The past couple of years have brought dramatic change to the Tax landscape. With the enactment of Federal Tax Reform and the Wayfair decision, the impact on the state and local tax function continues to be far-reaching. Here are three major state tax issues companies will have to address in 2020, along with suggested considerations:
Over the past two years, companies have tackled the threshold matters of state conformity, applicability of deductions, and initial year reporting. Still, there are next-level issues taxpayers will have to address in 2020, including:
With the taxation of foreign income through IRC Section 965 and GILTI and the 100% federal deduction for most foreign dividends under IRC 245A, companies are likely to see more distributions to the US from foreign subsidiaries. The expected tax-free federal result may not always translate the same for state tax purposes.
Federally, a distribution may qualify as excluded when it is previously taxed earnings and profits (PTEP) (for example, if taxed as Section 965 or GILTI income). If a state did not conform to either Section 965 or GILTI, such distributions may not be considered PTEP and may be subject to state tax. Further complications can arise as distributions move through a company’s multi-tiered structure.
Alternatively, a distribution may simply be a federally deducted foreign dividend under IRC Section 245A. If so, a state’s conformity to Section 245A or the applicability of a state specific deduction will have to be explored to determine whether the amount is subject to state tax.
Companies will experience the same federal and state tax differences around basis determinations for states that don’t adopt Section 965 or GILTI. Whether states follow the federal consolidated return regulation(s) treatment adds another layer of complexity.
Data reporting and analytics are crucial in this area in order to track different federal and state E&P and basis amounts for all of a company’s affiliates. Additionally, actual foreign cash distributions to US entities may not flow through to Schedule C and page 1 of the federal return, which further complicates the tracking and related state implications resulting from those items for state tax purposes. An understanding of the company’s underlying reporting is needed to fully understand the consequences of foreign distributions for state tax purposes.
The IRC Section 163(j) interest limitation is a complicated calculation that may vary for a taxpayer among states depending on whether reporting is on a separate, combined, or consolidated basis. Data and analytic solutions, including modeling, will help companies track the limitation amount, carryovers, and the applicability of interest addback in order to properly report the state tax impact of Section 163(j).
Other federal tax reform items continue to create complexities for state taxes, including GILTI, FDII, NOLs, Sec. 168(k), and opportunities zones. Businesses will have to continue monitoring and analyzing federal and state developments in these areas.
The Wayfair decision ushered in a new era of no “physical presence” under the Commerce Clause substantial nexus requirement. The Court found that sales tax “nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State.” While the Court remanded for further findings on the constitutionality of economic nexus (and the parties ultimately settled), it found the South Dakota law at issue in the case “includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce.” Among these features is a nexus standard premised on having more than $100,000 of in-state sales or 200 or more transactions for delivery into the state.
Other states have been quick to act following the Supreme Court’s decision. Now, forty-two of the 45 states imposing state sales and use taxes, plus the District of Columbia, have adopted similar (although varying) thresholds. In addition, 39 of these states have adopted “marketplace facilitator” provisions requiring certain transaction facilitators to collect and remit the tax.
As a result, out-of-state sellers must determine whether they have a collection and remittance responsibility based on preexisting state law seeking to apply the physical presence test (such as “click-through” and inventory nexus) as well as the new, varying economic nexus thresholds. Further, sellers must determine whether they have liability or risk resulting from undercollection or overcollection of taxes by marketplaces (which are a ubiquitous feature of commerce for today’s multichannel sellers). Purchasers are already seeing increased vendor errors resulting from this new and complex sales and use tax collection environment.
Data and analytics are a key to dealing with this challenging environment, from determining where nexus arises to meeting ongoing compliance requirements. An important consideration for choosing the right tools and processes is transparency. For example, does the solution provide the ability to see how information is flowing through to returns throughout the compliance cycle? Automating the compliance process allows employees to engage in value-added activities with specific emphasis on spending more time with the business from an operational perspective. Further, visibility into the compliance process allows for analysis and ultimately provides cost savings.
The current environment, while challenging, also presents an opportunity to consider ways to transform a company’s indirect tax function into a strategic business asset. Determining the right systems and technology, building a process and controls framework, and developing a people strategy and key performance indicators can produce a technology-enabled, indirect tax ecosystem ready to meet changing indirect tax requirements, both in the US and globally.
The trend around economic nexus is not limited to sales tax. Some states incorporated a sales factor presence standard for corporate income tax purposes prior to Wayfair. However, following Wayfair we’re already seeing new states adopt economic nexus for corporate income tax purposes, and we expect that trend to continue.
The implications aren’t just for nonfilers. An entity that’s part of a combined group in a “Joyce” state may have traditionally not included sales in group apportionment factors if it took the position that it wasn’t independently subject to tax in the state. Companies may have to evaluate their positions in light of an economic nexus standard.
Taxpayers also shouldn’t forget about P.L. 86-272 protections. If economic nexus threatens to bring a taxpayer into the taxing jurisdiction of a state, qualifying under P.L. 86-272 could result in the taxpayer not being subject to state tax.
Successful organizations adapt to change by anticipating and acting – rather than just reacting. State tax functions should act by recognizing the trends and challenges expected in 2020 and work to identify solutions today.