David D. Stewart: Happy New Year from Tax Notes. I'm David Stewart, editor in chief of Tax Notes Today International. This week: state status report, 2023.

As 2022 wraps up and people around the world prepare for the new year, we're looking ahead to see what 2023 may bring for tax policy, specifically for states here in the United States.

There are many issues to keep an eye on, and here to talk more about some of the most important ones is Tax Notes senior reporter Paul Jones. Paul, welcome back to the podcast.

Paul Jones: Hi, Dave. It's always a pleasure.

David D. Stewart: You recently spoke with someone about some of the key issues facing the states. Could you tell us about your guest?

Paul Jones: Sure. I spoke with Valerie Dickerson, who's a partner with Deloitte Tax LLP, and whose practice area focuses on multistate tax issues.

David D. Stewart: What sort of things did you talk about?

Paul Jones: We discussed a range of notable issues that states are likely to address in various ways this year, from new regulations for passthrough entities, transfer pricing rules, and even incentives for semiconductor companies related to the CHIPS Act.

David D. Stewart: All right, let's go to that interview.

Paul Jones: Valerie, thanks for taking time to talk with us.

Valerie Dickerson: My pleasure. Thanks for having me, Paul.

Paul Jones: What are some of the issues that you think are likely to get either new or renewed attention in 2023? I think one of the things you said previously was that there is some growing interest by states in looking into developing new or more detailed or specific rules for taxing large, complex multistate passthrough entities — things like better definitions and clearer sourcing rules. Can you talk to us about what states may be doing in 2023 on this issue?

Valerie Dickerson: Thanks, Paul. Yes, absolutely. The passthrough area, I believe, is an area where we will see continued development, and as you just mentioned, those are probably some of the areas. We've seen multistate tax commissions start to poke around in investment partnerships. We have seen some starting of defining terms in that area.

We see New York's issuance of draft regulations around working for certain investment partnerships, or investment management income. Then we see California having issued a couple of legal rulings around certain sourcing issues for partnerships, as well as a surge in litigation on the tax appeals level in California.

I think California and New York are the states that seem like they have already and are likely to continue to take the lead, and it seems like we'll probably continue to see some developments with the Multistate Tax Commission as well.

Paul Jones: Right. California and New York are obviously large states. The MTC is pretty influential. Are the developments that we're seeing with those states likely to clear a path for other states that want to follow suit? Or are the situations faced by California and New York — the types of businesses and multistate entities they're operating in them — is that something that's not necessarily going to translate to other states in the United States as easily?

I guess what I'm trying to ask is, are we seeing the foundation being laid by these two large states in the MTC for what other states may be able to just sort of copy and paste? Or is this going to be a longer effort with states coming up with their more bespoke solutions to this problem going forward?

Valerie Dickerson: It's certainly not an area of issue that's only for these two large states. Certainly, the other states are going to be interested in what is happening in these two states, but also interested for their own sake in what is going on in this area. While I mentioned California and New York, there have been cases developing in a number of other states: Massachusetts, Illinois, Ohio, and others. That's probably just a fraction.

I don't know that I would say that anyone's going to want to copy and paste what California or New York will do. But just the fact that they are doing something in more guidance is palpable, which I think does raise the interest level of the other states and makes it potentially more likely that more guidance will come out for those states as well.

Paul Jones: Correct me if I'm wrong, but when we spoke previously, I think I suggested that maybe the new audit regime rules that some states at least have been moving to conform to may have created an opening for states to start looking at how to better tax these passthrough entities.

Do you think that that's correct? Is that influencing the timing of states taking an interest in this? Obviously, for a long time states have focused a lot on corporations, corporate audits, etc. Why is there now a focus on developing rules to address these larger and more complicated passthrough entities?

Valerie Dickerson: It's a great question. I would say "yes, and"; certainly with states needing to have a way of dealing with the outcome of the Bipartisan Budget Act of 2015 audit from the service, and a number of states have started to adopt some rules and some skeletal rules, and the MTC took a stab at it, I think did highlight and make the timing more immediate.

