Report on the 1999 Connecticut Tax Law Changes
Report on the 1999 Connecticut tax law changes - This tax advisory summarizes the principal tax changes recently enacted by the Connecticut General Assembly. The new laws provide sweeping changes to the personal income tax, corporation business tax, sales and use tax, cabaret tax and real estate conveyance tax. The new laws also adopt for state tax purposes many of the taxpayer friendly provisions recently passed by Congress for federal taxes including the adoption of the innocent spouse relief provisions and the use of delivery services such as Federal Express and the United Parcel Service. For your reference, we briefly discuss some of these new changes we believe may be of general interest. Because we offer only summaries here, you should not reach a conclusion about the application of the legislation to a particular situation without first reviewing the relevant provisions of the law itself and obtaining legal advice if needed.
PERSONAL INCOME TAX CHANGES Increase in Property Tax Credit -Residents of Connecticut may take a credit on their state income tax return for taxes paid on their principal residence or their automobile. Under prior law, the maximum property tax credit available was $350. The new law, however, increases the maximum credit to $425 for 1999 and $500 for 2000 and thereafter. These increases benefit taxpayers by directly reducing their income tax liability.
Exemption of the remaining 25% of taxable social security income -Effective January 1, 1999, the new tax law exempts the remaining 25% of taxable social security income from Connecticut income tax for unmarried individuals or married individuals filing separately whose federal adjusted gross income is less than $50,000 and for individuals filing joint returns or for persons filing as head of household whose federal adjusted gross income is less than $60,000.
Sales Tax Rebate -Each resident of Connecticut who filed a 1998 state income tax return will receive a $50 rebate. Married individuals who filed a joint tax return will receive a joint tax rebate of $100. Unlike the 1998 tax rebate which was based on income and property taxes, the 1999 rebate is based on sales tax. As a consequence, individuals receiving such rebates will not have to report the amount as income on their 1999 federal or state income tax returns and thus will not have to pay tax on the amounts received. According to the DRS, the rebates should be mailed to taxpayers starting this fall.
CORPORATION INCOME TAX CHANGES Tax Credit for donation of open space land -A corporation is allowed a credit from the corporation business tax for 50% of the value of "donated open space land." "Donated open space land" means any land donated (or sold at a discount) to the state, a political subdivision of the state, or any nonprofit land conservation organization where such land is to be permanently preserved as protected open space. This credit is available for taxable years beginning on or after January 1, 1999 and is part of the State's goal to greatly increase the amount of state owned open space land.
Exclusion of capital gain from sale of open space land -If a corporation sells land to the state, a political subdivision of the state, or to any nonprofit land conservation organization, any gain from the sale is deducted by the corporation in calculating its taxable income provided that the land is to be permanently preserved as protected open space land. This deduction is available for taxable years beginning on or after January 1, 1999.
Expansion of net operating loss period -Current law provides that where a corporation's deductions for a particular year exceed gross income, the resulting loss may be deducted in any of the following five years to the extent that the corporation generates net income. If the loss was not used within the five year period, it is lost. This short time period for using the losses is particularly detrimental to start up companies which usually do not create net income until several years after commencing operations. Under the new law, however, for tax years beginning on or after January 1, 2000, a loss incurred in one year may be deducted in any of the following twenty years (again to the extent that the corporation generates net income).
Option to sell R&D credits -In general, corporations are entitled to a tax credit for research and development expenditures. Where the corporation does not incur a tax liability in the year of the expenditures, the corporation may use the credit in subsequent years. Under the new law, however, for taxable years beginning on or after January 1, 2000 companies with gross income of $70 million or less a year now have the option to either carry forward the credit to subsequent years or sell a R&D tax credit to the state in exchange for cash in the amount of 65% of the credit. Selling the credit as opposed to carrying the credit forward may be advantageous to cash strapped corporations or corporations who do not anticipate realizing taxable income for several years.
SALES AND USE TAX CHANGES No sales tax for sale/leaseback arrangements - Under the new law, sale of equipment (or other tangible personal property) is exempt from sales and use tax if within 120 days from the original sale the purchaser sells or contracts to sell the equipment to a retailer who will then lease the equipment back to the original purchaser in a taxable lease. This provision eliminates the imposition of two taxes on a sale/leaseback arrangement and enables the original purchaser to purchase the equipment free from sales and use tax even though at the time of purchase the original purchaser has not found a retailer to purchase the property and then lease such property back to the original purchaser.
Reduction in tax rate for patient care services -The tax rate for patient care services is reduced from 6% to 5.75%. Patient care services provided at a state operated short-term acute hospital are exempt from sales and use tax.
Sales of and repairs to vessels -The sale of vessels (meaning all types of watercraft other than seaplanes) to nonresidents who will not register the vessel in Connecticut are now exempt from sales and use tax. Also, repair and maintenance services to vessels are exempt from sales and use tax.
Phase out on tax of Renovation and Repair Services to Residential Property -The sales and use tax on paving, painting or staining, wallpapering, roofing, siding and exterior sheet metal work to residential real property is being phased out as follows: on or after July 1, 1999 the tax is 4%; on and after July 1, 2000 the tax is 2%; and on and after July 1, 2001 the services are exempt.
