This year has been unusually eventful for just about everyone, not least of all payers of state and local tax. In this article, we provide highlights of some of the most important SALT developments of 2020, including:

• The Pandemic Playbook: key COVID-19 developments, including the CARES Act, tax issues created by telework, and various state-offered pandemic relief programs;
• Wayfair’s Ripple Effects: the ongoing evolution of sales tax collection rules for marketplace facilitators and remote sellers;
• More Money, More Problems: the often-unsuccessful attempts of states to raise revenues through constitutionally dubious taxes; and
• Other Notable SALT Cases: additional highly anticipated cases from Pennsylvania, Mississippi, and Texas.

Recurring themes are increasingly “creative” efforts from states to increase revenues, constantly evolving and nonuniform guidance, and the ability of business taxpayers to secure surprising wins through vigorous advocacy in courtrooms and state legislatures.

The Pandemic Playbook

The economic consequences of COVID-19 dominated SALT developments in 2020 as tax practitioners analyzed the impact of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, state reactions to pandemic-related telework, and fallout from state tax incentive programs. Highlights of these areas follow.

The CARES Act

The CARES Act, a $2 trillion economic stimulus and health care assistance package, is the largest emergency relief bill in American history. The SALT impact of the CARES Act largely turns on whether and how states conform to the Internal Revenue Code (IRC) generally and on modifications to the IRC resulting from the CARES Act.

Signed into law on March 27, the CARES Act provides key relief as the pandemic transforms the US economy. Specifically, it:

• gives direct financial assistance to distressed businesses;
• significantly expands unemployment assistance; and provides rebates directly to taxpayers (so-called stimulus checks), with eligible taxpayers receiving up to $1,200 as individuals or $2,400 if married, and an additional $500 per child.

The CARES Act also includes several taxpayer-favorable changes to core federal tax provisions that were enacted or revised by the Tax Cuts and Jobs Act (TCJA) enacted less than three years ago. The CARES Act:

• establishes a new employee retention payroll tax credit;
• permits employers to defer the payment of payroll taxes; and
• creates modifications to:
  • net operating loss (NOL) provisions under IRC Section 172, including:
    • the temporary repeal of the TCJA’s eighty percent limitation of NOLs applicable to tax years beginning before January 1, 2021;
    • the provision of a five-year carryback period for NOLs arising in 2018, 2019, or 2020; and
      changes to the TCJA’s limitations for noncorporate taxpayers to deduct excess business losses;
  • business interest limitation provisions of IRC Section 163(j);
  • bonus depreciation provisions of IRC Section 168(k);
  • excess business loss limitation provisions under IRC Section 461(l); and
  • corporate alternative minimum tax (AMT) provisions under IRC Section 53(e).

New York was the first state to respond to the CARES Act through its fiscal year 2021 budget. The budget provides for temporary static conformity to the IRC as of March 1, 2020, through January 1, 2022, which effectively decouples the state and New York City from the federal changes to IRC Section 163(j) and the three-year ratable income inclusion for coronavirus-related distributions from retirement plans. New York will not have to deal with changes to NOLs, because the state had previously decoupled from the federal NOL provisions and provides specific rules for determining carrybacks. It remains to be seen how many states will follow New York’s lead as state legislatures reconvene in the coming months.¹

SALT Implications of WFH

The large numbers of US employees forced to work from home due to the pandemic will create SALT issues for many employers, including changes in tax withholding obligations, income tax nexus, and eligibility for income tax incentives. Specifically:

• Employee withholding. As with nearly every other tax issue, states take nonuniform approaches to employee withholding requirements. Some states allow employers to retain their same withholding for employees’ temporary pandemic-related telework locations, whereas other states have issued guidance indicating that changes may be needed.² Unemployment insurance and other withholding obligations should also be considered;
• Corporate income tax. The presence of a teleworking employee can create nexus for a state to impose a corporate income tax. For example, in 2010 the New Jersey Tax Court held that a Delaware company with its principal offices in Maryland was subject to the New Jersey Corporation Business Tax because it permitted a software developer to work remotely from her New Jersey home.³ However, the pandemic has motivated the states not to impose additional tax obligations directly on corporations who are present in a state solely due to a remote worker. Indiana, North Dakota, South Carolina, and Washington, D.C., are among the jurisdictions that issued guidance that they will not assert corporate income tax nexus based on temporary pandemic-related telework arrangements; and
• Credits and incentives. Some state tax credit and incentive programs have employment targets that are now difficult or impossible for businesses to meet in the current economic climate. Companies may be able to revise incentive agreements—including avoiding clawbacks—by invoking force majeure and material adverse change clauses, which can include national disaster declarations as “triggering” events.⁴

Implicit in much of the available state guidance is the assumption that employers actually know where their remote workers are working from. Although many states are being lenient during the pandemic, we believe this period of leniency will not last forever. Employers should consider putting in place policies to monitor employees’ remote work locations.

