Multistate Tax Update: October 29, 2015

New York: Draft amendments issued on rules for the franchise tax on general business corporations

The New York Department of Taxation and Finance (New York Department of Tax) issued draft amendments to the Business Corporation Franchise Tax Regulations which incorporate changes made by tax reform legislation contained in the 2014-15 and 2015-16 New York state budgets.

Significant tax reform in 2014-15

The New York Department of Tax characterized New York’s 2014-15 budget as the “most significant reform of its corporate tax system since the 1940s,” much of which is effective for the tax years beginning Jan. 1, 2015. The 2015-16 budget, enacted on April 13, 2015, contains technical and clarifying amendments to the corporate tax reform statute enacted in 2014, which are also effective for tax years beginning on or after Jan. 1, 2015.

One critical matter that the reform achieved was to impose the same rules on banks and financial institutions that offer equivalent services and perform comparable functions. Prior to this, these entities were taxed under different sections of the tax code, a system that had fallen out of step with changes in the financial services industry that allowed such firms to offer the same services.

Another feature of the reform was the elimination of impediments to locating or expanding a business in New York state. This was intended to encourage companies to capitalize on New York’s highly educated and creative workforce, and robust technology infrastructure, without increasing their tax burden. In recognition of the shift to a service and knowledge-based economy, the reform adopted a comprehensive market sourcing approach for state income taxes.

Corporate tax reform draft regulations

In an effort to incorporate these and other changes, the New York Department of Tax has crafted regulatory amendments that it will post to its website for public comment prior to their formal proposal and adoption.

In particular, on Oct. 15, 2015, the New York Department of Tax released draft amendments to two sections of the New York state corporate franchise tax regulations: Receipts from Sales of Digital Products and Receipts from Other Services and Other Business Activities.

With respect to both, the drafts set forth a list of principles and standards for identifying the source of such receipts, defines terms, and provides numerous examples of how to source receipts under a wide variety of circumstances. Public comments are due by Jan. 16, 2016.

Last month, the New York Department of Tax issued draft regulations addressing circumstances under which a firm is subject to the franchise tax by way of corporate nexus. Nexus refers to whether an entity has sufficient physical ties to a state to justify imposing certain taxes on it. Comments are due by Dec. 3, 2015.

Michigan: Revenue bulletin offers guidance on apportionment for sales of services

For corporate income tax purposes, the Michigan Department of Treasury allocates 100 percent of a taxpayer’s tax base to the state when that firm’s business activities are confined solely to Michigan. However, for those taxpayers that have business activities subject to taxation both inside and outside the state, the department apportions the tax base solely based upon a sales factor. The sales factor is a fraction: the numerator is total sales inside Michigan, and the denominator is all sales, both in and outside of Michigan.

To help taxpayers determine where the recipient of services receives the benefit of those services when calculating the apportionment sales factor, the department has recently released guidance by way of Revenue Administrative Bulletin 2015-20.

With respect to the numerator computation, if the recipient of the services receives all of the benefit of the services in Michigan, then all receipts from the performance of services are included in the numerator of the apportionment factor.

On the other hand, if the recipient of the services receives only some portion of the benefit of the services in Michigan, then receipts are included in the numerator of the apportionment factor in proportion to the extent that the recipient receives the benefit of the services in Michigan.

To make this determination, the bulletin sets forth several guidelines for both scenarios. All the benefit of a service is received in Michigan if any of these scenarios apply:

1. The service relates to real property that is located entirely in Michigan.
2. The service relates to tangible personal property that is owned or leased by the purchaser and located in Michigan at the time that the service is received or is delivered to the purchaser or the purchaser's designee(s) in Michigan.
3. The service is received in Michigan and provided to a purchaser who is an individual physically present in this state at the time that the service is received.
4. The service is received in Michigan and is in the nature of a personal service, such as consulting, counseling, training, speaking, and providing entertainment, that are typically conducted or performed first-hand, on a direct, one-to-one or one-to-many basis.
5. The service is provided to a purchaser that is engaged in a trade or business in Michigan and relates only to the trade or business of that purchaser in Michigan.
6. The service relates to the use of intangible property such as custom computer software, licenses, designs, processes, patents, and copyrights, which is used entirely in Michigan.

