While 2019 was a busy year in state and local tax (SALT) world, 2020 promises to be just as eventful. With cases pending in various courts dealing with personal income taxes and corporate income taxes, there's exciting SALT news on the horizon for almost everyone.

• Steiner v. Utah State Tax Commission, No. 20180223, 08/14/2019: A refund opportunity for taxpayers with taxes paid to foreign countries.

In a controversial opinion entered during 2019, the Utah Supreme Court held that the dormant commerce clause did not require Utah to grant credits for taxes paid by individuals to foreign jurisdictions and declined to extend the U.S. Supreme Court's ruling in Comptroller of the Treasury of Maryland v. Wynne, 575 U.S. ___ (2015), to the issue. Steiner arose out of Robert and Wendy Steiner's Utah joint income tax returns, particularly the taxation of Robert Steiner's business income. Robert Steiner was a shareholder of an S corporation (Steiner LLC) and a beneficiary of the G.A. Steiner Trust, which was Steiner LLC's majority shareholder. Steiner LLC was the only shareholder of Alsco Inc., a textile rental company that generated income from business in both U.S. and foreign locations. Alsco and its subsidiaries were taxed as qualified S subsidiaries, as such all income from those subsidiaries ultimately passed through to Steiner LLC's shareholders, including Robert Steiner.

On their Utah returns, the Steiners claimed a credit for taxes paid to other states for their U.S.-based income. Regarding taxes paid to foreign jurisdictions, the Steiners claimed—and received—a tax credit at the federal level. On their Utah returns, the Steiners claimed an "equitable adjustment" pursuant to Utah Code Section 59-10-115, seeking to exclude their foreign income taxes from Utah taxable income. The Steiners were audited, resulting in a disallowance of the equitable adjustment. Consequently, the Steiners challenged the disallowance of the equitable adjustment and the state's tax credit system.

Purportedly relying on Wynne, the Utah Supreme Court held that Utah's tax regime must satisfy the internal consistency test, but does not need to satisfy the external consistency test. The court reasoned: "In Wynne, the U.S. Supreme Court declined to require anything else of Maryland's tax … We accordingly apply Wynne and conclude that a state tax levied against individuals need satisfy only the internal consistency test to pass dormant commerce clause scrutiny. It would be an extension of Wynne to require that these taxes also satisfy external consistency. If the Supreme Court wishes to mandate such an extension, it is of course free to do so. But we will not do so here."

Further misconstruing the law, the Utah Supreme Court explained that all U.S. Supreme Court precedent on the dormant commerce clause has involved C corporations, which the court believed meant that the U.S. Supreme Court never indicated that there is a constitutional violation when a state taxes an individual based on residency within the state and denies a credit against foreign-based taxes.

The court's reasoning confounds U.S. Supreme Court precedent on the dormant commerce clause—including Wynne. To survive dormant commerce clause scrutiny, a tax must meet the Complete Auto four-prong test, see Complete Auto Transit v. Brady, 430 U.S. 274 (1977). One of those prongs is the fair apportionment prong, which is itself comprised of two tests—the internal consistency test and the external consistency test. Failure to meet either one of those tests is fatal to the constitutionality of the tax under the dormant commerce clause. The Wynne court found that the tax at issue violated the internal consistency test and was, therefore, unconstitutional. It was unnecessary for the court to find that the credit scheme also violated the external consistency test. Moreover, in its opinion, the Supreme Court cited to the Maryland high court's analysis of both the internal and external consistency tests. The court's silence on the external consistency test in its holding in no way invalidates the plethora of case law requiring a tax to meet both the internal and external consistency tests.

Further, the Utah Supreme Court's assertion that the dormant commerce clause somehow does not apply to individuals completely belies the Supreme Court's Wynne decision, wherein it asserted: "We have long held that states cannot subject corporate income to tax schemes similar to Maryland's, and we see no reason why income earned by individuals should be treated less favorably."

But … What does all of this have to do with Pennsylvania? Why should we care what happens in Utah? The Utah Supreme Court's decision is wrought with such blatant mischaracterizations of the law that it almost appears to be a direct challenge to the U.S. Supreme Court to take up the case. If the U.S. Supreme Court grants cert, the court's analysis will be directly applicable to Pennsylvania taxpayers with foreign tax credits. A number of Pennsylvania cases are on hold pending the decision in Steiner. Any taxpayers with foreign tax credits should file protective refund claims for all open years in the event the U.S. Supreme Court takes the case and the taxpayers prevail.

