On September 19, 2023, the Maryland Comptroller issued a letter to tax practitioners acknowledging a major deficiency in the agency’s process in accurately processing the income tax returns of pass-through entity (PTE) owners claiming refundable tax credits paid on their behalf by underlying PTEs doing business in Maryland.
A PTE is a subchapter S corporation, partnership, or limited liability company that is treated as a partnership for federal income tax purposes. PTEs are not directly subject to income tax at the entity level for federal, nor Maryland, income tax purposes but rather their owners are subject to tax based on their pro rata share of PTE taxable income. One exception for Maryland income tax purposes is the ability for a PTE make a pass-through entity tax (PTET) election to pay tax on behalf of all residents (domiciled) and nonresident (nondomiciled) owners by filing of Form 511, Electing Pass Through Entity Income Tax Return. In the case of nonresident individual owners included in a PTET election and filing, their share of Maryland PTE income tax liability is paid on their behalf in lieu of any required nonresident withholding or the filing of a composite income tax return on their behalf.
All owners are allocated refundable credits for their pro rata share of Maryland PTET filed and paid on their behalf to be applied against their state sourced PTE taxable income claimed on their respective Maryland income tax returns.
For the last 18 months, there have been widespread errors and delays in the processing of Maryland PTE owners’ state individual income tax returns claiming their share of PTET Refundable Credits as an offset against their respective state tax liabilities resulting in either—
- ▪ long delays in the receipt of refunds for excess Credits exceeding their calculated tax liability, or
- ▪ the issuance of erroneous underpayment assessment notices reflecting tax due attributable to the owner’s share of Refundable Credit paid on their behalf not being applied against their tax liability.
The Comptroller’s Letter acknowledged these problems have been attributable to staff shortages and outdated technology to where more than 176,000 PTET returns for the 2021 tax year are being or have been processed with needed validation of the refundable credits claimed in comparison to estimated payments made coupled with the individual PTE owner claiming the proper amount of such credit. In the letter, the Comptroller conceded that agency’s lack of automation and the large value of these credits has resulted in the need to conduct manual validations of such credits claimed.
The Comptroller’s Letter provides the following actions and long-term solutions to address this issue:
- ▪ A team of revenue agents has been trained to solely focus on validating and resolving PTE returns to handle practitioner calls to quickly implement account adjustments.
- ▪ Income tax assessments notices for taxpayer underpayments have been temporarily stopped until their validation process yields a higher accuracy rate; however, notices will continue to be generated to notify taxpayers when the refundable credit cannot be granted in the event the PTE has not paid the PTET in full.
- ▪ Tax practitioners are encouraged to file Maryland PTET returns, and the PTE individual owners are encouraged to apply the eight steps in submitting such filings to ensure a faster and more accurate process in applying the refundable credits to their Maryland personal income tax returns.
- ▪ In the long term, the Comptroller has commenced a multi-year tax processing replacement project; however, the personal income and PTE components will not be live in the next two years. The agency is also assessing a parallel robotic processing automation tool to eliminate the need for manual handling of the validation process.
Although not addressed in the Comptroller’s Letter, nonresident individual taxpayers and their preparers have also experienced similar widespread errors and delays associated with the filing of Maryland Form 510, Pass-Through Entity Income Tax Return, along with the state nonresident individual income tax returns of their owners. These errors and delays involve Maryland nonresident withholding not being properly applied on their behalf by PTEs against their state personal income tax liabilities, despite the inclusion of all proper documentation with their filings.
In light of the Maryland Comptroller’s acknowledgment of delays and errors associated with the proper crediting of state nonresident withholding or PTET paid against an individual income taxpayer’s Maryland tax liability, CPAs should consult any impacted clients.
Governor Phil Murphy recently signed into law New Jersey’s fiscal year budget bill AB 5669, alongside AB 5323, enacting substantial amendments to the New Jersey Corporate Business Tax (CBT) laws, namely by modifying the Corporate Business Nexus Standards for the state. (Note there was an identical companion bill, SB 3737.) The bill made substantial changes to New Jersey’s economic nexus rule for corporate income tax purposes by copying its economic nexus thresholds used for sales tax purposes.
