Last week, the National Conference of State Legislatures (NCSL) Task Force on State and Local Taxation considered a wide range of key tax issues at its two-day meeting in California. The Task Force is a bipartisan group of legislators that meets several times a year to explore pertinent state and local tax issues. Legislators from 32 states currently serve on the Task Force, which hears often from tax practitioners, industry representatives, and tax-oriented research organizations. The group also establishes best practices and tax reform principles regarding the issues they deliberate. Most importantly, the Task Force serves as a forum for state legislators to discuss and debate new and emerging tax policy issues with fellow lawmakers.
Our state tax policy team attends each of the Task Force meetings and often has the opportunity to contribute to discussions of state and local tax trends and tax policy best practices. This meeting was no exception; here we provide an overview of the meeting's key sessions.
NCSL Staff Update on Tax-Related Ballot Measures and 2017 Expectations
NCSL staff opened the Task Force meeting with an update on the outcome of several state tax-related ballot measures that will have future implications in the states that passed them (see our tax-related election coverage here). NCSL predicts that budget shortfalls will be one of the key driving factors in legislative sessions next year (see our overview of states projecting FY 2017 budget shortfalls here). Further, they anticipate that many states will consider digital goods and services taxation (given that consumption has shifted away from tangible goods and moved towards digital) and the tax implications of marijuana legalization.
Taxation of Short-Term Lodging Rentals
MultiState presented to the Task Force regarding the state and local tax implications of the changing short-term lodging rental market, where a sizable share of lodging is now booked via online rental marketplaces (see our slides here). State and local governments impose varying taxes on short-term lodging rentals, and oftentimes taxes on rentals booked via an online marketplace aren't collected as legally required. This creates a tax disparity between traditional and non-traditional lodging accommodations. Unfortunately, it would be burdensome for a property owner who occasionally rents a room to register, collect, and remit taxes, so compliance is and will continue to be low without appropriate changes .
Fortunately, the expansion of online lodging marketplaces provides a build in solution that eases burdens on property owners and supports compliance with tax laws in a simple and efficient way. The solution is to clarify that online lodging marketplaces are responsible for collecting and remitting applicable taxes on short-term rentals facilitated through those marketplaces. These marketplaces have all of the information needed to ensure tax compliance at the ready, and the marketplaces also facilitate the transfer of funds from the renter to the owner. This solution meets standard principles of taxation, such as simplicity, neutrality, and transparency. A distinction should be made between online marketplaces that act as a financial intermediary and those that do not. Tax collection and remittance is feasible for the former, but may not for the latter.
Voluntary collection agreements for lodging taxes (VCAs), such as those several states and local jurisdictions have entered into, are a suboptimal solution. With VCAs, there is no certainty for state and local governments because they can be terminated at any time, and these agreements unnecessarily limit governments' ability to verify that the proper amount of tax was collected and that the total amount of tax collected was actually remitted. Further, VCAs generally specify tax is based on something other than what the customer has paid, which violates the principles of transparency and neutrality and does not comport with standards of consumption taxes.
During the 2016 legislative session, there were 83 bills introduced in 24 states dealing in some way with short-term rentals. Some of these bills dealt only with regulatory issues, while others included tax considerations, as well. Of the 83 bills, 47 of them (in 20 states) dealt in some way with taxation. Only 7 tax-related bills (in 5 states) were ultimately enacted (a few of these simply dictated that the legislature compete a study of short-term rental regulation and taxation). States must undertake continued consideration before the issue is fully resolved, making it a key emerging state tax trend for 2017.
Tax Expenditure Reporting: Defining the Normal Tax Base
We know, this issue doesn't exactly sound very exciting. But the reality is that behind every state tax bill purporting to “close loopholes” is a tax expenditure report. And, unfortunately, existing tax expenditure reports don't do anyone any favors. Our thoughts on this can be found in a study published by Tax Notes (subscription required).
The Task Force has recognized these flaws and has done extensive work on putting together best practices for states to use when drafting or updating state tax expenditure reports. The most recent formal action in this process was the adoption of a “Best Practices” document at the August 2014 meeting. This document defined a tax expenditure as an exemption, deduction, credit, exclusion, or other deviation from the “normal” tax structure.
It follows, then, that the most critical component of defining a tax expenditure is deciding on the “normal” tax structure (here's a presentation we did for the Task Force in January explaining what “normal” means in this context). Several provisions that people tend to call tax expenditures aren’t really tax expenditures—they’re key structural provisions in the tax code that help define the baseline tax base, such as sales tax exemptions for business inputs or net operating loss income tax deductions. The problem with including them in tax expenditure reports is that tax expenditures are the first thing on the chopping block when states encounter budget trouble or want to undertake comprehensive tax reform. Including them in the reports puts these import structural provisions at risk, and this is why defining “normal” correctly is crucial.
This “normal” concept is difficult to define and will differ from state-to-state, so the Task Force voted to put together a list of questions state legislators can consider as they work to define their state's normal tax base. This process formally began at the November 2015 Task Force meeting in Miami, Florida. Our team helped spearhead the process, organizing interested parties to begin creating a draft for NCSL to consider. After months of study and deliberation, a final draft was presented to the Task Force last week, was conditionally accepted, and will now be submitted to the NCSL Executive Committee in January of 2017 for adoption. We'll post the final version here once that occurs.
