CPAs need to be aware of current tax developments in key states to properly advise their clients that are doing business in multiple jurisdictions. This article provides an overview of some key developments in California, Florida, Indiana, and Pennsylvania.

California: Extension of Filing Deadline for Taxpayers Impacted by Winter Storms

California Governor Gavin Newsom extended the California income tax deadlines to file individual and business income tax returns and payments to October 16, 2023, for taxpayers affected by the December and January winter storms.

The extension applies to taxpayers impacted by severe winter storms, flooding, landslides, and mudslides in more than 50 specified counties. It is intended to align state due dates with the extended due dates announced by the IRS.

The extended deadline applies to original deadlines occurring on or after January 8, 2023, and prior to October 16, 2023. For calendar-basis taxpayers, this includes:

  • Individual tax returns typically due April 18, 2023
  • Estimated tax payments typically due January 17, April 18, June 15, and September 15, 2023
  • Business tax returns typically due March 15 or April 18
  • Pass-through entry (PTE) elective tax payments typically due June 15, 2023

California taxpayers located in the applicable counties should consider availing themselves of the relief provided.

Florida: Court Reaffirms the State’s Cost-of-Performance Sourcing for the Sale of Services

A circuit court in Florida reaffirmed the state’s cost-of-performance (COP) standard for sourcing the sale of services in Target Enterprise, Inc. vs. Florida Department of Revenue [Fla. Cir. Ct (2d), No. 2021-CA-002158, 11/28/22]. In this case, Target Enterprise, Inc. (TEI) was providing services to its parent company, Target Corporation (Target). TEI provided Target with merchandising, marketing and strategy, and management consulting services.

In sourcing its services, TEI based its sales in Florida on the portion of income-producing activity that took place in the state. The state [Fla. Admin. Code Ann. R. 12C-1.0155(2) (l)] requires that taxpayers source services to Florida when a greater proportion of the income-producing activity that generated the sales revenue is performed by the taxpayer in the state. Income-producing activity is defined as “the transactions and activity directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profits,” according to the Florida Department of Revenue (DOR).

The DOR stated that, under audit, TEI failed to provide proper documentation of its position for using COP, so the DOR took the position that sales should have been sourced based on the square footage of Target stores in Florida, compared with Target stores everywhere.

The court found that TEI had provided proper documentation to the DOR, including referencing the DOR’s own regulation that requires the use of COP sourcing. The court went on to state that even if TEI had not provided this documentation, the DOR’s method of comparing the footprint of Target’s stores was not appropriate, as it conflated Target’s business activity in the state with TEI’s business activity.

In several places throughout the decision, the court found that the most reliable indication of where the COP is located is where the taxpayer’s payroll is based. For example, TEI’s Florida payroll for the tax years under litigation was only 0.07%, while their Minnesota payroll was approximately 94.9%.

This court’s decision in the proper application of sourcing service revenues is in direct contradiction to the DOR’s recent interpretations of this regulation. For some years, the DOR has been issuing Technical Assistance Advisement (TAA) rulings that attempt to shift Florida away from the regulation’s COP sourcing towards a market-based methodology. For example, the DOR issued Florida Technical Assistance Advisement 21C1-005 (July 2, 2021), in which it concluded that revenue should be sourced to the location of the customer. In this TAA, the DOR stated that sales of services should be sourced to Florida to the extent that, “deliverables from those services are forwarded, sent, delivered or provided, to a location in Florida for the customer.” This TAA also states that Florida is “frequently referred to as a ‘market state’ because its sales apportionment is based on where the sales transaction takes place rather than where contracts are approved, where payment is made, or where the customer’s headquarters is located.”

In TAA. 21C1-010 (Mar. 5, 2021), the DOR provided that income from services should be sourced to “the location to which the services are provided, on a market basis.”

These TAAs are just two of a series of rulings in which the DOR attempted to reinterpret its own regulation towards a market-based methodology, in contradiction to the stated COP requirement, in sourcing service revenues for income tax apportionment purposes.

The ruling not only brings into question the DOR’s ability to use its special apportionment power, but also brings the focus of apportioning services back to the COP standard detailed in the regulation.

The court’s ruling in Target Enterprises, Inc. disallowed the DOR’s attempted use of an alternative apportionment factor, as the taxpayer was able provide clear documentation regarding where its costs were incurred. In addition, the court found that, as applied to this taxpayer, the best primary evidence of where the costs incurred to perform taxpayer’s services were located was the taxpayer’s payroll apportionment workpapers.

This ruling gives taxpayers a firmer footing when apportioning sales of services to Florida, as well as when exploring potential refund opportunities for taxpayers that had followed the DOR’s market-sourcing methodologies—pending whether the DOR appeals the court’s ruling. The clear deviation from the regulation in the DOR’s recent TAA rulings created uncertainty for taxpayers as to which methodology is appropriate in sourcing revenue to Florida.

Indiana: Pass-Through Entity Tax Enacted

On February 22, 2023, Indiana Governor Eric Holcomb signed Senate Bill 2 (SB2), which created an optional pass-through entity tax (PTET) in the state.

