Federal Tax Treatment of Proposed NY Inflation Refunds

12/9/24 news release

Per a December 9, 2024 story at the New York State website, Governor Hochul has proposed "sending 8.6 million New Yorkers an Inflation Refund Check as first proposal of 2025 State of the State."

The rationale is that inflation increased the price of taxable goods and services on which sales tax was charged. So, the state collected more sales tax than it would have without inflation's affect on prices. Governor Hochul proposes giving "everyday New Yorkers":

   $500 for families making under $300,000

   $300 for individuals making under $150,000

Big question ... Will these "tax refunds" be subject to federal income taxes (must the recipients include them in their federal income tax)?

I think the answer is yes.

Income is broadly defined at IRC §61 and case law as being derived from any source and something that is an accession to wealth. In Notice 2023-56 suggested how the tax law applies to various payments received from a state and sought public comments for the IRS's final guidance (which has not yet been issued).

In Notice 2023-56, the IRS noted that the name given to a payment is not controlling but instead, the substance of the payment arrangement controls. If a tax "refund" is limited to how much tax the individual actually paid, the payment is likely to be a non-taxable tax refund (taxable though if the taxpayer claimed a deduction (tax benefit) for the tax later refunded).

The NY proposal is the same for everyone at a specified income level or marital status. It appears to have no relation to how much sales tax the recipient actually paid.

Notice 2023-56 also explains the general welfare exclusion where payments are made based on need. This also won't apply to the NY "refunds" as the income levels at which they can be issued is well beyond "needs" and the median income level.

Is there anyway to avoid the federal tax hit so that 100% of the refunds can stay in New York?  Well, they could be changed to be, for example, 10% of the actual sales tax paid. But people won't have these records. It could be achieved by temporarily lowering the sales tax rate to give buyers back some portion of sales tax by paying less today than they otherwise would. They could use the additional sales tax collected to provide funding for services available to low-income individuals.

I think they could significantly lower the income level for these payments, so that they are truly only provided to those in need making them excludable under the general welfare exclusion.

What do you think?

Would Broader Sales Tax Base Deliver Simplification? Yes!

I've got a tax policy post originally posted on SalesTaxSupport.com on complexities of numerous exemptions to sales tax bases. I just pull a few recent rulings from New York as illustration of the complexity, but it exists in all states.  .

A broader base will also allow for a lower tax rate.

A review of a few recent sales tax advisory opinions issued by the New York State Department of Taxation and Finance, remind us of the complexities of sales tax exemptions and special definitions of taxed items. This is an issue in most states with a sales tax. For example, you likely have heard of recent issues as to whether hot coffee to go is subject to sale tax, and litigation on this issue in some states. New York makes its advisory opinions easily accessible on its website which makes it easy to "pick" on New York as an example of sales tax complexity. New York also taxes more than tangible personal property which increases the likelihood of tax base questions. For example, New York taxes furnishing of information and some services.

Following are brief summaries of four rulings issued in April and May 2016.

·         TSB-A-16(13)S (4/26/16) - Sales tax applies to taxpayer's fees charged for high intensity interval training fitness classes, as well as fees to enter weight loss challenges, offered at facilities in NYC. While the taxpayer is not selling taxable dues or membership fees to an athletic club or taxable personal training servicfes, it is selling services of a weight control or health salon which is taxable in NYC.

·         TSB-A-16(14)S (4/27/16) - Sales tax applies to cookies sold in any of three ways: (1) for immediate consumption, (2) in to-go boxes holding rout to a few dozen cookies, and (3) cookies to be delivered. "Whether Petitioner sells cookies in small quantities in its stores, in larger quantities in to-go boxes or delivers cookies to customers, the cookies are always sold in a heated state. Thus, pursuant to Tax Law § 1105(d) and 20 NYCRR § 527.8, Petitioner’s receipts from the sales of cookies are taxable, whether sold for on-premises or off-premises consumption."

·         TSB-A-16(19)S (5/20/16) - Data storage services found not subject to sales tax. This is not the sale of software or an information service or storage of tangible personal property. Thus, it doesn't fall under the taxing statute.

