TWIST - This Week in State Tax

Kentucky: Retroactive Changes Made to Law Taxing Enumerated Services

Recently enacted Kentucky House Bill 360 makes changes to the statutes that imposed sales and use tax on various new services effective January 1, 2023. First, the bill removes “marketing services” from the list of taxable services. New definitions are adopted for taxable “lobbying services” and “executive employee recruitment services,” and the definition of “cosmetic surgery services” is amended to exclude medically necessary surgery services to reconstruct or correct dysfunctional areas of the face or body.  An interesting change has been made to the definition of taxable telemarketing services, which previously meant services provided via telephone, facsimile, email and other modes of communication, to another person, which are unsolicited by that person, for the purposes of (a) promoting products or services; taking orders; or providing information or assistance regarding the products or services; (b) soliciting contributions. House Bill 360 revises the definition of “telemarketing services” to also include services provided via text messages or various forms of social media.

Certain of the change address prewritten computer software access services, which were newly taxable as of January 1, 2023. Warranties for prewritten computer software access services are now included in the definition of “extended warranty services” and are therefore taxable.  A new carve out from the definition of “use” applies to “prewritten computer software access services purchased for use outside the state and transferred electronically outside the state for use thereafter solely outside the state.” Finally, a new exemption applies to prewritten computer software access services sold to or purchased by a retailer that develops prewritten computer software for prewritten computer software access services for print technology and uses and sells prewritten computer software access services for print technology.  All these changes are effective retroactively to January 1, 2023, but no interest will be paid on any refund resulting from the enactment of House Bill 360. Please contact Dave Perry with questions on House Bill 360.

Mississippi: Legislation Confirms Taxability of Remotely Housed Software; Other Services

Recently enacted legislation, Senate Bill 2449, clarifies the Mississippi sales tax treatment of computer software and certain other services provided over the Internet. Although computer software was historically subject to sales and use tax in Mississippi, newly added language provides that computer software maintained on a server located outside Mississippi and accessible for use only via the Internet is not a taxable retail sale. “Computer software services,” which are taxable under House Bill 360 only if performed in Mississippi, are newly defined to mean the technical design and programming of computer software and includes installing, configuring, debugging, modifying, testing, or troubleshooting computer hardware, networks, programs or computer software.  A nonexclusive list of services are excluded from the definition of “computer software services,” including platform as a service or infrastructure as a service; information and data processing services (as newly defined under the bill), and services that use a computer, computer equipment, or computer software as a tool to perform or complete that service; Internet access services or charges; payment processing or banking services; real estate listing or pricing services; electronic advertising and marketing services; and social media services. The bill also makes clear that sales of computer software, computer software services, electronically stored or maintained data, and specified digital products are not taxable telecommunications services. Electronically stored or maintained data is also specifically excluded from the definition of tangible personal property under the bill.

The legislation also has extensive provisions addressing when a purchaser buys both taxable and non-taxable software and services. If a single license fee or other payment encompasses taxable computer software and/or computer software services, along with other nontaxable items, the seller, service provider, user or consumer may allocate such fee or payment between the taxable and nontaxable items based on a reasonable allocation of the payment to each separately identifiable item or service encompassed by the fee or payment, if properly supported by the books and records of the seller. The bill specifically mandates that there is no presumption that the entire amount is taxable simply because it includes taxable and nontaxable elements. If the Commissioner challenges or contests the allocation method used, the Commissioner must establish by a preponderance of the evidence that the method used was not reasonable and the Commissioner’s proposed method is the most reasonable. The bill also sets forth enumerated reasonable methods for a purchaser to use to allocate the costs of the software or related services if they are purchased for use in Mississippi and in other states. The Commissioner is required to adopt rules and regulations providing for the issuance of a permit to purchasers and users of computer software or computer software services to purchase such items and services without paying tax to the vendor. In lieu of doing so, such persons will report and pay the tax directly to the Commissioner, and the vendor will be relieved of collecting and remitting the taxes. Finally, computer software or computer software services provided by one legal entity to another affiliated entity will be treated for sales and use tax purposes as nontaxable transfers between different segments of one legal entity. Please contact Randy Serpas with questions on Senate Bill 2449.

