This Week in State Tax

In a pending precedential opinion, the California Office of Tax Appeals (OTA) held that a real estate investment trust (REIT) could not both eliminate intercompany dividends paid to it by a unitary affiliate and claim a dividends-paid deduction (DPD) with respect to those same dividends. The affiliate, a “taxable REIT subsidiary” (TRS) filed a separate federal corporate income tax return and paid dividends to the REIT from earnings and profits generated by the TRS’s activities. The REIT distributed its entire federal taxable income, inclusive of the qualified dividends, to its shareholders. For the relevant tax years, the REIT reported the dividend as taxable income for federal income tax purposes and claimed the DPD on its federal return. In California, the REIT filed a water’s-edge combined report that included the REIT and the TRS. The group eliminated the dividend paid by the TRS to the REIT per California combined reporting rules in Revenue and Tax Code (R&TC) section 25106. At the same time, because California begins a REIT’s income computation from federal taxable income after the dividends-paid deduction (DPD), the group’s starting income also included its federal DPD. The California Franchise Tax Board (FTB) denied the dividend elimination and assessed tax providing that this treatment was an impermissible double deduction. The taxpayer appealed, arguing that denial of either the elimination or the deduction would result in impermissible double taxation.

The OTA concluded that, while the dividends qualified for elimination under R&TC section 25106, the taxpayer could not simultaneously obtain the benefit of a DPD attributable to those same dividends. OTA reasoned that, because California law provides that the eliminated dividends cannot be taken into account in determining the tax of any member of the unitary group, the REIT could not use those same dividend amounts to claim its DPD. Moreover, under both federal and California treatment, the TRS’s income is taxed once at the entity level and the REIT’s subsequent distribution is taxed once at the shareholder level; the resulting two levels of tax did not constitute duplicative entity-level taxation. Accordingly, OTA sustained the assessments, although it used a different mechanism than that adopted by the FTB by requiring a California addback of the DPD attributable to the eliminated dividends.

A dissenting opinion argued that California law expressly conforms to the federal REIT DPD provisions and that R&TC section 25106 should not be used to effectively limit a deduction that the Legislature chose to allow. The majority rejected the argument that California's conformity compelled a different result. Instead, the majority reasoned that California conforms to federal law only “except as otherwise provided” in the Corporation Tax Law and that section 25106 constituted such an exception. Accordingly, while the dividends were properly eliminated, the taxpayer was required to add back the portion of its DPD attributable to those dividends.

Please contact Doug Middleton, Brad Wilhelmson, or Datus Tomasovich with questions about OTA Case No. 230713916; Matter of Kimco Realty Corp.

The District of Columbia recently enacted budget support legislation to extend its decoupling from certain provisions of the Internal Revenue Code (IRC) which were affected by the passage of One Big Beautiful Bill Act (OB3), address the treatment of passthroughs under Unincorporated Business Tax (UBT), and delay a sales tax increase. The District enacted two separate measures, an emergency act, Bill B26-0724, and its permanent counterpart, Bill B26-0661. The emergency act expires November 11, 2026. Following congressional review, the permanent legislation became effective October 2, 2026.

The new legislation adopts many of the decoupling provisions that had been previously adopted for tax year 2025. [Recall that the District’s Attorney General concluded that congressional disapproval of that bill did not apply in tax year 2025; see our TWIST of March 2, 2026 for more background on this development.] Under the new legislation, the District continues to decouple from the following provisions of the Internal Revenue (IRC) with sunset dates added for certain departures from federal law:

1. The amendments to IRC section 163(j) (interest expense disallowance), for tax years beginning before January 1, 2030;
2. IRC section 168(k) (bonus depreciation), with no sunset date;
3. IRC section 168(n) (bonus depreciation for qualified production property), for tax years beginning after December 31, 2024, but before January 1, 2030; and
4. IRC section 174A (full expensing of domestic research & experimental (R&E) expenditures), for tax years beginning after December 31, 2024, but before January 1, 2028.

The legislation also disallows the OB3 transitional rule elections related to IRC section 174A, which either permitted accelerated expensing of previously unamortized domestic R&E expenditures from tax years 2022–2024 over a one year or two-year period, or permitted small businesses to amend prior year returns to immediately deduct prior year domestic R&E expenditures.