·         TSB-A-16(17)S (5/2/16) - This involves an uncommon fact pattern. A Florida LLC entered a purchase agreement with a New York art dealer to purchase a sculpture being created in Germany. Taxpayer also entered an agreement with a NYC museum, an exempt taxpayer, to display the sculpture and arrange for its transportation from Germany. The museum would cover transportation and insurance. While that constitutes consideration to the taxpayer, no sales tax was owed becuase the taxpayer is a nonresident and the museum has an exempt organization certificate. Also, taxpayer took possession of the sculpture in Germany so there was no transfer in New York.

This is just a few of the rulings released in April and May involving sales tax. These rulings indicate that the New York sales tax law does not meet the certainty or simplity principles of good tax policy. Clearly, the taxpayers asked for rulings because the law was not clear. Each ruling involved a few statutory definitional provisions where it was not obvious how they applied.

A possible solution to the certainty and complexity issues is to follow an approach more common to VAT. Apply sales tax to every transaction where some type of compensation is received from a customer for the acquisition of goods or services, as broadly defined. If the buyer is a business, when they file their sales tax form, they also list the sales tax they paid and it offsets the sales tax the business collected. The difference is submitted to the government. If the business paid more sales tax than it collected, the government sends a refund of the difference.

The law would be easier to apply because no definitions would be needed for the sales tax base because everything sold would be taxed. Rules would be needed to define business and business use, sourcing (to determine, for example, where the sale of the sculpture took place), and administrative/compliance procedures. Also, the base would be broader than we have today enabling states to lower their sales tax rate making the tax less regressive.

What do you think?

State taxes and bitcoin

What state tax rules and issues exist when a business accepts bitcoin from customers? What about for the customers? In March 2014, the IRS told us that convertible, virtual currency should be treated as property (rather than as currency under any special rule for currency, such as Code Section 988). That was in Notice 2014-21. States have mostly been silent on the topic.  Where states conform to the federal system, that means, treat as property as well. But what about treatment for sales tax and some special state income tax issues, such as sourcing?

New York recently issued guidance on both income and sales tax. I've got a short post in SalesTaxSupport.com on this - click here (12/19/14 post).

I'm working on an article about state tax issues and virtual currency. What issues do you see for this topic?  Is there state guidance you are seeking?

Happy Holidays!  Did anyone give you bitcoin for Christmas or Hanukkah?

Logical sales tax ruling on a web-based business

Since the start of e-commerce and web-based businesses, uncertainties have existed about how sales tax applies to their operations. Often, the state eventually issued guidance for many types of transactions, particularly those involving software. Where there was no specific guidance, you just need to read the statute, understand the technical and legal nature of the business operations and what it provides to customers, and derive an answer. Some companies have also sought rulings from state agencies.

I think a recent ruling from the New York Department of Taxation and Finance reaches a logical conclusion. TSB-A-14(27)S (8/20/14) involves a business (B) that operates a website where people can place an order with a restaurant and pay. B’s website lists about 5,000 restaurants in 27 cities. Website visitors search for a restaurant, see the menu, place an order and pay. B generates money by charging various services to the restaurants: one-time activation fee, menu update fee, and a marketing services fee. The latter fee is charged for every order. When a customer pays for their order, B charges the customer including sales tax and remits those funds to the restaurant less the marketing services fee. Restaurants are responsible for handling sales tax compliance, food returns and complaints. B provides customers with a receipt for their order.

NY imposes sales tax on food and drink sold in or by restaurants and similar establishments if consumption is on the premises or where the vendor serves food off the premises.

The Commissioner ruled that B was not liable for sales tax as it did not operate a restaurant or provide catering services. B’s business is “Internet advertising services and fulfillment services to the restaurants.” The ruling notes that if B does not remit the sales tax it collects to the restaurant, “the Commissioner reserves the right to collect those funds from [B] under the doctrine of money had and received.” Finally, B’s services are not subject to sales tax.

Seems logical. Too bad the law wasn't crystal clear enough to avoid the time for the taxpayer and state of issuing the Advisory Opinion.  It looks like there is no fee charged for obtaining one, but certainly, costs of the research and drafting by the taxpayer and their tax advisers and the state in issuing the ruling.  [Click here for the form to request an opinion and here for the instructions if you want to see what is involved in getting an opinion.]

Note - the result might not be the same for all states. B is only potentially liable for sales tax in a state if they have a physical presence there and if they are selling something subject to sales tax. Most states do not tax many services, but B needs to check. B also needs to see if its connection with a restaurant in a state causes B to be considered physically present in the state.  Fun stuff!

