In January, the New York Department of Taxation and Finance issued a notice regarding sales tax registration requirements for businesses with no physical presence in New York.  The notice responds to the U.S. Supreme Court’s ruling in South Dakota v. Wayfair, 138 S.Ct. 2080 (2018), which overruled prior precedent prohibiting states from imposing sales tax collection requirements on businesses with no physical presence in the state.

The notice requires a business (1) that made more than $300,000 in sales of tangible personal property delivered in New York, and (2) that conducted more than 100 sales of tangible personal property delivered in New York, in the four preceding sales tax quarters, to register as a sales tax vendor and collect and remit New York and local sales taxes.  This rule applies even if a business has no physical presence in New York.

The New York Department of Taxation and Finance urges businesses that meet this threshold, but that have not registered as vendors, to register now.  Information about the sales tax registration process is found in the New York Tax Bulletin, How to Register for New York State Sales Tax (TB-ST-360).

The Pennsylvania Department of Revenue recently issued guidance in response to the Supreme Court opinion in South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (2018), clarifying when remote sellers are considered to maintain places of business in Pennsylvania and thus, required to collect and remit Pennsylvania sales taxes.  In Wayfair, the Supreme Court overruled previous precedent requiring a business to have a physical presence in a state before the state could require the business to collect its sales taxes.  See Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  After Wayfair, economic nexus may be sufficient for a state to require an out-of-state business to collect and remit its sales tax.  The newly issued Pennsylvania guidance provides that any person who made more than $100,000 of gross sales in Pennsylvania in the past 12 months has sufficient economic nexus to be considered to maintain a place of business in Pennsylvania and thus, is required to collect and remit Pennsylvania sales tax.  This rule applies to transactions that occur on or after July 1, 2019.

Remote businesses must carefully determine whether they meet states’ economic nexus definitions and are required to collect and remit sales taxes.

New Jersey recently announced the New Jersey Tax Amnesty program.  The New Jersey Division of Taxation has indicated that both individuals and businesses may qualify for the program.  The amnesty program began on November 15, 2018 and goes through January 15, 2019.  The New Jersey Division of Taxation will waive late filing and late payment penalties for taxpayers who come forward through the program.  The New Jersey Division of Taxation will also waive half of any interest due as of November 1, 2018.  Taxpayers who choose not to participate, however, face stiff penalties.  These taxpayers will incur a 5% penalty, which the New Jersey Division of Taxation will not waive.  The 5% penalty is in addition to the other penalties and interest.

Taxpayers with outstanding New Jersey tax issues should strongly consider participating in the program.  The New Jersey Division of Taxation offers guidance for how to apply for amnesty here.

The Treasury Department recently issued proposed regulations addressing the availability of charitable deductions when taxpayers receive or expect to receive corresponding state or local tax credits for contributions.  The proposed regulations require a taxpayer who makes a contribution to a charitable organization to reduce his charitable deduction by any state or local tax credit that he receives or expects to receive.

Taxpayers have traditionally been allowed itemized deductions for paying state and local taxes.  The Tax Cuts and Jobs Act enacted last year, however, caped the deduction for payments of state and local taxes at $10,000.  This cap hits taxpayers in high tax states like New York, New Jersey, and California hardest because many taxpayers in those states pay over $10,000 in state and local taxes.  These states have attempted to circumvent the $10,000 cap by considering or passing new state and local tax credit programs.  The programs give taxpayers who make charitable contributions to state or local tax credit programs state or local tax credits, while also being designed to create federal charitable deductions for the same contributions.

The proposed regulations put an end to this strategy by limiting any federal charitable deduction by the state or local tax credit a taxpayer receives or expects to receive.  For example, suppose an individual pays a charitable organization $1,000.  In exchange for the payment, the individual receives a 70% state tax credit.  Under the proposed regulations, the individual’s charitable deduction is reduced by $700 (70% of $1,000) for federal tax purposes.  He may only take a $300 charitable deduction on his federal return.

