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21st Annual Health Sciences Tax Conference State of the states: an overview of SALT developments 6 December 2011

State of the states: an overview of SALT developments

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

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Presenters

► Laura Zaplishny Director, Taxation Ikaria Hampton, New Jersey

► Michele Raber Ernst & Young LLP 99 Wood Avenue South Iselin, New Jersey 08830 +1 732 516 4786 [email protected]

► Stephen Shiffrin Ernst & Young LLP

One Renaissance Sq Ste 2300 Two North Central

Phoenix, Arizona 85004 +1 602 322 3961

[email protected]


Today’s agenda

► Current state

► Income tax developments

► Sales and use tax developments


Current state


50-state study: key findings

► Level of FY2010 collections reflects both ► Positive impact of the economic recovery on businesses, and ► The lingering effects of the recent recession on state and local government

► State and local taxes paid by businesses in FY2010 totaled $619 billion, a 0.3% decrease compared with FY2009

► Total state taxes (business and household taxes) declined by 1.2% and total local taxes increased by 2.3%

► While corporate income tax is the focus of much debate, it only represented 7.1% of total state and local taxes (individual income on pass-through business income accounted for 5.3% of the total taxes)

► Non-income-based taxes account for 88% of state and local business tax revenue

Information from “Total state and local business taxes: State-by-state estimate for fiscal year 2010” (July 2011). Prepared by Ernst & Young LLP’s Quantitative Economics and Statistics (QUEST) practice in conjunction with the Council on State Taxation (COST) .


Business taxes FY2009 FY2010 % total taxes

One-year growth

Property taxes on business property $247.0 $249.5 40.3% 1.0% General sales taxes on business inputs 127.7 124.4 20.1% -2.5% Corporate income and other license taxes 46.9 44.1 7.1% -5.8% Business and corporate license 37.1 37.0 6.0% -0.3% Individual income tax on business income 34.4 33.0 5.3% -4.1% Unemployment insurance 31.4 32.4 5.3% 3.1% Excise taxes 28.8 30.4 4.9% 5.7% Public utility taxes 28.7 28.7 4.6% 0.0% Insurance premiums taxes 15.8 16.5 2.7% 4.9% Other business taxes 23.4 23.0 3.7% -1.8% Total business taxes $621.2 $619.0 100.0% -0.2%

State and local business taxes FY2009–FY2010 ($billion)


Where are we today?

► State taxes are rebounding ► State tax revenue grew by 9.3% in Q1 of 2011 as compared with

Q1 of 2010, but state tax revenues are still below their 2008 peak ► Marks five consecutive quarters of year-over-year growth ► Income (12.8%) and sales (6.3%) tax revenues both showed

growth, with corporate income tax revenues increasing by 5.1% ► Q2 of 2011 may see collections exceed pre-recession highs

► But local tax collections are declining due to significant reliance on property tax ► Property tax revenues make up two-thirds of local tax collections ► Local taxes declined 0.6% over the last 4 quarters ► Property tax declined 3% in Q4 of 2010 and 1.6% in Q1 of 2011 ► Local sales tax collections were up 4% in Q1 of 2011


What have states done to combat revenue shortfalls?

► Main focus – spending cuts ► Also:

► Tax changes and increases ► Increased enforcement and settlements ► Enacting and expanding tax credits to retain and attract

business ► One-time accounting gimmicks


What issues are states facing?

