A recent Ohio Board of Tax Appeals (“Board”) ruling (The Auto Place, LLC vs. Jeffrey A. McClain, Tax Commissioner of Ohio) is a cautionary tale for taxpayers seeking to avoid sales tax on expensive purchases such as collectible cars and recreational vehicles. Many of us have seen the Ferrari with the Montana license plate or heard about individuals avoiding tax by shifting the jurisdiction of a sale to a state with no sales tax. This ruling by the Board highlights the risks when tax mitigation strategies are uncovered and determined to be tax avoidance strategies by state tax officials.

Initially, The Ohio Tax Commissioner (“Commissioner”) issued assessments totaling approximately $950,000 in use tax, plus penalties and interest against The Auto Place, LLC, The Auto Museum, LLC and The Beck Group of Oregon, Inc. (“appellants”), all of which were owned by Mr. Harry G. Yeaggy, a Cincinnati businessman. Two of the entities were established in states that do not impose sales taxes, Montana and Oregon, respectively. The third was an Ohio LLC that obtained an Ohio Dealer’s License, presumably so it could claim Ohio’s sale for resale exemption. The entities served to purchase collectible cars on behalf of Mr. Yeaggy.

The appellants put forth several arguments against the assessments, but primarily contested the assessments on the basis that the cars were purchased with the intent to resell them. Ohio statutes provide an exemption for resales by a person engaging in business.

• 5739.01(E) “Retail sale” and “sales at retail” include all sales, except those in which the purpose of the consumer is to resell the thing transferred or benefit of the service provided, by a person engaging in business, in the form in which the same is, or is to be, received by the person.
• 5739.01(F) “Business” includes any activity engaged in by any person with the object of gain, benefit, or advantage, either direct or indirect. “Business” does not include the activity of a person in managing and investing the person’s own funds.

Mr. Yeaggy, through his counsel, chief mechanic, and expert witness asserted that his purchase of the collectible cars was a business and was not, as the Commissioner asserted, a hobby. The appellants argued that Mr. Yeaggy established a showroom for the cars and operated as a dealer, in accordance with Ohio’s requirements for vehicle dealers, since the showroom had the requisite signage and business hours posted. The showroom was open to the public during advertised hours (“every Wednesday until noon and by appointment”).

His arguments were not well received by the Board as they countered that “there is far more evidence in the record that he uses the cars to advertise his status as a successful businessman rather than advertising the vehicles for sale to others.” Mr. Yeaggy only sold four of the seventeen cars from the assessments. While great weight was placed on the dealership license, by the appellants, the Board concluded that his showroom was not a dealership based on the facts of the case, including its limited hours, availability to the public, and articles that described the showroom as Mr. Yeaggy’s personalized garage.

The Board ruled that the appellants were not in the business of purchasing cars for resale nor did they operate a legitimate dealership. They reasoned that tax cannot be avoided because one seeks to make a profit on his purchases and has the means to purchase a location and hire personnel to oversee his collection. Finally, the fifteen percent (15%) penalty imposed by the Tax Commissioner was also sustained.

Taxpayers making expensive purchases are advised to understand the sales and use tax implications before implementing tax mitigation strategies. Utilizing Montana registration is a well-known strategy, often promoted by Montana law firms, but it is also familiar to state tax authorities and may result in tax assessments and unwanted attention. While there are valid tax mitigation strategies, they carry risk and often require strict compliance to the details (i.e., property must remain in one state or a specific state). Taxpayers can cost themselves substantial dollars if they veer from the spirit and intent of certain exemptions.

If you have questions on Ohio’s ruling or other SALT matters, please contact the HBK SALT Advisory Group at hbksalt@hbkcpa.com.

On September 9, 2022, the Commonwealth Court of Pennsylvania granted summary relief to the Online Merchants Guild (“Guild”) in its dispute with the Pennsylvania Department of Revenue (“Revenue”). The Guild is made up of members that participate in Amazon’s Fulfillment by Amazon (“FBA”) Program. Merchants (“FBA Merchants”) participating in FBA commit their inventory to Amazon warehouses in Pennsylvania or other states and do not control where the inventory is stored. Revenue viewed participation in FBA by merchants as creating state tax obligations on the basis that inventory stored in the state constitutes physical presence.

