Of Note Nevada

A Tax By Any Other Name . . .

Over the weekend, the Reno Gazette-Journal ran an editorial suggesting that it's time for Nevadans to consider a corporate "margins" tax.  The Las Vegas Sun wrote that a coalition has formed to push for a margins tax via an initiative petition.  Unsuccessful legislation to enact a margin tax was considered by the Nevada Legislature in the first half of 2011, and was modeled on a similar tax enacted in Texas in 2006.

The Texas Constitution is similar to the Nevada Constitution in that both prohibit an income tax on individuals.  Members of a limited partnership in Texas recently filed a lawsuit alleging that the margins tax violates the Texas Constitution because it is (1) a thinly disguised income tax and (2) the individual income of each partner is their share of partnership profits which is being taxed.  (As a side note, the Texas margins tax has come in well under projections, and continues to cause political headaches for Texas politicians - read more here).

Many Nevadans similarly derive their individual income via a business entity such as a limited partnership, LLC or a pass-through corporation, meaning their individual incomes could well be within the scope of a margins tax - and also meaning the implementation of a margins tax to their income would raise constitutional issues. 

It's Not Only State Revenues That Have Declined . . .

As the Governor and Nevada Legislature prepare to enact a budget for the next two years, speculation has been rampant that the state will look to local governments to make up a large part of the deficit.  Local government revenues have historically (at least in the past few decades) been relatively stable, as they are premised in large part on property taxes. 

However, the ongoing recession has significantly impacted both commercial and residential property values, and although assessments traditionally lag behind market shifts, the decline in values is starting to show up.  In Washoe County, taxable values dropped 8 percent.  In Clark County, taxable values dropped significantly more.  The Clark County Assessor notes that last year, the County received $500 million less in tax revenue due to declining property values.  These drops are significant and, in some instances, may translate directly into less local government revenue at the same time the state is considering taking a larger part of county revenues.  (I say "may" translate because some properties, particularly those properties that remain overvalued still have not seen the property tax cap catch up with artificially inflated taxable values, so even a decrease in taxable value can result in an increased tax bill - a subject much too lengthy for this blog entry). 

 Despite the sizable decreases in taxable value, there is still a high likelihood that both commercial and residential properties are overvalued by the county assessor.  By law, taxable value cannot exceed market value.  The tricky part is defining market value.  The methodology used by an assessor to calculate taxable value tends to rely on outdated sales data while discounting relevant market value data as well as discounting economic obsolescence, resulting in a taxable value that often exceeds market value.

The question remains as to how many property owners will appeal their valuations and the level of success they will achieve.  The deadline to appeal property tax valuations is January 18, 2011.  Once the various appeals are resolved, we'll have a better picture about how much revenue local governments can count on from property taxes in the coming fiscal year - and how those tax savings (or decreases in revenue from a government perspective) will play out in the legislative session.

 

 

Now What?

As all remain hopeful that the recent special session will keep the state budget in the black through the biennium, the looming problem of a budget deficit that could reach $3 billion (around 50% of the general fund ) in the next biennium inches closer.  Anjeanette Damon wrote a comprehensive overview of the situation here.

The stimulus crutch will be gone, and most of the temporary tax increases from the 2009 session are set to expire.  The fiscal problem facing the state is severe and the solutions that come out of the 2011 session will surely reverberate for years.  Going into an election year, candidates are loathe to discuss specific ways to solve the problem, as nearly all solutions will be difficult and unpopular.  Other states have enacted a variety of solutions, including tax increases and spending reductions, to solve their budget problems. 

But the sheer magnitude of the upcoming deficit in Nevada means even a combination solution will require dramatic action on both the spending and revenue fronts.  Consider that the two largest tax increases in Nevada history occurred in the past decade, each being around $1 billion.  Another tax increase of that size would only go to about 1/3rd of the budget deficit.  Consider also that the SAGE Commission recommendations are estimated to be $2 billion.  And given that much of the SAGE recommendations are long-term savings, even implementing every recommendation in the next biennium (which is impossible anyway) will not solve the budget shortfall.

With respect to existing revenues, the state is projecting general fund revenues of approximately $2.7 billion for the 2011-2013 biennium.  In terms of actual dollars, that equates to revenues received in the 1995-1997 biennium.  In terms of dollars adjusted for inflation, it's equivalent to revenues received in the 1989-1991 biennium.  (Information courtesy of the Nevada Department of Administration).

In hopes of an economic turnaround, the state has swept nearly every reserve fund possible in forestall further cuts to operating expenses.  While this action has allowed the state to keep it's budget balanced for the current biennium, it leaves a significant funding cliff for 2011-2013.  The budget decisions that seemed so contentious and difficult in 2009 and 2010 will likely seem easy compared to what is to come in 2011.