► Revenues are increasing, but states still have to deal with: ► High unemployment ► Increasing costs of health care ► Increasing costs of state employee pensions ► Replacing federal funds that are expiring

► End of federal stimulus funding ► Costs of education, prisons and other state-run services ► Local governments need more aid ► Downgrade of federal government’s credit rating

► Increased borrowing costs ► Slowing recovery, with modest projected growth in upcoming

fiscal year


► Reporting of uncertain tax positions (UTP) ► Directors of Revenue discussing how the information reported to

the IRS will benefit the state ► States may attempt to introduce their own state-level variants of

Schedule UTP ► California requiring disclosure of 2010 federal UTP ► Alabama requires federal UTP to be attached to corporate

income return

► Proposed nexus bills in Congress ► Business Activity Tax Simplification Act (H.R. 1439) ► Sales/Use Tax (SST bill) – Sen. Durbin (D-IL) and Rep. Jon

Conyers (D-MI) introduce Main Street Fairness Act (S. 1452; H.R. 2701)

Federal issues that impact the states


Income tax developments


Overview

► Nexus ► Federal conformity issues ► Treatment of alternative taxes ► Net operating losses ► Allocation and apportionment ► Rates and surcharges ► Legislative updates ► Judicial updates ► Employment tax


Economic nexus (adopted since 2007)

► Factor presence standards adopted ► Multistate Tax Commission (MTC) model rule (October 2002) ($50,000

property, $50,000 payroll, $500,000 of sales OR 25% of property, payroll and sales)

► California – $500,000 effective 1 January 2011 ► Colorado – $500,000 effective 30 April 2010 ► Michigan – $350,000 effective 1 January 2008 ► Washington – $250,000 effective 1 June 2010

► Purposeful direction of business to the state/doing business in the state ► Connecticut – effective 1 January 2010 ► New Hampshire – effective 1 July 2007 ► Oregon – effective 8 May 2008 ► Wisconsin – effective 1 January 2009


Federal conformity issues: Bonus depreciation and increased expensing

Arizona Hawaii Maryland New York* South Carolina*

Arkansas Idaho* Massachusetts* North Carolina* Tennessee*

California Illinois*^ Michigan* Ohio Texas

Connecticut* Indiana Minnesota Oregon Vermont*

District of Columbia Iowa* Mississippi* Pennsylvania*^ Virginia*

Florida Kentucky New Hampshire Rhode Island Wisconsin

Georgia Maine New Jersey

*Decouple from IRC §168 but not IRC §179 (some states may only conform to the IRC §179 increase under the HIRE Act). ^IL and PA conform to the 100% bonus but not to the 50% bonus.

► Small Business Jobs Act extends bonus depreciation through 2010 ► Tax Relief, Unemployment Insurance Reauthorization, and Job

Creation Act of 2010 allows 100% expensing for capital investments through 2011, 50% bonus depreciation in 2012

States decoupling from 2010 bonus depreciation and increased expense limit:


► Cancellation of debt income (CODI) deferral election under IRC §108(i) ► States that decoupled or do not conform due to IRC conformity

date ► Arizona, Arkansas, California, Connecticut, District of Columbia,

Florida, Georgia, Hawaii, Indiana, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Mississippi, New Hampshire, New Jersey, North Carolina, Oklahoma, Oregon, Rhode Island, South Carolina, Texas, Virginia, Wisconsin

► Production deduction (IRC §199) ► Kentucky – for tax years beginning on or after 1 January 2010, the

amount of the deduction is calculated at 6% ► Virginia – for tax years beginning on or after 1 January 2010, the

amount of the deduction is calculated at two-thirds the federal limit

Federal conformity issues (cont.)


Treatment of alternative state business taxes

► Whether a state will provide a tax credit or require an addback for the Texas Margin Tax, Ohio Commercial Activity Tax (CAT), Michigan Business Tax (MBT) or other alternative tax depends on if the tax is based on net income ► California – Margin Tax: depends on the method used to compute the tax ► Georgia – Margin Tax: not considered an income tax ► Kansas – Margin Tax: is a tax based on net income ► Minnesota – CAT and Margin Tax: neither is based on net income ► South Carolina – business income tax portion of the MBT, the Margin Tax

and CAT: none allowed as a deduction, but modified gross receipts tax portion of the MBT and the Ohio CAT can be deducted