Revenue began pursuing FBA Merchants through business activity questionnaires that implied enforcement actions were pending for FBA Merchants that did not respond to Revenue’s requests or take advantage of the voluntary compliance program offered in the letter. The Online Merchants Guild filed a petition for review in June 2021 asking the Court to determine whether FBA merchants were subject to Pennsylvania’s tax statutes.

One of the primary questions addressed by the Court was whether participation in FBA gave Revenue jurisdiction and authority to investigate the participating merchants and determine their tax liability. The Court concluded that Pennsylvania statutes, under Section 272, applied to “taxpayers, not individuals or entities Revenue suspects may be taxpayers”. The Court went on to address Due Process Clause concerns that effectively limit Revenue’s ability to request business information from entities. A taxing authority cannot, under due process, subject an entity to taxation unless there is a connection between the entity and the taxing authority (state) and the entity has availed itself to that state’s market (“protections, opportunities, and services”). The Court determined participation in FBA did not come with the expectation by the merchant that its goods “would be purchased by a customer located in the Commonwealth, or has availed itself of the Commonwealth’s protections, opportunities or services.”

The Court ruled in the Guild’s favor on two points essentially providing that Revenue did not have jurisdiction or authority to pursue the FBA Merchants. First, the Commonwealth had not provided anything to the merchants, “for which it can ask [in] return.” Second, the Department of Revenue does not have statutory authority over “persons or records located outside the Commonwealth”. The Court’s ruling is affirmation of the due process clause and may impact other states’ ability to pursue businesses with similar circumstances. Taxpayers should always exercise caution and check with their state and local tax advisor when responding to state tax questionnaires or state tax inquiries.

The full text of the Commonwealth Court ruling can be viewed here.

If you have questions on Pennsylvania’s ruling or other SALT matters, please contact the HBK SALT Advisory Group at hbksalt@hbkcpa.com.

*On December 8, 2022 New Jersey issued Publication ANJ-14 addressing the tax treatment of sign fabricators or installers. The sales tax rules applicable to sign vendors changed on October 1, 2022 as the result of legislation.

New Jersey passed legislation that changes the sales tax rules for sign fabricators and vendors. The new law, effective October 1, 2022, allows sign fabricators and installers to purchase signs and materials exempt as sales for resale. In addition, the law will require that the vendor bill the customer sales tax on the sale of the sign and the installation charges. Prior to effective date of the law change, sign vendors were subject to the state’s rules on contracting and capital improvements. The new law clarifies that the sale and installation of signs are taxable. The exemption for installation charges, under the capital improvement rules, will no longer apply.
For more information on New Jersey’s tax changes applicable to sign vendors, visit the New Jersey Division of Taxation website here.

If you have questions on New Jersey’s sales tax change or other SALT matters, please contact the HBK SALT Advisory Group at hbksalt@hbkcpa.com.

On June 1, the Ohio legislature passed SB 246 allowing Ohio pass-through entities (PTEs), like S and limited liability corporations, to elect to be taxed at the “entity level,” at a rate of 5 percent of 2022 taxable business income, then 3 percent in subsequent years Ohio Bill Allows Pass-Through Entity Deduction. The bill is considered Ohio’s workaround for the $10,000 limit on the deductibility of state and local taxes set by the Tax Cuts and Jobs Act of 2017.

Previously, Ohio PTEs filed a withholding tax (form IT 1140) or a composite tax (form IT 4708). Both taxes were to be filed and paid by the entity, but on behalf of the entity’s shareholders or members. Because neither tax is imposed on the entity directly, the taxes paid using either form are deductible as an itemized deduction federally, and therefore subject to the SALT cap.

SB 246 provides qualifying PTEs a third filing option, effective for the tax year 2022, an entity-level tax (form IT 4738). Provisions of the bill for entities choosing the SALT cap workaround include:

• Refundable tax credits will be available to the entity’s owners equal to their proportionate share of the tax.
• Entities must elect the entity level tax separately and irrevocably each tax year.
• Entities paying the entity tax are not subject to current Ohio withholding requirements.

