84 CBJ 23. 2009 CONNECTICUT TAX LAW DEVELOPMENTS.

• Author: By John R. Shaughnessy and Scott E. Sebastian

Connecticut Bar Journal

Volume 84.

84 CBJ 23.

2009 CONNECTICUT TAX LAW DEVELOPMENTS

Connecticut Bar JournalVolume 84, No. 1, Pg. 23MARCH 20102009 CONNECTICUT TAX LAW DEVELOPMENTSBy John R. Shaughnessy and Scott E. Sebastian(fn*)The tax news for 2009 centered primarily around the biennial 2010-2011 budget. In the face of a failing economy and declining resources, the Governor vetoed the Democrats' first effort to enact a budget. The General Assembly labored mightily again and brought forth a second package somewhat reducing the income tax and corporate tax hikes of the first effort. Neither vetoed nor signed, that version of the budget became law in September, well after the biennium had begun.(fn1) Meanwhile, behind the scenes, an early retirement initiative adopted to reduce expenditures resulted in the departure of Commissioner Law and took a heavy toll on the Department of Revenue Services (the "Department") with the sudden loss of several high-level employees with long experience. They have been replaced with able public servants, but it will be some time before the Department recovers from the loss of institutional memory.

A welcome aspect of the early retirements was the naming of Richard Nicholson as Commissioner. The first months of his administration have seen a reopening of the lines of communication with taxpayers and practitioners. This has resulted in adoption of a I4-day safe harbor for Connecticut withholding on wages paid to nonresident employees and in ongoing efforts to address the nonresident contractor provisions of the statutes in light of the Supreme Court's decision in Rainforest Cafe, Inc. v. Department of Revenue Services, as well as other issues of current importance.(fn2)

1. Legislative Developments

   The $37.6 billion 20I0-20II biennial budget ultimately passed both chambers on August 3I, 2009 and took effect without Governor M. Jodi Rell's signature on September 8, 2009(the "Budget Act").(fn3) As noted above, this marked the second time that the general Assembly passed a budget, with governor Rell vetoing the first version on July 1, 2009 ("Vetoed Budget").(fn4)

   Adoption of the Budget Act did not actually end the political wrangling, which continued through later special sessions and resulted in additional legislation. Together, these acts contained a variety of revenue-raising provisions, with the burden falling most heavily on corporations and high-income individuals. There were, however, items that provided relief to state taxpayers, highlighted by an expansion of the estate and gift tax exemption to $3.5 million starting in 2010and a 25% reduction in estate tax rates. The General Assembly also enacted legislation to lower the sales and use tax rate starting in 2010, but the rate decrease did not take effect because tax revenues fell short of the revenue projections specified in the legislation. However, the most aggressive revenue-generating measure by far was the adoption of an "economic nexus" standard - an effort to expand the income-taxing jurisdiction of the state to include out-of-state businesses with no physical presence in the state.

   1. Corporate and Income Taxes

      1. Economic Nexus

         The Connecticut economic nexus legislation defines nexus as a substantial economic presence manifested by "a purposeful direction of business toward this state."(fn5) Factors establishing economic nexus include the frequency, quantity, and systematic nature of this direction of activity. This legislation lowers the bar for nexus to exclude any physical connection with the state. In so doing, Connecticut is testing the boundaries of the constitutional limits on a state's power to tax.(fn6) This new provision applies the economic nexus standard to corporations, to S corporations and to business entities taxable as partnerships. S corporations and partnerships are required to disclose the names and identification numbers of all shareholders or partners, whether or not they are Connecticut residents. As a result, each nonresident S corporation shareholder or partner of an entity with "economic nexus" will be obligated to file an income tax return, even though neither they nor the entity has any physical presence within the state.