The proposed regulations are in line with the Supreme Court’s charitable contribution jurisprudence.  The Supreme Court has held that a charitable contribution is a transfer of money or property without adequate consideration.  As a result, a payment is not a charitable contribution if the contributor expects a substantial benefit for the payment.  See United States v. American Bar Endowment, 477 U.S. 105, 116-118 (1986); see also Singer Co. v. United States, 449 F.2d 413, 422-423 (Ct. Cl. 1971).  Taxpayers who receive state or local tax credits for contributions receive substantial benefits for their contributions, so they are not entitled to charitable deductions.

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Four states have filed suit in U.S. District Court for the Southern District of New York, challenging the constitutionality of the new $10,000 cap on the federal tax deduction for state and local taxes, or SALT, enacted as part of the federal Tax Cuts and Jobs Act in 2017. The lawsuit is the latest effort by states to invalidate the SALT cap. It follows legislative workarounds enacted by New York and New Jersey, granting taxpayers in those states credits against state taxes for making contributions to state-created funds. The Internal Revenue Service has for its part responded by warning taxpayers that the federal law controls the characterization of deductions for federal income tax purposes and that taxpayers who utilize the state law workarounds do so at their peril. While this latest effort to challenge the SALT cap places the legality of the provision before the courts, the long-term fate of the SALT cap is more likely to be decided by the political, rather than the judicial, process.

The SALT Cap

Enacted in 2017, the TCJA was touted as the most significant tax reform legislation in three decades. Among its provisions is a $10,000 annual limitation on the deduction for state and local tax, which includes state and local income taxes, local real estate taxes and state sales taxes. Previously, there was no monetary limitation for an individual taxpayer’s SALT deduction. The new limitation is more detrimental to individuals in high tax states, such as California and New York. The average SALT deduction in California was around $18,500, while the average deduction in New York was around $22,000. The SALT limitation imposed by the TCJA applies to taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026.

State Efforts to Work Around the SALT Cap

Some states are attempting to work around the SALT limitation using creative legislative solutions. Earlier this year, New York Gov. Andrew Cuomo signed into law a new state-operated charitable contribution fund to accept donations for the purposes of improving health care and public education in New York state. Taxpayers who itemize deductions may claim these charitable contributions as deductions on their federal and state tax returns. Any taxpayer making a donation may also claim a state tax credit equal to 85 percent of the donation amount for the tax year after the donation is made. Taxpayers may also make qualified contributions to certain not-for-profit organizations for specified purposes. The law also authorizes local governments and school districts to establish charitable gift reserve funds and to offer real property tax credits to incentivize contributions to these new local charitable funds.

New Jersey soon followed suit, with Gov. Phil Murphy signing into law a measure allowing municipalities, counties and school districts to establish charitable funds where taxpayers can donate in return for a property tax credit. In return for donations, taxpayers would receive credits on their property tax bill of up to 90 percent of the donation. Taxpayers would then be able to claim their donation as a charitable deduction on their federal income tax return.

Efforts to work around the SALT cap are also underway in California. The California Senate has passed a bill that would allow taxpayers a credit against their state income tax for contributions to the newly created California Excellence Fund. A similar bill is pending in the California Assembly.

IRS Warns Taxpayers Regarding Efforts to Bypass SALT Cap

Earlier this year, the Internal Revenue Service notified taxpayers that it will soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes. At the same time, the IRS reminded taxpayers that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law. These forthcoming regulations will be targeted at the state-level work-arounds described above.

The IRS said that the regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The IRS also warned that it is continuing to monitor other state legislative proposals being considered to ensure that federal law controls the characterization of deductions for federal income tax filings.

Is the SALT Cap Unconstitutional?

The latest effort by the states to challenge the SALT cap is the lawsuit filed by states New York, New Jersey, Connecticut and Maryland. The suit names as defendants the Secretary of the Treasury, the Acting Commissioner of Internal Revenue, the Internal Revenue Service and the United States of America. The states allege that the SALT cap violates numerous provisions of the U.S. Constitution, including the 10th Amendment, the 16th Amendment and Article I, Section 8.

According to a press release issued by Gov. Cuomo, the SALT cap was enacted to target New York and similarly situated states, interferes with states’ rights to make their own fiscal decisions and will disproportionately harm taxpayers in these states. An analysis by the New York State Department of Taxation and Finance shows that the cap will increase New Yorkers’ federal taxes by $14.3 billion in 2018 alone and an additional $121 billion between 2019 and 2025. A press release issued by Connecticut Gov. Dannel Malloy similarly said that Connecticut taxpayers will lose an estimated $10.3 billion in SALT deductions in 2018 and see an increase in federal income tax liability of approximately $2.8 billion in 2018.