The Internet Tax

The Governor's callfor the recent special session asked that the Legislature consider extending the use tax to online vendors.  The Legislature did not take action on this issue. 

Currently, online vendors without a nexus in Nevada are not required to remit sales or use taxes to Nevada and consequently the purchasers of goods from those vendors do not pay the tax either.

The use tax in Nevada is commonly misunderstood in its application.  The use tax is a compliment to the sales tax.  The sales tax is due when tangible goods are sold in Nevada and is paid by the customer to the retailer who in turn pays the state.  However, when tangible goods are sold from outside of Nevada (and in some other circumstances), such as in an online transaction, the retailer has no legal obligation to pay the state and therefore does not require payment from the customer.  But that does not mean the tax is not owed.  In those situations, the customer directly owes the state the use tax on those goods.  However, because the use tax in this situation is only collected if self-reported by customers, and because enforcement is effectively impossible, many use taxes go unreported and uncollected.  Moreover, many Nevadans are simply unaware that they even owe the state a tax in these situations.

Under the interstate commerce clause of the United States Constitution, states have generally been prohibited from taxing out of state vendors without a nexus in the state.  However, with the recent budget shortfalls across the country states have been more aggressive about trying find ways around that prohibition and to impose use taxes on out of state vendors.  In several states, rather than litigate against such rules, online vendors have simply terminated relationships with in-state affiliates, which has the negative effect of shutting down business for those affiliates.  The vendors thereby eliminate any potential nexus with the state and are able to avoid taxation under the interstate commerce clause.   

Some legislators in Colorado are trying a new tactic.  Instead of requiring online vendors to collect and pay the tax, the proposed legislation would require online vendors to turn over a list of customers and purchases to the state taxing authority, and to provide those customers with a tax invoice showing what they owe on their purchases.  Presumably, the taxing authority would then proceed to collect directly from those customers or alternatively, the online vendor would instead collect and pay the tax as a matter of convenience to its customers.  If that legislation proceeds, it could become a model used by other states looking to shore up declining sales and use tax revenues.  But, the streamlined sales and use tax act under consideration by Congress could accomplish the same result, and in a much cleaner and more uniform manner.  It will be interesting to see if the Colorado legislation gains any steam as Colorado's legislative session goes on. 

Tax Amnesty

The recent legislative special session resulted in some good news for Nevada taxpayers in the form of a tax amnesty program to be implemented this summer.  Details are below:

Nevada Taxpayers Receive Relief from Penalties and Interest on Outstanding Taxes

On March 12, 2010, the Governor of Nevada signed Assembly Bill 6. One section of the bill enacts a new tax amnesty program in Nevada, allowing for the waiver of all penalties and interest on certain outstanding Nevada tax liabilities in exchange for full payment of the tax due. Applications for amnesty will be accepted from July 1, 2010 to October 1, 2010.

The Nevada Department of Taxation has not yet declared what tax liabilities will be covered by the amnesty program. However, it appears that the covered taxes will likely include:

• sales and use taxes;
• modified business taxes (i.e. the payroll tax);
• certain aviation and motor vehicle fuel taxes;
• net proceeds of minerals taxes (i.e. the mining tax, which also applies to geothermal projects);
• the financial institutions tax;
• certain live entertainment taxes;
• liquor and tobacco taxes;
• estate taxes;
• generation skipping transfer taxes;
• city-county relief taxes;
• certain taxes for special purposes; and
• certain infrastructure support taxes.

This tax amnesty program will be broader in scope than a prior amnesty program implemented in 2008. The 2008 amnesty program covered only sales and use taxes, modified business taxes, city-county relief taxes, certain special purposes taxes and certain infrastructure support taxes.

The amnesty program will apply to any business or individual owing the covered taxes in Nevada, regardless of whether that business or individual is still doing business in Nevada. The program applies to any covered taxes that were due and payable before July 1, 2010.

Certain restrictions apply to taxpayers who have already entered into settlement agreements or offers in compromise with the Nevada Department of Taxation.

This document is intended to provide you with general information about issues related to Nevada Assembly Bill 6. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorney listed below or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions.

Joshua J. Hicks jhicks@bhfs.com T 775.850.5851

Reno Office 9190 Double Diamond Parkway Suite 128 Reno, NV 89521-4842 T 775.850.5850

The Fiscal Crystal Ball

Yesterday I attended the annual Nevada Taxpayers Association luncheon in Las Vegas.  The keynote speaker was renowned economic forecaster Dr. John Silva of Wells Fargo.  Other panelists included Jeremy Aguerro from Applied Analysis, Bill Anderson from the Nevada Department of Employment, Training and Rehabilitation, Kevin McCarthy of the Arizona Taxpayers Association, David Kline of the California Taxpayers Association and Dale Craymer of the Texas Taxpayers and Research Association.