SB2 creates an optional PTET that creates a work-around on the federal limitation on the state and local tax deduction. The bill allows both partnerships and S corporations to elect to pay tax at the entity level while offering an offsetting individual income tax credit for shareholders/members. The tax is retroactive to tax years beginning on or after January 1, 2022. Unlike other states’ elective PTET regimes, SB2 does not provide for any sunsetting tax year of such election.

For tax years beginning on or after January 1, 2022, the election can be made retroactively between March 31, 2023, and August 31, 2024. SB2 provides that retroactive election must be made “in the form and manner prescribed by the [Indiana] Department [of Revenue, DOR].” No such guidance for making the election on a 2022 tax year return has been issued by the DOR, but should soon be forthcoming.

For tax years that begin in 2023 or later, the election is to be made any time up to the extended due date of the pass-through entity’s return. Once the election is made, it is irrevocable for that tax year. The election will be made annually on a form or via a method to be determined by the DOR.

Estimated payments are required for tax years ending on or after June 20, 2023. These estimated payments do not effectuate the election and can be credited to the owners should they later decide to forego the election.

Indiana residents are allowed a refundable tax credit equal to their share of the amount of tax paid by the electing entity. SB2 also expands the definition of credit for taxes paid to other states beyond withholding or composite taxes paid to include PTETs paid to other states. Prior to the enactment of SB2, Indiana residents were not allowed a credit for PTETs paid to other states. SB2 adds language that expands the definition of taxes paid to other states to include taxes paid by a pass-through entity on behalf of its owner.

Pennsylvania: Supreme Court Upholds DOR’s Interpretation of Sales Sourcing Rules

In a decision dated February 22, 2023, the Pennsylvania Supreme Court agreed with the taxpayer and Pennsylvania Department of Revenue’s (DOR) interpretation of the state’s pre-2014 statute pertaining to sourcing sales of services for apportionment purposes. Although the decision generally has no bearing on current Pennsylvania corporate income tax apportionment rules applicable to open years, it offers considerable insight into the court’s analysis of apportionment statutes.

This court’s decision in the proper application of sourcing service revenues is in direct contradiction to the DOR’s recent interpretations of this regulation.

Synthes USA HQ is a Pennsylvania-based corporation that provided management and research and development services to its affiliates both within and outside of the state. On its originally filed 2011 Pennsylvania corporate income tax return, Synthes sourced service revenue using the state’s statutorily prescribed majority of COP methodology on the basis of where the services were being performed. As a result, all of its sales were sourced to Pennsylvania, where Synthes was headquartered and maintained its principal place of business and operations.

In 2014, Synthes filed a refund claim for $2 million for the 2011 tax year based on the DOR’s interpretation of the sales sourcing provisions in effect at that time. Before January 1, 2014, state law [72 P.S. section 7401(3)2.(a)(17)] required C corporation taxpayers to source sales of services to Pennsylvania if the greater proportion of the income-producing activity took place in the state, based on the cost of performance. For tax years beginning on or after January 1, 2014, C corporations are required to source revenues on the basis of where services are delivered [72 P.S. Section 7401(3)2. (a)(16)(C)(I)].

The DOR’s interpretation of this pre-2014 provision, which applied to non-domiciled corporations, was that the income-producing activity was completed where a customer received the service’s benefit—an approach that was consistent with state precedent that the sales factor is focused on the “contribution of Pennsylvania customers and purchasers to the entity’s sales,” according to the DOR, without regard to where the performance activities occurred.

Initially the DOR rejected Synthes’ 2014 refund claim. Synthes eventually appealed this decision to the Pennsylvania Commonwealth Court, which allowed the claim. Interestingly, the Pennsylvania Attorney General argued on behalf of the state that the DOR’s interpretation of the pre-2014 statute was incorrect and that Synthes was not entitled to a refund claim. The DOR intervened in the case and the court upheld the DOR’s interpretation of the apportionment provision in a July 2020 decision. The Attorney General then appealed the case to the Pennsylvania Supreme Court.

The Pennsylvania Supreme Court held in the decision that, given that the critical terms of the apportionment provision were not defined in the statute, “colorable arguments can be made that the ‘income-producing activity’ occurs either where the taxpayer produces the service or where the customer receives the service.” The court reasoned that the provision should be read in context of other apportionment provisions, looking specifically to the sourcing of the sale of tangible personal property, which was (and still is) sourced to the location where the property is received by the customer.

The court further stated that a change to the sourcing statute effective January 1, 2014, was not an attempt to change how the sales of services are to be sourced, but rather acts to clarify how these sales should be sourced based on prior DOR interpretations.

Although the court’s decision only impacts pre-law change tax years beginning before January 1, 2014, this precedent could still be applied to Pennsylvania filing corporations that have extended their statute of limitations for any such years remaining open, including such corporations that had filed protective refund claims awaiting the outcome of this decision.

Corey L. Rosenthal, JD, is a principal and the state and local tax practice leader at CohnReznick LLP, New York, N.Y.
Faith Gorman, CPA, is a principal and member of CohnReznick’s state and local tax practice, Boca Raton, Fla.