In August, the Ohio Department of Taxation issued additional guidance on the law known as SB 246. The guidance lays out the types of partnership/S Corp tax payments that are subject to deduction in computing federal adjust gross income (AGI), and which must be itemized. In short:

• Taxes imposed on the entity are deductible in computing federal AGI, and thus circumvent the SALT Cap.
• Taxes paid by the entity on behalf of its shareholders are deductible as an itemized deduction, and thus subject to the SALT Cap.
• IT 4738 serves as the Ohio filing for the entity’s nonresident and trust investors, provided they don’t have other Ohio-sourced income.
• Like the credits allowed for IT 1140 and IT 4708 payments, investors can claim a refundable credit for their proportionate share of the tax paid by the entity on the IT 4738.

In its additional guidance, the Department included a list of yet-to-be-answered questions about SB 246, including:

• What if an electing PTE is owned by other PTEs?
• Does a PTE’s election bind PTEs that invest in it?
• How are credits/deductions allocated among the electing PTE’s investors?
• Does the investor PTE need to file?
• What if the electing PTE is owned by a C Corp or other exempt entity?
• Can the C Corp claim the refundable credit paid by the electing entity?

The law had passed both the Ohio House and Senate with overwhelming majorities. About two dozen other states have voted on legislation to provide a workaround for the SALT deduction cap. Proponents of SB 246 argued that the cap left Ohio businesses less competitive with companies domiciled in those states.

For more information on how rulings and legislation related to state and local taxes might impact your business, contact an HBK SALT professional at hbksalt@hbkcpa.com or visit our website.

Historically, manufacturers have been concerned primarily with the sales and use tax rules in their home states and how the rules impacted their purchases, and to a lesser extent, their sales. That all changed on June 21, 2018, when the U.S. Supreme Court rendered its decision in Wayfair v. South Dakota. The ruling allowed states to impose sales tax collection requirements based on a seller’s economic activity in their states, and what has followed is legislation in every state that imposes a sales tax to capture that additional revenue via economic nexus thresholds. The impact on manufacturers’ income can be substantial and the new laws make it imperative for manufacturers to understand key aspects of contemporary sales and use taxes, including economic nexus, manufacturing exemptions, exemption certificates, and sales tax compliance.

Economic Nexus

Before the emergence of economic nexus in 2018, the sales tax nexus standard was physical presence. A taxpayer was not required to collect or remit a state’s sales tax unless it had a physical presence (office, employees, property, etc.) in that state. Prior to Wayfair, it was common for a manufacturer to be registered and filing sales/use tax returns only in its home state. Now, any manufacturer with substantial sales outside its home state likely has economic nexus in one or more states. Economic nexus laws, along with their sales and transaction count thresholds, vary by state. The sales or receipts threshold is never less than $100,000 and a few states are as high as $500,000 (California, New York, and Texas). The transaction count threshold is typically either 100 or 200, although many states have chosen to forgo a transaction count when determining whether activity is sufficient to create economic nexus. Another consideration for manufacturers when assessing economic nexus is whether they are selling at retail or wholesale; several states do not count wholesales or nontaxable sales against the receipts threshold. Manufacturers with multi-state sales should evaluate their activity in each state to determine if economic nexus exists.

When an entity creates sales tax nexus it needs to take additional actions to achieve compliance. To file the required sales tax return, a business must register with the state and create an online tax account. Then the business needs to consider how it will determine the taxability of its sales and manage customer exemptions and the related exemption certificates. In most cases, sales of tangible personal property are taxable, but there are many potential exemptions that vary by state, including resale, use in manufacturing, and product specific exemptions, such as clothing or medical devices.

If your business has a robust ERP or sales system, taxability by state may be easily configurable. But for manufacturers lacking tax software or advanced systems, the process is manual, time-consuming, and prone to error. An efficient implementation is possible if you understand all the considerations associated with creating economic nexus for sales tax.

Exemptions

Sales tax exemptions for manufacturing are nuanced and subject to interpretation. The exemption language in most states includes phrases such as “directly used” or “directly and primarily” used in production. These phrases can be interpreted in different ways. Operations personnel often argue that manufacturing cannot occur without a specific piece of equipment, but that does not necessarily mean the equipment is directly used in production. Conversely, auditors will often attempt to narrow the scope of the manufacturing exemption based on when the production process begins and ends.

To further complicate matters, every state’s manufacturing exemption is different. For example, New Jersey, Ohio, and Pennsylvania all have manufacturing exemptions, but New Jersey’s does not apply to parts with a useful life of less than a year. Ohio and Pennsylvania exempt parts on equipment or machinery directly used in manufacturing.