The states’ lawsuit challenging the SALT cap asserts three causes of action arising under the U.S. Constitution. The first alleges that by capping the amount of the SALT deduction, the federal government has impermissibly interfered with the states’ sovereign authority to determine their own fiscal authority, thereby violating the 10th Amendment. In their second cause of action, the states allege the federal government has exceeded its powers under the 16th Amendment by failing to provide for a deduction for all, or a significant portion of, state and local taxes. Finally, the states allege a violation of Article I, Section 8, which provides Congress with the “[p]ower to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States.” Specifically, the states contend that the SALT cap interferes with their sovereign authority to determine their own taxation and fiscal policies by “coercing the Plaintiff States into lowering their taxes and cutting the services those taxes support.”

The U.S. Department of Justice is expected to vigorously defend the SALT cap as a legitimate exercise of the federal government’s taxing power. The Justice Department will no doubt point out that the newly enacted SALT cap was not specifically targeted at the four plaintiff-states; rather, the cap applies uniformly throughout all of the states, even though it may have disproportionate impact in states with high property taxes. In addition, SALT cap defenders will note that although state and local taxes have been deductible since the creation of the federal income tax code in 1913, Congress has many times modified the scope of the allowable SALT deduction, including in the Tax Reform Act of 1986 and, most recently, in 2005. Finally, the Justice Department will surely rely upon the federal government’s constitutionally imbued and well-settled powers to tax and spend as set forth in Article 1, Section 8 Constitution in defending the SALT limitation.

While a federal judge will ultimately have to decide whether the states’ lawsuit has merit, the long-term viability of the SALT deduction cap will likely be determined by the political process instead. The outcome of the November mid-term elections will dictate which political party controls Congress. If the Democrats succeed in wresting back control of the House, expect to see legislation introduced to undo much of the TCJA, including the SALT cap deduction. If, on the other hand, the Republicans maintain their current majority in the House, the SALT cap will likely remain on the books, with its fate to be eventually determined by the courts — most likely an appellate court and potentially the Supreme Court of the United States.

Reprinted with permission from Law360. (c) 2018 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

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The States of New York, Connecticut, Maryland, and New Jersey filed a federal court lawsuit this week challenging the constitutionality of the new $10,000 cap on the federal tax deduction for state and local taxes (SALT). The lawsuit, filed in the Southern District of New York, names as defendants the Secretary of the Treasury, the Acting Commissioner of Internal Revenue, the Internal Revenue Service, and the United States of America. The States allege that the SALT deduction cap, enacted as part of 2017 tax reform, violates numerous provisions of the United States Constitution, including the Tenth Amendment, the Sixteenth Amendment, and Article I, Section 8.

According to a press release issued by New York Governor Andrew M. Cuomo, the lawsuit argues that the new SALT cap was enacted to target New York and similarly situated states, that it interferes with states’ rights to make their own fiscal decisions, and that it will disproportionately harm taxpayers in these states. An analysis by the New York State Department of Taxation and Finance shows that the cap will increase New Yorkers’ federal taxes by $14.3 billion in 2018 alone, and an additional $121 billion between 2019 and 2025. A press release issued by Connecticut Governor Dannel P. Malloy similarly estimated that Connecticut taxpayers will lose an estimated $10.3 billion in SALT deductions in 2018, and will increase Connecticut taxpayers’ federal income tax liability by approximately $2.8 billion in 2018.

The SALT deduction cap has been one of the most controversial provisions of the 2017 tax reform legislation.  We previously wrote about efforts by some states, including New York and New Jersey, to pass laws providing for mechanisms to work around the cap. These “workarounds” would allow taxpayers to make payments to specified entities in exchange for a tax credit against state and local taxes owed.  In May, the IRS the Internal Revenue Service notified taxpayers that it would soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes, and issued a not-so-subtle reminder that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law.

