Special Session Ends with Handful of Noteworthy Tax Bills, Predictions for Next Special Session

State & Local Tax Alert: Alabama Edition

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The first Special Session of 2015 ended on Tuesday, August 11, without accomplishing the primary objective of passing a General Fund budget for the 2015-2016 fiscal year. The Governor’s “call” for the special session included over $300 million in tax increases that he believes are necessary to adequately fund state services. While the House indicated a willingness to consider some of the Governor’s proposals (business privilege tax reform, tobacco tax increase, limited use tax transfer, among others), any momentum for tax increases quickly subsided when the tobacco tax proposal failed to pass out of committee. As a result, the House Ways and Means General Fund Committee passed a General Fund budget that cut Medicaid by $156 million. The full House ultimately passed a budget that cut General Fund agencies by $228 million.

While the Senate majority has consistently expressed opposition to tax increases, there was brief (and limited) support for SB 51, sponsored by Senator Linda Coleman (D-Birmingham), that would have imposed unitary combined reporting for multistate corporate groups. It is estimated that this legislation would result in a significant tax increase on many Alabama businesses. The bill was reported out of the Senate Finance and Taxation Education Committee, but went no further.

Ultimately the Senate passed a budget that level-funded Medicaid and cut most other agencies by approximately 18%. The House rejected the Senate budget and the Legislature adjourned sine die. As discussed below, it is important to note that the Legislature passed and the Governor has already signed or is expected to sign several bills that are estimated to generate up to $35 million annually in new revenue. It is anticipated that the Governor will call another special session to address the General Fund in early September.

Act 2015-505 (H.B. 49) – Factor Presence Nexus: On August 11, without any fanfare, Governor Robert Bentley signed into law HB 49, sponsored by Rep. Rod Scott (D-Fairfield). The act establishes broad “factor presence” nexus standards for taxpayers with various business activities in Alabama. Specifically, a nonresident individual or business entity is deemed to have a substantial nexus with Alabama, and thus an Alabama income or financial institution excise tax and a business privilege tax filing obligation, if in any tax period the taxpayer’s property, payroll, or sales in Alabama exceeds certain dollar thresholds. While the bill only adds new Section 40-18-31.2 to the Code of Alabama (the income tax chapter) and only mentions “income tax” in the preamble, it apparently also applies to business privilege and financial institution excise taxes.

If the taxpayer has $50,000 or more in property, $50,000 or more in payroll, $500,000 or more in sales, or 25% of its total property, payroll, or sales, apportioned to Alabama, the taxpayer automatically has nexus with the state. The bill is retroactive and, as such, applies to all tax years beginning after December 31, 2014.

The bill also affects pass-through entities, such as LLCs, LPs, and S corporations, as well as trusts, by applying the threshold amounts at the entity level. If the property, payroll, or sales of the entity in Alabama exceeds the nexus threshold, the owners of the pass-through entity are automatically subject to state income tax on their allocable share of the entity’s Alabama income. Unlike past versions of the legislation, the bill acknowledges that the federal Public Law 86-272 protections for certain solicitation activities still apply, even if the taxpayer exceeds one or more of the thresholds described above.

The bill is based on the model MTC statute, but opponents of unitary combined reporting were successful in convincing the Legislature to strip out the portion of the model language that assumed the state mandated or allowed unitary combined reporting or that could be interpreted as granting the ADOR the authority to force unitary combined reporting.

A handful of other states have enacted factor presence nexus rules; as Ferdinand Hogroian of the Council On State Taxation (COST) points out, however, there are constitutional issues with these rules, and pending litigation in Ohio may provide at least a preliminary answer.

Act 2015-504 (H.B. 42) – Repeal Withholding Exemption: Effective September 1, 2015, this act repeals a section of the income tax code that allows withholding exemption certificates to be used by individual taxpayers to claim a total exemption from Alabama income tax, and thus no wage withholdings. Now, the employee must file an income tax return with the ADOR annually and claim a refund, if he or she is entitled to a refund. Reportedly, there was much abuse of this provision, and the ADOR suggested that the “loophole” be closed in an effort to increase both taxpayer compliance and revenues flowing into the Education Trust Fund.

Act 2015-503 (H.B. 25) – Vehicle Sales Tax Reciprocity : A bill designed to create a level sales tax playing field for vehicle sales between the states of Alabama and Florida, and potentially other states, was also signed into law by Governor Bentley last week. The bill was designed to either force the state of Florida into a full reciprocity agreement or to impose sales tax on Alabama residents who purchase a vehicle from a Florida dealer and return to the state.