Although, in some situations, and probably the two lead states we've already mentioned, there's been awareness that the states have been interested already. But I do think that the timing has kind of come into being probably because of what has happened at the federal level with BBA audits.

Paul Jones: Again focusing on 2023, is this something that we're going to be seeing play out much in the legislature? Or is this mainly going to be something that progress on is made by departments of revenue promulgating rules and tax controversies with commissions and courts issuing rulings that help shore up which definitions or approaches — for example, to sourcing — are appropriate?

Valerie Dickerson: Honestly, some of the issues are complicated. Some of the issues with how you're going to report and let entity or partner get adjusted from a BBA perspective is not necessarily cut and dry. There's a lot to think through here. There's a lot to think through in terms of definitions.

I guess I would say, from an ideal perspective, it seems to me that legislation would certainly need to be undertaken if any kind of policy change is going to be evident, or a change in how these matters are analyzed.

That being said, already we've seen California and New York start to put some things in writing in terms of guidance. I suspect that we'll see some more policy thinking get put into writing at the administrative level before we see legislation. That's a guess on my part. There's always that balance of needing to be within the confines of what the statutes actually say when that guidance does get issued.

Paul Jones: So, definitely something to keep an eye on. On the topic of passthrough entity rules, I think we should also probably note that there's obviously been a lot of states that have adopted the passthrough-entity-type workaround to the state and local tax deduction cap from the Tax Cuts and Jobs Act.

Subsequently, there's been some effort by states to sort of address various issues and make some tweaks to them. Looking forward now in 2023, I think half the states have such workarounds.

Do you think that there are going to be more that adopt them? And of those that have adopted them, what do they need to do now? The legislation's done. There may be some statutory tweaks that they put out in the coming year. If you're a taxpayer that's interested in utilizing this workaround, what do you still need from these states in order to figure out if this is going to be the best approach for you to take?

Valerie Dickerson: A couple of questions in there. I would not be surprised if the additional states take up the passthrough entity elections, especially with the service sort of OK'ing it, if you will. In terms of what the states may do, I suspect that as the positions are taken and returned to the process, and potentially audits happen, there will be some tweaking that needs to happen that will be discovered and done. Whether it needs to be done legislatively or administratively is going to be a little bit case-by-case.

In terms of taxpayers, I think taxpayers are going to find themselves in the position of needing guidance. True to state and local taxation, there's some uniformity, but not true uniformity in how many of these were adopted. Taxpayers that might be in a situation paying in multiple jurisdictions, they're going to be looking for some continuity, which is always a desire, in order to make the administrative processes more efficient.

I do think the taxpayers will probably be looking for additional guidance, or would want the dates to line up, or just be more clear about what's in or what's out, and what the impact is both at the entity level and partner level. I think we'll continue to see some tweaks, whether they're coming at the request of taxpayers, or whether they're coming administratively.

Paul Jones: Yes, and one comment that I've heard from a number of practitioners is that they are concerned that these states' tax credits that are provided to the partners or members of passthrough entities are written in such a way that they may not be recognized by another state when that state is trying to determine how much tax to offset for a partner or a member that they paid in that state versus another state.

Now that we're shifting the incidence of the tax to the entity rather than the actual recipient of the income, is there a need for states to ensure that there's some reciprocity there so that people are able to use these workarounds without endangering their situation in another state?

Valerie Dickerson: There's always been a little bit of inconsistency around how states applied the out-of-state tax credit on an individual basis. What you suggest in terms of "is there going to be potential leakage between states in how terms are defined, or understood, or what they're understood to be acceptable at the entity level," I do think, at least in some limited number of states, is probably going to come to the forefront to a certain degree.

Paul Jones: Last question on this topic. Obviously, a lot of the TCJA provisions expire within a few years, including the SALT cap. Of course, it's important for taxpayers to get certainty as to how this workaround applies for the years that predate that. Isn't it also the case that there may be some suspicion amongst taxpayers and practitioners that the SALT cap will ultimately become a permanent feature?