Potential Problems With Pandemic Relief

A number of state and local governments offer pandemic relief loans and grants. Eligibility for these incentive programs varies, including the eligibility of individual locations or franchises of larger companies. Before applying for such programs, taxpayers should review whether benefit recipients are publicly disclosed and whether the potential public relations consequences of such a disclosure outweigh the benefits of program participation.

Wayfair’s Ripple Effects

Over two years after the US Supreme Court’s decision in South Dakota v. Wayfair, there continue to be noteworthy developments regarding sales tax collection obligations for transactions involving online marketplaces. Examples include:

• Inadequate sales tax definitions. A number of states have put in place statutory regimes requiring online marketplaces to collect tax on sales made by third-party vendors on the platform. However, some states have pursued marketplaces for sales tax liability prior to enactment of these “marketplace collection” laws. On January 29, the Louisiana Supreme Court found that an online marketplace was not obligated to collect local sales tax on third-party sales facilitated through its marketplace program.⁵ In Normand v. Wal-Mart.com USA, LLC, the court rejected Jefferson Parish’s position that the marketplace constituted a “dealer” under then-existing Louisiana tax law. The state subsequently enacted, on June 11, a marketplace facilitator sales tax collection law that took effect on July 1;⁶
• Locals join the party. Colorado home rule cities that collect their own sales taxes are rapidly adopting a model marketplace facilitator and economic nexus ordinance promoted by the Colorado Municipal League (CML).⁷ The CML encourages participating jurisdictions to adopt its model ordinance in conjunction with Colorado’s Sales and Use Tax System (SUTS), a state-administered single point of remittance portal poised to dramatically simplify sales tax remittance for Colorado localities; and
• New laws. Mississippi enacted its marketplace facilitator law on June 30, which has a noteworthy exclusion for third-party food delivery marketplaces that deliver food on behalf of unrelated restaurants.⁸ Meanwhile, Kansas’ second attempt to pass a remote-seller and marketplace facilitator bill failed when its special legislative session adjourned on June 4 without addressing HB 2014. Kansas, Florida, and Missouri are the only states without a marketplace facilitator collection law.

More Money, More Problems

This year featured a variety of revenue-raising measures that tested the constitutional restrictions on state and local taxing authority. Noteworthy 2020 tax expansion proposals include:

• Advertising taxes. On May 7, Maryland Governor Larry Hogan vetoed HB 732, which proposed a first-of-its-kind digital advertising tax that violated the Internet Tax Freedom Act (ITFA) by discriminating against online commerce.⁹ Similarly, on July 23, the Council of the District of Columbia voted to amend the Fiscal Year 2021 Local Budget Act of 2020 to eliminate a proposed expansion to tax advertising services and personal information.¹⁰ The business community widely opposed this tax expansion due its potential broad application and vague definitions;
• Discriminatory bank surtax. On May 8, a Washington state judge ruled that a surtax on large financial institutions violates the Commerce Clause by illegally targeting out-of-state taxpayers.¹¹ In Washington Bankers Association et al. v. State of Washington et al., King County Superior Court Judge Marshall Ferguson held that although the tax did not facially discriminate against out-of-state banks, the tax nevertheless violated the Commerce Clause because of its discriminatory purpose and effect. The legislative history for the tax revealed that lawmakers intended for the bank surtax to illegally promote local banks by taxing large financial institutions operating in interstate commerce;
• False Claims Act expansion. California lawmakers revived a previously failed proposal to amend the California False Claims Act (CFCA) to allow private parties to bring lawsuits on behalf of the state alleging tax violations, known as qui tam actions. Supporters of the bill, AB 2570, claimed that the measure would help uncover uncollected tax revenues, but these assertions were not supported by the experiences of other states. Qui tam lawsuits are ripe for abuse, because businesses will be coerced to settle or face the prospect of the CFCA’s financially devastating penalties and the legal costs associated with responding even to frivolous claims. A similar bill, AB 1270, failed last year after widespread opposition from California’s business community;
• Local voter initiatives. Another noteworthy California development is ongoing litigation regarding a recent wave of local tax initiatives passed by a simple majority of voters.¹² State courts do not agree whether the California Constitution imposes a two-thirds vote requirement for voter-initiated local taxes or whether a simple majority is constitutionally sufficient;
• Classification of gig economy workers. There is ongoing uncertainty regarding California AB 5, a bill passed in 2019 that deems many “gig economy” workers, such as rideshare drivers, as the employees (and not independent contractors) of rideshare companies. Characterizing drivers as employees will have significant tax and nontax consequences. A ballot initiative, Proposition 22, would partly roll back AB 5 and define app-based transportation and delivery drivers as independent contractors;
• City streaming taxes. On March 25, the Illinois Supreme Court declined to hear an appeal of an Appeals Court decision holding that the application of the City of Chicago’s nine percent “amusement tax” to streaming services does not violate the state constitution.¹³ The Chicago suburb of Evanston subsequently expanded its amusement tax to streaming services on June 15;¹⁴
  Virginia BPOL taxes. The Norfolk, Virginia, Circuit Court held on August 4 that the ITFA prohibits Virginia localities from imposing a business, professional, and occupational license (BPOL) tax on gross receipts from internet access.¹⁵ The court concluded that the BPOL fits squarely within the definition of a “tax on internet access” prohibited by the ITFA. The decision mirrors a similar win for the same taxpayer in Fairfax County, Virginia, last February; and
• Payroll tax. The City of Seattle Council passed a so-called JumpStart payroll tax on July 6, which applies to salaries over $150,000 for companies with more than $7 million in annual payroll taxes.¹⁶ This tax follows the enactment and quick repeal of a 2018 head tax. Seattle’s mayor, Jenny A. Durkan, returned the JumpStart ordinance without signing it, citing the cost of defending the tax against a legal challenge.¹⁷

