Connecticut adopts significant tax changes in biennial budget
TAX ALERT |
Update: On Dec. 29, 2015, Connecticut Governor Dannel Malloy signed into law 2015 Connecticut Senate Bill No. 1601 (SB1601), making numerous adjustments to the state’s biennial budget and implementer bills enacted earlier in the year. These adjustments include:
- Single sales factor apportionment: Pursuant to SB1601, multistate taxpayers that are not required to use industry-specific apportionment methodologies must use single sales factor apportionment to determine their Connecticut income.
- Tax increase cap: SB1601 caps the tax computed on a combined unitary basis from exceeding the nexus combined base tax amount by more than $2.5 million. When computing such net income or loss, intercorporate dividends, any intangible expenses and costs, any interest expenses and costs, and any income attributable to such intangible expenses and costs or to such interest expenses and costs shall be eliminated.
- Federal consolidated return regulations: The federal treasury regulations under IRC section 1502, including the principals relating to deferrals, eliminations, and exclusions, apply to the extent consistent with the Connecticut combined group membership and combined unitary reporting principles.
- Investment partnerships: The distributive share of income received by a limited partner from an investment partnership is not considered to be derived from a unitary business unless both the investment partnership’s general partner and the limited partner have common ownership.
- Capital base: A combined group is required to exclude assets and liabilities attributable to transactions with other members of the group, including financial service companies, when calculating its capital base.
- Water’s edge group: SB1601 repealed the requirement that the water’s edge group include any member that earns more than 20 percent of its gross income from intangible property or service related activities.
- Net operating losses (NOLs) for combined groups: Combined groups with over $6 billion in unused NOLs from tax years prior to 2013 may elect to relinquish 50 percent of their NOLs incurred in tax years prior to 2015, and use the remaining amounts to reduce the combined group’s tax to $2.5 million in any income year beginning on or after Jan. 1, 2015.
- Tax havens: SB1601 repealed the requirement that the commissioner publish a list of tax havens. Further, a tax haven excludes jurisdictions that have entered into a comprehensive income tax treaty with the United States.
- R&D credit cap: SB1601 increased the credit cap for research and development (R&D) expenditures. The current cap is 50.01 percent of the amount of tax due prior to the application of the credit. The cap increases each year until 70 percent of the tax may be offset by credits for tax years beginning on or after Jan. 1, 2019.
- Individual withholding: For individual taxpayers, SB1601 provides that compensation paid to nonresident employees present in Connecticut for not more than 15 days does not constitute income derived from sources within the state. If the nonresident employee performs services in Connecticut for more than 15 days, all compensation the employee receives for the rendering of those services is derived from sources within the state.
Taxpayers should review these changes as they may significantly impact the tax effect of Connecticut’s 2015 state’s biennial budget and implementer bills.
Update: On June 30, 2015, Connecticut Gov. Dannel Malloy signed the state’s biennial budget for fiscal periods 2016 and 2017, as well as a so-called “implementer bill” that revises tax changes included in the original budget. The implementer bill:
- Delays the effective date of mandatory unitary combined reporting until Jan. 1, 2016
- Freezes the sales and use tax rate on computer and data processing services at 1 percent
- Freezes the sales tax rate on services involving the creation, development, hosting and maintenance of a website at 1 percent and delays the expanded computer and data processing base from July 1, 2015, to Oct. 1, 2015
- Extends the carryforward period for film tax credits issued after July 1, 2015
- Maintains the current sales and use tax exemption for employer-provided parking
- Increases the total amount of business tax credits available under the Urban and Industrial Sites Reinvestment program
- Increases the annual cap on Neighborhood Assistance Act tax credits effective July 1, 2017
- Allows cities and towns to levy local property taxes on certain hospital and college property.
On June 3, 2015, the Connecticut General Assembly passed Connecticut's biennial budget for fiscal periods 2016 and 2017, including numerous changes to the state's personal income tax, sales and use tax, and corporation business tax. Gov. Dannel Malloy is expected to sign the legislation. Significant changes are summarized below.
Personal income tax changes
With a retroactive effective date of Jan. 1, 2015, the legislation features a new top tax bracket and rate changes. Specifically, the following rate changes will take effect for taxable period 2015:
- The state's top income tax rate will rise to 6.99 percent for single filers with taxable income over $500,000 and joint taxpayers with taxable income over $1 million. This increase in marginal tax rate reflects a 0.29 percent escalation and is the rate applicable to the state's newest tax bracket.
- For single taxpayers earning between $250,000 and $500,000, and joint filers with taxable income between $500,000 and $1 million, the applicable tax rate will rest at 6.9 percent, a 0.2 percent increase under former law.
The bill also increases the flat income tax rate for trusts and estates from 6.7 to 6.99 percent.
The adjustment to the state's marginal tax rates represents the second time in the last half-decade that Connecticut has increased its tax rates and modified its tax brackets, the changes for taxable period 2015 following the jurisdiction's major revisions for taxable periods starting on or after Jan. 1, 2011. Additionally, the budget bill reduces, from $300 to $200, the maximum property tax credit available against the personal income tax. Supplementing the property tax credit reduction is a two-step phase-out contraction that determines the percent of property tax paid eligible for credit receipt.