► Virginia – Margin Tax: not based on net income ► Wisconsin – MBT and Margin Tax: may qualify as net income tax if certain

conditions are met


State net operating loss (NOL) deductions

► California ► NOL deduction suspended for 2008, 2009, 2010 and 2011

► Colorado ► Limited utilization of NOLs (maximum of $250,000) from 1 January

2011 to 1 January 2014

► Maine ► Addback of 10% of federal NOL in excess of $100,000 of any NOL

that is being carried over ► NOL deduction suspended for tax years 2009, 2010 and 2011

► Pennsylvania ► 2010 and thereafter, cap on NOL is the greater of $3 million or

20% of taxable income


Allocation and apportionment

► Sales factor changes ► Single sales factor adopted: Washington (adopted for

royalties and most services) ► Single sales factor being phased in: Indiana, Minnesota,

New Jersey, New York City, South Carolina, Utah, Virginia ► Weight of sales factor increased: Pennsylvania ► Alabama – adopts double-weighted sales factor, throwout

rule and market-based sourcing ► California – adopts “elective” single sales factor, Finnigan

and market-based sourcing (but taxpayer must use cost of performance sourcing if it uses three-factor double- weighted sales factor apportionment formula)

► District of Columbia – double-weighted sales factor ► Indiana – single sales factor fully phased in


Allocation and apportionment (cont.)

► Adoption of market-based sourcing: Oklahoma and Washington

► Throwout/throwback ► New Jersey – throwout rule repealed as of 1 July 2010 ► Washington – throwout rule effective 1 June 2010

► Joyce/Finnigan ► Maine – switched to Finnigan


Rates and surcharges

► Arizona – currently 6.968%; 6.5% in 2014; 6% in 2015; 5.5% in 2016; 4.9% in 2017 and thereafter

► Connecticut – in 2012 and 2013, surcharge of 20% will be imposed unless minimum taxpayer or if company’s adjusted gross income (AGI) is less than $100m

► Illinois – 2011 through 2014 rate increased to 7% ► Louisiana – phase-out of the debt portion of the corporation

franchise tax ► Massachusetts – reduced rates for corporations (8.75% from

9.5%), rate also reduced for S corporations ► North Carolina – 3% surtax, based on tax payable by the

corporation ► West Virginia – phase-out of the business franchise tax


Legislative developments: Combined reporting

AK

HI

ME

RI

VT NH

MA NY* CT

PA NJ

DC**

DE WV

NC

SC

GA

FL

IL OH*** IN

MI

WI

KY

TN

AL MS

AR

LA TX

OK

MO KS

IA

MN

ND

SD

NE

NM AZ

CO UT

WY

MT

WA

OR ID

NV

CA VA

MD

* New York City and state require combined reporting when there are substantial intercorporate transactions

** DC is placeholder language requiring the city council to adopt combined reporting effective for 2011

*** For purposes of the CAT

As of 4 May 2011 Key

Combined reporting/consolidated return required prior to 2004

Combined reporting/consolidated return adopted for 2004 or later

Combined reporting legislation proposed in 2011

Separate return state

No income tax

NY City*


Legislative developments (cont.)

► District of Columbia ► A19-0098 (signed into law 14 September 2011) – mandatory unitary

combined reporting and a double-weighted sales factor apportionment formula, effective for taxable years beginning after 31 December 2010

► Water’s edge unless worldwide election is made ► Minimum franchise tax increased to $250 ($1,000 if DC gross receipts are

over $1m)

► Florida ► H.B. 142 (enacted 31 May 2011)

► Certain taxpayers that make qualified capital expenditures of at least $250 million can elect to use a single sales factor apportionment formula

► Creates a spaceflight project credit and an R&D credit ► Makes other changes to credit provisions



► Indiana ► H.B. 1004 (enacted 10 May 2011) makes various changes to the

corporate income tax, including: ► Eliminate NOL carryback after 31 December 2011 ► Reduce corporate income tax rate in phases (from 8.5% for Indiana

AGI earned before 1 July 2012 to 6.5% for Indiana AGI earned after 30 June 2015)

