2010 State and Local Tax Legislative Update

With the close of the 2010 calendar year approaching, states are still looking for ways to minimize budget deficits. What measures did states take during 2010 to close their budget gaps and what can taxpayers expect to see in 2011? This article highlights some of the changes we saw in 2010 with a look ahead to some of the trends we expect to see in 2011.

Corporate Income/Franchise Tax

The root of state taxes relies on the existence of nexus or a taxable presence. States continually attempt to expand the definitions of nexus in an effort to increase their tax base. Within the last few years concepts of economic, affiliate, and agency nexus developed and started to spread throughout the country. Among these concepts, economic nexus is the most common. Some states adopt this standard for income, franchise, and gross receipts tax purposes. For example, Michigan, Ohio, and Washington now apply an economic nexus standard for purposes of their gross receipts taxes. Similarly, Oregon and Wisconsin also apply economic nexus standards for corporate income/franchise tax purposes. More recently, Colorado and Connecticut revised their corporate income/franchise tax laws to include economic nexus for tax years beginning on or after January 1 of this year. Finally, California will apply an economic nexus standard effective for tax years beginning on or after January 1, 2011. Thus, many states are clearly seeking opportunities to expand their tax bases by adopting broader nexus standards–a trend we expect to continue during 2011.

With the economic recession and added pressures on state budget deficits, we also witnessed many states turn to changes in filing requirements in order to generate additional revenue. One recent trend is the transition from separate filing to a mandatory combined filing for members of an affiliated group. For example, Massachusetts, West Virginia, and Wisconsin are the most recent states to change their filing methodologies and require combined filing. Other states such as Connecticut, Florida, Missouri, New Mexico, North Carolina, Pennsylvania, Rhode Island, and Tennessee proposed bills to enact required combined reporting. We also expect to see more states consider this approach in an effort to increase their tax bases during 2011.

Throughout the last few years, many states began moving toward adjusting apportionment formulas in order to shift the tax burden to out-of-state businesses and create additional revenue. While several states revised their tax laws to reflect the double-weighting of the sales factor, the movement toward adopting a single-sales factor apportionment formula is the trend we expect to continue in 2011. The following is a summary of some of the states that already adopted a single-sales factor formula:

  • Indiana and Minnesota both began phasing in a single-sales factor formula on January 1, 2007. This will be fully phased in on January 1, 2011, and January 1, 2014, respectively;
  • Georgia adopted a single-sales factor for tax years beginning on or after January 1, 2008;
  • Colorado adopted a single-sales factor for tax years beginning on or after January 1, 2009;
  • this year, Utah passed legislation to enact the phase-in of a single-sales factor formula which begins in 2010 and is expected to be fully completed by January 1, 2013; and
  • for tax years beginning on or after 2011, California is allowing an irrevocable single-sales factor election for certain taxpayers.

As states continue to do their best to close their budget deficits, we expect to see many states look for other ways to increase revenue. For example, some states will likely look to establishing gross receipts taxes such as Michigan’s Business Tax which includes both an income and gross receipts tax component. We may also see more states suspending or temporarily disallowing certain tax credits and/or incentives. These measures could include suspending the use of net operating losses, decoupling from certain federal provisions, revising state credit and incentive programs, or making modifications to minimum taxes (as Oregon had done in 2009 when it changed from a flat minimum tax to a minimum tax based on gross receipts).

State Sales and Use Tax

State sales and use tax issues continue to develop as the consumer market evolves. States will likely look to make changes in this area to raise additional revenue. Over the last few years, advances in technology changed the way companies do business. These changes present unique challenges to states in determining how to tax these new products and services. As a result, many states recently changed their laws to impose sales/use tax on digital products and services. For example, North Carolina, Washington and Wisconsin recently enacted state laws to address the taxation of digital products/services, yet another trend we expect to continue to evolve in 2011.

One of the more recent changes we witnessed in the digital world is a move toward “cloud computing.” Cloud computing allows companies to use the technology infrastructure of another company by renting space on the “cloud.” Examples of large cloud providers are Amazon, Microsoft, Google, and AT&T. These companies provide access to business applications online and store their software and data on the cloud provider’s servers. These emerging business models will continue to create uncertainty with respect to the application of sales tax and we expect to see a lot of change and controversy in this area. Many states that do not currently address the taxation of digital products and services could soon revise their laws accordingly in an attempt to increase revenue and balance their budgets.