Estimated deficits of $200 billion over the next three years face U.S. states according to the National Governors Association. Because many states are required to eliminate funding gaps by their fiscal year end, many states are revising their tax rates and making other changes to their tax codes in efforts to increase revenues.

The Tax Foundation, a nonpartisan educational organization promoting sound tax policy, has compiled an annual index on 37 categories of states’ taxing and spending since 1937. Because of the number of state tax code changes, the Tax Foundation updated its report in mid-year for the first time in its history.

No doubt, these changes will keep New York-based CPA firms and company accountants busy complying with changes in the state and city tax code.

Sales Tax Law Changes in New York City

Effective August 1, 2009, Chapter 200 of the Laws of 2009 amended the Tax Law and the Administrative Code of the City of New York, to increase the local sales and use taxes to 4.5% from 4.0%. This change means that the combined state and local sales and use tax rate in New York City now total 8.875%, including the 4.5% New York City local tax, the 4.0% state tax and the Metropolitan Commuter Transportation District (MCTD) tax.

New York City Local Exemption for Clothing and Footwear

New York City previously exempted clothing and footwear purchases, regardless of the cost, from local sales tax. However, this exemption has been repealed and New York City will conform to the New York State rule that limits for clothing and footwear costing less than $110 per item or pair. As a result, as of August 1, 2009, purchases of clothing and footwear costing under $110 will remain exempt from sales tax, while purchases over $110 per item or pair will be assessed the full sales tax rate.

Transportation and delivery of gas or electricity

Effective August 1, 2009, all revenues from transporting, transmitting, distributing and delivering gas or electricity will be subject to the 4.5% New York City local tax, even if purchased from a third party (i.e. not the actual vendor of the gas or electricity). Gas and electricity are already subject to the New York City local tax.

Narrowing of Transportation Exemptions

There were also changes made to the sales tax exemption for commercial aircraft and the use tax exemption for motor vehicles, vessels, and aircraft purchased by non-residents. The commercial aircraft exemption is provided to purchasers of airplanes that transport persons or property, for hire and/or in the general conduct of business. This exemption does not apply to company planes used mainly for transporting the firm’s personnel, whether or not purchased by a non-resident or resident entity doing business in-state.

Changes to the sales and use tax returns

In addition to changes in the tax codes, there have been changes made to ensure the proper reporting on the sales and use tax returns and schedules. CPA firms and company accountants will be kept busy, as the sales tax return for June 1 through August 31, 2009, will require a double set of entries for rate affected by the increases. One line entry will record sales and uses for the period June 1 to July 31, while the second line will report the information August 1 through. All the accountants must ensure that the transactions are reported on the correct line based on the date of occurrence.

Reporting requirements

With an effective date of August 1, 2009, there is new transaction and tax reporting requirements reflecting the new rates and other changes. Companies will need to work with their CPA firms and company accountants to ensure compliance with these new reporting requirements.

These new reporting requirements relate to the local sales and use taxes, clothing and footwear exemption, commodities (gas and electricity) transactions, hotel occupancy, cleaning and maintenance services, fuel sales, and other areas.

Affiliate Nexus

Another major tax issue relates to the sales tax on Internet sales to residents of New York.

New York began charging online retailers (etailers) sales tax on shipments into New York last year. Companies are usually required to collect sales taxes only in states in which they have a physical presence, but if the etailers do not collect sales or use taxes, then it is rarely paid by the buyers. However, in an effort to increase tax revenues, New York claimed that etailers’ affiliates (websites that refer customers and earn commissions on sales) constitute operations in state, thus the seller should collect and remit state sales tax.

Amazon, the largest etailer in the U.S., began collecting sales tax on shipments into New York last year in compliance with the new law. However, Amazon then sued New York, claiming the law was unconstitutional and challenging New York’s definition of affiliates as an in-state presence, believing their affiliate agreements were simply a type of advertising.

Overstock.com, another major etailer, filed a similar lawsuit, but also ended its relationships with affiliates in New York, so will not collect New York sales tax on sales into the state.

In addition, Amazon believes that the law’s wording was so vague that it could be applied to non-Internet out-of-state retailers that place sales advertisements in New York-based print media. The state has stated that the new law applies only to Internet-based businesses, which led Amazon to challenge the law as being contradictory to equal protection clauses of the U.S. and New York state constitutions.

Justice Eileen Bransten, of the State Supreme Court, has initially sided with New York’s imposition of the sales tax, stating that the law “imposes tax-collection obligations on sellers who contractually agree to compensate New York residents for business they generate and not simply for publicity.“

“In the end, the Commission-Agreement Provision does not broadly tax any and all Internet sales to New York consumers. It requires a substantial nexus between an out-of-state seller and New York through a contract to pay commissions for referrals with a New York resident along with realization of more than $10,000 of revenue from New York sales earned through the arrangement. The neutral statute simply obligates out-of-state sellers to shoulder their fair share of the tax collection burden when using New Yorkers to earn profit from other New Yorkers.”

Though the ruling will have no effect on Overstock, they will appeal the ruling because the firm is concerned that other states will follow suit. Jonathan E. Johnson III, the president of Overstock, said “As states have budgetary crises and are looking for others to become their tax collectors, we are not interested in that job,” he said.

Amazon is also likely to appeal, but a final decision through state and federal courts could take years to settle. In the interim, etailers, including Amazon, with New York-based affiliates will be collecting New York state sales on purchases by New York residents.

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