► Extend period for filing amended Indiana return after federal modification (from 120 days to 180 days) and for filing a protest (from 45 days to 60 days)



Michigan Business Tax ► Consists of both business income tax

base at 4.95% AND modified gross receipts tax base at 0.8% along with 21.99% surcharge

► Taxes flow through entities ► Economic nexus standard ► Water’s edge (US) unitary combined

reporting ► Single sales factor apportionment ► Market-based sourcing methodology for

sales other than tangible personal property ► Expanded credits ► Treated as a component of income tax

expense for financial reporting

Corporate income tax ► Corporate income tax at 6% ► Taxes entities classified as C

corporations for federal income tax purposes

► Economic nexus standard ► Water’s edge (US) unitary combined

reporting ► Single sales factor apportionment ► Market-based sourcing methodology

for sales other than tangible personal property

► Only credit allowed is a small business credit

► Treated as an income tax for financial reporting

► Michigan – H.B. 4361 and H.B. 4362 (enacted 25 May 2011)


► Missouri ► S.B. 19 (enacted 26 April 2011) – phases out the franchise tax beginning

in tax year 2012, with full phase-out by 2016

► Mississippi ► S.B. 3097 (enacted 25 April 2011) – receipts for sales to a distribution

facility for certain pharmaceutical products by certain major suppliers are not included in the Mississippi apportionment factors for purposes of determining franchise tax

► New Jersey ► Research and development credit limit elimination

► Beginning 1 January 2012, New Jersey has eliminated the limit on the R&D credit ► The R&D credit may be used to eliminate corporate business tax (CBT)

liability (subject to the statutory minimum) ► Unused R&D credits may be carried forward for up to seven years



► North Carolina ► H.B. 619 (enacted 30 June 2011) – provides guidance to taxpayers

as to when the Department of Revenue (DOR) will require taxpayers to either: ► File a combined return, or ► Add back, eliminate or otherwise adjust income reported to the state due to

intercompany transactions ► Generally effective 1 January 2012

► H.B. 200 (enacted 15 June 2011) – exclusion of reserves for amortization of intangible assets from the capital base in determining the taxpayer’s franchise tax liability ► Basically, taxpayers can adjust the calculation of the Schedule C taxable base

to the extent accumulated amortization of intangible assets for income tax purposes exceeds accumulated amortization of intangible assets for book

► Applicable to tax years beginning on or after 1 January 2007



► Wisconsin ► A.B. 40 (enacted 26 June 2011) implements the 2011–13

Executive Budget Bill. Key tax changes: ► Amend combined reporting provisions to allow combined groups, effective for

taxable years beginning after 31 December 2011, to share net business loss carryforwards incurred by group members before 1 January 2009, with certain limitations ► Unused losses can be carried forward for up to 19 years

► Prohibit the Department of Revenue from disregarding a taxpayer’s election to include a controlled business in the combined group, effective retroactively to taxable years beginning on or after 1 January 2009

► Establish a qualified production activities income tax credit, the amount of which would increase from 1.875% in 2012 up to 7.5% for 2015 and thereafter

► Create subtractions for certain capital gains ► Couple to the IRC in effect as of 31 December 2010, but continue to decouple

from bonus depreciation, deferral of cancellation of debt income, the increased expense limitation and the domestic production deduction

Legislative developments (cont’d)


Judicial developments

► New York ► Interaudi Bank (NYS Tax App. Trib.) – Taxpayer must include an out-of-state

subsidiary in its New York combined report because excluding the subsidiary created distortion

► New Jersey ► Whirlpool Properties (NJ Sup. Ct.)

