Is Your Business Eligible for State and Local Tax Savings during the Pandemic?

One of the looming state tax issues created by the COVID-19 pandemic is how businesses allocate their service revenues among states and localities in light of current telecommuting and shelter-in-place orders. Typically, state laws source service revenues using one of two basic approaches: cost of performance or market-based. Depending on which option a state utilizes, how these provisions are applied will have a significant impact on a business’ overall tax liability and could actually lead to state tax savings in 2020.

Cost of Performance Sourcing

Jurisdictions that employ a cost of performance standard focus on where the services provided by a business are essentially performed. Under this approach, only the percentage of revenues related to the services performed within their boundaries need be sourced to the taxing state. A minority of states qualify this approach by mandating that all revenues arising from services performed will be sourced to their jurisdiction if the majority of the services rendered by the taxpayer for a particular project occur within that state.

Market-Based Sourcing

Under the market-based sourcing approach, the sourcing rules shift from the location of the performance of services to the location where the services are received. Generally, tax provisions adopting this approach look to where the services are delivered or where the benefit of the services is received. Revenues are then sourced for income tax purposes to this state.

Pandemic Service Revenue Sourcing

In general, many taxing states and cities apply the cost of performance sourcing methodology, particularly with respect to non-corporate entities such as partnerships, LLCs and LLPs. Accordingly, in the current telecommuting and remote-work environment, cost of performance sourcing may substantially alter a business’ tax exposure. For example, New York City’s 4% Unincorporated Business Tax regulations require cost of performance sourcing for revenues generated in connection with services rendered in the City. However, since March, many New York City-based businesses have operated remotely with countless employees working from Long Island, New Jersey or even a vacation home in Florida. Under the City’s sourcing rules, the remote services being rendered are not sourced to the City and, consequently, are not taxable by New York City. This results in potentially significant savings for many New York City-based service providers who have employees working from various locations outside of the City’s limits.

New York City is not the only jurisdiction where cost of performance rules may produce tax savings during the pandemic. Texas, Virginia, Florida, Idaho, South Carolina and Philadelphia, in addition to many other localities, are further examples of taxing jurisdictions that use the cost of performance methodology for the sourcing of service revenues.

While the taxing jurisdictions themselves are facing a substantial loss of revenue from their sourcing laws, businesses operating in these locations may be able to secure substantial tax savings.

If you need help determining whether you are eligible for these potential tax savings, please contact Alan Goldenberg, Leader of Anchin’s State and Local Tax (SALT) group, or your Anchin Relationship Partner.