SALT Top Stories of 2011

A prolonged economic slump, political challenges at the state and federal level and long_ term structural budget issues continued to impact states in 2011. Viewing this big picture in a vacuum, it would be easy to harken back to the last couple of years and ask whether anything has changed from 2010, or even 2009. While the big picture seemed to stay about the same, significant changes in many of the states really did come about this year, inspired by governors and legislatures empowered to make some difficult choices, and buttressed by active judiciary systems willing to decide SALT matters of importance. Some states made the difficult choice to raise taxes on a broad swath of citizens. Others tried reforming their tax systems, with winners and losers still to be determined.

It is not surprising that the disparate tax policies tried by the states are outgrowths of their overall budget situations. Some states, like Iowa and Indiana, have been successful at substantially reducing the structural budget gap that grew during the last several years, due in part to stabilization and in some cases, increased growth in revenues. These states have not made major changes to their tax structures in the past several years. In contrast, other states, like California, Illinois and New York, continued to struggle with closing their structural deficits despite modest improvements in revenue levels, in large part because of the effect of large pension obligations and other nonnegotiable costs. These states have tended to make more substantial changes to their tax structures.

According to a Center on Budget Priorities and Policies (CBPP) report published earlier this year, 42 states and the District of Columbia were trying to close $103 billion in budget gaps in fiscal year 2012, on top of fiscal shortfalls faced by states in the previous three years.1 Though the aggregate amount of budget gaps is very high, and will remain so for several years, an interesting dichotomy may be developing, between the states that have taken proactive steps to reduce their budget gaps (along with a select number of states that did not go into recession because of a plethora of natural resources that rose in value) and states that did not effectively deal with budget gaps and have been forced to take stern austerity measures. The budget conditions in the more fiscally sound states are likely to dictate tax policies that will be vastly different from the states that have been unable to get a handle on their finances.

At the local level, budgetary problems could remain an issue for a longer period of time than at the state level, due to local government reliance on property taxes, which does not always grow in line with other types of taxes. Over the past several years, the fair market value of real property has significantly declined in many geographical markets and those values are only now beginning to stabilize. However, the assessed values on which the property tax base is calculated actually continued to rise well into the heart of the recession, because of limitations on the rates of increases on such values during the real estate market boom. But now, the assessed values are faltering (even as localities may wish to artificially keep such values as high as possible), and as a result, real property collections are likely to continue declining until assessed values or tax rates start to rise. For localities that are already seeing cutbacks from state government funding, the reduction in collections from the property tax base could be disastrous. To date, it may come as somewhat of a surprise that the municipal bond market utilized by these localities has not suffered a serious downturn already. Though the risk of a meltdown in the municipal bond market appear to have temporarily abated at the present time, local governments will need to continue to evaluate how they can derive the most out of their limited revenue streams even in a looming recovery, as it is uncertain as to how robust future property tax growth will be.

The continuing challenges brought on by budgetary constraints will require states to consider how to expand their revenue streams by taxing growing sectors of the economy and new technologies. One way to do this is to broaden the reach of the taxes imposed by the states as much as possible, for example by utilizing factor presence nexus standards in the realm of the corporate income tax. As the barriers preventing companies from remotely selling products on a domestic and international basis have dissipated by reason of new technologies, states have increasingly turned to factor presence nexus statutes and regulations to impose corporate income tax obligations on companies without actual physical presence. This policy will have tremendous implications for domestic companies selling to other regions of the United States, as well as for global trading partners with no physical presence at all in the United States, but discover that they have corporate income tax filing requirements and liability because of factor presence nexus rules that have no federal income tax counterpart. While these policies might temporarily benefit a state's bottom line, they may act to curb economic growth in the long run as companies become reticent to do business in jurisdictions that are quick to impose taxes on these sales, along with consequent tax compliance requirements. Further, there is no guarantee that such policies satisfy constitutional muster.

States will also need to consider how to tax special products derived from the new technologies being created. For example, cloud computing, pursuant to which companies utilize offsite providers for various types of computing services accessed through the Internet, will present a challenge to the states from both a sales tax and income tax perspective. At an elemental level, does the receipt of cloud computing services have nexus implications? For sales tax purposes, are cloud computing services taxable or exempt, and can the answer change depending upon what types of services or products are provided? For income tax purposes, does the character of each distinct cloud computing item being sold impact the method by which the receipts from such sale are sourced for purposes of apportionment? Most states are still considering how to resolve these and other issues, and it is far from certain that the states will come to uniform conclusions. The choices made by the states will have tremendous budgetary impact in the future as new technologies continue to grow in importance.

If 2011, from a SALT perspective, can be captured in one global comment, it would be the following: covering SALT developments truly progressed from a part_time endeavor requiring some focus, to a full_time activity needing constant attention. Until recently, practitioners and taxpayers spent the late winter and most of spring tracking state legislative activity, with the occasional important case arising from a state supreme court that would require review, as well as guidance from state tax authorities from time to time. As the developments from 2011 show, many of the large state legislatures work twelve months a year, significant decisions are being released from state courts on a regular basis, the regulations authorized by state tax authorities are becoming incredibly complex, and SALT issues are having their day in Congress. The good news is that there is no more "busy season" in tracking SALT issues. The bad news is that each day can bring unpredictable and substantial changes to the SALT landscape, with information overload a real possibility. The end result seems to be that the predictability that taxpayers seek in order to make stable business decisions has been lacking. We hope to provide some perspective (and at least some sort of respite from information overload) in this year's review of material SALT events.

1. Legislatures gone wild: Amazon rule, sales tax disclosure, and affiliated nexus rules explode

   The issue of collection and remittance obligations for remote sellers, along with potential solutions, has captured the interest of the SALT world and beyond, and in the eyes of many, was the dominant SALT issue of importance this year. States considered several different approaches to require remote sellers to comply with sales tax collection and remittance requirements, most notably by way of click_through and affiliate nexus rules, as well as disclosure regimes.

   The click_through nexus rules target out_of_state Internet retailers utilizing resident Web site owners to advertise for such retailers, in return for a commission on sales resulting from the followed link, by generally requiring the retailers to collect and remit sales tax even though they have no actual physical presence in the state. In 2011, Arkansas,2 Connecticut3 and Illinois adopted these rules.4 Interestingly, Amazon.com, the company that inspired much of this legislation, initially fought proposed and final enactments through litigation (ongoing in New York) and the termination of many of its in_state associate programs. In 2011, Amazon shifted its focus to negotiations with several states, and attempted to procure delays in the implementation of the click_through nexus rules, by promising additional in_state jobs and investment. In California, Amazon was instrumental in persuading the legislature to temporarily and retroactively repeal click_ through and affiliate nexus provisions5 by dropping a planned referendum challenge to these provisions, and promising to create substantial numbers of jobs and capital investment.6 The temporary repeal is tied to the effort to adopt federal remote seller legislation. If the federal legislation is not enacted by July 31, 2012, the click_through and affiliate nexus provisions will again become operative on September 15, 2012. Even if the federal legislation is adopted by July 31, 2012, if California...