Massachusetts State and Local Tax Update—Second Quarter 2022

There haven’t been many tax cases to report on since the beginning of the pandemic, when the Massachusetts Appellate Tax Board officially stopped conducting in-person hearings. This shutdown continues because of ongoing renovations at the tax board’s offices. Practitioners hope to see resumed hearings and some return to normalcy by the end of summer. In the meantime, pre-pandemic tax litigation has yielded a few reported decisions from the board. However, most of the activity has been at the appeals courts.

One tax appeal that has lingered for years was finally put to rest by the Massachusetts Supreme Judicial Court. While the main issue was addressed, the court’s decision appears to cast doubt on established principles relating to the taxation of corporate partners in Massachusetts. The original dispute centered on whether the state could tax a nondomiciliary corporation on a capital gain derived from the sale of its 50% membership interest in an in-state limited liability company, despite the lack of a unitary relationship between the two entities.

In VAS Holdings & Investments LLC v. Commissioner of Revenue, the court ruled that taxation of the gain was constitutionally permissible because the corporation received financial benefits from the LLC, whose growth was tied to the protections, opportunities, and benefits provided by Massachusetts. The so-called “investee approach” allows taxation of income derived from another entity, via investment or otherwise, based on the other entity’s property and activities in the taxing state. However, the court unilaterally determined that the commissioner did not have the statutory authority to use the investee approach or otherwise deviate from the unitary business principle, even though the taxpayer never challenged the commissioner’s authority at trial or in its arguments before the court.

In his motion for reconsideration, the commissioner argued that the court ignored established partnership tax principles. Under Massachusetts tax law, an LLC not taxed as a corporation is treated as a partnership. As a rule, the activities of a pass-through entity are attributed to its individual members. Since VAS held a 50% interest in the LLC, it effectively was conducting a trade or business in Massachusetts. This was sufficient authority to tax the gain, the commissioner claimed.

The court denied the commissioner’s motion without explanation, leaving open the question of the proper taxation of nondomiciliary corporate partners. In his motion, the commissioner warned that the decision could upend existing and long-accepted practices. For example, ordinary distributive share income of a nondomiciliary corporate partner or nonresident individual partner of a Massachusetts-based partnership may be exempt from Massachusetts tax unless the partner is engaged in a unitary business with, or actively participates in the operations of, the partnership.

In U.S. Auto Parts Network Inc. v. Commissioner of Revenue, the Appellate Tax Board held that a taxpayer’s use of cookies and apps did not constitute a physical presence in the state for sales and use tax purposes. The commissioner’s appeal ispending before the state Supreme Judicial Court, which recently requested amicus briefs addressing two questions: whether the commissioner had authority to require the taxpayer, an internet vendor with no traditional physical presence in Massachusetts, to collect sales taxes on internet sales to Massachusetts customers based on the taxpayer’s internet contacts in Massachusetts such as a mobile application,cookies, and third-party content distribution networks; and whether such requirement violates the Commerce Clause or the Internet Tax Freedom Act.

Letter Ruling 22-1: Taxability of Continuous Glucose Monitors discusses whether sales of wearable medical devices, which measure and store individuals’ blood glucose levels, are exempt from sales tax, as they are sales of medicine or equipment worn for correcting or substituting any functioning portion of the body. The commissioner previously determined that products that merely diagnose, detect, or identify medical problems do not fit within the exemption’s definition of medicine. The ruling concluded that the devices are not medicine nor substitutes for a functioning portion of the body.

In Oracle USA, Inc. v. Commissioner, the Supreme Judicial Court held that taxpayers have a statutory right to apportion sales and use tax on software transferred for consideration for use in more than one state, and that the statutory abatement process is available to taxpayers seeking refunds based on such apportionment. In response, the Department of Revenue issued Technical Information Release 22-8, which states that while Oracle addressed the general procedure for claiming a tax abatement for software transferred for multistate use, it did not address specific methods of apportioning the sales or use tax on such transfers. The commissioner will generally accept an apportionment method based on the number of licensed users in a particular state.

But based on the specific facts, other methods may also be considered reasonable. The method used must accurately reflect actual use, or a reasonable approximation of use, of the software in Massachusetts. The chosen method must be consistent, uniform, and supported by the taxpayer’s books and records. The burden of proving that the apportionment method meets the reasonableness requirements will fall on the taxpayer.

The Department of Revenue has circulated a proposed regulation that sets forth the rules for imposing marijuana retail taxes on the retail sale of marijuana. All retail sales of marijuana by marijuana retailers are subject to up to three taxes imposed on the total sales price of the marijuana sold:

1. Marijuana retailers are required to collect and remit a marijuana excise imposed on their retail sales of marijuana;
2. Marijuana retailers operating in cities or towns that have accepted the marijuana local tax option must collect an additional tax imposed at a rate of no greater than 3%; and
3. Sales of marijuana are subject to the sales tax.

The sale of medical marijuana is not subject to any of these taxes. The proposed regulation explains the imposition of the marijuana retail taxes on retail sales of marijuana by marijuana retailers, exemptions from these taxes, and administrative provisions applicable to marijuana retailers, such as record-keeping requirements and the procedures for filing returns and remitting payments.

Another proposed regulation explains the criteria and procedures a taxpayer must follow in applying for spousal relief from joint income tax liability. This regulation is being amended in response to statutory changes to G.L. c. 62C, Section 84 that align with federal rules for relief.

As amended, the statute provides for three types of relief from joint tax liability for a requesting spouse: innocent spouse relief, separation of liability relief, and equitable relief, each with its own requirements. The regulation describes the eligibility requirements of the three types of relief available. It also sets out when and how a taxpayer should apply for relief and details the opportunity of the non-requesting spouse to participate.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Philip S. Olsen is a tax attorney at the Boston law firm of Davis Malm, where he focuses on state and local tax consulting and litigation. He has over 25 years of experience litigating and resolving major tax controversies before courts and administrative boards.

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