In a recently released administrative pronouncement (TB-108, issued Sep. 5, 2023), the New Jersey Division of Taxation provided details regarding its new bright-line nexus standards and updated its Public Law (PL) 86-272 guidelines. (In brief, PL 86-272 is a federal law that essentially protects outof-state companies from income-based taxes by states where their only activity is soliciting orders of tangible personal property. The protections do not apply to services.) All of these new guidelines are effective for tax years ending on or after July 31, 2023.
Bright-line economic nexus standard.
Under New Jersey’s new bright-line nexus rules, a business is deemed to have substantial nexus and be subject to the CBT when a corporation—
- ▪ derives receipts from New Jersey sources in excess of $100,000 during the corporation’s fiscal or calendar year; or
- ▪ has 200 or more separate transactions delivered to customers in New Jersey during the corporation’s fiscal or calendar year. For any transaction that is a service transaction, “delivered to a customer” shall mean where the benefit is received under New Jersey’s market-based sales factor sourcing rule, the pronouncement states.
These bright-line nexus thresholds apply regardless of whether a corporation files as a single filer or as a member of a New Jersey combined group. Note also, “for corporate partners that are unitary with a partnership that has New Jersey receipts or transactions with New
Jersey customers, the corporate partner will have nexus with New Jersey if the corporate partner’s proportionate share of the partnership’s activities in New Jersey satisfy the bright-line economic thresholds,” the pronouncement states.
PL 86-272 ‘protected activities.’
The updated guidelines clarify the application of PL 86-272 protections, which generally state that if a corporation’s only business activity within the state consists of the solicitation of orders by the corporation or its representatives of tangible personal property, then there is no obligation to file corporate income tax. The new guidance states that for New Jersey, “Even though a corporation’s activities may be protected by PL 86-272, if it is registered or otherwise has nexus in New Jersey, it is subject to the Corporation Business Tax minimum tax and must file a Corporation Business Tax return.”
The guidance also provides a non-exhaustive list of activities that New Jersey deems to exceed the protections offered under PL 86-272. This guidance aligns with the Multistate Tax Commission’s (MTC) guidelines on protected activities, namely identifying several Internet-based activities that are not protected under PL 86-272, among them:
- ▪ Soliciting credit cards and other financial products and services to New Jersey customers
- ▪ Offering, soliciting, selling, accepting, or buying of digital assets (i.e., virtual currency or non-fungible tokens)
- ▪ Offering, selling, providing maintenance, or performing such duties under a warranty or extended warranty service contract for the performance of services under the contract through any means, whether in person or through the Internet
- ▪ Contracting with a marketplace facilitator to facilitate the sale of the taxpayer’s products on the facilitator’s online marketplace, where the marketplace facilitator maintains the corporation’s products at fulfillment centers in New Jersey
- ▪ Placing software or ancillary data (e.g., apps or Internet cookies) on computers and devices in New Jersey to gather market or product research that is packaged and sold to data brokers or other third parties
- ▪ Contracting with in-state customers to stream (but not download) videos and music to electronic devices
- ▪ Inviting or accepting applications for employment through an Internet-based platform that are not specifically targeted to in-state residents or for in-state job positions other than for sales positions.
This new guidance provides better clarity for out-of-state corporations in determining whether their activities rise to the level of doing business for New Jersey CBT purposes. In addition, following New Jersey’s adoption of many of the MTC’s guidelines regarding when Internet-based activities do not qualify for PL 86-272 protection, out-of-state companies may now be deemed to be doing business in New Jersey as a result of their Internet-based business activities. Accordingly, it is important for such businesses and their CPAs to review these changes and consider their implications.
The North Carolina legislature recently ratified House Bill 259 through a veto-proof supermajority vote, after Governor Roy Cooper did not sign the bill. The appropriations bill includes changes to income, franchise, and sales and use tax provisions. The bill also creates a new transportation commerce tax that will apply to gross receipts derived from for-hire ground transport service providers, such as Uber, Lyft, and traditional taxi services.
Personal income tax rate.
