did not clearly err when it determined the state’s change of position “was calculated to make a mockery of the courts”. Of particular importance was the determination by both courts that the state’s decision to “strategically reverse course on the stipulated fact solely because intervening court decisions had, in the state’s words, made that fact (i.e., that water carriers competed with railroads) ‘go from irrelevant to paramount.’” The Court of Appeals also drew attention to the fact that the state had “hedged its bets” by staying the present cases while it litigated its position in CSX only to then change its position after CSX was finalized; the appellate court also stressed the reliance various courts had placed on the stipulation. Accordingly, the Court of Appeals, with one dissenting judge, determined the district court did not err and had ample support for its application of judicial estoppel. As such, it upheld the district court judgment that Alabama cannot impose its tax on diesel fuel consumed by interstate railroads while exempting interstate water carriers from the levy. Alabama has until about November 1, 2026, to seek review by the U.S. Supreme Court.

Please contact Scott Jackson, Justin Stringfield, or Harley Duncan with questions regarding BNSF Railway Company v. Alabama Department of Revenue.

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The California Office of Tax Appeals (OTA) ruled that a taxpayer was ineligible for California research and development (R&D) tax credits because it could not provide contemporaneous documentation regarding its research activities. The taxpayer was a consulting firm that specialized in testing hazardous materials (such as mold, asbestos, and lead). In 2022, the taxpayer engaged a third-party advisor to investigate its eligibility for R&D credits; the advisor determined that five of the taxpayer’s activities in the 2019 and 2020 tax years qualified for credits. The study concluded that the taxpayer’s activities satisfied the qualified research test and stated that “contemporaneous documentation and corroborating evidence exists to substantiate” the taxpayer’s qualifying R&D activities, which the taxpayer’s CEO could provide in the event of an audit. The taxpayer subsequently filed amended returns for 2019 and 2020 claiming credits for both years. After the Franchise Tax Board (FTB) requested documentation substantiating the eligibility of the activities, the taxpayer provided the 2022 study prepared by the third-party advisor; the FTB denied the credits due to insufficient documentation, and the taxpayer appealed to the OTA.

California conforms to federal rules concerning research credits, which require that “[a] taxpayer claiming a credit … must retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.” The taxpayer argued that, although it did not submit contemporaneous documentation, federal case law did not require it to do so, providing that “[a] taxpayer is not required to keep records in a particular manner so long as the records maintained substantiate [its] entitlement to the credit.” The OTA disagreed with the taxpayer’s reliance on the case law because eligibility for the credits was not an issue there; rather, the dispute concerned the amount of the credit. In the OTA’s view, the taxpayer in this case had not “retain[ed] records … to substantiate that the expenditures claimed are eligible for the credit” as required under the federal rule. Finally, although the taxpayer argued that the IRS had accepted its R&D credits by issuing federal refunds for 2019 and 2020, the OTA found no evidence that the IRS had audited or accepted the credits and noted that the FTB was not bound by IRS determinations it considered erroneous.

Contact Candace Axline or Geoffrey Way with questions about In the Matter of Advanced American Laboratories.

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Illinois is holding its first tax amnesty for remote sellers, running from August 1^st through October 31^st. The program allows remote sellers who pay their outstanding liabilities for prior periods during the amnesty to receive a waiver of both penalties and interest as well as to benefit from a simplified filing mechanism for the taxes paid during the amnesty. The amnesty is open to taxpayers having unpaid sales tax liabilities for periods between January 1, 2021 and June 30, 2026, who have no physical presence in Illinois, but are selling tangible personal property to customers in the state in amounts sufficient to meet the state nexus threshold. From January 2021 through December 31, 2025, the nexus threshold was $100,000 in annual gross receipts or 200 separate transactions during the preceding year. From January 1, 2026, forward, the threshold is $100,000 in annual gross receipts.

