68 CBJ 10. Survey of 1993 Connecticut Tax Developments.

• Author: By JOHN R. SHAUGHNESSY, JR. AND RICHARD W. TOMEO (fn*)

Connecticut Bar Journal

Volume 68.

68 CBJ 10.

Survey of 1993 Connecticut Tax Developments

10Survey of 1993 Connecticut Tax DevelopmentsBy JOHN R. SHAUGHNESSY, JR. AND RICHARD W. TOMEO (fn*)In a year with no significant fiscal pressures, the General Assembly was able to enact a series of corporate and sales tax exemptions aimed at improving the business climate and made other changes which focus on improvement in the operation of the tax system. However, the most interesting, and indeed exciting, development from the practitioner's viewpoint is the creation of the new Tax Session of the Superior Court, popularly referred to as the Tax Court. In what promises to be a successful effort to break the logjam of tax cases on the trial docket, the two Tax Court Judges had, by year's end, scheduled every pending case for at least a status review. Moreover, even though the Tax Court was in operation for less than four months last year, this article comments on more Superior Court decisions than in the two most recent years. This development bodes well, not just for litigants who now will get speedy resolution of their claims, but for all taxpayers and practitioners, who can only benefit from the careful and reasoned explication of the law by the courts.

1. LEGISLATIVE DEVELOPMENTS

   1. Corporation Business Tax

      11One of 1993's more important enactments concerns the treatment of S corporations. Though Connecticut does not recognize the federal S election, double tax is avoided when a corporation's deduction for salaries paid to principals reduces corporate income to a low level. This can lead to an assertion on audit that such compensation is unreasonable and represents a disguised dividend. While the potential for unreasonable compensation issues has been of concern to practitioners for some time, the Department of Revenue Services (DRS) first published its position on the issue in Announcement 92(7), stating it would not raise the reasonable compensation issue for years beginning before 1993, but would consider raising the issue for 1993 and later years even if the Internal Revenue Service had not done so. The possibility that taxpayers and the DRS would face costly litigation on this point was laid to rest in Public

      11Act 93-332 (fn1) which prohibits an adjustment to the income of an S corporation by adding back the compensation of any officer or employee.

      Although not a state tax matter strictly speaking, the new Connecticut Limited Liability Company Act (fn2) is worthy of mention as well. By the passage of this Act, Connecticut joined a growing number of states which have enacted a means by which the owners of a business may receive the benefits of pass-through of income and deductions while enjoying a limitation on their liability for the entity's acts. However, the Limited Liability Company is more than merely an alternative to the S corporation. Its membership may include trusts, corporations and foreign persons, and the number of members may exceed the current limit of 35 on S corporation shareholders.

      In another important development, the General Assembly has lowered the corporate tax rate, currently at 11.5%, for years beginning in 1995 to 11.25%, in 1996 to 11%, in 1997 to 10.5% and thereafter to 10%. (fn3) This reduction in future rates was accompanied by a number of additions to the tax credits available to corporations, some applicable against 1993 income and others available for credit only in future years. In addition to the research and development credits enacted in 1992, (fn4) there is now available for qualifying research and development expenditures, a new and potentially very substantial research and development credit computed on a graduated scale ranging from 1% of the first $50,000 of expenditures to 6% for expenditures over $200,000,000. (fn5) Qualified research and development expenses are broadly defined to include both research and experimentation expenditures deductible under Internal Revenue Code (Code) section 174 and basic research payments as defined by Code section 41. (fn6)

      While expenses incurred in 1993 and later years are eligible for the credit, they will first be creditable on 1995 returns. Only one third of the credit earned in a year may be taken in that year, but the remainder may be carried forward indefinitely. The

      12 overall limitation on the annual combination of current credit and carryforwards is the greater of fifty percent of pre-credit tax liability and that number which is the lesser of two hundred percent of the credit allowed for that year and ninety percent of tax liability before the credit. The credit is adjusted if the corporation also takes the incremental research and development tax credit or the credit for research and development grants, (fn7) and may not be included in a company's calculation of estimated taxes for any year beginning before January 1, 1997. Further, when the eligible expenditures in any year exceed $200 million, the credit allowable for that year is reduced if the company's Connecticut workforce has been reduced by 2% or more. (fn8) A Connecticut workforce reduction of 6% eliminates the credit for the year in which it occurs.