Other Highly Anticipated SALT Cases

The final category of noteworthy 2020 SALT developments concerns anticipated cases in various arenas, including the sourcing of service receipts, agency deference, and the application of Texas’ cost of goods sold (COGS) deduction.

• Sourcing of service receipts. The Pennsylvania Commonwealth Court issued its much-anticipated decision on July 24 in Synthes USA HQ Inc. v. Commonwealth of Pennsylvania. The court upheld the Department of Revenue’s position that under the state’s pre-2014 costs-of-performance (COP) statute, service providers were required to apportion their receipts based on where customers received the benefits of the service rather than where the taxpayer incurred the costs of performing the service. In so holding, the court rejected the Pennsylvania attorney general’s position that the department’s benefits-received interpretation was incorrect and ordered the department to issue a refund to the taxpayer after determining that the benefit of the taxpayer’s service was received outside Pennsylvania. This decision may have implications for service providers with open years prior to 2014 as well as businesses with receipts from licensing intangibles, which may continue to be sourced pursuant to a COP statute.¹⁸
• Agency deference. On May 28, the Mississippi Supreme Court held that a state chancery court erred in deferring to the Mississippi Department of Revenue and Mississippi Gaming Commission’s regulatory interpretation of a Mississippi tax statute governing the computation of the state gaming license fee.¹⁹ Mississippi is one of several states that has limited or abandoned agency deference in recent years, along with Arizona, Florida, and Wisconsin.
• Texas cost-of-goods-sold deductions. On April 3, the Texas Supreme Court issued three decisions addressing the availability and scope of the COGS deduction, which may have implications for a wide range of taxpayers. The three decisions were as follows.
  • The first, and most anticipated, decision was Hegar v. American Multi-Cinema, Inc., where the court held that a movie-theater chain was not entitled to the COGS deduction related to film exhibition costs, because the exhibition of films did not constitute the sale of films.²⁰
  • In the next case, Hegar v. Gulf Copper & Manufacturing Corp., the court held that a company was not entitled to deduct COGS for its costs to survey, repair, and upgrade offshore oil-and-gas rigs for rig owners and drilling contractors, because the labor and materials were not furnished to or incorporated into the real property itself.²¹
  • Finally, in Sunstate Equipment Co., LLC v. Hegar, the court held that a heavy-construction equipment rental and leasing company was not entitled to a COGS deduction, because its delivery and pickup costs were not acquisition costs and a taxpayer may not deduct costs associated with transporting goods for sale or goods it has already sold.²²

Conclusion

This year taught all of us to expect the unexpected, including dramatic shifts in state and local taxation. As states and localities continue to react to the new economic realities of the pandemic, we anticipate additional pandemic-related guidance, new tax expansion efforts, and new attention-grabbing SALT cases in the year to come.

Jeffrey Friedman is a principal and Dennis Jansen is an associate at Eversheds Sutherland.