In contrast, if the recipient of the service receives only a portion of the benefit of the service in Michigan, then the receipts are included in the apportionment factor in proportion to the extent that the benefit of the service is received in Michigan. Thus, here are the guidelines taxpayers should use to correctly apportion a service where the recipient of the service receives only a portion of the benefit of the service in Michigan:

1. If the service relates to real property that is located in this state and in one or more other states, the benefit of the service is received in Michigan to the extent that the real property is located in Michigan.
2. If the service relates to tangible personal property that is owned or leased by the purchaser and located in this state and in one or more other states at the time that the service is received or is delivered to the purchaser or the purchaser's designee(s) in this state and in one or more other states, the benefit of the service is received in Michigan to the extent that the tangible personal property is located in Michigan, or is delivered to the purchaser or the purchaser's designee(s) in Michigan.
3. If the service is provided to a purchaser that is engaged in a trade or business in Michigan and in one or more other states, and the service relates to the trade or business of that purchaser in this state and in one or more other states, the benefit of the service is received in Michigan to the extent that it relates to the trade or business of the purchaser in Michigan.
4. If the service relates to the use of intangible property such as custom computer software, licenses, designs, processes, patents, and copyrights, which is used in Michigan and in one or more other states, the benefit of the service is received in Michigan to the extent that the intangible property is used in Michigan.

A taxpayer is free to choose the method for apportioning the benefit of a service between Michigan and one or more states, as long as it is “reasonable and appropriate in light of all existing facts and circumstances,” applied uniformly and consistently, and that the taxpayer’s records support its methodology, among other things.

The bulletin lays out numerous illustrations to show how these guidelines apply.

Finally, the bulletin states that if a receipt from the sale of services is not addressed by a specific statutory subsection, then the receipt is sourced based on where the benefit to the customer is received or, if where the benefit to the customer is received cannot be determined, to the customer's billing address.

California: Officials audit claims of head of household status

More than 15 percent of Californians claim to be head of household on their tax documents. A head of household (HOH) is an unmarried taxpayer who cares for a child or other relative for more than half of a year, and covers more than half of the household’s annual costs.

In a recent press release, the California Franchise Tax Board (CFTB) announced that it will be contacting approximately 83,000 taxpayers who claimed the head of household status on their 2014 tax returns, seeking justification of the designation. The rules about the HOH status are strict, because it entitles the taxpayer to a higher standard deduction than either the single or married/registered domestic partner (RDP) filing separately filing status, which can dramatically lower one’s overall tax rate.

The audit is part of the CFTB’s normal, annual filing status review. To this end, the CFTB is sending letters asking those who declared HOH status to review their 2014 income tax return to make sure it is correct. The letter contains 11 questions, along with numerous steps to assist with relevant determinations, such as marital status and identification of a “qualifying person” that qualifies a taxpayer as a HOH, among other things.

A taxpayer is entitled to the HOH filing status only if all of the following apply:

• The taxpayer was unmarried and not an RDP, or met the requirements to be considered unmarried or considered not in a registered domestic partnership, on the last day of the year.
• The taxpayer paid more than one-half the costs of keeping up his or her home for the year.   
• The taxpayer’s home was the main home for him or herself and a qualifying person who lived there for more than half the year.
• The qualifying person was related to and met the requirements to be a qualifying child or qualifying relative.   
• The taxpayer was entitled to a dependent exemption credit for his or her qualifying person. However, the taxpayer does not have to be entitled to a dependent exemption credit for one’s qualifying child if one was unmarried and not an RDP, and the qualifying child was also unmarried and not an RDP.   
• The taxpayer was not a nonresident alien at any time during the year.

The press release cautions taxpayers that those who do not qualify as heads of household may be required to pay more. Additionally, taxpayers who do not respond will have their tax liabilities recalculated and may be charged a penalty.