2020 has brought significant change to almost all aspects of life—and the tax code hasn’t been immune. Individual and trust taxpayers, corporations, and pass-through entities are all impacted by the various updates and guidance that has been released this year.
Here, we provide an update for western states on legislative actions, court decisions, and voter initiatives that will affect taxpayers in the coming year.
No significant developments.
Personal Income Tax Rate Increases
On November 3, 2020, Arizona voters passed Proposition 208. This measure will increase Arizona’s marginal income tax rates on high-income earners. Effective for tax years beginning on or after January 1, 2021, Arizona will impose an 8% income tax rate on income over $250,000 (single filers) or $500,000 (joint filers). This represents a substantial increase in Arizona income taxes from 2020, when the highest marginal rate of 4.5% was imposed on income over $159,000 (single filers) or $318,000 (joint filers).
Net Operating Loss Suspension
On June 29, 2020, Governor Newsom signed Assembly Bill (AB) 85, suspending the application of net operating loss carryovers for three tax years—2020–2022—for corporate and personal income tax purposes. AB 85 suspends the use of net operating losses for taxable years beginning on or after January 1, 2020, and before January 1, 2023. The law extends the applicable carryforward period by one to three years, depending on the tax-suspended loss carryover year. The suspension doesn’t apply to corporate taxpayers with net business income of less than $1 million for the taxable year. For personal income taxpayers, the suspension doesn’t apply to modified adjusted gross income of less than $1 million for the taxable year.
Paycheck Protection Loan Forgiveness
On September 9, 2020, Governor Newsom signed AB 1577 allowing an exclusion to the calculation of California gross income for Paycheck Protection Program (PPP) loans that are forgiven as part of the (Coronavirus Aid, Relief, and Economic Security Act) CARES Act. Under current law, California conforms to the Internal Revenue Code (IRC) as of January 1, 2015.
Consequently, absent legislation, the state’s tax code wouldn’t automatically conform to changes to the federal tax laws made by Congress. Under AB 1577, gross income doesn’t include any covered loan amount forgiven pursuant to Section 1106 of the CARES Act or under the Paycheck Protection Program Flexibility Act. AB 1577, however, also disallows any credit or deduction for loan forgiveness eligible expenses to the extent of the amount of the forgiven loan.
Defeat of California Proposition 15
On November 3, 2020, California voters defeated a Proposition 15, a proposition that would’ve substantially modified California’s property tax system.
In 1978 California voters passed Proposition 13, a measure that required all categories of real property to be assessed at the same rate and valuation standard. Proposition 13 capped local property rates at 1% of the property’s assessed value and capped property tax increases to 2% per year. Only when the property was sold did Proposition 13 permit a re-assessment of the property’s value based on the purchase price. Finally, Proposition 13 applied to all property types—commercial, industrial, and residential.
Proposition 15 was intended to bifurcate this system by applying different formulas and rates to commercial and industrial properties, with residential properties still covered under the Proposition 13 requirements.
Alternatives for Addressing Budget Deficit
The failure of this proposition will leave lawmakers in Sacramento searching for alternative ways to raise revenue in addressing the state’s COVID-related budget deficit.
Some proposals that were introduced in 2020 that may be considered in 2021 include:
- AB 2088. This bill seeks to impose a 0.4% net-worth tax on California residents, part-year residents, and temporary residents for their worldwide net worth in excess of $30 million. A person’s net worth would include stocks in publicly held corporations, stock in S corporations, partnership interests, mutual fund interests, financial assets held outside the United States, real property, and other similar asset types. This tax would also impose a 10-year lookback period where individuals that move out of California would still be subject to the tax.
- AB 1253. This bill would raise the income tax rates for high-income taxpayers if enacted. If passed, individuals would effectively pay a 14.3% income tax rate on income between $1 million to $2 million, a 16.3% rate on income between $2 million and $5 million, and a 16.8% rate on income over $5 million—subject to inflation adjustments.
Reduced Colorado Income Tax Rates
On November 3, 2020, Colorado voters passed Proposition 116. This measure reduces Colorado’s single income tax rate from 4.63% to 4.55%. This tax rate applies to both corporations and individuals.
Property Tax Changes
On November 3, 2020, Colorado voters repealed the Gallagher Amendment, which limited the total share of property taxes paid on residential property to 45% of overall statewide property tax base. The repeal of this amendment creates the potential for higher property taxes on residential real property.