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Today the Internal Revenue Service notified taxpayers that it will soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes. The IRS also reminded taxpayers that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law. These forthcoming regulations are targeted at efforts by some states, including New York and New Jersey, to pass laws providing for mechanisms to work around the newly-enacted federal cap on state and local deductions. These “workarounds” typically allow taxpayers to make payments to specified entities in exchange for a tax credit against state and local taxes owed.

The federal Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. The IRS said that the regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The IRS also warned that it is continuing to monitor other legislative proposals being considered to ensure that federal law controls the characterization of deductions for federal income tax filings. The limitation imposed by the TCJA applies to taxable years beginning after December 31, 2017, and before January 1, 2026.

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The State of Minnesota has joined the growing list of states that are criminally prosecuting business owners for using “zapper” programs to commit tax evasion.  Yesterday the Minnesota Department of Revenue and the St. Louis County Attorney’s Office announced the convictions of a Duluth restaurant and its owners for tax crimes based upon their use of sales suppression software.  This represents the first time that Minnesota has criminally prosecuted anyone for using a zapper.

Commonly called “zappers,” sales suppression software programs run on a point-of-sale computer or cash register and are used to secretly delete some or all of a restaurant’s cash transactions and then reconcile the books of the business. The result is that the company’s books appear to be complete and accurate, but are in fact false because they reflect fewer sales than were actually made. Business owners using zapper programs often maintain two sets of books, in order track the business’ real revenue. A recent article published by BNA estimates that tax-zapping software costs states $21 billion in taxes annually and that 30 percent of the electronic cash registers, or point-of-sale systems, in the United States have a zapper installed.

The restaurant in question, Osaka Sushi Hibachi & Steak House, is owned by Dan Xu and Zhong Wei Lin.  Dan Xu pleaded guilty to one felony count of aiding in the filing of false tax returns.  Zhong Wei Lin pleaded guilty to one felony count of failing to pay sales tax.  The court stayed prison sentences for both individuals in lieu of the immediate payment of restitution in full and a year of probation.  The restaurant itself pleaded guilty to two felony counts of aiding in the filing of false tax returns and fifteen felony counts of failing to pay sales tax.  The court ordered the corporation to pay restitution as well.  All three defendants paid restitution in the total amount of $292,760.

During their plea hearing, Xu and Lin admitted to intentionally using “zapper” computer software in the point of sale system at their restaurant.  The software, which was called “Happy World,” was contained on a thumb drive that was discovered by investigators during a search of the restaurant.  The Happy World software automatically created a second set of books that removed line items from cash transactions after the fact, allowing the business to underreport its monthly sales and avoid paying sales tax collected from customers.

“These are first-of-their-kind convictions in Minnesota and highlight our investigators’ efforts to combat the growing use of sales suppression software,” said Revenue Commissioner Cynthia Bauerly.  “These convictions demonstrate our determination to level the playing field so that businesses who report and pay their fair share of tax don’t have to compete with those who break the law.”

“Deliberately failing to turn over sales taxes collected increases the tax burden on all residents.   We hope this case sends a message to others engaging in this kind of behavior that it will not be tolerated, and you will be prosecuted when caught,” said St. Louis County Attorney Mark Rubin.

As we have previously reported, state revenue departments and attorneys general (and not the Internal Revenue Service) are leading the effort to combat the use of zappers.  More than half of the states have now enacted laws criminalizing the use of sales suppression devices, and in the last two years, authorities in Washington, Michigan, Illinois, and Connecticut have successfully prosecuted criminal cases against businesses and their owners – primarily in the restaurant industry.  The Minnesota case is yet another example of aggressive action undertaken recently by state authorities against zappers, and should serve as a stern warning to business owners using (or considering using) such technology.

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A number of parties have filed amicus curiae briefs in South Dakota v. Wayfair, a case that could substantially reshape the state sales tax landscape.  See here.  Perhaps one of the most interesting amicus briefs was filed by a group of U.S. Senators who support South Dakota in its urging the Supreme Court to overturn the Quill Corp. v. North Dakota physical presence standard.  The Senators are Heidi Heitkamp from North Dakota, Lamar Alexander from Tennessee, Richard Durbin from Illinois, and Michael Enzi from Wyoming – two Democrats and two Republicans.