Pennsylvania’s exemption includes purchases of “tangible personal property and otherwise taxable services to be used directly in research operations …” while other states such as Ohio largely limit the research and development portion of the exemption to “… capitalized tangible personal property, and leased personal property that would be capitalized if purchased ….” The contrast illustrates the disparate approaches states take with their manufacturing exemptions.

Utilities used in production are commonly included in a manufacturing exemption, though not by all states. Here again there is a lack of consistency: New Jersey provides no exemption from tax for electricity used in manufacturing; Florida, Ohio, and Pennsylvania offer exemptions on utilities used in production in most cases. Utility exemptions are frequently based on utility studies that quantify production use versus general use. But utility studies are rarely updated on a regulation basis and can be out of date or inaccurate resulting in either exposure or opportunity if the manufacturer’s operation has changed since the previous study.

The use of a forklift is another issue that can result in exposure or opportunity. Forklifts may be used to unload raw materials (typically considered pre-production) or move finished goods (usually considered post-production). In most cases, these uses of a forklift are taxable, but what happens when that same forklift moves in-process goods or materials? The answer depends on the state’s statutes and regulations, but in many cases, that forklift—or at least its percentage of use in the exempt activity—will be eligible for exemption.

Sales Tax Compliance

Filing requirements due to economic nexus can overwhelm a tax department or the individuals responsible for filing the manufacturer’s sales tax returns. Many businesses have gone from filing in one state to filing in 40-plus states since Wayfair was decided in 2018. Filing multiple sales tax returns is a major adjustment that requires investment in technology and people. There are over 10,000 discrete state and local sales tax rates in the United States. Accurately charging and reporting sales tax is a monumental task without advanced software. Is your business prepared to handle sales tax and filing returns in all states where you have sales if required? Based on increased sales and use tax filing obligations, you may need to consider compliance options, including outsourcing or software solutions.

Exemption Certificates

With more sales tax obligations in more states, the complexity around compliance increases. Are you obtaining exemption certificates from customers that purchase goods tax-free? If yes, is the certificate valid as completed by those customers? Florida, for example, requires a new certificate every year to qualify for its resale exemption. Other states require the seller to verify the purchaser’s tax ID on the state website. In addition, the “good faith” rules imposed by states vary dramatically, and incomplete or invalid exemption certificates prove an unwelcome surprise during a sales tax audit. As anyone who has been through an audit knows, tracking down exemption certificates three or four years after a sale is like playing craps, you roll for a while with some success, but eventually you crap out and lose to the house, or in this case, the state. Being prepared means knowing each state’s requirements and reviewing certificates as they are received.

Solutions

The HBK SALT Advisory Group is here to provide solutions based on your unique set of circumstances. Whether you require consulting, compliance, or audit defense services, we are your SALT partner and resource. Collectively, our team has more than 50 years of experience with indirect taxes and has been advising our manufacturing clients since before the turn of the century. We can help you address economic nexus, apply manufacturing exemptions, and explore outsourcing your sales tax compliance.

To initiate a conversation with the HBK SALT Advisory Group, email us at hbksalt@hbkcpa.com or visit our website for more information on our capabilities here.

Pennsylvania is joining the ranks of several other U.S. states that are responding to an improved financial standing by lowering tax rates, which they contend will make businesses located there more competitive. A bill approved by the legislature July 7 and signed by Governor Tom Wolf reduces the corporate net income tax rate incrementally over the next six years from its current 9.99 percent to 4.99 percent by 2031. Governor Tom Wolf championed the legislation as part of his 2023 budget proposal.

Like similar bills being passed in other states, HB 1342 looks to shift some of that corporate tax burden to out-of-state businesses selling into Pennsylvania with market-based sourcing and economic nexus rules. Specifically, the bill changes the sourcing of intangible property from a cost-of-performance approach to a market-based approach. Under cost-of-performance, receipts are apportioned to the state based on the location where the taxpayer incurs its expenses providing its services. The market-based approach seeks to match the receipts to the source of the corresponding revenue, which translates into collecting more taxes from out-of-state businesses with substantial economic activity in the state.

