The top 10 SALT issues for 2023

February 16, 2023 9:00 AM

Major issues in the world of state and local tax continue to reflect the past, such as government response to COVID, the Supreme Court decision in Wayfair, and the Tax Cuts and Jobs Act. Some of last year's major concerns continue to apply today, including topics such as remote workers, pass-through entity taxes, and states' reaction to the tax mandate in the American Rescue Plan Act,. Meanwhile, new topics have appeared to concern practitioners.

With the belief that the best approach to dealing with challenges is to know in advance what they are, each year Jamie Yesnowitz, state and local tax leader at Grant Thornton's Washington National Tax Office, prepares a set of issues believed to be most important during the year ahead. Yesnowitz and his team are coming off a year in which well over half of their predictions from last year were fulfilled.

The following are their predictions for 2023.

1. PTE taxes

"Over the past couple of years, most states have addressed the $10,000 SALT deduction limitation through the adoption of pass-through entity taxes," observed Yesnowitz.

These taxes permitted a PTE to deduct its state and local taxes as a tax on the business at the federal level, followed by a deduction for the PTE tax on the distributive share of the owners' income. Depending on the structure of the PTE tax, owners typically claim a corresponding tax credit against their personal income tax liability or an exclusion on the portion of the owner's pass-through income tax.

Prediction: Although the pace of adoption has slowed, Yesnowitz and his team predict that two to four additional states will adopt PTE tax regimes in 2023.

2. Tax collection seesaw

"State budgets were in a really good spot in 2022, but there are potential indicators that this may not last," said Yesnowitz. "Economic headwinds are beginning to blow and the specter of an economic recession during 2023 looms. The changing economy may produce large fluctuations in state tax collections during the year, and so we expect a lot of variation in state approaches to general revenue in 2023."

Prediction: The GT team predicts that while income tax relief will continue, with at least four additional states deciding to lower corporate and/or personal income taxes in the form of rate reductions and/or phaseouts, at least three additional states will act to raise revenue through "sin tax" legislation such as the taxation of sports betting and/or recreational marijuana.

3. ARPA tax mandate litigation

President Joe Biden signs the American Rescue Plan in the Oval Office.

Doug Mills/Bloomberg

Since it was passed as part of the American Rescue Plan's COVID aid package, the tax mandate, also known as the tax cut ban, has been challenged by a number of states. The act restricts states that receive federal aid from using the funds to "either directly or indirectly offset a reduction in the net tax revenue."

A number of cases that considered the merits found for the states, finding the provision to be unconstitutional. Several cases decided that the states lacked standing to sue. The ARPA tax mandate litigation is reaching a critical juncture, Yesnowitz believes, with courts reaching inconsistent conclusions in several jurisdictions.

"Notably, the uncertainty resulting from when the tax mandate provision serves to prevent a tax cut has not stopped states from going forward with plans to reduce taxes over time," said Yesnowitz. "At the same time, it is clear that the Treasury Department plans to continue litigating in support of the guidance that it has provided on this subject to date. The challenge between the states and the federal government is precisely the situation for which the ultimate judicial arbiter should weigh in."

Prediction: Yesnowitz and his team predict that the U.S. Supreme Court will grant review of at least one of the ARPA tax mandate cases to resolve the split between federal appeals courts over whether states have standing to challenge the tax mandate and determine the constitutionality of the tax mandate.

4. Continuing Maryland digital advertising tax litigation

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A Maryland county circuit judge held last year that the state's digital advertising tax is unconstitutional. The decision found that it violated the Constitution's prohibition on state interference with interstate commerce, and also violates the Internet Tax Freedom Act, since it discriminates against electronic commerce.

All signs lead to the Maryland Supreme Court being the court of last resort with respect to whether this tax will be revived. The Maryland attorney general most recently filed a direct appeal with the Maryland Supreme Court, arguing that the state trial court judge wrongly accepted the case and ruled on a constitutional issue because the plaintiffs had not first objected through the state's administrative appeals process.

"While the state's high court considers the matter, potentially impacted companies are still somewhat uncertain as to how to comply with a tax that is on the books, with adopted regulations, forms and the like, but has been stricken by a court," said Yesnowitz.

Prediction: They predict that the invalidation of Maryland's digital advertising services tax will be upheld by the Maryland Supreme Court, stalling any other state attempts to enact similar taxes.

