Tax Changes Impacting 2024 Filings: NOL and Credit Suspension, Sales Factor Adjustments, and More

California enacted S.B. 167 and S.B. 175 as part of the 2024-25 budget on June 27 and June 29, 2024, respectively. These bills suspend the use of net operating losses (NOLs) and limit business credits to $5 million for the 2024-2026 tax years, among other changes. Key points include:

• NOL Suspension: Suspends the use of NOL deductions for taxpayers with California net income or modified adjusted gross income of $1 million or more for tax years starting January 1, 2024, through January 1, 2027. Extends the NOL carryover period for up to three years for suspended NOLs. The suspension will not apply for 2025 and 2026 if the Director of Finance determines that budget goals are met.
• Credit Limitation: Imposes a $5 million annual limit on the use of income tax credits, including the pass-through entity elective tax credit, for the same period. Disallowed credits can be carried over for additional years equal to the number of taxable years that the income tax credit was disallowed. The governor can end these suspensions early if state revenue meets certain criteria.
• Refundable Credits: Allows an irrevocable election to receive a 20% refund of most tax credits exceeding the $5 million limit for tax years 2024-2026, starting refunds in the third taxable year after the election. Certain credits, like the pass-through entity elective tax and low-income housing credits, are excluded from this refund option.
• Sales Factor Gross Receipts: Prohibits including income not part of California net income in the sales factor for apportionment, overruling the recent Office of Tax Appeals decision in the Microsoft case. This change disallows gross repatriated dividends in the sales factor and requires net dividends to be used after the qualifying dividend deduction. It applies both retroactively and prospectively.

Court Excludes Foreign Subsidiaries from Unitary Group for Tax Apportionment

The New Mexico Court of Appeals ruled on June 17, 2024, in Apache Corp. v. New Mexico Taxation and Revenue Department, that foreign subsidiaries should not be included in the unitary group for income apportionment. This decision reversed an earlier ruling by the Administrative Hearing Officer, which had included these subsidiaries. The court clarified that New Mexico’s definition of a “unitary corporation” explicitly excludes foreign subsidiaries not engaged in U.S. trade or business during the taxable year even if they meet the ownership, control, and unities tests. This interpretation aligns with U.S. Supreme Court precedents on state taxation of extraterritorial income.

2.5% Corporate Transit Fee Surtax Enacted for 2024-2028

On June 28, 2024, New Jersey Governor Phil Murphy signed A.B. 4704, enacting a “corporate transit fee” as part of the state budget. This surtax imposes an additional 2.5% tax on allocated taxable net income exceeding $10 million for privilege periods from January 1, 2024, to December 31, 2028. This raises the effective tax rate for affected businesses to 11.5%, making it the highest in the country. The surtax applies to any business entity or combined group subject to the Corporation Business Tax (CBT), excluding S corporations and public utilities. No credits are allowed against the surtax liability except for those related to installment payments, estimated payments, or overpayments from prior periods.

The corporate transit fee replaces the previous CBT surtax, which applied to businesses with net income over $1 million and expired at the end of 2023. The new surtax is projected to generate over $1 billion in additional tax revenue for fiscal year 2025, supporting the state transit system and leveraging federal funding for new projects. Taxpayers should reassess their tax planning strategies, especially those near the $10 million income threshold, to manage potential impacts. The fee is administered according to the CBT Act, with penalties and interest for underpayments due to the surtax waived in the first year.

Supreme Court Limits P.L. 86-272 Protection for Pre-Book Orders

On June 20, 2024, the Oregon Supreme Court ruled in Santa Fe Natural Tobacco Co. v. Department of Revenue, concluding that certain activities exceed the protection afforded by Public Law 86-272 (P.L. 86-272). Specifically, the Court held that “pre-book orders”—advance orders for products not yet released or manufactured—are not protected under P.L. 86-272. This federal law shields businesses from state income taxes if their only in-state activities are soliciting orders, provided these orders are approved and shipped from outside the state.