The Senators argued that, as of 2015, there were almost $26 billion in uncollected sales and use taxes because of Quill.  Merchants with physical locations in the Senators’ states are at an economic disadvantage because they must charge higher prices than out-of-state retailers who need not collect tax.  The Senators noted that their states –North Dakota, Tennessee, Illinois, and Wyoming – rely heavily on state sales taxes for revenue.  As a result, when Wayfair makes sales in those states, the Senators argued, Wayfair has a significant price advantage over businesses with physical presences in those states because it is not required to collect those state taxes under Quill.

The Senators emphasized that Justice Kennedy has said that Quill was “questionable even when decided, [and] now harms States to a degree far greater than could have been anticipated earlier.”  Direct Mktg. Ass’n v. Brohl, 135 S.Ct. 1124, 1135 (2015) (Kennedy, J., concurring).

The Senators also tried to persuade the Court that there would be no confusion if the Court overturned the bright-line rule in Quill.  First, they argued that there is little evidence that states would pass burdensome use tax collection laws if Quill were overturned.  According to the Senators, the same internet technologies that make Quill problematic—because they facilitate large scale remote sales that deprive states of sales tax revenue they would collect from brick-and-mortar retailers—have driven down compliance costs, which reduces the likelihood that state laws would impose significant costs on remote sellers.  Second, the Senators argued that the overturn of Quill would not mean the Court could not protect interstate sellers though other doctrines, such as the balancing test in Pike v. Bruce Church, Inc., 397 U.S. 137 (1970).  Third, Congress, the Senators argued, is standing by to act if states overstep by imposing harsh burdens on out-of-state retailers.  This last point is interesting, but it is worth questioning whether it is persuasive, because Congress has yet to legislate Quill away, despite the fact that it has had many years to do so.  As a result, it is worth considering whether Congress would get involved.

The Supreme Court will hear oral arguments April 17, 2018.

As clients reach retirement age, many often consider a change in their domicile as part of their retirement plan. Aside from the warmer winters, Florida is a popular state for change of domicile because it has no income tax and no state inheritance tax. Another important aspect of becoming a Florida resident is the Florida Homestead Exemption provided by the Florida Constitution. In addition to allowing for a reduction in local real estate taxes, the Homestead Exemption also provides that the homestead is exempt from claims of creditors of the Florida resident.

Illustrated "Welcome to Palm Beach, Florida" Retro Poster.Most times, the tax authorities challenging the change in domicile are from the state the taxpayer is leaving, since they are losing a taxpayer, rather than the new state. For example, New York, Pennsylvania and New Jersey have a 183-day rule which provides that if you are present in the state for 183 days you are deemed to be a resident for income tax purposes. This means that you would have to pay income tax as a resident if you are present in that state for 183 days. Florida, on the other hand, does not have a 183-day rule for purposes of determining whether you are a resident. So it is often the exit state that challenges a change in domicile when the taxpayer files a final resident return.

In the recent Florida case of Ramos v. Motamed, decided by the Circuit Court for Palm Beach County, the taxpayer’s change of domicile was challenged in the destination state of Florida rather than the exit state of California. The case was not initiated by Florida. Rather, it was a creditor seeking to enforce a judgment against the debtor. The creditor argued that the Homestead Exemption should not apply to the debtor because he was not really a Florida resident, and therefore should not protect the taxpayer’s luxury condominium from being used to satisfy the creditor’s judgment.

The taxpayer did all of the usual steps to establish a new domicile, such as obtaining a property in the state, changing his voter registration, obtaining a Florida driver’s license and even obtaining a new local library card.

However at trial, the creditor provided other evidence indicating that the debtor did not actually move to Florida. In particular, he presented gym records showing that the debtor attended his gym in California 300 out of 365 days in 2015. The court determined that based on this evidence, the taxpayer did not actually change his domicile to Florida. He was therefore not entitled to Florida’s Homestead Exemption, and his condominium could be used to satisfy the creditor’s judgement. The property was listed for judicial sale and sold shortly thereafter.

If you are considering a change in your state of domicile, this case shows that while changing your driver’s license, voter registration and other administrative details are relevant factors, the most important thing is that you actually move to the new state.

At least for this one taxpayer, who loved to go to the gym, you could say that his attempt to change domicile was an exercise in futility which did not work out.