For the second year in a row, uncertainty about legislation and court decisions affecting state and local tax laws complicated auditing firm Grant Thornton’s outlook on state and local taxation issues. This year, however, the economic crisis added yet another element of uncertainty to its review of 2008 state and local tax rulings — many of which are unfavorable to taxpayers.
“The economic situation has the potential to drive many policy decisions that will profoundly affect multistate taxpayers,” the Grant Thornton report states. The following are the firm’s top ten notable areas of controversy in state and local taxes during 2008:
1) The U.S. Supreme Court weighed in on two unitary business rule cases in 2008. First, it help set the definition of a unitary business in MeadWestvaco v. Illinois Department of Revenue, saying that the company and its unit, Mead and Lexis, were not unitary businesses and therefore Mead didn’t have to pay taxes on the sale of Lexis to the state of Illinois, where Lexis is located. In a Kentucky case, the court ruled that states can base taxation of interest accrued on state bonds on the location of the issuer of the bonds.
2) A number of new state and federal tax laws have reduced the uniformity between state tax laws. The federal Economic Stimulus Act, for one, changed a federal tax deduction in ways that make depreciation taken on eligible property inconsistent from state to state.
3) In addition to the Mead case, a number of significant cases around the U.S. addressed the definition of unitary businesses. In a case in Alabama, for example, it was decided that just because two entities of a corporation are in the same general lines of business, unity is not necessarily proved.
4) Related-party transactions were in the spotlight this year, as taxpayers challenged various statutes. Wisconsin, for example, became the first state to address rental transactions.
5) In a case in Maryland’s tax court, the ruling was that tax deductions between a parent with Maryland nexus, and a subsidiary, can be revoked if the subsidiary doesn’t have “economic substance.”
6) New York state passed a provision with implications for “remote sellers” doing business via the Internet, amending the definition of a vendor. Now, Internet retailers that push New York web site owners to advertise for them, in return for a commission on sales, will be considered vendors. And if the retailer’s New York sales exceed $10,000 a year, the retailer will be presumed “doing business” in the state and subject to charge sales tax on all sales in the state.
7) The sale-and-use tax on software has always differed from state to state. In Wisconsin this year, a state Supreme Court case decided that the plastics, packaging, and paperboard company Menasha Corp. should qualify for a $342,000 tax refund for the purchase of SAP business software, because under the regulation software that is made exclusively for one customer is exempt from sales and use tax.
8) Massachusetts joined a list of states that have adopted combined reporting for corporations that are engaged in unitary business operations. The law also reduced corporate and financial services tax rates, modified tax rates for large S corporations and aligned the state with federal check-the-box rules.
9) As a way of gathering information and measuring the potential revenue impact from proposed changes to Maryland’s corporate income tax law, that state enacted legislation that requires members of corporate groups to file extensive electronic-format disclosures with the state’s comptroller for the next five tax years. The state also enacted a $5,000 a day penalty for late filers and has imposed numerous penalties in an effort to get groups to pay compliance.
10) Several state tax changes were made this year in California, which is battling a budget crisis. The state suspended the use of net operating loss deductions and carried over California NOL deductions for 2008 and 2009. The state also passed an underpayment penalty of 20 percent that would be applied to companies that underreport income or overstate deductions of $1 million or more.