Endnotes

1. Generally, most states conform to the IRC through “rolling” conformity, thereby adopting the IRC as-amended, as in Maryland, Massachusetts, and Washington, D.C., or through “fixed” or “static” conformity, adopting the IRC as of a specified date, as in Florida, Georgia, and Virginia. Some states, such as Arkansas, California, Mississippi, New Jersey, and Pennsylvania, have “selective conformity,” where they conform to specific provisions of the IRC. Further, all states selectively decouple, to varying degrees, from certain IRC provisions. For example, most states do not adopt bonus depreciation under Section 168(k), and many states have separately enacted NOL rules and dividends-received deductions that differ from the IRC provisions.
2. Mississippi, New Jersey, and South Carolina issued guidance indicating they will allow businesses to retain their same withholding for employees’ temporary pandemic-related telework locations. Illinois, Minnesota, and Maryland issued guidance indicating that teleworking employees may create new withholding obligations. Further, Ohio passed legislation providing that pandemic-related remote work does not count toward the twenty-day withholding threshold for municipal income taxes.
3. Telebright Corp., Inc. v. Director, New Jersey Div. of Taxation, 25 N.J.Tax 333 (Tax 2010) (affirmed 424 N.J.Super. 384, 2012).
4. Nebraska issued guidance to this effect. Neb. Rev. Stat. Section 77-5727(9). Nebraska Department of Revenue, GIL 29-20-1 Tax Incentives: Effect of the COVID-19 National Emergency on Recapture Under the Nebraska Advantage Act (April 22, 2020).
5. Normand v. Wal-Mart.com USA, LLC, — So.3d —, No. 2019-C-00263 (2020). The authors’ firm represented Wal-Mart.com in this litigation.
6. Louisiana SB 138.
7. “CML Model Ordinance: Economic Nexus and Marketplace Facilitators,” Colorado Municipal League, accessed August 31, 2020, www.cml.org/home/advocacy-legal/Members39-Guide-to-Legal-Consulting-Services-and-Amicus-Briefs/cml-model-ordinance—economic-nexus-marketplace-facilitators.
8. Mississippi HB 379.
9. HB 732 proposed a new tax on the annual gross revenues derived from digital advertising services in Maryland. The definition of digital advertising services broadly includes “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” The tax rate varies from 2.5 percent to ten percent of the annual gross revenues derived from digital advertising services in Maryland, depending on a taxpayer’s global annual gross revenues. To be required to pay the tax, a taxpayer must have at least $100,000,000 in global annual gross revenues and at least $1,000,000 in annual gross revenues derived from digital advertising services in Maryland. Determining whether digital advertising taxes are “in Maryland” is problematic. The final version of the tax used an undeveloped apportionment fraction to apportion the tax to Maryland. The legislation directs the comptroller to adopt regulations that will entirely determine how to source digital advertising service revenues to the state. The proposal mirrors European taxes that are opposed by the federal government, compounding the constitutional issues with this bill.
10. Unlike HB 732, D.C.’s proposed tax would have expanded the sales tax base instead of adopting a separate tax on gross revenues from digital advertising services. The act’s advertising service sales tax would have applied to all advertising services, including “digital advertising services,” which were defined as “[a]dvertising services related to advertisements displayed on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, or other comparable advertising.” Advertising services would have been subjected to a reduced rate of three percent instead of the general six percent sales tax rate. The proposed Budget Support Act would have also expanded the sales tax to personal information at the same reduced three percent sales tax rate. “Personal information” is defined as “information or data that is derived from a person that identifies, relates to, describes, or is capable of being associated with a particular person.”
11. Washington Bankers v. Washington, No. 19-2-29262-8 (Wash. Sup. Ct. King Cty. 2020).
12. Article XIII C, Section 2(d) of the California Constitution provides that “[n]o local government may impose, extend, or increase any special tax unless and until that tax is submitted to the electorate and approved by a two-thirds vote.”
13. Labell v. City of Chicago, 144 N.E.3d 1175 (Table) (2020).
14. Evanston Ordinance 55-O20 (2020).
15. Cox Commc’ns Hampton Roads, LLC v. City of Norfolk, No.: CL19-4764 (Va. Cir. Ct. Aug. 3, 2020).
16. Seattle Council Bill 119810, Ord. 126108 (2020).
17. Letter from City of Seattle Mayor Jenny A. Durkan to Monica Martinez Summons, Seattle City Clerk (July 31, 2020).
18. The Pennsylvania legislature amended the COP statute to expressly require a market-based sourcing methodology effective as of the 2014 tax year.
19. HWCC-Tunica, Inc. / HWCC-Tunica, LLC v. Miss. Dep’t of Revenue and Miss. Gaming Comm’n, Dkt. No. 2019-CA-00336-SCT (Miss. May 28, 2020).
20. Hegar v. American Multi-Cinema Inc., No. 17-0464 (Tex. Apr. 3, 2020).
21. Hegar v. Gulf Copper & Manufacturing Corp., No. 17-0894 (Tex. Apr. 3, 2020).
22. Sunstate Equipment Co., LLC v. Hegar, No. 17-0444 (Tex. Apr. 3, 2020).