      The General Assembly accelerated by one year the phase-in of each stage of the employee training credit enacted in 1992, (fn9) making the first 5% increment of qualifying expenditures creditable beginning in 1994. (fn10) Extended through 1997 were the existing credits relating to vehicles powered by clean alternative fuels, and the credit for natural gas filling stations was expanded to include stations for recharging electric vehicles. (fn11) Newly enacted credits include one intended to assist employers in attracting employees who cannot bear the full cost of housing in Connecticut by allowing a credit for amounts paid into a loan fund administered by the Connecticut Housing Finance Authority. (fn12) This credit is limited to $100,000 per year and may be carried back or forward five years.

      Another new credit is aimed specifically at small corporations. Effective for 1995 and later years, corporations with 500 or fewer full-time, permanent employees receive a credit of 5% of the excess of machinery and equipment purchases in one year over purchases in the preceding year. (fn13) For companies with 250 or fewer employees, the rate of credit is 10%. Finally,

      13effective July 1, 1993, the 50% credit for tax allocable to enterprise zone facilities includes facilities used in the production of live or broadcast entertainment and located in an approved entertainment zone. (fn14)

      The legislature also reduced the rate of interest on underpayments of tax from 20% per annum to 15%, effective for taxes due and payable on and after January 1, 1994. (fn15) It restricted the existing exemption from tax for corporations engaged in the research, design, manufacture, sale or installation of alternative energy systems to those deriving at least 75% of their gross annual revenues from these activities, but broadened the exemption to include those engaged in such activities with respect to motor vehicles powered by electricity, natural gas or solar energy, or parts or components therefore. (fn16)

      Non-life insurance companies, in making the unpaid reserve adjustment (the Code section 83(b)(5)(B) adjustment), are no longer required to reduce the deduction by a portion of tax exempt interest and dividends received. (fn17)

      Finally, the General Assembly saw fit to include for the first time a definition of gross receipts for purposes of the one-factor apportionment formula. (fn18) Gross receipts for this purpose have the same meaning as gross receipts for purposes of the three-factor formula.

   2. Sales and Use Taxes

      1. Additions to the tax base

      The General Assembly resolved the question of taxability of business management services provided by a general partner to a partnership by providing that such services are taxable if: (l) the compensation of the general partner is other than through a distributive share of partnership profits; and (2) the general partner offers management services to others, including any other partnership. (fn19) An important aspect of this enactment is that it is effective for sales made on or after January 1, 1994, which reverses the DRS position stated in Policy Statement 92(6) that these services were taxable for prior periods of time. The General Assembly also put to rest the question whether transportation 14charges included in an invoice for the sale of goods are part of the gross receipts. Since the tax was first enacted, the statute has provided that such charges incurred after purchase are not taxable when separately stated on the invoice, (fn20) a provision which has given rise to much disputes about the passage of title. Effective for taxable sales of goods on and after July 1, 1993,such charges are no longer excepted. (fn21)

      Effective July 1, 1993, all manufactured dwellings receive the treatment now accorded mobile manufactured homes. (fn22) As of that date, all manufactured dwellings are subject to sales tax based on 70% of the manufacturer's sales price and "resales" of such dwellings are to be taxed as conveyances of real property not subject to the sales tax. (fn23) A further change shifts a portion of the funding of uncompensated medical care " from a separate assessment system to the sales tax. Thus, added to the tax base are all hospital charges for patient care services, except amounts paid by Medicaid, Medicare and...