Expansion of nonprescription medicines -The exemption for nonprescription medicines is expanded to include many additional items used in or on the body. The exemption now includes, among others, vitamin or mineral concentrates; dietary supplements; natural or herbal medicines; and cough, cold or allergy medicines. Excluded from the exemption are cosmetics, dentifrices, mouthwash, shaving and hair care products, soaps and deodorants.
Expansion of exemption to services between wholly-owned entities - The exemption from sales tax for intercompany services rendered between wholly owned corporations is expanded to included services between business entities where one entity owns a 100% controlling interest in the other or where both entities are 100% owned by the same individuals or entities. Entities eligible for this exemption include corporations, trusts, estates, partnerships, limited partnerships, limited liability partnerships, limited liability companies, sole proprietorships and nonstock corporations. This expansion in the law reflects the growing trend of doing business in various forms other than as a corporation.
Creation of Managed Compliance Program -In order to optimize audit coverage and improve audit efficiency, the new law creates two types of managed compliance programs: the Managed Audit Program and the Managed Compliance Agreement. The Managed Audit Program is an agreement between the DRS and a taxpayer that provides for a self-audit by the taxpayer. Under the supervision of the DRS, the taxpayer retrieves its own records, provides its internal accounting expertise and compiles proposed adjustments. As an incentive for participating in the Managed Audit Program, the DRS may waive the first $10,000 of interest and 10% of any additional interest and may also waive penalties. By contrast, the Managed Compliance Agreement is an agreement between the DRS and a taxpayer that specifies an agreed upon method for calculating and remitting use tax on the taxpayer's purchases. Under a "true-up" procedure, at the end of the agreement term (up to 3 years) the DRS determines whether the amount of tax reported accurately reflects the taxpayer's tax liability during the term. If the error percentage after a true-up falls within an acceptable range, then no assessment or refund claim will result. Through these two programs, Connecticut is joining only a handful of states that are seeking novel ways to better utilize audit resources. Time will reveal whether these programs result in more effective and equitable audits.
REPEAL OF CABARET TAX - Effective July 1, 1999, the 5% cabaret tax is repealed. The tax was imposed on all amounts charged for admission, food and drink, service or merchandise at any cabaret or similar establishment furnishing music, dancing, or other entertainment for profit in conjunction with the selling or serving of alcoholic beverages. The DRS warns that persons operating establishments that were subject to the cabaret tax should be aware of the 10% admissions tax which is imposed on admission to any place of amusement, entertainment or recreation. Charges for food, beverages, merchandise and service sold in such establishments, however, are not subject to the admissions tax.
EXEMPTION TO REAL ESTATE CONVEYANCE TAX WHERE NO CHANGE IN BENEFICIAL INTEREST - The DRS historically has assessed a conveyance tax on the fair market value of real property contributed by members to limited liability companies or partnerships notwithstanding that there has been no change in beneficial ownership. In many cases, this made it very costly to form a family limited partnership or LLC for estate planning purposes. Under the new law, however, effective for transfers on or after October 1, 1999, the real estate conveyance tax will no longer apply to transfers of real property to a limited liability company or partnership where the transfer represents a mere change in the identity or form of ownership. Thus, for example, unlike under present law, on or after the effective date, individuals may transfer Connecticut real estate to single person LLC or a family owned LLC in exchange for LLC interests without being subject to the real estate conveyance tax. This should make family LLCs much more enticing for holding real estate.
ADOPTION OF FAVORABLE TAX PROVISIONS UNDER FEDERAL LAW Suspension of refund claim period, Innocent spouse relief, Use of delivery services other than the United States Postal Service -Ordinarily, a taxpayer has a limited time to file a claim for refund with the DRS. Once that time has expired, the taxpayer has lost his right to obtain the amount due. Under the new tax laws, the time period for seeking a refund is suspended during any time that the taxpayer is "financially disabled" (i.e., unable to manage financial affairs due to significant mental or physical impairment). This provision follows a similar provision adopted last year for federal tax purposes and is effective immediately. When a husband and wife file a single joint return, both spouses are jointly and independently responsible for payment of the entire tax liability reported and unreported. This rule at times created a hardship on spouses who "innocently" signed the tax return without having any knowledge of what was and was not reported because the IRS often held that "innocent" spouse liable for unpaid taxes when the other spouse could not be located. In response to these hardships, Congress last year expanded provisions aimed at protecting the "innocent spouse" from incurring tax liabilities when it would be inequitable to do so. Under the new tax laws, Connecticut has adopted the expanded "innocent spouse" rules for state tax purposes. In order to take advantage of this relief, it must be established that (1) the understatement of tax is attributable to the other spouse; (2) the "innocent spouse" did not know and had no reason to know that the joint return understated the amount of tax due; (3) under the facts and circumstances it would be inequitable to hold the "innocent spouse" liable for the tax deficiency; (4) the "innocent spouse" elects the favorable innocent spouse relief within two years from the date the DRS begins collection activities. This "innocent spouse" rule is effective immediately.Under current state law, the filing of a tax return or the paying of tax is considered timely filed if it is postmarked by the United States Postal Service on or before the due date irrespective of when it is received by the DRS. The postmarks from any commercial delivery services currently do not have the same effect. Following recent changes made under federal law, however, effective for returns or payments made on or after October 1, 1999, postmarks from delivery services such as Airborne Express, DHL, United Parcel Service and Federal Express will be respected by the DRS as the date of filing in the same way as the U.S. Mail postmark.