Remote Sale Tax Collection in the States
One of the most sweeping tax trends we saw across state legislatures during the 2016 legislative session was legislation aimed at enhancing sales tax compliance by expanding tax collection obligations to as many sellers as possible (42 bills were introduced in 16 states and four bills were ultimately enacted—see our coverage of that here). As we pointed out in August, the bill enacted in South Dakota spurred litigation (as did regulations issued in Alabama):
In South Dakota, litigation is already under way, with the state having sued three remote sellers earlier this year. Litigation has also been initiated in Alabama. Alabama adopted an economic nexus position—asserting substantial nexus based on economic activity rather than physical presence—via the regulatory process, effective January 1.
This panel gave a brief overview of this litigation and expressed frustration at the lack of Congressional action on this issue. The flurry of activity in state legislatures has renewed pressure on federal lawmakers, however. While it appears that no further action on federal remote sales tax bills will occur during the Congressional lame duck (see below), the stage has been set for action further action in the state legislatures, courts, and potentially Congress in 2017.
The Lame-Duck Session and Remote Sales Tax Collection in Congress
Representatives from NCSL and the Retail Industry Leaders Association provided the Task Force with an update on the state of federal remote sales tax legislation, including the differing approaches proposed by House Judiciary Committee Chairman Goodlatte (R)—who prefers hybrid-origin sourcing and released legislative language in late August—and proposals such as the Marketplace Fairness Act and the Remote Transactions Parity Act (both use traditional destination sourcing and were introduced by Senator Enzi (R) and Representative Chaffetz (R), respectively).
At this point, there is no real consensus between the competing plans. It is unlikely that any language pertaining to this issue will be included in an end-of-year spending package originating in the House. On the Senate side, movement also appears to have stalled. While Majority Leader McConnell (R) promised supporters of the Marketplace Fairness Act a vote on the MFA bill this year, it was announced recently that there would be no vote in 2016 due to inaction in the House.
The panel pointed out that despite—really, because of—this inaction, state legislative and regulatory developments are creating a new sense of urgency among federal lawmakers to find a solution in 2017. They also noted that a federal legislative solution is the best option for everyone involved because it protects small sellers and offers simplifications for all sellers.
The audience questioned what position the newly-elected administration had on the issue, and the panel expressed confidence that President-Elect Trump would be supportive based on comments be made during the campaign.
Communications Disruption and State Taxation
A panel of representatives from the communications industry provided an overview of industry trends and their tax implications for states. In particular, they explained where various product and service spaces are moving, including wireless, wireline, multi-channel video, and steaming video (see the full presentation here).
Wireless technology emerged in the late 1990s and experienced fast growth from 2000 to 2010, but that growth rate began slowing in 2011. Consumers don't use voice services as much as they use data services and Internet access on their wireless devices, and subsidized handsets are becoming a thing of the past. Consumers are also “cutting the cord,” or moving fully away from landline phones. The multichannel video market has become increasingly competitive over the years, and recently this has been as a result of non-network companies offering steaming video services.
As a result of these market and technological changes, tax regimes based on market dynamics that don't exist any more and technologies that are decreasing in importance will experience a dwindling tax base. According to the panel, “state and local tax policies should not be picking winners and losers—states need to modernize their statutes to reflect the current marketplace.” Issues that need to be addressed by policymakers include the modernization of video service taxation (so that there is parity between different types of providers), digital goods and services sourcing, nexus for remote sellers, and 911 program funding.
Is Federal Tax Reform Possible? What Would it look Like? What are the Potential Impacts on the States?
Representatives from the Bipartisan Policy Center (BPC) and the retail community gave their perspectives on whether or not federal tax reform is likely in the next Congress (spoiler: it is likely!) and what that means for state and local tax revenues.
The BPC is confident that tax reform will happen in the 115th Congress, noting that it's important to not think of federal tax reform in isolation, but in the context of the federal budget as a whole. According to BPC, President-Elect Trump's tax plan includes a $6 trillion tax cut and enacting something such as this would significantly drive up the national debt (see an overview and analysis of Trump's tax plan here).
An similar proposal was put on the table by Speaker Ryan (known as the “A Better Way” plan) and House Republicans have been working on it for quite some time (see details of that plan here, starting on page 15). The House Republican plan is intended to be revenue neutral. In order for it to be revenue neutral, it must include significant base broadening to pay for rate reductions.
This is where the interaction with state tax revenues arises. Most states use the Internal Revenue Code as a starting point for determining their state taxable income. As a result, if federal income tax broadening occurs and states automatically conform to federal changes, states will see more income tax revenue without any rate increases (note that some states have automatic conformity while others have to explicitly adopt federal changes).
Also worth noting is the plans' treatment of the federal deduction for state taxes paid. If this deduction is eliminated or reduced, it puts pressure on states that are looking to increase income tax rates (in effect, the federal government would no longer be sharing those costs if the deduction were eliminated). There could also be interaction with state sales tax regimes because of base broadening provisions.