TWIST - This Week in State Tax

Illinois: Challenge Filed to “Leveling the Playing Field” Act

A remote seller of pet medications has filed a petition with the Illinois Tax Tribunal challenging Illinois’ Leveling the Playing Field Act (Act), which requires retailers without an Illinois physical presence to collect state and local Retailer’s Occupation Tax (ROT) based on the destination of the products sold. In contrast, in-state retailers are required to collect both state and local ROT on an origin sourcing basis. The taxpayer notes there can be seven different ways that ROT and use tax can apply to a transaction, depending on slightly different facts. The taxpayer was audited for compliance with Illinois ROT laws and was assessed over $1 million in additional tax, interest, and penalties. In challenging the assessment, the taxpayer alleges that Act discriminates against interstate commerce by requiring destination-based sourcing on sales by remote retailers and origin-based sourcing on sales by similarly situated retailers with an Illinois presence. In the taxpayer’s view, destination-based sourcing requires compliance with significantly more local taxing rates and jurisdictions, which places greater burdens on remote retailers, as opposed to in-state retailers who enjoy the benefit of complying with one or significantly fewer local tax jurisdictions under the origin-based sourcing rules. The taxpayer also cites to Wayfair and alleges that the Act violates the Commerce Clause by imposing undue burdens (e.g., reporting to the state on ROT collected in over 900 local jurisdictions) on remote retailers that are not imposed on retailers with a slight physical presence in the state. 

In Count II of the petition, the taxpayer argues that the Act also violates the Uniformity Clause of the Illinois Constitution, which provides that a tax must be “uniform as to the class upon which it operates.” To pass muster, a tax classification must be based on real and substantial differences between taxpayers and bear a rational relationship to the object of the legislation or public policy. Because similarly situated taxpayers are treated “vastly differently for tax purposes” under the Act, and there is no articulate policy justification for this treatment, the taxpayer argues that Uniformity Clause is implicated. Please stay tuned to TWIST for updates as PetMeds Express, Inc. v. Illinois Dep’t of Revenue progresses.

Minnesota: Gain from Sale of Goodwill was Apportionable Business Income

The Minnesota Supreme Court recently reviewed a dispute between the Commissioner of the Department of Revenue and a taxpayer over whether gain from the sale of goodwill was apportionable business income or nonbusiness income that was allocated.  The taxpayer was an S corporation that did business in Minnesota and Wisconsin and was owned in part by a Minnesota nonresident. Following the sale of the S-corporation to another business, the taxpayer and its nonresident partial owner filed Minnesota tax returns characterizing the gain on the sale of goodwill as income that was not subject to apportionment.  This approach was taken after consultation with advisors and was supported by a 2006 Minnesota Tax Court decision, Nadler. The tax court in Nadler determined that income generated by the sale of goodwill constituted “nonbusiness income” that was subject to allocation. However, unbeknownst to the taxpayer and its advisors, the Department of Revenue did not acquiesce to the Nadler decision and did not publicly share this position until it issued a notice in 2017.  Upon audit, the Department treated the taxpayer’s gain as apportionable. The matter eventually went the tax court where the Commissioner prevailed. This appeal followed.

The first issue before the court was whether the Department was required to adhere to the Nadler decision with respect to the taxpayer’s audit and assessment. The court noted that it was “troubled by the Commissioner’s conduct that this case has brought to light.” Specifically, the Department had declined to appeal the Nadler decision, but had internally decided— without notice to the public—not to follow it. Nevertheless, the court noted that as the state’s highest court, it was not bound by a tax court decision and therefore did not need to decide whether the Commissioner was bound by Nadler to decide the appeal. The court next turned to the substantive issue, which was one of statutory construction. The taxpayer argued that the gain on the sale of its goodwill was allocated under Minn. Stat. § 290.17, subd. 2(c). The Commissioner, however, asserted that the taxpayer’s income was subject to apportionment because it was business income derived from a unitary asset, which was apportioned under another subdivision of Minn. Stat. § 290.17.  After reviewing the statutes, the court determined the language of the statute was ambiguous and therefore it was appropriate to look to legislative history to determine the legislature’s intent. After doing so, the court concluded that the Commissioner’s interpretation of the statute was more reasonable.  The legislative history reflected the intent to overrule a decision setting forth a functional test and put in place a purely constitutional distinction between business and nonbusiness income. The income at issue, which was derived from a unitary asset, did not constitute nonbusiness income and was therefore subject to apportionment. Two justices dissented on the basis that the Commissioner should be bound by a decision that it did not appeal unless it provided public notice of its disagreement with such decision. Please contact Caroline Balfour with questions on Cities Management, Inc. v. Commissioner of Revenue.

Washington State: Tax Implications of Selling Self-Published Books through Marketplaces

The Washington State Department of Revenue has recently issued guidance on its website addressing the tax consequences when self-publishing authors use marketplace facilitators for book sales and distribution. While the guidance is specific to sales by self-published authors, it may be applicable to other types of sales.  The guidance notes that there are two common methods that marketplaces use to distribute self-published books. In the first, the facilitators sell the author's book under a distribution arrangement whereby the author does not receive an advance and is responsible for preparing the book for sale. The marketplace facilitator typically charges a fee for each book sold. In this instance, the author must report retailing B&O tax on the full selling price of book sales made to Washington consumers and cannot deduct any fees they paid to the marketplace facilitator. For example, if an author sells a book for $10, and the marketplace facilitator keeps a $3 service fee, the author must report the $10 selling price. The guidance notes that some marketplace facilitators call the amount paid to the authors a “royalty payment.” In the Department’s view, this payment is the author's portion of the book sales and these payments do not qualify for the royalties B&O tax classification. With respect to sales and use tax collection, the author does not need to collect sales tax on sales they made through a marketplace facilitator if they received confirmation from the marketplace that the facilitator will collect sales tax. The author may claim a “Gross Sales Tax Collected by Facilitator” deduction under the retail sales tax classification.  If the author does not get confirmation from the facilitator, the author needs to collect and submit retail sales tax on book sales to Washington consumers. In the second type of common distribution method, the author grants the facilitator the right to print and sell the book. In this case, the author pays royalties B&O tax on the gross income received from the facilitator. Please stay tuned to TWIST for more marketplace facilitator guidance.