Valerie Dickerson: Yeah, I think that's kind of what the states will need to decide, is how much they want to invest in tweaking something that may or may not go away. I'm not sure that I could speculate, but it seems like there is a possible scenario in which, for whatever reason, it is favored by some or enough in Congress to want a SALT cap to stay around, or that it's representative of something that's needed or not ready to be negotiated, and maybe perhaps it stays in.

I think it's just impossible to know right now whether or not that expiration really will come to pass. Maybe it will; maybe you don't overinvest in making it perfect. But maybe it stays. I imagine that, to some degree, that is maybe why some states are a little less inclined to be first in line around this.

Paul Jones: Yeah, that makes sense. You can sort of hedge your bets. Let's talk about another thing that we may see some activity on: transfer pricing issues. Particularly, I'm interested also in advance pricing agreement programs that states might look at. Can you comment on that? What do you think might happen in 2023 and beyond on that issue?

Valerie Dickerson: That's interesting. It's interesting in some regard that the MTC sort of pulled its committee, but on the other hand I think that they, in a sense, did do their job in terms of helping educate, helping the states with their audit programs. I think states have gotten comfortable with what they're doing, whether or not it's necessarily the perfect way of auditing. There's been at least three states that have come forward with some sort of program. I would not be surprised to see more of that develop.

However, the service let on that they're looking into this area of advance pricing agreements as well, and into some of the regulations. So, more may be coming out of the service, and I imagine that states will be interested in that as well, and maybe even taking a little bit of a wait-and-see approach before doing much more tweaking on their ends.

Paul Jones: Right. With respect to Indiana, obviously that state developed, I think it's a formal APA program that taxpayers can use. Do you think that people are going to take a look at that and see how well that works, how much use or demand there is, before deciding whether it might be of interest for states to follow in Indiana's footsteps?

Valerie Dickerson: I do. I do think they would be looking at that and seeing, does it work? Are taxpayers coming forward? I imagine taxpayers will be curious, to the extent that they can find it out, how it's working for other taxpayers as well, and think of it as consideration. I'd also say just because a state doesn't have a program doesn't mean they couldn't approach the state with a proposal, if it was something that they wanted certainty around, to try to close out a set of years anyway, and maybe have done so with the service. Why not take a run with it with the state as well?

Paul Jones: Right, because it's possible to set up sort of informal agreements. Indiana just set up a formal approach that kind of laid out how it works, correct?

Valerie Dickerson: Yeah. An audit-closing letter, or something within an audit, or something volunteered, sure.

Paul Jones: Let's shift topics to something kind of unrelated to what we've been discussing previously. Maybe not totally unrelated.

Looking at tax incentives for businesses, or incentive deals, the passage of the CHIPS and Science Act provided billions and billions of dollars in subsidies to shore up specifically domestic microchip manufacturing. We've already seen some activity by states and localities trying to set up deals with semiconductor businesses to get fabs and factories built in a given area, which obviously any time you have an incentive deal there's potential benefit to the business, the locality, and the state, and obviously also some risks as well.

Do you think we're going to see more activity on that? If so, what are some of the policies that states might be offering?

Valerie Dickerson: Well, there already has been more activity, honestly. I think in terms of the energy-type credits, or the green-type credits, we've already seen some states conform or tweak their programs to make it known that the federal-eligible programs would be eligible for their existing programs as well, so that a taxpayer can potentially qualify for both the federal program and the state program. Especially if it's kind of close in principle to what the state was already trying to achieve.

Certainly, the states are going to want to compete for the spending in their states, as well as the jobs that come along with that.

Paul Jones: Yeah, and obviously there have been, before, high-profile deals that have not necessarily fallen through, but that didn't turn out the way they were intended to. There have been some, obviously, that have fallen through. Do you think states and local governments have gotten better at designing these deals so that they are hedging — offering a lot, but also making sure that they're not on the hook for too much unless the company delivers?