Liabilities relating to the Retailers’ Occupation Tax (ROT) and locally imposed ROTs administered by the Illinois Department of Revenue are eligible for the program. In addition to having related penalties and interest waived, amnesty participants will be able to pay a simplified, combined state and local ROT rate of 9 percent (or a combined rate of 1.75 percent for certain qualifying items, such as food for home consumption, medicines, drugs, and medical appliances), without being required to separately account for local ROTs or to source the transaction to specific jurisdictions. Taxpayers can register for the Remote Retailer Amnesty Program through the MyTax Illinois online portal.

For questions regarding the Remote Retailer Amnesty Program, please contact Andrew Olson or Catherine Lake.

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A Massachusetts appellate court upheld an Appellate Tax Board ruling that a shoe company qualified as a manufacturer and was therefore required to use single sales factor apportionment. [For background on this matter, see our TWIST of June 16, 2025.] Recall that, prior to 2025, Massachusetts allowed non-manufacturers to use a three-factor apportionment method but required manufacturers to use the (now-default) single sales factor method. A manufacturing corporation is a corporation that is “engaged, in substantial part, in transforming raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature and adapted to a new use.” In its decision, the Board agreed with the Commissioner of Revenue that the taxpayer’s product development and prototype design activities—performed before third-party mass production—satisfied the statutory quantitative thresholds for manufacturer treatment. The taxpayer appealed.

The appellate court largely affirmed the determinations made by the Board, concluding that the taxpayer’s activities were an essential part of the manufacturing process. The court emphasized that the taxpayer controlled key aspects of product design, prototyping, materials selection, revisions, molds, and testing standards, even though third-party manufacturers performed the mass production.

The taxpayer sought to raise an additional argument that, even if its manufacturing activities met the quantitative, percentage-based test, these activities were “merely trivial or only incidental to its principal business.” The taxpayer noted that “there is also a subjective -- or qualitative -- component to the analysis under the statute.” The appellate court disagreed on three grounds. First, the argument had been waived because it was not raised at the lower level. Second, while Massachusetts does allow a taxpayer that does not meet any of the four quantitative tests to argue that subjectively it is a manufacturer based on other factors. The court ruled that a taxpayer’s manufacturing activities are, by definition, “substantial” if they meet one of the quantitative tests, and there is nothing to suggest that satisfying one of the four tests is not dispositive. Finally, based on the facts, the taxpayer’s manufacturing activities were not trivial or incidental, and objectively, it is engaged in manufacturing.

Contact James Carregal with questions about Sketchers USA v. Commissioner of Revenue.

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The FY 2027 New York State budget bill enacted a real property tax surcharge on certain properties in New York City. The surcharge applies to residential cooperatives and condominiums valued at greater than $1 million and to one, two, or three family homes valued at over $5 million, if the property is not the primary residence of the owner, an immediate relative of the owner, or a qualifying lessee of the property. The surcharge, commonly referred to as the “pied-a-terre tax”, is effective for the fiscal year beginning July 1, 2026, with the first charges appearing on property tax bills due in January 2027. [For additional information, see our TWIST of June 8, 2026.]

In July, the New York City Department of Finance issued final regulations for implementing the surcharge. In accord with the enabling legislation, the regulation requires the Department to notify taxpayers that, based on the information available to it, their property may be subject to the surcharge, and that the property owner has until August 30, 2026, to file an application for exemption from the surcharge by providing documentation that the property is their primary residence or is otherwise not subject to the surcharge. Only owners receiving the notice were required to respond. The City has recently extended the exemption application and documentation deadline for eligible property owners to September 18, 2026.

The initial implementation of the surcharge has created some backlash against the City, with concerns about the number of properties identified as potentially being subject to the surcharge as well as the process for seeking relief from the initial notice. According to the Mayor's Office, the extension of the deadline is intended to give affected owners more opportunity to establish that the property is a primary residence, to gather supporting documentation, and to receive assistance from the Department before submitting an application. On August 7, a group of taxpayers filed an action in state court seeking to delay the rollout of the surcharge based on what it termed the “mass confusion” by the initial notices.

Please contact Alec Schwartz with questions about the New York City pied-a-terre property tax surcharge.

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