Sales and use tax changes
Gov. Malloy included in his biennial budget proposal in February 2015 a reduction of the state sales tax from 6.35 to 5.95 percent by 2017. This reduction was not included in the new law. Instead, the passed bill sustained Connecticut's 6.35 percent sales and use tax rate, and included the following provisions designed to raise the collection of state's sales and use taxes:
- Effective July 1, 2015, the state's luxury tax will increase from 7 to 7.75 percent on specified luxury items, including motor vehicles costing in excess of $50,000 (certain exceptions apply), jewelry (real or imitation) costing more than $5,000, and clothing, footwear, handbags, luggage, umbrellas, wallets, and watches costing in excess of $1,000.
- The sales and use tax rate on computer and data processing services will rise from 1 to 2 percent on Oct. 1, 2015, and from 2 to 3 percent on July 1, 2016. For such services sold on Oct. 1, 2015, the bill exempts services performed by an entity for one of its affiliates (this is applicable to a person that, directly or indirectly, owns, controls, or is owned or controlled by, or is under common ownership or control with another person). The bill also expands the types of computer and data processing services subject to the sales and use tax, now including the creation, development, hosting and maintenance of a website. The provision applies to sales occurring on or after Oct. 1, 2015, and sales of services billed to customers for a period that includes Oct. 1, 2015, except that the computer and data processing service expansion is effective July 1, 2015, and applicable to sales occurring on or after July 1, 2015, and sales of services billed to customers for a period that includes July 1, 2015.
Corporation business tax changes
The corporation business tax received four major revisions in the budget bill: (1) the state extended the corporation business tax surcharge; (2) the legislation restricted the utilization of net operating loss carryfowards; (3) Connecticut reduced the limit for tax credit usage; and (4) the state adopted mandatory combined reporting, abandoning its elective combined reporting regime.
Corporation business tax surcharge extension
The act extended the 20 percent corporation business tax surcharge through taxable periods 2016 and 2017, eliminating the sunset of the surtax that was in place for taxable periods starting on or after Jan. 1, 2016. The legislation also imposes a temporary 10 percent surcharge for taxable period 2018. The surcharge generally applies to companies that have more than $250 in corporation business income tax liability. Companies with less than $100 million in annual gross revenue in periods in which the surcharge applies are exempt from the surtax, unless the company joins in a combined or unitary return.
Net operating loss carryforward utilization limitation
Effective for taxable periods starting on or after Jan. 1, 2015, corporations are limited in the amount of net operating loss eligible for carryforward. A corporation may carry forward net operating losses to the lesser of (1) 50 percent of net income, or for corporations with taxable income in other states, 50 percent of the net income apportioned to Connecticut, or (2) the excess of net operating loss over the net operating loss being carried forward from prior income periods.
Tax credit utilization limitation
Prior to the legislation's passage, corporations were permitted to utilize tax credits to reduce their corporation's business income tax by up to 70 percent in any taxable period. The budget reduces the tax credit limitation to 50.01 percent, starting with taxable period 2015.
Combined reporting requirement
The most controversial aspect of the budget bill is the act's provision mandating combined reporting for companies that have membership in a group of related corporations meeting certain criteria. Under the new law, a combined group includes all companies that have common ownership, are engaged in a unitary business, and have at least one member that is subject to the Connecticut corporation business tax. Businesses are considered under common ownership if the same entity or entities directly or indirectly own more than 50 percent of the voting control of each of them. The owners do not have to be members of the combined group. Indirect control is determined according to federal authority. A unitary business is defined as a single economic enterprise that is interdependent, integrated, or interrelated enough through its activities to provide mutual benefit and produce significant sharing or exchanges of value among its entities or a significant flow of value among its separate parts. A unitary business can constitute either separate parts of a single entity or a group of separate entities under common ownership. Business conducted or connected through partnerships or S corporations may be considered unitary if such pass-through entities meet certain conditions. Under the bill, combined group members include taxable members and nontaxable members.
The new mandatory combined reporting system provides a combined group with the option of determining its members' net income, capital base and apportionment factors on either a worldwide or affiliated group basis. Under the legislation, an affiliated group is generally any group treated as an affiliated group for federal tax purposes, except that it also includes (1) certain domestic corporations that are commonly owned (either directly or indirectly), and (2) any member of the combined group, determined on a worldwide basis, incorporated in a defined tax haven. This election is binding for the income year in which it is made and for the following 10 years. If the group does not elect worldwide basis or affiliated group basis reporting, it must determine net income, capital base, and apportionment factors of each of its taxable members on a water's-edge basis. Water's-edge basis means that a group must include the net income, capital base and apportionment factors of a nontaxable member only if:
- The member is incorporated in or formed under the laws of the United States, any state, the District of Columbia, or a United States territory or possession, excluding members that have at least 80 percent of their property and payroll during the income year located outside such jurisdictions;
- 20 percent or more of the member's property and payroll during the income year is located in the United States, any state, the District of Columbia, or a United States territory or possession; or
- The member is incorporated in a jurisdiction defined as a tax haven.
The tax package contained within this contentious bill, one that passed through the House of Representatives by only a 73-70 margin and narrowly passed the Senate in a 19-17 vote, includes notable tax provisions not incorporated into the budget plan that Gov. Malloy originally proposed. The revenue-raising tax provisions in the legislation are intended to close an estimated $3 billion budget deficit spread over two years. These provisions maintain many immediate and short-term effective dates, and taxpayers – both businesses and individuals – are expected to feel the impact of the act. Interestingly, the budget legislation comes as Connecticut's blue ribbon state tax panel – a committee formed to examine the entirety of the jurisdiction's tax model – continues its work to provide tax policy and administration recommendations to the state in the near future. Thus, it is unlikely that this bill, when it is signed into law, will signal the end of major tax reform within Connecticut.