What do you think would make sales tax life easier for B?

States Reaching to Find Sales Tax Nexus

In April, New York changed its sales tax law to try to make a few large vendors subject to sales tax collection - most notably, Amazon.com. The new law creates a rebuttable presumption that a vendor is soliciting business and thus required to collect tax if, per an agreement, they compensate New York residents for directly or indirectly referring potential customers. Referrals may be made through a website or other means. The presumption only applies to sellers with over $10,000 of sales to New York customers made via the referrals in the prior four quarters. Sellers may rebut the presumption by showing that the residents did not solicit sales in New York for them. (Bill Summary, p. 10)

Amazon's "Associates Program" causes it to have many associates who may be New York residents. Amazon filed a lawsuit as soon as the law went into effect challenging the new law as unconstitutional. It also started collecting the tax!

Another company that fell under the law change is Overstock.com. Their remedy was to cancel its agreements with its New York affiliates who were helping Overstock.com advertise.

Arguably, the associates who have a link to Amazon or Overstock on their website are third party advertisers, not sales agents or representatives of these companies.

For more information on this law change and vendor reaction, see this short article - Grabbing Remote Vendors.

In a hard to find NY Senate bill - S 8638, senators voted on June 24 to repeal the provision. Here is information from the NY Legislative website:

"STATUS: S8638 RULES No Same as Tax LawTITLE....Repeals provisions of law relating to an evidentiary presumption to facilitate the administration of the sales and use tax
06/19/08
REFERRED TO RULES
06/24/08
ORDERED TO THIRD READING CAL.2231
06/24/08
PASSED SENATE
06/24/08
DELIVERED TO ASSEMBLY
06/24/08
referred to ways and means
BILL TEXT: STATE OF NEW YORK ________________________________________________________________________
8638
IN SENATE
June 19, 2008 ___________
Introduced by COMMITTEE ON RULES -- read twice and ordered printed, and when printed to be committed to the Committee on Rules
AN ACT to repeal subparagraph (vi) of paragraph 8 of subdivision (b) of section 1101 of the tax law relating to an evidentiary presumption to facilitate the administration of the sales and use tax where a person making sales of taxable property or services in the state uses resients in the state to solicit sales
The People of the State of New York, represented in Senate and Assembly, do enact as follows:
1 Section 1. Subparagraph (vi) of paragraph 8 of subdivision (b) of 2 section 1101 of the tax law is REPEALED. 3 § 2. This act shall take effect immediately."

There appears to be no other action on this proposal. The April law change was estimated to generate $47 million in 2008/2009 and $73 million in 2009/2010 (see links in above article - Grabbing Remote Vendors). That's a lot of money. If this estimate is anywhere close to being accurate, it means that lots of New Yorkers are not self-remitting use tax on purchases they make from the vendors who are subject to the law change. (All states have similar problems - most people don't know what a use tax is or don't keep sufficient records to measure it every year or ignore it.)

All of this illustrates the challenges sales and use taxes face in e-commerce where it is very easy to have a physical location in just one state, but customers in all states. Such a vendor is only legally obligated to collect sales tax from customers in the state where the vendor resides (where they have a physical presence). Customers in other states must self-report their use tax on the purchases.

So, some states modify their sales tax laws to grab remote vendors by trying to connect them to some physical location in the state (such as Amazon's New York Associates). But, there are constitutional restraints that limit this. Given current case law, New York will likely have difficulties defending its law change.

States should do a better job educating their citizens about use tax and the benefits to the state (and its citizens) of collecting it. New York law allows individuals to use a table to estimate the use tax owed so they don't need to keep records. Given the revenue estimates attached to the April 2008 law change, compliance must be low. New York should take out some on-line ads to help buyers understand the use tax and how to pay it. In the long run, that would be better than enacting laws of questionable constitutionality that will be challenged in court.

Another option for states is to not allow the state or its agencies to purchase from sellers who do not collect sales tax. Unless a state has perfect recordkeeping (or doesn't require its agencies to pay sales tax), when purchases are made from remote vendors, it is possible that the use tax payment gets overlooked. Also, some schools and home-and-school clubs have Amazon links on their websites. Perhaps those sites should at least be told to include a note about the need to pay use tax (which in most states helps fund schools!).

What do you think states should do to get more of their residents to pay use tax?