5. Sales tax inventory nexus litigation

Thorsten Wagner/Bloomberg

A growing number of states have asserted "inventory nexus" for remote sellers in the Fulfillment by Amazon program, prior to the Wayfair decision and the enactment of marketplace facilitator laws. Under the program, goods of remote sellers may be temporarily stored without the retailer's knowledge in an intermediate state on their way to the ultimate customer.

States such as California, Pennsylvania and Washington have begun assessing nexus, and sales tax collection and remittance obligations on such remote sellers, who have brought several lawsuits challenging the practice. In one case the suit was held to be barred by the federal Tax Injunction Act, and the dismissal was upheld by the Ninth Circuit. The first court to rule on the merits, a Pennsylvania appellate court, held that Pennsylvania failed to establish that FBA sellers had sufficient minimum contact with the state under the Due Process Clause to mandate collection and remittance of sales tax.

Prediction: Given that other courts are likely to reach varying conclusions on pending inventory nexus cases around the country, Grant Thornton predicts that two to four additional federal or state court decisions will be issued addressing sales tax inventory nexus issues on the merits, with a split developing across jurisdictions as to whether the practice satisfies due process.

6. State adoption of revised P.L. 86-272 guidance

P.L.86-272 provides taxpayers with immunity from state income taxes when their connections within a state are minimal or solely related to solicitation of sales of tangible personal property. The Multistate Tax Commission's revised statement on the legislation has generated controversy due to its position on internet business activities narrowing the protection of the law in many cases. Both California and New York have adopted the MTC's position.

Prediction: Yesnowitz's team predicts that two or three additional states will adopt the MTC's revised statement providing that various activities conducted via the internet exceed P.L. 86-272 protection through regulation or administrative action.

7. Reactions to previously planned changes in TCJA

Given the Tax Cuts and Jobs Act's dramatic and shifting effect on state corporate income tax bases, states will need to closely consider and reevaluate how they conform to the act's most significant provisions.

Prediction: Grant Thornton's experts predict that states will react to these TCJA changes as follows:
1. At least two more states will provide for permanent 100% bonus depreciation in light of the planned federal reduction in this benefit;
2. At least two states will reposition their conformity policy on the IRC Section 163(j) limitation to either decouple from the change in the interest limitation calculation, or completely decouple from the limit; and,
3. In the absence of federal legislation extending more beneficial provisions relating to IRC Section 174 at least two more states will effectively extend such provisions.

8. Inflation and an uncertain economic environment

In response to inflationary pressures, many retailers are looking for ways to pass along some of their higher costs to consumers. Recent guidance from the South Carolina Department of Revenue addressed the sales tax treatment of inflation fees, convenience fees and non-cash adjustment fees added to customer invoices or receipts to recover some of their increased costs.

Prediction: In response to inflation and additional fees imposed in the post-COVID environment, Grant Thornton predicts that at least four more states will issue guidance on the sales tax treatment of these types of fees.

9. Remote work tax policy

Maintaining a team feeling while working remotely blog image

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Remote work continues to foster complexity for employers regarding income tax withholding, nexus and apportionment considerations. For example, New York's aggressive enforcement of the convenience of the employer rule [under which employees that work in one state but remotely perform their work in another state are subject to tax on their wages in the state where their employer's office is located] has added effect in the current environment in which out-of-state employees may no longer be required to regularly commute into a New York office. As a result, border states like New Jersey are evaluating potential legislative responses.

Prediction: Considering the increasingly detrimental revenue effect on states that border convenience states, Yesnowiz and his team predict that at least two states will enact legislation or propagate regulations to address income tax withholding rules in response to a bordering state's enforcement of a convenience rule.

10. Novel sales tax collection approaches and sales tax on novel products

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Last year, Colorado adopted a retail delivery fee on certain motor vehicle deliveries to Colorado locations. Despite confusion over administration, other states are likely to consider similar fees. Moreover, there is a growing focus on taxing new types of products. For example, the dramatic increase in the market for NFTs has sparked interest by states seeding to impose sales and use tax.

Prediction: GT's experts predict that at least two states will propose retail delivery fees, but no states will enact this type of fee in 2023. And at least three states will provide regulatory or administrative guidance on the treatment of NFTs for sales and use tax purposes.