As well, inspired by the landmark Wayfair v. South Dakota U.S. Supreme Court decision, HB 1342 creates an economic nexus for businesses based outside Pennsylvania with more than $500,000 in a year in remote sales, that is, sales into the state. The bill also increases several tax credit caps.

The bill won broad support by both parties, passing 38-12 in the Senate and 184-16 in the House. Republican Senate Majority Leader Kim Ward praised the bill as “a comprehensive modification to our taxes in Pennsylvania,” noting that state revenues had been higher than expected and that coupled with funds received through the American Rescue Plan Act allowed the commonwealth to “prioritize job creation and business growth through the reduction of the corporate net income tax.”

For more information on Pennsylvania corporate income tax, contact us at hbksalt@hbkcpa.com or visit our website here.

As we previously reported here, Ohio passed legislation allowing refund claims for 2021 to employees that worked from home but paid municipal income tax to a jurisdiction associated with their employer’s office (often at a higher rate). However, refunds for 2020 have been on hold due to pending litigation.

The Supreme Court of Ohio has accepted a case addressing the 2020 tax year. In the midst of the COVID-19 pandemic, Ohio passed a rule that work done from home by an employee was deemed work performed at the employer’s location for municipal income tax purposes. Ohio’s rule was challenged by taxpayers in several jurisdictions. The Supreme Court’s decision in this case is expected to resolve the issues surrounding tax year 2020 and clarify whether refunds will be permitted.

If you have questions on Ohio municipal income taxes or other SALT matters, please contact the HBK SALT Advisory Group at hbksalt@hbkcpa.com.

As part of New Jersey’s recently passed budget, the state enacted a back-to-school sales tax holiday. The sales tax holiday will run from August 27th through September 5th and the exemption will apply to school supplies, school art supplies, instructional materials, computers, and computer supplies such as printers. The sales tax holiday is intended to provide New Jersey taxpayers (and parents) with a bit of relief from recent inflationary pressures.

The New Jersey Division of Taxation established a webpage related to the upcoming sales tax holiday. Information on the sales tax holiday including definitions, limitations and FAQs can be viewed on the Division website.

If you have questions on New Jersey’s sales tax holiday or other SALT matters, please contact HBK’s SALT Advisory Group at hbksalt@hbkcpa.com.

The Pennsylvania Department of Revenue has issued an update to its Notice of Taxable and Exempt Property. The Commonwealth is required to periodically update this list which addresses different categories of property and provides taxability on an item-by-item basis. The Notice is also incorporated into the Retailer’s Information Guide (REV-717) published by the Department.

The updated Notice provides for tax treatment of new items and/or clarification or changes from prior versions. This year’s version includes the addition of guidance on non-fungible tokens (“NFTs”) which are taxable in Pennsylvania. The changes and clarifications in the notice address treatment of CBD that is vaped, flea-related pet supplies, residential fuel, and specified farming supplies.

The state’s current Retailer’s Information Guide can be accessed here.

The current Notice of Taxable and Exempt Property is available here.

If you have questions on the taxability of goods or services in Pennsylvania or other SALT matters, please contact HBK’s SALT Advisory Group at hbksalt@hbkcpa.com.

Philadelphia’s 2023 budget, passed by the City Council on June 23, will include tax cuts on business income and wages. The city’s business income and receipts tax rate will be reduced from 6.2 percent to 5.99 percent. Taxes on wages are being reduced as of July 1, 2022, for residents from 3.8398 percent to 3.79 percent, and for non-residents from 3.4481 to 3.44 percent. Mayor Jim Kenney heralded the changes to wage taxes, considered among the highest in the nation, as being reduced to their lowest levels in more than 50 years.

In a related move, the Council passed an ordinance designed to move the city toward market-based sourcing for business income and receipts taxes on sales of intangibles and services by providing exclusions for receipts on intangibles used outside the city limits.

Market-based sourcing generally taxes services based on where the benefit of the service is received. In moving toward market-based sourcing, service businesses in Philadelphia will only be required to pay business income and receipts tax on sales delivered to customers located within the city. Market-based sourcing is the trend in state and local taxation. The transition to market-based sourcing should help level the playing field for Philadelphia-based service providers with companies located outside of Philadelphia.

For more information on how rulings and legislation related to state and local taxes might impact your business, contact us at hbksalt@hbkcpa.com or visit our website here.