The ruling centered on the activities of the taxpayer’s representatives in Oregon, who persuaded retailers to place pre-book orders with wholesalers. These orders triggered contractual obligations for wholesalers to accept and process them, with significant penalties for non-compliance. The Court deemed this process as going beyond mere solicitation and more akin to making direct sales, thus exceeding P.L. 86-272’s protections. This decision narrows the scope of P.L. 86-272 protection in Oregon, potentially increasing tax liabilities for out-of-state businesses that previously relied on this safeguard. Companies engaging in similar practices must reassess their compliance with Oregon’s evolving interpretation of P.L. 86-272 to avoid unexpected tax obligations.

Court Enforces Combined Reporting for CarMax

On July 12, 2024, the South Carolina Administrative Law Court (ALC) ruled in CarMax Auto Superstores, Inc. v. South Carolina Department of Revenue that the Department was justified in requiring combined unitary reporting to accurately reflect income earned in the state. The court found that CarMax’s corporate structure distorted its business activity in South Carolina by using transfer pricing and partnerships to allocate income to other states, thereby reducing its tax burden. The ALC determined that combined reporting was a fair and reasonable alternative to correct this distortion. However, the case was remanded to the Department to apply the Finnigan method for apportioning taxable income between CarMax East and CarMax West.

It’s important to note that while South Carolina recently enacted legislation on March 11, 2024, establishing a framework for when and how the Department of Revenue can require combined reporting, this new legislation did not impact the CarMax ruling. The CarMax case was decided under the law in effect before the new legislation. The new law provides conditions under which combined reporting can be required, includes procedural requirements for notifying taxpayers, and allows for appeals, thereby offering more protection and transparency. This framework aims to reduce reliance on case-by-case judicial interpretations by providing clearer guidelines for future cases. The legislation also excludes certain entities from combined returns and applies broadly, ensuring fair and consistent application of tax laws going forward.

Elimination of Remote Seller 200-Transaction Nexus Threshold

On July 1, 2024, North Carolina enacted H.B. 228, changing the remote seller economic nexus standards for sales tax. Previously, remote sellers had to meet either a $100,000 gross sales threshold or 200 separate transactions to be subject to North Carolina sales tax. The new legislation eliminates the 200-transaction threshold, effective July 1, 2024. Retailers solely meeting the transaction threshold can now close their registration with the North Carolina Department of Revenue. This amendment aims to reduce burdens on small businesses and align with the Streamlined Sales Tax Agreement’s best practices, providing relief to remote sellers with low sales volume.

On July 1, 2024, Tennessee introduced new sales tax sourcing rules as part of the Tennessee Works Tax Act (TWTA), aligning with the Streamlined Sales and Use Tax Agreement (SSUTA). The updated rules clarify how to source sales tax for interstate transactions involving services performed on tangible personal property and computer software. Under the new rules, sales tax is primarily sourced to the location where the purchaser receives the service or product. Specific sourcing hierarchy and fallback rules are outlined to handle various scenarios, such as deliveries, leases, and direct mail.

These changes aim to simplify and standardize the determination of sales tax jurisdiction, reducing administrative burdens for businesses operating across state lines. By conforming to SSUTA guidelines, Tennessee seeks to streamline tax compliance and minimize disputes over tax obligations in interstate transactions. It’s important to note that while these updates provide general guidance, they do not constitute formal revenue rulings or letter rulings. Businesses should consult the full updated manual or seek professional advice for specific situations regarding sales for resale and wholesale sales classifications.

DOR Adopts New B&O Tax Sourcing Rules with Retroactive Application

On May 15, 2024, the Washington Department of Revenue (DOR) adopted changes to Rule WAC 458-20-19402, effective June 15, 2024, to clarify the sourcing of services for Business & Occupation (B&O) tax purposes. The amended rule specifies that service receipts should be sourced to the location where the customer receives the benefit, which is essential for determining economic nexus and tax obligations. The rule also allows for retroactive application to 2015, requiring taxpayers to reassess past filings for potential exposures or refund opportunities.