• Synthes USA HQ v. Commonwealth, 108 FR 2016 (Pa. Cmwlth Ct.): Do all roads lead to market-based sourcing?

When sourcing service revenue to a state, there are two general methods: Cost of performance (COP); or market-based sourcing (MBS). Historically, most states utilized COP—which provides that service revenue is apportioned to the state where the income-producing activity is performed. If the income-producing activity is performed across multiple states, the revenue is apportioned entirely to the state in which the greatest proportion of the revenue was earned based on COP, i.e., the cost incurred to generate the revenue. Often, COP is looked at as an all or nothing type sourcing rule because the majority state is assigned all of the revenue whereas the other state(s) receives no allocation. Conversely, MBS generally allocates the service revenue to the state in which the benefit of the service is received.

For tax years prior to 2014, receipts from services were sourced to Pennsylvania based on COP. For tax years 2014 and thereafter, Pennsylvania shifted to MBS for service receipts for purposes of its corporate net income tax (CNIT). However, the Pennsylvania Department of Revenue (DOR) has taken the position that for the COP analysis, the "income-producing activity" is the receipt of the benefit of the service—thus, a roundabout analysis resulting in essentially MBS treatment even in COP years.

A number of cases are pending in Commonwealth Court challenging the DOR's interpretation. However, Synthes is a case in which the taxpayer instead accepts the DOR's MBS view of COP and is seeking a refund based on that analysis. In Synthes, the taxpayer is arguing that it received revenue for research and development and management services from its affiliates and that such services were ordered, utilized and ultimately benefited customers outside of Pennsylvania. Therefore, the taxpayer posits, the receipts from those services should be removed from the sales factor numerator.

The taxpayer filed its brief during December 2019 and the commonwealth will file its reply brief shortly, which should slate the case for oral argument sometime in the first half of this year. The Commonwealth Court's decision will be important for its analysis of COP, particularly for the litany of cases pending that are challenging the DOR's interpretation of the sourcing method for pre-MBS years. Further, COP is still the sourcing method for intangibles, so an analysis of COP by the courts will be instructional for present tax years, too.

• The constitutionality of economic nexus for income taxes.

In South Dakota v. Wayfair,138 S. Ct. 2080 (2018), the U.S. Supreme Court upheld economic nexus, finding that physical presence is not required in order for a state to require sellers to collect sales and use tax from customers located in the taxing state. In the aftermath of Wayfair, a few states and localities adopted economic nexus principles for purposes of their income taxes. During 2019, the Pennsylvania Department of Revenue created a $500,000 "presumption" of nexus for purposes of its CNIT and the city of Philadelphia established a $100,000 economic nexus threshold for purposes of its business income and receipts tax. While states have adopted economic nexus for income tax purposes pre-Wayfair, there was debate about whether the "physical presence" requirement applied equally to sales taxes as to all other taxes. Wayfair's removal of the physical presence requirement made that debate moot.

Notably, Wayfair was a sales and use tax case—not an income tax case. Why does that distinction matter? Where imposed, sales and use taxes are always due—it is just a question of which party is paying the tax to the taxing state. When a company does not collect sales tax from the customer, the customer should pay the reciprocal use tax to the taxing state. In practice, however, customers generally were not paying the use tax when remote sellers failed to collect the sales tax—hence the issue that needed to be addressed in Wayfair. Yet, an income tax imposed on a remote company is different—it is a tax that is not so obviously due to the taxing state and the analysis in Wayfair does not necessarily jive with an income tax analysis.

In Apex Laboratories International  v. City of Detroit, Mich. Ct. App., No. 338218, 1/2/20, the Michigan Tax Tribunal is being asked to decide whether remote businesses can be subject to Detroit's 2% local corporate income tax based purely on economic nexus. Detroit is seeking more than $400,000 in taxes, penalties and interest from Apex, a Delaware company. While dealing with Michigan's statutes, the case could nonetheless have (nonprecedential) application in Pennsylvania as taxpayers begin challenging post-Wayfair economic nexus standards imposed by states and localities, including potentially Pennsylvania and Philadelphia.

Pennsylvania taxpayers should keep an eye on these three key issues as we dive into 2020 in SALT.

Jennifer Weidler Karpchuk is a partner at the law firm Cozen O'Connor in Philadelphia. She focuses her practice on state and local tax compliance and litigation, and represents clients in a range of taxation matters, with an emphasis on the minimization of state and local tax obligations. Contact her at [email protected].