United States: Highlights Of Tax Changes In The 2011-2013 CT Budget Bill

Introduction

Governor Malloy signed the much-discussed Connecticut (CT) biennial budget bill, now known as Public Act 11-6, on May 4, 2011.  The Act contains numerous tax changes.  We are highlighting the changes that affect the broadest cross section of our clients, though there are additional changes not covered herein.  In addition, there are other tax proposals in various phases of consideration.  The success or failure of obtaining a cost-cutting agreement with state employees could affect the need for additional revenue to balance the budget.  The legislature is in session until June 8, 2011 so more tax changes could still be enacted. 

As always, our tax professionals are available to discuss the impact of any of these provisions with you.

Personal income tax

The most impactful personal income tax provision is the one increasing marginal tax rates on most taxpayers, effective for all of 2011.  Another change is to reduce the maximum property tax credit from $500 to $300. 

Currently, there are three tax brackets (3%, 5% and 6.5%).  First, the legislation adds 5.5% and 6.7% brackets.  Most levels of income will be subject to higher marginal rates.  Second, the benefit of the 3% bracket will be phased out at certain income levels.  Former 3% income will be taxed at 5%.  Finally, there will be a "recapture" of the benefits of the lower brackets.  Joint filers with CT AGI of $700,000 or more will pay a flat 6.7% tax on all of their income [previously, they would have paid 3% on the first $20,000; 5% on their next $680,000.]  At CT AGI levels between $400,000 and $700,000, the recapture provision operates to eliminate $150 of lower bracket benefits for every $10,000 of CT AGI.  The recapture would result in additional tax of $4,500 for such joint filers.  The joint filer with $700,000 of CT AGI will pay an extra $12,300 (more than a 35% increase) in tax as a result of the three changes. 

New withholding tables will be issued as soon as possible.  Also, taxpayers who make estimated tax installments may need to adjust their September 2011 installments to reflect the bill's changes. 

Sales and Use Taxes

Increase in the sales and use tax rates

All rate changes take effect July 1, 2011.  The general sales tax rate will increase to 6.35%.  The room occupancy tax will increase to 15%.  For rentals or leases of motor vehicles of 30 days or less, the rate will go to 9.35%.  Finally, so-called "luxury items" will be taxed at 7% on their entire selling prices. Many motor vehicles selling for over $50,000 (with exceptions carved out for nonresident military vehicles weighing over 12,500 lbs. and certain commercial vehicles) will be included, as will jewelry sold for more than $5,000, vessels over $100,000 and clothing or footwear, and various accessories, any of which sell for over $1,000 each.

New taxable services

The following services will be taxable in CT for services rendered on or after July 1, 2011:

• Motor vehicle storage services.
• Packing and crating services.
• Motor vehicle towing and "road" services.
• Intrastate transportation services.
• Pet grooming, obedience and boarding services.
• Cosmetic medical services.
• Manicure, pedicure and other nail services.
• Spa services, including body waxing and wraps, peels, scrubs and facials.

Exemptions eliminated

The following sales and use tax exemptions are eliminated, effective for sales or services rendered on or after July 1, 2011:

• Yoga instruction services at yoga studios.
• Voluntary evaluation, prevention, treatment, containment or removal of hazardous wastes services.
• Airport valet parking services.
• Non-prescription medicines.
• Clothing and footwear under $50.
• Property or services used in operating solid waste-to-energy facilities.
• Smoking cessation products.
• Cloth or fabric for noncommercial sewing.

Click-Thru Nexus ("Amazon Law")

This is one of the more talked about provisions in the Act.  The legislature's hope is to raise revenue by requiring remote retailers, like Amazon.com, to collect CT sales taxes as a remedy for the massive noncompliance in the consumer use tax realm. 

Here is the premise:  retailers lacking a physical presence in CT ("nexus" is the technical term) are not required to collect sales or use tax from CT residents.  So-called "Main Street" or "bricks and mortar" retailers (those with, e.g., a CT store) are required to collect CT sales tax.  Their legitimate complaint is that there is not a level playing field with the remote retailers who, if not collecting sales or use tax, can effectively sell their products for less.  While CT consumers are required to remit compensatory use taxes with their CT individual income tax returns, compliance is poor.  Therefore, the CT legislators are looking for ways to level the playing field for their CT retailers.  Thus, we have the "Amazon Law."

Under the new law, if Amazon (or similarly situated retailers, but we'll stick with Amazon to illustrate) puts a link on the website of a retailer with CT nexus (called an "affiliate" even though this is their only affiliation with Amazon) and that retailer receives commissions from Amazon as the result of sales made by Amazon via that click-through, Amazon will have CT nexus. 