         The summary provided to legislators by the Office of Legislative Research noted that the expansion of nexus would extend tax liability to out-of-state financial service companies, particularly credit card companies, mortgage lenders, automobile finance companies, and online services companies, and the fiscal note attached to the legislation indicated an expectation of only $I0 million of additional revenue.(fn7) Yet, the breadth of the legislative language provides no indication that the intent is to so limit its application. At the time of this writing, the Department has not indicated how it will interpret this "economic nexus" provision and is engaged in discussions with practitioners and taxpayer groups in that regard.

      2. Decoupling From Federal Tax Benefits

         Connecticut elected to decouple from the federal deferral of cancellation of debt income ("CODI") provided under Section I08 of the Internal Revenue Code, as amended by the American Recovery and Reinvestment Act of 2009.(fn8) As a result, any amounts that would have been deferred by a corporation or individual under the federal tax regime must be included in Connecticut adjusted gross income in the taxable year during which the debt is discharged. The legislation also decoupled the corporate and personal income taxes from the federal deduction for qualified domestic production activities.(fn9)

      3. Corporation Business Tax

         The Budget Act imposes a 10% corporation tax surcharge for tax years beginning in 2009, 2010, and 2011.(fn10) While substantial, this represents a significant reduction from the 25% surcharge that was part of the Vetoed Budget. The 10% surcharge is not applicable to companies with annual gross income of less than $100 million or those subject only to the $250 minimum tax. The surcharge is imposed on the net income or capital base tax before credits.

         Effective for tax years beginning January 1, 2012, the General Assembly created a Green Buildings Tax Credit for allowable costs associated with the construction or renovation of qualifying green buildings.(fn11) A project qualifies for this new credit when energy use does not exceed 70% of the energy use permitted by the state building code for new construction (80% for renovation or rehabilitation of an existing building), and the project uses equipment and appliances meeting Energy Star Standards. The amount of the Green Buildings Tax Credit, the base amount of which ranges from 5% to 10.5%, varies depending upon the type of construction and the level of LEED(fn12) certification for such project.(fn13) An additional increment of 0.5% may be added to the base credit for projects that (i) are mixed-use developments with at least 25% of the internal square footage being used for residential use, (ii) are located in a brownfield or enterprise zone, (iii) do not require a sewer extension of more than one-eighth of a mile, or (iv) are located within close proximity to public transportation.(fn14)

         As part of the initial application, the taxpayer must submit an eligibility certificate from a LEED, or equivalent, accredited architect or engineer. The company may not claim more than 25% of the credit in any year, with the remaining credit eligible to be carried forward for a period of not more than five years. The statute declares that credits are fully transferrable and assignable and refers specifically to transfers by an owner to a "pass through partner." An aggregate of $25 million in Green Buildings Tax Credits are available to be issued by the Secretary of the Office of Policy and Management.

         The Budget Act also doubled to $500,000 the maximum preference tax for entities filing a combined corporation tax return form.(fn15) This increase became effective on September 8, 2009 and applies to income tax years commencing January 1, 2009.

         The Film Production Tax Credit, Digital Animation Production Tax Credit, and the Infrastructure Projects in the Entertainment Industry Tax Credit all underwent a number of changes in 2009. With respect to the both the Film Production and Digital Animation Production credits, the definition of "production expenses or costs" was amended to increase the cap for aggregate compensation for star talent to $20 mil-lion.(fn16) At the same time, the legislation disallows as production expenses any amounts related to the requirement of an independent certification.(fn17) The Budget Act also amended the rate of credit applicable to both the Film Production and Digital Animation Production credits by introducing a multi-tier rate based on new aggregate amounts of eligible production expenses or costs.(fn18) Effective for income years beginning on or after January 1, 2010, a 10% credit is available for expenditures between $100,000 and $500,000; a 15% credit is available for expenditures over $500,000 and up to $1,000,000; and a 30% credit is available for expenditures in excess of $1,000,000.(fn19) A new requirement is that qualification for the Film Production credit is contingent upon the taxpayer's spending either at least half of the photography days within Connecticut or half of the postproduction costs within the state.(fn20) Finally, with respect to the Infrastructure Projects credit, the Budget Act eliminated the existing tiered...