Market-Based Sourcing Effective in 2020
In 2019 Hawaii enacted Senate Bill (SB) 394, adopting market-based sourcing for Hawaii income tax purposes for tax years beginning after 2019. Under this legislation, receipts from services will be sourced to Hawaii if the service is used or consumed in the state. In addition, receipts from intangibles are sourced to Hawaii to the extent the intangible property is used in the state. In an information release published by the Hawaii Department of Taxation, these new sourcing rules will align with the sourcing treatment for these items under the state’s General Excise Tax or sales tax.
Economic Nexus Effective in 2020
In 2019 Hawaii enacted SB 495, creating an economic nexus standard for income taxes. For tax years beginning after 2019, persons are presumed to have nexus in Hawaii for income tax purposes if they engage in 200 or more transactions with Hawaii customers or have $100,000 or more of gross receipts sourced to Hawaii. Moreover, the Hawaii Department of Taxation recently published that engaging in 200 or more Hawaii transactions or having $100,000 of Hawaii receipts are outside the scope of Public Law (PL) 86-272 protection.
No significant developments.
No significant developments.
Tax Amnesty in 2021
The Nevada legislature authorized the state to participate in a tax amnesty program. SB 3 requires the Nevada Department of Taxation to conduct a tax amnesty program for up to 90 days, with the amnesty period ending by June 30, 2021.
The amnesty legislation provides that persons with unpaid Nevada taxes won’t be subject to penalties and interest if they participate in the amnesty program. The amnesty will apply to those taxes and fees that are due and payable prior to the enactment of the amnesty legislation, which was July 20, 2020. Amnesty isn’t available to taxpayers that have entered into compromises or settlement agreements with the Nevada Department of Taxation, nor is available to taxpayers that are currently under audit and haven’t been issued a final notice of deficiency determination.
Worldwide Combined Reporting Effective in 2020
In 2019, New Mexico enacted legislation that requires, for tax years beginning on or after January 1, 2020, combined reporting for corporations that form a unitary group. Corporations must file on a worldwide unitary combined basis, unless the taxpayer elects to file on a water’s-edge basis. Alternatively, the taxpayer can elect to file on a consolidated group basis, with the group mirroring the taxpayer’s federal consolidated return group. These elections are made on the first original return required to be filed under the new law. The elections, once made, are binding for seven years.
Market-Based Sourcing Effective in 2020
As part of the same legislation that enacted combined reporting, New Mexico will require gross receipts from services and intangibles to be sourced, for apportionment purposes, based on market-sourcing principles. Under this legislation, gross receipts from services are sourced to New Mexico if the service is delivered to the state while gross receipts from intangibles are sourced to location where the intangible is used. To the extent the receipt can’t be reasonably sourced, or the taxpayer isn’t taxable in the state where the receipt is assigned, the receipts are thrown out of the sales factor entirely.
Changes to Corporate Activity Tax Combined Reporting
In 2020, Oregon enacted House Bill (HB) 4202 which contained several changes to the Oregon Corporate Activity Tax (CAT). Notably, as originally enacted the CAT required combined reporting of all persons that:
- Met the above 50% direct or indirect ownership threshold
- Constituted a unitary business
The mandatory combined reporting provisions didn’t account for whether a person was a domestic (US) person or foreign. HB 4202 now allows taxpayers to modify the unitary group membership to exclude all foreign members that don’t have Oregon commercial activity.
This election must be made on a timely filed original return, including extensions. Each election is a binding, annual election and must be made separately for each tax year.
Updates to the Oregon CAT Agency Exclusion
Under the CAT, persons that are agents may exclude the fair market value of property, money, or other amounts from their Oregon CAT base to the extent the property, money, or other amounts are received or acquired on behalf of another.
The Oregon Department of Revenue has published more detailed regulations that provide helpful examples of how this agent exclusion operates. These examples include scenarios that apply to general contractor, employee staffing companies, payroll processors, escrow companies, and relationships involving cost-reimbursable contacts.
New Local Taxes in Portland Metro Region
In 2020 voters approved two local measures that will increase local income taxes.
In May 2020, voters in the Portland metro region, an area that includes Multnomah county and parts of Washington and Clackamas counties, approved Measure 26-210 to fund homeless services. This measure imposes a 1% income tax on households with over $125,000 of taxable income (single filers) or over $200,000 of taxable income (joint filers). The tax is imposed on residents of the Metro District and on nonresidents that derive income from sources with the district. The measure also imposes a 1% tax on business entities that generate more than $5 million of gross receipts per year. This tax is effective for tax years beginning on or after January 1, 2021.