Currently, North Carolina personal income tax statutes provide for annual reductions in the tax rate from 4.99% in 2022 to 3.99% for tax years beginning after 2025. HB 529 provides for further annual income tax rate reductions in 0.5% increments for tax years beginning in 2027 to a floor of 2.49%, presuming annual state general fund collection amounts are achieved.
Partnerships that elect to be taxed at the entity level may now have partners that are trusts if such trust’s beneficiaries consist only of individuals, estates, trusts, and subchapter S corporations. Partnerships that were unable to make the taxed partnership election for tax year 2022 but are now eligible to make the election as a result of the law change, may amend their timely filed partnership return until October 15, 2023, to make the election.
Franchise tax changes.
HB 529 provides for a higher flat $500 minimum tax on the first $1 million of tax base for C corporations. The portion of a C corporation’s franchise tax base that exceeds $1 million will continue to be taxed at a rate of $1.50 per $1,000 of tax base. Currently, the flat minimum franchise tax for C corporations is $200.
Subchapter S corporations will continue to be subject to a lower flat $200 minimum tax on their first $1 million tax base. The portion of an S corporation’s franchise tax base that exceeds $1 million will continue to be taxed at a rate of $1.50 per $1,000 of tax base. These changes are effective for taxable years beginning on or after January 1, 2025, and applicable to the calculation of franchise tax reported on the 2024 North Carolina income tax year corporate income tax return.
Sales tax exemption for continuing care retirement communities.
HB 259 will exempt the sales of items by a provider of continuing care to its residents, other than sales of alcoholic beverages. “A provider of continuing care must pay sales and use tax on the purchase price of an item that is exempt from tax under this subdivision as if the provider is the user of the item,” the bill states. “As a result, the provider of continuing care is not required to pay sales or use tax if the purchase would be exempt if purchased for use, not resale, by the provider.” This exemption becomes effective November 1, 2023, and applies to sales occurring on or after that date.
Sales tax exemption for breast pumps.
N.C.G.S. section 105-164.3 exemptions have been expanded to include sales of breast pumps, breast pump kits, and breast pump collection and storage supplies. The exemption applies to items designed and marketed to be used with the breast pump. Items such as bottles, traveling bags or carrying accessories, cleaning supplies, nursing bras and similar items, and creams are not exempt unless sold as part of a kit.
Expand aviation sales tax exemption.
The definition of a “qualified aircraft” in N.C.G.S. Section 105-164.3(197) will be updated from “more than 9,000 pounds but not in excess of 15,000 pounds” to “2,000 pounds and above.” This change will align the parts and accessory exemption with the labor exemption for the same types of aircraft. This exemption becomes effective November 1, 2023, and applies to sales occurring on or after that date.
Extend sunset on exemption for aviation and jet fuel for commercial airlines.
The sales tax exemption on fuel sold to an interstate air business for use in a commercial aircraft in N.C.G.S. section 105-164.13 will be extended through January 1, 2029. It was set to expire January 1, 2024.
Expanded sales tax exemptions on boats used to transport freight.
The bill expands sales tax exemptions for “fuel and consumables used by boats transporting freight on inland and intracoastal waterways.” It updates the definition of boat operators in N.C.G.S. section 105-164.13 to include “watergoing vessels” that engage in “the transport of freight in intrastate, interstate, or foreign commerce, whether on the high seas, intercoastal waterways, sounds, or rivers.” The bill also grants exemptions to “the transport of passengers for hire exclusively on the high seas.” This exemption became effective November 1, 2023, and applies to sales occurring on or after that date.
Transportation commerce tax.
HB 259 creates a new excise tax that will apply to gross receipts derived from each for-hire ground transport service provided by a for-hire ground transport service provider (e.g., Uber, Lyft, traditional taxi services). The tax rate is 1.5% for exclusive ride services and 1% for shared ride services. The new tax applies to subject services occurring on or after Jan. 1, 2025.
The bill largely expands taxpayer-friendly individual income tax rate reductions that have previously been enacted, as well as providing for new and expanded sales tax exemptions.
This new legislation provides significant changes to corporate and partnership taxpayers doing business in North Carolina. As such, it is important for CPAs to review these changes and consider their implications.