The new rule establishes clear guidelines and procedural requirements for transparency and consistency in sourcing rules. Taxpayers with customers in Washington should review their receipt sourcing methods to ensure compliance and accurate tax liabilities. Given the retroactive nature, businesses may need to conduct a thorough review of past returns and consider filing amended returns if necessary.

Enaction of Major Tax Changes for 2024: NOL Cap, Sales Tax on Leases, and More

On June 7, 2024, Illinois Governor J.B. Pritzker signed H.B. 4951, enacting significant changes to state tax laws. Key changes include limitations on net operating loss (NOL) deductions, amendments to apportionment for financial organizations, increased franchise tax exemptions, and expanded sales tax applications.

Key Points:

• NOL Deduction Limitation: For taxable years ending on or after December 31, 2024, and before December 31, 2027, the maximum NOL deduction for C corporations is limited to $500,000 annually. The carryforward period for NOLs that cannot be deducted due to the cap is extended by the number of years the deduction was suspended.
• Apportionment for Financial Organizations: For tax years ending on or after December 31, 2024, the sourcing of a financial organization’s investment income will be based on the sourcing of other types of income that the financial organization sources to the state. Investment income will be apportioned to Illinois using a ratio of Illinois-sourced non-investment income to total receipts, excluding investment income, instead of the previous method based on the fixed place of business.
• Franchise Tax Exemption: Starting January 1, 2025, domestic and foreign corporations’ first $10,000 in franchise tax liability is exempt. For 2024, the first $5,000 in liability is exempt for domestic corporations, and the first $5,000 is exempt for foreign corporations, up from $1,000 previously.
• Sales and Use Tax:
  • Tax on Leases: Effective January 1, 2025, Illinois will impose sales tax on leases of tangible personal property, excluding motor vehicles, watercraft, aircraft, and semi-trailers. Leases will be taxed as transfers of possession or control for consideration.
  • Vendor’s Discount Limitation: Beginning January 1, 2025, the 1.75% discount that vendors may retain for most types of sales transactions is capped at $1,000 per month.
  • Interchange Fees Prohibition: Effective July 1, 2025, credit card interchange fees on sales taxes, excise taxes, and gratuities are prohibited, provided merchants inform acquirer banks of these amounts during transaction processing.
  • Online Travel Companies: Starting July 1, 2024, online travel companies, considered “re-renters of hotel rooms,” must collect the Hotel Operators’ Occupation Tax if they meet specific revenue or transaction thresholds.

Council Enacts Emergency Budget Act with Key Tax Changes and Incentives

On July 15, 2024, the Council of the District of Columbia enacted emergency legislation (Fiscal Year 2025 Budget Support Emergency Act of 2024, B25-875) without the mayor’s signature. This action is part of the council’s authority to pass emergency measures to address urgent issues without the usual procedural delays. This legislation, which expires on October 13, 2024, includes the following key tax changes and updates:

• Apportionment Method Change: For tax years beginning after December 31, 2025, the District will switch from the Joyce to the Finnigan method for combined reporting, treating a combined group of entities as one taxpayer for sourcing unitary receipts.

• Repeal of QHTC Benefit: The act repeals the 3% tax on capital gains from the sale or exchange of an investment in a Qualified High Technology Company (QHTC), which was previously provided in lieu of an income tax.
• Sales Tax Increase: The sales tax rate will increase from 6% to 6.5% on October 1, 2025, and to 7% on October 1, 2026.
• Central Washington Activation Program: This program offers a 15-year property tax freeze for converting certain office spaces to commercial, entertainment, or retail spaces.

These changes aim to adjust tax policies and stimulate economic activity through property conversions and increased tax revenues. Additionally, permanent legislation with similar provisions, known as the Fiscal Year 2025 Budget Support Act of 2024 (B25-0784), remains pending.