► Throwout is facially constitutional when applied to untaxed receipts from states that lack jurisdiction to tax the corporation either due to insufficient nexus or the protection of P.L. 86-272

► Throwout is NOT constitutional when applied to untaxed receipts from a state that does not have an income (or similar) tax

► Case goes back to the Tax Court to determine the constitutionality of the rule as applied to the facts of the taxpayer ► Note: Throwout rule repealed effective 1 July 2010

► NJ Division of Taxation announced that in accordance with NJ Supreme Court’s ruling, its audit policy has been revised concerning receipts assigned to Nevada, Wyoming and South Dakota


► Current tax amnesty programs available: ► Ohio – 1 May 2012 to 15 June 2012

Tax amnesty programs


► Pennsylvania Act 32 ► Restructuring of earned income tax (EIT) collection system,

effective 1 January 2011, but not mandatory until 1 January 2012 ► There are some early adopters ► Philadelphia is excluded

► Objective: increase efficiency and compliance by consolidating the collection of local earned income tax on a countywide basis

► Requires that employers withhold EIT at the greater of the employee’s residence tax or the nonresident tax of the jurisdiction in which the workplace is located

► Reduces tax collection districts from 590 to 68 ► New hires and change of addresses must provide a residency

certificate ► Some collection districts may require residency certificate for everyone

Employment tax considerations


Sales and use tax developments


Topics

► Nexus ► Medical devices ► Durable medical equipment ► Pharmaceuticals ► Promotional items and samples ► Services ► Exemptions ► Streamlined Sales Tax ► Questions


Nexus developments

► Current nexus standard remains physical presence ► States continue to enact aggressive “attributional nexus”

provisions aimed at remote sellers ► At least 20 states have enacted or considered laws since 2008 ► Laws generally focus on activities of/relationship to in-state affiliates ► Under challenge in a number of jurisdictions

► Some states providing exemption from collection for businesses that hit specified job creation/investment levels

► Two bills introduced in Congress to eliminate physical presence standard ► SST bill (Main Street Fairness Act) ► Non-SST bill (Marketplace Equity Act of 2011)


Medical devices

► Medical Device Excise Tax scheduled to go into effect for transactions occurring on or after 1 January 2013 ► 2.3% federal excise tax on sales of certain medical devices by the

manufacturer or importer of the device

► Law defines “taxable medical device” as any device defined in the Federal Food, Drug, and Cosmetic Act, intended for humans

► Certain items are specifically exempt, including: ► Eyeglasses ► Contact lenses ► Hearing aids ► Any other medical device determined to be of a type that generally

is purchased by the general public at retail for individual use


Durable medical equipment and medical supplies

► South Carolina: 2011 S.B. 36, effective 8 June 2011 ► New law phases out the sales tax on durable medical equipment and

related supplies by 1 January 2013 ► The sales tax on durable medical equipment was reduced to 3.5% on

1 July 2011 and is further reduced to 1.75% on 1 July 2012

► Missouri: Medical Positioning, Inc. v. Director of Rev., No. 009-1104RS (Mo. Admin. Hearing Com., 7 October 2010) ► Manufacturer of medical equipment and padded movable tables was not

entitled to a sales tax exemption for sales of hospital beds and accessories or ambulatory aids because items did not aid the patient in walking or moving from place to place and were not used overnight

► Missouri: Letter Ruling 6884 (25 August 2011) ► Implants used to correct human tissue defects may be exempt if used to

replace all or part of a malfunctioning internal organ


Durable medical equipment and medical supplies (cont.) ► Indiana: Letter of Finding 04-20100597 (Ind. Dept. of Revenue,

1 March 2011) ► “PillCams” used by gastroenterologist to take virtual x-rays of patients’

digestive tracts constituted medical devices, and thus were not exempt

► Indiana: Letter of Finding 10-0103 (Ind. Dept. of Revenue, 1 March 2011) ► Manufacturer and distributor of medical implants and surgical devices was

required to pay use tax on items withdrawn from inventory and used for R&D purposes


Pharmaceuticals

► Colorado: SB 263, effective 1 July 2011 ► New law grants a sales tax exemption for medicine and medical supplies

furnished to a patient by a licensed medical provider who is not a doctor, including advance practice nurses, dentists, optometrists and veterinarians

► Rhode Island: 2011 H.B. 5894, signed 30 June 2011 ► Effective 1 October 2011, new law expands the sales and use tax base by

taxing non-prescription drugs

► Washington (B&O Tax): Wellpartner, Inc. v. Dept. of Revenue, No. 10-228 (Wash. Tax App. Bd., 15 September 2011) ► Out-of-state mail-order pharmacy that sold directly to individuals did not

qualify for lower business and occupation (B&O) rate because the company did not resell drugs to qualifying health care providers


Pharmaceuticals (cont.)