Valerie Dickerson: Well, let me just say this: When a taxpayer is going to make an investment like this, it's real money being spent, real facilities being built, people being hired, and all of those. Things don't always pan out for whatever reasons. There could be academic reasons. There could be other reasons, microscopic business-level things that may or may not pan out. I think that the states are pretty good at recognizing that, yes, programs can be the perfect program, but taxpayers aren't 100 percent driven by these programs necessarily.

It is careful consideration on them by both parties here. As long as everybody understands that if the programs aren't put into place lightly, and these types of decisions from a business perspective are not made lightly, then I think that the states will continue to try to have programs that are appealing to businesses, and then businesses need to be able to count on those programs that made the right investment.

Paul Jones: That's definitely something for state and local governments and businesses to keep in mind when working out incentive deals.

Let's take a look at another trend on the opposite side of the ledger, where you have localities actually looking to increase taxes either on businesses or just expand their base to raise revenue or capture certain activities.

There's been a rise in action by cities and counties to capture more revenue. Particularly, I think we've seen cities on the West Coast that have been looking and moving to adopt local income taxes or taxes on executive compensation. I think that there is even a ballot initiative pending qualification in Multnomah County in Oregon that would actually try and tax capital gains on the local level. Can you comment on that trend? Is that something that you think might continue to spread?

Valerie Dickerson: I think that the local taxes area, especially things like these examples you just gave, are an area that many of us have been walking for a while. So yes, I do think it's going to continue into 2023. That being said, it's also an area that we've been watching for a while and saying it's going to continue for a while, and it has been. How quickly or how much it spreads outside of maybe these more western states, I think, is a little bit yet to be determined.

We're seeing some challenges in the area, and obviously depending on how for some of the business taxes where maybe there's been a component that rests on whether people are located in a certain city, or something in that matter; and then, of course, we had what everyone faced with a pandemic year, which potentially changed the tax base for certain companies, or maybe even for everybody. I do think that, on the one hand, localities are continuing to look for ways to expand the tax base and raise revenues, and maybe take note of some of the newer business models that are out there and fill the need to drive revenue at them.

On the other hand, I think something like the pandemic, with the remote working potentially changing the tax base, is a reason to give very careful consideration to exactly how you come up with a tax base that's least volatile, promotes doing business in the city or locality, and really drives things economically that are desired as well. It's a little bit of a lessons learned in informing how to go forward, but I would speculate that we'll continue to see this trend.

Paul Jones: When you have local governments passing things like income taxes, that creates challenges to taxpayers above and beyond just the actual increased tax burden. I did a story recently on how a number of governments in the Portland region worked to update their tax codes to adopt the state's apportionment rules in an attempt to simplify things — or at least that was one of the things that they were trying to do by taking that action.

When you have local governments that are trying to shore up their base, maybe they're seeing property taxes decline because of increased remote work that has emptied out offices and ended leases or something like that, and they think, "Well, let's go after income by the corporations that operate in our area." It's not as simple as just flipping a switch; they have to consider that they're moving into a territory that traditionally has been dominated by much larger geographical entities like states. Now they're bringing the complexity of complying with unique income tax codes down to the local level. Is that a problem?

Valerie Dickerson: Yeah, you raise a really interesting question. It may seem simple to adopt a particular tax regime, and it may feel as simple as a copy/paste from a state statute or something like that with this thought of, "We'll develop blah-blah-blah." The thing is that none of this is simple. None of this came into being overnight. It was a very long time, with resources and people dedicated to interpretation, whether you're talking about the service or whether you're talking about the state level and many different states involved sometimes in many different ways.

If there's going to be something that's beyond the simplest tax system, then there need to be the resources there at the jurisdiction level to deal with the administration questions, the processing ability, and then disputes and interpretations, because that is part of what comes with more complexity. It's definitely a balancing act. One could potentially sympathize with the needs for revenue, but I think the other part of that equation is the responsibility that comes with putting into place a particular taxation regime.