Currently, a Mobile, Alabama dealer selling a vehicle to a Florida resident may jointly complete a drive-out certificate with the customer, which allows the Florida resident to pay no sales tax to the state of Alabama and localities, but the Florida resident will pay full taxes when he or she registers the vehicle in Florida. Conversely, if a Mobile, Alabama resident purchases a vehicle from a Pensacola, Florida dealer, the Florida dealer is required to charge the Alabama resident 2% Florida sales tax (equivalent to Alabama’s state tax rate for vehicle sales), but when the Alabama resident returns to Alabama, he or she is not required to pay sales tax to the state. He or she will be required to pay sales tax to Mobile County and the City of Mobile, however. According to the Automobile Dealers Association of Alabama newsletter, residents of states that do not allow full reciprocity will be required to pay the 2% Alabama sales tax when they return to the state with their new vehicle. Dealers could still use the drive-out certificate procedure to avoid the collection of city and county sales taxes. That amendment becomes effective January 1, 2016.

Act 2015-502 (H.B. 18) – Cash Register “Zappers”: This act makes it illegal to sell, purchase, install, transfer, or possess any automated sales-suppression device or “phantom-ware” that could be used to cause a cash register not to capture all sales information and, thereby, to under-report sales tax liability. A similar bill was advocated by the ADOR last session, but it did not pass.

SB 24 – Annual Exemption Certificate Requirement: Sponsored by Senator Trip Pittman (R-Montrose), this bill awaits Governor Bentley’s signature as of today. Touted as preventing the abuse of tax exemption certificates by tax-exempt entities, the bill passed by a close vote on the last day of the special session—much to the surprise of the nonprofit community. The bill would affect not only charities across the state but also Alabama retailers who sell to them.

If signed into law by the Governor—and that is not a sure bet—the bill would require all entities that are exempt from sales/use or lodgings tax under Alabama law (other than governmental entities and public universities) to apply annually for a certificate of exemption (COE) with the ADOR and to provide the department with other information on their tax-free purchases. The bill does not require the ADOR to issue a COE, nor does it impose a deadline by which the ADOR must either issue or deny the certificate, or state the grounds for denial or the appeal process if the application is either denied or simply not acted on. Failing to obtain an annual COE or to file an annual report (the content of which is not specified in the bill) would cause the otherwise tax-exempt entity to forfeit its ability to purchase items tax-free or to rent hotel rooms or other accommodations without lodgings tax, despite the clear statutory authority for doing so. A number of nonprofit organizations have requested that the Governor veto the bill and work toward a compromise version for introduction next session.

If enacted, the bill would become effective January 1, 2016, although the effective date of the new annual reporting requirements appears to be 2017.

Bills That Died in the First Special Session but Will Likely Resurface

SB 51, sponsored by Senator Linda Coleman (D-Birmingham), would have repealed portions of the Alabama corporate income tax code that permit separate entity reporting and consolidated tax returns and required all corporate groups with at least one member doing business in Alabama to begin filing a unitary combined return. The bill was introduced one afternoon and passed out of the Senate Finance & Taxation Education Committee the next morning in a close vote. The bill did not progress further, as the business community coalesced quickly and convinced both Senate and House leadership to shelve the bill. No other state in the Southeast imposes unitary combined reporting, and letters from the Economic Developers Association of Alabama and the Business Council of Alabama pointed out that fact and warned of the likelihood of damaging the state’s industrial recruiting efforts as well as efforts to encourage existing businesses to expand their operations in the state.

The Simplified Flat Tax Bill, SB 43, was introduced again but, as in the 2015 regular session, this constitutional amendment died without extensive debate. Its champion, Senator Bill Hightower (R-Mobile), pledged to reintroduce the bill with some modifications.

HB 34, by Representative Elaine Beech (D-Chatom), would have increased the annual business privilege tax cap from $15,000 to $25,000 annually. The bill would also have altered the tax rate schedule so that the rate would be a function of net worth instead of net income as it is today. Further, the bill would have exempted entities with small net worth from the business privilege tax. The bill would have also amended the due date for taxpayers subject to the financial institution excise tax from March 15 to April 15, which would have been beneficial to financial institutions, which are subject to a $3 million annual cap.

Another controversial bill, HB 24, which Governor Bentley included in his call, would have repealed the deduction for FICA taxes withheld from wages, along with the equivalent taxes paid on self-employment income. That bill would have raised approximately $182 million annually but was opposed by the majority of the Legislature.

More surprising was the quick demise of the proposed tobacco tax bill, HB 9, which failed to pass out of a House committee by one vote. This bill had been considered the least objectionable tax among lawmakers. Once this tax failed, the remaining revenue-raising measures proposed by the Governor seemed to quickly grow unpopular.

Another bill that many observers thought had a reasonable prospect of passage was SB 30, sponsored by Senate President Pro Tem Del Marsh (R-Anniston). The bill would have transferred the revenues from the consumer use tax from the Education Trust Fund to the ailing General Fund. This bill was opposed by the education community as well as Senator Trip Pittman (R-Montrose), the powerful chair of the Senate Finance & Taxation – Education Committee. The bill made it out of committee but no further.

Senator Marsh’s bills to allow a constitutional referendum on both an education lottery and casino gambling never made it out of committee, but we could see these proposals again.