► Policy Letter No. 09300051 (17 August 2009) ► Free flu vaccines distributed by a drug store are subject to tax because

it is “use” of tangible personal property “incident to ownership” in the state

► Because the vaccine was not a prescription drug, it was not exempt from taxation and, notwithstanding the “worthy activity,” the use is subject to tax

► Kentucky: PCA-Corrections, LLC v. Kentucky Finance and Admin. Cabinet, No. K-20207 (Ky. Bd. Tax App., 6 January 2009) ► A drug typically sold over the counter does not acquire the

categorization of a “prescription drug” for purposes of sales and use tax exemptions simply because the over-the-counter drug is dispensed by an inpatient rehabilitation or convalescent institution


Promotional items and samples

► South Carolina: Revenue Ruling 10-2 (12 January 2010) ► Clarifies that medicine and prosthetic devices sold by prescription,

including free samples of prescription medicine distributed by its manufacturer, and any use of such free samples, are exempt

► Kansas: Nursing Home & Health Care Facilities Self-Audit Fact Sheet (Kan. Dept. of Revenue, 15 September 2011) ► Promotional items purchased by a company – including but not

limited to calendars, mugs and items of clothing – are taxable

► South Dakota: Sales Tax Facts (S.D. Dept. of Revenue, 1 March 2011) ► Samples of drugs given to a physician, chiropractor, optometrist, dentist,

podiatrist, audiologist, clinic or hospital are exempt from sales tax because these drugs must be prescribed, dispensed or administered by the same


Services

► IT and computer-related services ► Cloud computing:

► Use of software hosted on remote servers and owned by a third party ► Most states have not articulated a sales/use tax position ► Where no formal position exists, state treatment of electronically delivered

software may be instructive

► Data processing and medical transcription: ► Data processing generally treated as an exempt service transaction ► Several exceptions: e.g., Texas Letter Rul. 201004665L (29 April 2010):

company that provided medical transcription services over the internet using software-as-a-service (SAAS) voice recognition software was providing taxable data processing service

► Medical transcription typically treated as exempt professional service

► Personal services ► Therapeutic services generally not subject to tax


Exemptions

► Illinois: GIL ST-11-0074 (13 September 2011) ► Medical supplies sold to Medicare and Medicaid patients are exempt from

the retailers’ occupation tax (ROT) as sales to a government body, provided that the government agency makes payments directly to the provider or vendor

► Florida: TAA 11A-025 (12 August 2011) ► Manufacturer's sales of allergy skin testing devices are exempt from sales

tax because the test kits are considered medical devices for human use

► Missouri: Letter Ruling 6791 (Mo. Dept. of Revenue, 22 July 2011) ► Amounts paid to third party for the manufacture of a brain scanning

prototype device were subject to tax because the device did not qualify for the R&D exemption


Streamlined Sales Tax

► Georgia became 21st full-member state (1 August 2011)

► SST does not require states to tax or exempt drugs, durable medical equipment (DME), promotional items, etc. ► Streamlined Sales and Use Tax Agreement (SSUTA) merely sets uniform

definitions, requires consistency within state sales tax regime ► Provides definitions for: drug, durable medical equipment, grooming and

hygiene products, mobility enhancing equipment, over-the-counter drug, prescription and prosthetic device

► Ultimate goal of SST is to simplify state sales and use tax laws in order to allow Congress to repeal physical presence nexus standard


Questions

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