New York started this process in court several years ago and, although the New York court battle is still unresolved, other states have been copying them, and CT is now one of them.  But, here is the problem:  Amazon simply removes their links from retailers in states that enact this law.  This ends up hurting the local "affiliate" businesses.  That's not just a threat; Amazon has already done this in other states and may have already done it with CT "affiliates."  With that, and the unresolved litigation in New York, it is highly unclear whether CT will reap any significant benefits from this law.

Corporation Business Tax

The nominal corporation business tax rate is 7.5%, applicable to "C corporations" only.  For tax years beginning 2011, there is a 10% surcharge added to the tax before subtracting credits, making the effective rate 8.25%.  The tax act extends the concept of the surcharge for two more years but also makes it 20%, yielding an effective tax rate of 9% for tax years beginning in 2012 and 2013. 
C corporations paying the $250 minimum tax are not subject to the surcharge nor are taxpayers with less than $100 million of gross income—unless such taxpayers file a combined or unitary tax return. 

The other significant corporation tax change is how credits are limited.  Most taxpayers are limited in their use of tax credits to 70% of the pre-credit tax.  As an incentive to "add CT jobs," for tax years beginning in 2011 and 2012, corporate taxpayers can increase their credit limit by $6,000 times its average net monthly increase in 35 hour/week employees, potentially reaching a limit of 100% of the pre-credit tax.  Any such new employees will not be counted if they were employed by a "related person" in the previous twelve months. 

Estate and Gift Taxes

The taxable estate and gift tax thresholds (the nontaxable allowance of estates or gifts) will be lowered for decedents dying and gifts made on or after January 1, 2011.  The estate tax threshold is reduced from $3.5 million to $2 million.  The existing minimum 7.2% tax rate will be extended to estates of
$2 million or more.  The rest of the higher tax rates for estates over $3.5 million will apply to the same tax brackets as before.  Gift taxes will follow similar rate schedules.

With respect to CT taxable gifts, a donor must aggregate all gifts made on or after January 1, 2005 (including 2011 and subsequent years), calculate tax on the aggregate amount using the new estate and gift tax thresholds and then subtract the CT taxes paid on gifts made in prior years beginning in 2005. 

Real Estate Conveyance Tax

The state rate will increase by 0.25% for conveyances of real estate on or after July 1, 2011.  Nonresidential property (other than unimproved land) and residential sales over $800,000 will be taxed at 1.25% while, the first $800,000 of a sale of residential property and any sale of unimproved land will now be taxed at 0.75%.  The municipal rate, which had long been 0.11% and which had been temporarily increased to 0.25% through July 1, 2011, will become permanent.  Some targeted municipalities will also have the right to increase their rate to 0.5%.  It is anticipated that many will do so.  Thus, combined rates could become as high as 1.75% [the 1.25% maximum state rate plus the maximum (potential) local rate of 0.50%].

Other Taxes

• A tax of ¼ of one cent per kilowatt hour of electricity generated will be imposed from
  July 1, 2011 through June 30, 2013.
   
• Admissions tax exemptions will be eliminated beginning January 1, 2012 for a whole host of venues and facilities that had been exempted (stadiums, arenas, etc.).  

Other tax proposals still under consideration

• SB 1214 would make significant revisions to the rules requiring nonresident contractor bonding or withholding.  Such changes would be in the nature simplifying the rules.  The Department of Revenue Services (DRS) worked with the business community to develop these proposed changes and DRS supports the bill's passage.  The Connecticut Business and Industry Association (CBIA), while also supporting the bill, has made comments which we are hoping get incorporated into a final bill. 
   
• SB 127 would extend the neighborhood assistance credit, presently only available to
  C corporations, to the business entity tax paid by pass-through entities.  There are groups lobbying to extend the proposal to make pass-through entities eligible to pass the credits through to its owners. 

If these or any other tax proposals pass in their present or amended forms, we will inform you. 

Conclusion

The 2011 tax changes are many and significant in their impact, both in terms of the number of taxpayers affected and also the magnitude of the impact.  The highlights outlined above are intended to only alert you of the changes without detailing all the specifics.  If you would like more detailed, specific information on any of the provisions of Public Act 11-6, please contact one of our tax professionals and we would be pleased to assist you.

Doug Joseph, is a Tax Partner and partner-in-charge of the firm's state and local tax consulting practice for BlumShapiro, the largest regional accounting, tax and business consulting firm based in New England with offices in West Hartford and Shelton, Connecticut and Rockland, Massachusetts. The firm serves as business advisors for today's leading middle-market companies, non-profit organizations and government entities, working to strategically tailor and consistently deliver tested solutions for unlocking an organization's full potential. For more information about BlumShapiro, visit blumshapiro.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.