Year-End State and Local Tax Planning

Now that the dust has started to settle on post-Wayfair sales tax nexus requirements, states are switching their sales tax efforts to finding ways to expand the sales tax base. With economic nexus standards now firmly in place, the focus is on broadening the scope of things that are subject to tax such as software, services and digital advertising.

In addition, while the U.S. Supreme Court in Wayfair addressed only sales tax nexus, states are applying economic nexus standards for both sales tax and income tax.

Economic nexus presents risk and opportunity for taxpayers. States use differing sourcing rules and methodologies to assign sales to a particular state for multistate businesses. Although a business might have economic nexus in a state, with proper planning, income tax burdens can be alleviated or reduced with a sales-sourcing analysis, which ensures sales are correctly apportioned among the states. As states continue to adopt single-factor sales apportionment coupled with market-based sourcing, many businesses are actively reexamining their sales sourcing approaches to reduce state taxes.

With economic nexus here to stay, sales and use taxes are likely a significant financial burden for multi-state businesses if proper procedures are not in place and appropriately maintained. The issues of taxability review, the use of marketplace facilitators, and exemption certificate management have garnered more analysis in a post-Wayfair world.

Companies should regularly review their sales and use tax process and procedures, including, but not limited to:

The following states have proposed sales tax legislation related to on streaming services.

Any time a business launches a new product or service line, it should perform a taxability analysis and review recent state tax developments regularly. For example, states like New York have been pushing the limits on what qualifies as taxable software or taxable digital services, (e.g., information services, data processing), which can potentially impact a company’s tax liability.

A business should be considering state and local income tax nexus and sales sourcing assessment, if:

Several states have recently enacted corporate or personal income tax rate changes. While the majority of state statutory rate changes have lowered tax rates for individuals and businesses, California enacted the nation’s highest personal income tax rate (14.4%) and New Jersey enacted the Nation’s highest corporate income tax rate (11.5%). Companies should review Deferred Tax Asset estimates to determine if state income tax rate changes will affect those calculations.

In the aftermath of Wayfair, the Multistate Tax Commission (MTC) has targeted one of the remaining legal barriers that businesses have to shield themselves from state assertions of income tax economic nexus – P.L. 86-272.

On August 4, 2021, the MTC voted to adopt a revision to its “Statement of Information” whereby a business could lose P.L. 86-272 protection solely by engaging with customers through the internet. In 2022, New York and California issued guidance that they were adopting the MTC’s revised Statement of Information. Currently, there are legal challenges to the adoption of the MTC guidance in both states. The taxpayer was recently successful in overturning the state’s adoption of the MTC guidance in California; however, the case was decided on procedural grounds and the court did not reach the question of whether the MTC guidance violate federal law. Other legal challenges are sure to follow.

Effective July 31, 2023, New Jersey adopted the MTC’s P.L. 86-272 revisions. It is expected many other states may adopt the MTC’s guidance implicitly through their MTC conformity provisions. The loss of P.L. 86-272 protection may result in additional income tax filing obligations for many businesses. The federal law known as P.L. 86-272 was passed over 60 years ago, and it prohibits a state from imposing a net income tax on businesses that only sell tangible personal property (TPP) and whose activities in a respective state do not exceed the solicitation of orders. For many years, even preceding the Wayfair case, for income tax, it has been generally accepted that economic nexus has been the law of the land unless a business was otherwise protected by limiting its activities to those outlined in P.L. 86-272.

The MTC’s Guide provides examples of when the use of an interactive website will exceed P.L. 86-272 Protection, including:

One of the centerpiece provisions of the 2017 TCJA was the $10,000 cap on state and local taxes (SALT) that individuals (including pass-through businesses) could claim as an itemized deduction on their federal income tax returns. The SALT deduction limitation profoundly impacted many business owners and residents in high-tax states such as NJ, NY, CA, CT, and MA.

States responded by enacting pass-through entity taxes (PTETs) as a workaround to mitigate the impact of the SALT deduction limitation for the owners of pass-through entities. 36 states have enacted PTETs, making the availability of PTETs the rule rather than the exception. In theory, the utility of PTETs will cease on January 1, 2026, when the $10,000 SALT deduction limitation expires, but we anticipate that some states may retain their PTET elections in the event the SALT deduction limitation is extended or to bring AMT relief. A number of states linked their PTET rules to the TCJA rules. In the event that the TCJA sunsets, an analysis is required to determine which states will automatically continue their program versus a state that will require legislative action in order to continue their program.

Prior to making a pass-through entity election, there are several key issues that businesses need to consider:

As the economy continues to evolve, widespread remote working and state budget shortfalls have increased the focus on state and local taxes. Although telecommuting raises many concerns, some of the central issues put into focus are:

Nexus, with respect to telecommuting, is generally straightforward. An employee’s presence in a state creates nexus unless the company is engaged in activities that are protected by P.L. 86-272. For income tax apportionment, in some states, the consequence of an employee working from a different state could affect sales sourcing, payroll, and the property factor. For example, the New York City UBT (for non-corporate entities) uses cost-ofperformance sourcing, which can lower taxes if employees leave New York to telework in nearby states. Such sourcing is generally determined based on where the services are performed.

Payroll withholding also presents challenges. Most states source employee wages to the state where the employee performs the services; however, with “Convenience of the Employer” rules, such as those in New York, there is added complexity. These rules, some of which preceded the pandemic, essentially require non-resident wages to be sourced to the state’s office where the employee is assigned, even if the employee works remotely in another state. The New York Division of Tax Appeals recently upheld the state’s implementation of the convenience of the employer rule but there will likely be more litigation to come on this issue.

This could result in double withholding requirements for the employer. Some of the key issues impacting payroll withholding decisions include:

Employee mobility and telecommuting are here to stay, and businesses must adapt and plan for the many tax issues that arise.

Now that working from home has become more common, are you considering a move to another state? Perhaps to a low-tax or no-tax state? If so, you are not alone, and here are some of the things you should be considering for income tax purposes.

In order to change one’s domicile, an individual must physically move to a new jurisdiction with the concurrent intent to make the new jurisdiction their fixed and permanent home. Individuals domiciled in a state are subject to that state’s taxing authority on all their income. An individual who is required to pay tax as a nonresident in a state, even though they are domiciled elsewhere, is only subject to tax on income derived from sources originating outside his or her state of domicile (e.g., wages earned while working in a nonresident state, pass-through entity income).

Domicile is the place you regard as your permanent home — the place to which you intend to return after a period of absence (e.g., a vacation, a short-term business relocation, educational leave). As a practical matter, you can only have one domicile at any point in time, although you may have multiple residences. Once established, domicile continues until you affirmatively establish a new domicile.

Determining where an individual is domiciled requires a subjective analysis of several factors, including, but not limited to:

Additional factors demonstrating an intent to permanently move include voter registration and obtaining a driver’s license and vehicle registration in the new state. The burden of proof is upon the person asserting a change of domicile. They must maintain sufficient records to demonstrate an intention to abandon their previous domicile and establish a fixed and permanent home in a new one. Proper planning and understanding of the residency rules in the states the taxpayer is leaving and moving to are critical for individuals contemplating a change of domicile.

Additional considerations when planning a change of domicile include:

Disclaimer: No action should be taken without advice from a member of Withum’s Tax Services Team because tax law changes frequently, which can have a significant impact on this guide and your specific planning possibilities.