Mississippi: Legislation Decoupling from TCJA Changes to Section 174 and Allowing for 100 Percent Bonus Depreciation Enacted

Mississippi House Bill 1733 was signed into law on March 27, 2023. This bill provides that for purposes of computing income tax for tax years beginning after December 31, 2022, a taxpayer will be allowed to treat research or experimental expenditures paid or incurred by the taxpayer during the tax year in connection with the taxpayer's trade or business as expenses that are not chargeable to the capital account. Expenditures so treated are allowed as an immediate deduction. A taxpayer may alternatively treat the depreciation of such research or experimental expenditures in accordance with the schedule provided in IRC section 174. The method elected by the taxpayer, whether taking an immediate deduction or depreciating the expenditures in accordance with IRC section 174, is irrevocable unless the Commissioner of Revenue specifically allows a change in the method.

In addition to essentially decoupling from the TCJA changes to IRC section 174, House Bill 1733 will allow 100 percent bonus depreciation for qualified property or qualified improvement property placed in service during the tax year, notwithstanding any changes to federal law related to cost recovery beginning on January 1, 2023 or some other date. Alternatively, a taxpayer may elect to treat the depreciation of such assets as in accordance with IRC section 168. The method so elected by the taxpayer is again irrevocable unless the Commissioner specifically allows a change in the method. “Qualified property,” “qualified improvement property,” and “specified research or experimental expenditures” are defined as defined under the Internal Revenue Code as it existed on January 1, 2021.  Finally, Mississippi will conform to the full expending provisions of IRC section 179 also effective for tax years beginning after December 31, 2022.  Please contact Greg Aughenbaugh with questions on Mississippi House Bill 1733.In the orders, the judge struck down the requirement in TAC §§ 3.340 and 3.599 requiring taxable entities to establish by clear and convincing evidence that they qualify for the research sales tax exemption or are entitled to the research and development activities credit.  However, the judge did not strike down the requirement in the rules that all qualified research expenses and activities be supported by contemporaneous business records. In addition, the judge ruled that the revised rules published in October 2021 may not be applied retroactively. This is a significant development, as the revised rules narrowed the scope of expenses that qualify, and the Comptroller has been applying the revised rules to earlier years on audits. It remains to be seen whether these rulings will be appealed. Please contact Jeff Benson with questions on these rulings.

Washington State: Capital Gains Excise Tax Does Not Violate State Constitution

The Washington State Supreme Court recently reversed a lower court ruling and in doing so upheld the constitutionality of the state’s capital gains tax. Enacted in 2021, the capital gains tax is imposed at a rate of 7 percent on an individual’s Washington allocated capital gains after a standard deduction of $250,000 for both individuals and joint filers. The enactment of the tax was controversial, and several plaintiffs filed suit to invalidate the tax on three grounds. First, they argued that the tax was a property tax on income that violated the uniformity and levy limitation requirements for property taxes set forth in the state Constitution. The state, on the other hand, argued that the capital gains tax was an excise tax not subject to the uniformity and levy restrictions. The plaintiffs also alleged that the tax violated the Washington State privileges and immunities clause and the federal dormant commerce clause. After a trial court judge concluded that the capital gains tax was a property tax on income that violated the uniformity clause, the state appealed directly to the state’s highest court.

On appeal, the court noted that the central question it must answer was whether the capital gains tax constituted a property tax. The answer to this question was governed by a “steady line of cases,” including Culliton v. Chase in which the Washington State Supreme Court invalidated a graduated income tax on the grounds that streams of income fell within the definition of property and were therefore protected by the uniformity clause. On appeal, the court held that Culliton did not apply. Relying on the state’s long history of distinguishing between property taxes—those levied on owners of property merely because they are owners—and excise taxes—those imposed upon the exercise of rights in and to property, such as its lease or sale, the court noted that the state had long permitted taxes measured by income so long as they were not imposed on income. Because the capital gains tax is imposed on the sale of assets, rather than on their ownership, the court determined that the tax was properly characterized as an excise tax, even though it was measured by taxpayer’s gains from those assets.

The court next rejected the privileges and immunities clause challenge on the grounds that there was no fundamental right under the state constitution to be exempt from taxes from which other Washingtonians are exempt. Regardless, the legislature’s classification choice (e.g., the $250,000 exemption) was reasonable. The capital gains tax, in the Court’s view, complied with the four-part test from Complete Auto Transit v. Brady, meaning there was no dormant commerce clause violation.

A two-justice dissent argued that the tax was a graduated income tax prohibited by Culliton because it is a tax on the recognition of income from a capital transaction (rather than on the transaction itself) and is imposed on net (rather than gross) income.  Although the capital gains tax return due date is extended if a taxpayer’s federal income tax return is extended, there are no extensions for making payments. The first payment is due on April 18, 2023, and the Department’s online system is open to make tax payments. Please contact Michele Baisler with questions on Quinn, et al. v. Washington.