Additionally, beginning with tax year 2026, the legislation replaces the income exclusions for owners’ shares of unincorporated business and S corporation income with nonrefundable credits for District franchise taxes paid by those entities. It also requires taxpayers claiming a credit for taxes paid to another jurisdiction to add back their share of certain taxes paid by a pass-through entity to that jurisdiction. Finally, the legislation delays a general sales and use tax rate increase from 6 percent to 7 percent until October 1, 2027.

Please contact David Meyer and Tom Dexter-Rice with questions regarding the conformity activity in the District of Columbia.

The New Jersey Tax Court recently rejected a trade association’s challenge to the New Jersey Division of Taxation’s regulations treating certain internet-based activities provided by out-of-state sellers as an in-state business activity that may exceed the protections of P.L. 86-272. The American Catalog Mailers Association (“ACMA”), a trade group representing out-of-state internet sellers of tangible goods, filed a declaratory judgment action arguing that P.L. 86-272 preempted Division regulations regarding two online seller practices: (1) providing interactive technical support to New Jersey buyers and (2) placing internet tracking cookies on their computers as in-state business activities that create income tax nexus. Both parties moved for summary judgment.

The court held that the Division regulation treating synchronous post-sale assistance, including electronic chats and internet help desks, as a business activity conducted in New Jersey that goes beyond mere solicitation was not preempted by P.L. 86-272. In the court’s view, interactive technical support occurs both where the seller provides it and where the customer receives it. Part of the activity occurred in New Jersey and extended beyond solicitation, meaning it was not an activity protected under P.L. 86-272. In contrast, a static set of frequently asked questions posted on a website are asynchronous and do not constitute business activity conducted in the state. The court declined, for lack of a developed factual record, to decide how delayed-response e-mail or AI chatbot interactions should be classified.

The court declined to rule on the treatment of cookies used to gather and assemble market or product research for sale to third parties as being beyond mere solicitation because neither party presented evidence that sellers assembled or sold such data.

Please contact Andrew Eskola with questions about Am. Catalog Mailers Ass'n v. Dir., Div. of Tax'n, N.J. Tax Ct., No. 010021-2025. [Ed. Note: The opinion contains an extensive discussion of the background and history of P.L. 86-272 that is informative and is worth the read.]

The Texas Comptroller of Public Accounts recently issued a pair of executive orders directing agency staff to begin rulemaking that would reverse interpretations addressing data processing services and “information services” previously issued by the Comptroller’s office.

The first order would remove marketplace and platform facilitation fees from the definition of taxable data processing services. In 2025, the Comptroller’s office interpreted its data processing services regulation to apply to services of marketplace providers when they perform computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. [See our TWIST of April 7, 2025, for discussion of this interpretation.] The Comptroller now characterizes this interpretation as double-taxation on fees charged to marketplace sellers by marketplace providers: once when the platform fee is charged to the seller, and again when tax is applied to the underlying sale to the end customer. The order requires that the Comptroller’s staff propose amendments to the data processing services regulation [34 Tex. Admin. Code § 3.330], which would exclude from taxation such platform fees charged to marketplace sellers, be published in the Texas Register “without delay.” It identifies sellers and service providers on ecommerce marketplaces, food and grocery delivery apps, rideshare apps, and “gig-economy” among the marketplace providers affected by the proposed change.

The second order directs the agency staff to file a proposed amendment to the information services rule [34 Tex. Admin. Code § 3.342] providing that charges for electronic health record systems, electronic medical record systems, patient portals, and other health care technology systems used to maintain, access, or share medical records are considered neither taxable information services nor taxable data processing services. In explaining the directive, the order cites reports of physicians being charged sales tax to access the electronic medical records of their patients and states that those costs are ultimately passed through the health care system, increasing the cost of care for Texans. The order further states that information maintained in electronic health records and electronic medical record systems is gathered on behalf of a particular client and is proprietary to that client. Based on that characterization, the order concludes that the sale of such information should not constitute a taxable information service or data processing service under the existing Texas regulatory structure.

The draft rules under both orders will be published in the Texas Register and be open for public comment for a 30-day period before becoming final. Contact Sarah Vergel de Dios with questions about Executive Orders DH-2026-01 and DH-2026-02.