In November 2020 Multnomah county voters approved Measure 26-214 to fund pre-school services in the county. This measure levies a 1.5% income tax (increasing to 2.3% in 2026) on individuals with more than $125,000 of taxable income (greater than $200,000 for joint filers). An additional 1.5% tax is imposed on individuals with more than $250,000 of taxable income (greater than $400,000 for joint filers). This will increase to a 3.8% tax in 2026. The tax is imposed on residents of Multnomah county as well as nonresident with taxable income derived from Multnomah county sources. This tax is effective for tax years beginning on or after January 1, 2021.
Service Receipts Sourced Under the End-Product Test
In Hegar v. Sirius XM Radio Inc., the Texas Court of Appeals held that a subscription-based satellite radio service company must source its gross receipts to the location of its subscribers, and not where it produced its programming. In apportioning total revenue under the Texas Franchise Tax, gross receipts from services are sourced to the location where the service is performed. If services are performed both inside and outside of Texas, then Texas receipts are determined based on the fair value of the services rendered in Texas.
In the case, the taxpayer sought to source its receipts from satellite radio broadcast services outside of Texas, in the location where it produced the content. The court disagreed, instead finding the receipt-producing, end-product act controlled how the receipt would be sourced. According to the court, the relevant end-product act occurred when the taxpayer decrypted the program in the customer’s satellite radio, which took place where the satellite radio was located and customer resided.
This end-product act methodology creates the potential to source, in some instances, service receipts to the customer location rather than where the service originated from or was otherwise performed.
Comptroller Issues Draft Regulations in Sourcing Service Receipts
In November 2020, the Texas State Comptroller proposed amendments to the Texas Franchise Tax apportionment sourcing rules. The Texas Franchise Tax is apportioned using a single receipts factor, which equals a percentage based on Texas-sourced receipts divided by a taxpayer’s total revenue. The Comptroller’s proposed amendments modify the way service receipts are sourced to Texas.
For example, under the modified regulation, receipts from advertising services would be sourced to the location of the advertising audience. The modified regulation would also formally adopt the so-called end-product act—the final act in performing the revenue-producing service controls for sourcing purposes—in attributing receipts from the sale of digital services to Texas.
Gross receipts from an internet hosting service would be sourced to customer location. These changes, which could potentially be applied retroactively, reflect a shift towards customer-based sourcing of service revenue in attributing receipts to Texas.
Foreign Military Sales not Apportionable to Texas
In Lockheed Martin Corp. v. Hegar, a defense contractor’s sales of fighter jets to the US government under the Foreign Military Sales (FMS) program weren’t Texas sales for franchise tax purposes. The taxpayer had a contract to deliver fighter jets to the US government, and the US government had a contract to deliver the fighter jets to the foreign government. Sales of tangible personal property were attributable to Texas if the property was delivered to a buyer in the state of Texas.
The questions raised by the case included:
- The identity of the buyers
- If the jets were delivered to buyers in Texas
According to the Court, the sales were to the foreign governments for whom the jets were manufactured and ultimately delivered. The US government’s involvement in each transaction was a merely condition of the sale. Title and possession of the jets shifted to the US government at the contractor’s Texas manufacturing facility. But US government pilots then delivered the jets to the ultimate buyers in foreign countries.
The case is significant in opening avenues to source sales of tangible personal property to their ultimate destination for Texas Franchise Tax apportionment purposes if certain facts and circumstances exist.
Seattle Enacts a Payroll Excise Tax
The Seattle City Council enacted a payroll tax on employers with Seattle payroll in excess of $7 million annually. This tax is an excise tax imposed on Seattle employee compensation for employees earning over $150,000. The tax rate depends on the employer’s total payroll Seattle payroll expense, with larger employers being taxed at a higher rate.
In addition, a greater tax rate is imposed on Seattle employee compensation in excess of $400,000. For example, an employer with less than $100 million of Seattle payroll expense would pay a 0.7% tax on the payroll expense of employees whose annual compensation is at least $150,000 but less than $400,000, and a 1.7% tax on the payroll expense of employees whose annual compensation is $400,000 or more.
The Seattle Finance Department is currently engaged in rulemaking, which will provide more detail surrounding this tax.
No significant developments.
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