Paul Jones: Yeah, it's sort of one of those situations where you're gifted an apartment complex, but now you also have to take over all of the hurdles of administering it, managing it, etc. It's a potential income generator, but it's also a huge responsibility.

Another thing that localities are doing that I think you had mentioned is looking at specific activity taxes. We've seen disruptive industries pop up. Everybody knows about app-based ride-hailing companies, but you've also got delivery companies, grocery companies, etc. I think we've seen localities take a look at those.

I'm sort of curious: Do you think we're going to continue to see that trend? Is that about replacing tax revenue that used to come from one base that's now sort of been disrupted by these new industries? Or is that just another effort to increase revenues overall?

Valerie Dickerson: I suppose on one hand there's a little bit of a concern as to if there's going to be increased traffic, for example, in the area, or increases of a certain type of service, is there going to be an increased burden on the city? I guess you could theoretically get into these debates as to whether these are fees or taxes, and of course you have to be very specific to a certain program. There's a whole body of law around that that we don't have time to talk about today.

I certainly think they could be looked at as, "OK, well, here are these new businesses. We're missing out if we don't register them and tax them in some way." But also there could be regulatory concerns with just wanting to know what's out there, and sometimes the fee that comes along with that. I think it kind of feeds a little bit into what you were just talking about in terms of the complexity of the taxation fees. Some of these can be fees or taxes that are relatively low.

Then you just get into an administrative hurdle of "you're doing business in 1,000 cities, how do you know every single one of these cities? Have these cities made it easy to comply, or are you dealing with old-fashioned websites or making up forms and have nobody to call?" There's risks in this. Complying at the state level, we have systems and software and all kinds of good stuff. It just gets more burdensome first to even find out about the tax, and then to be able to easily comply with it.

Depending on the size of the business, it needs to be something that's taken into consideration, but sometimes the definitions of what's being taxed in and of itself isn't necessarily what companies feel like they are doing. There can be a true knowledge gap there.

Paul Jones: As we're looking forward to 2023, are there any other topics, any other areas of policy activity, that you think people listening should keep an eye out for?

Valerie Dickerson: I think we've done a pretty good job. We've been talking a lot over the past few years about remote work, and I think that will continue to be a theme with developments and litigation, and hopefully guidance.

Then the other thing is, everyone is continuing to watch, or watching — I don't know how much development will happen within the next 12 months, let's say, but it certainly is going to be an area of continued development, and that's around digital assets and things like NFTs, and the impacts of those, or the way to think about those from a state and local taxation perspective. Things to watch could probably be their own hour session, if so desired.

Paul Jones: Yeah, certainly. In fact, all of this will benefit from the substantial analysis in the coming year. It's good to just remind everyone what are some of the key issues to keep an eye on.

With that, Valerie, thank you so much for lending your expertise and your insight to us. I know we all appreciate it.

Valerie Dickerson: Thank you, Paul. It's been a pleasure.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?

Paige Jones: Thanks, Dave. This week we're highlighting the Person of the Year, as chosen by each of our magazines.

Tax Notes Federal selected Senate Majority Leader Chuck Schumer as its Person of the Year, reviewing his 2022 tax policy achievements, including his role in the passage of the Inflation Reduction Act.

Tax Notes State recognized Sharonne Bonardi, the executive director of the Federation of Tax Administrators as its 2022 Person of the Year for her trailblazing achievements in state and local tax.

Tax Notes International chose Grace Perez-Navarro, director of the OECD Centre for Tax Policy and Administration as its Person of the Year for her many contributions to the OECD over the years.

Before we go, be sure to check out our Opinions page where Nana Ama Sarfo has examined recent tax transparency shareholder proposals, and Joe Thorndike has questioned why and when the IRS stopped auditing the President.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. Be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. As always, if you like what we're doing here, please leave a rating or a review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.