Dr. Silva pained a fairly optimistic economic picture for Nevada, opining that while Nevada remains in a recession and will likely be in one for at least another year, signs of recovery are present and Nevada could come out of the recession in a good position "as long as it doesn't do something stupid."  Dr. Silva noted that both California and Oregon have become increasingly unfriendly to businesses, leading many of those businesses to look more for more friendly tax climates.  Nevada, with no personal or business income taxes, is primed to capture many of those fleeing businesses. 

Mr. Aguero noted that Nevada's heavy reliance on sales and gaming taxes is increasingly difficult for budget planning purposes as per capita revenues from each tax continue to decline year after year.  Mr. Aguero also noted, however, that there is "great danger" in changing a tax structure at the bottom of an economic recession.  Mr. Aguero also discussed how uncertainty over water rights applications in Nevada (as the result of a recent court decision) can have detrimental economic impacts as investors worry about the existence and availability of water for Las Vegas in the future.

Mr. Anderson noted the looming problem of repaying federal loans taken in Nevada (and many other states) in order to pay unanticipated and expensive unemployment insurance claims.  Nevada had a healthy reserve fund for such claims, but once unemployment reached 13% the level of claims outgrew the reserve.

And to show that Nevada is not alone in the current recession, representatives from California, Arizona and Texas all spoke to the budget challenges facing those states.  California's representative noted California is 6 billion (with a b) short on its budget just since June of 2009.  Arizona's general fund revenues have declined a staggering 35% since 2007.  And Texas faces similar problems and budget gimmickry to make ends meet.  A common theme emerged from all representatives - their government has continued to put off difficult decisions in hopes that the recession will end soon and the economic climate will improve, while using stimulus funds as a crutch to minimize impacts to operational expenses.

The State of the State

Today the Governor announced he will call a special session beginning February 23 to address a projected budget shortfall of almost $900 million.  The Governor has yet to issue his official proclamation calling the session, where the agenda for the session will be spelled out.

In his speech, the Governor pointed out the continuing economic woes plaguing Nevada and blamed the Legislature for raising taxes and failing to enact stiffer budget cuts in 2009.  The Governor took potshots at Senator Harry Reid as well, noting that Nevada came in 50th in per-capita stimulus funding.  Just about all that was missing from the critique was a challenge to settle things out behind the bleachers after school.

As for specific budget solutions, neither the Governor nor the Democratic response provided exact details on how to come up with $900 million.  The Governor spoke of reducing state salaries, closing the aging Nevada State Prison, laying off hundreds of state employees, reducing health care levels, and reducing spending for both K-12 and higher education.  The Governor reiterated his vow to not raise taxes, and said he would not look to county or municipal revenue coffers.  The Democratic response from Senator Steven Horsford noted the already severe cuts in state services and disagreed in principle with the Governor's recommended budget cuts.  While Senator Horsford said there is no appetite to raise taxes in a special session, he was very straightforward that tax reform would be on the table in 2011 and that mining and big business would be expected to pay their "fair share."  Senator Horsford also said the state must do a better job of collecting unpaid taxes which seemed somewhat odd given that just recently the Department of Taxation concluded a successful tax amnesty program that brought in $40 million in unpaid taxes without costing the state anything.

What was very apparent in the speech and response was the lack of an agreement between the Legislature and the Governor on how to fix the budget shortfall.  Recent media reports claimed there had been good cooperation and communication between the Governor and the Legislature but that cooperation and communication will certainly be strained by the Governor's aggressive comments about the Legislature.  Leaving the solutions for a budget deficit unresolved also threatens to result in a lengthy and contentious special session. 

As dire as the situation appears now, it will only grow worse in the next biennium when the budget shortfall could reach 50%.  Coupled with the loss of many experienced legislators to term-limits, the 2011 session may well be one of the most challenging sessions in our state's history.  In the current biennium, the challenge for the Governor and Legislature has been to maintain the existing state government.  In the 2011 session, they will have to redefine how that same government functions in the 21st century.

The Coal Case and the Impact on the Budget

In a post on December 30, 2009 I noted that the budget deficit could increase due to some pending tax refund cases, one of which deals with the taxability of coal burned in power plants in Nevada.  This particular case began in 2002 when Southern California Edison (Edison) requested a refund for use taxes paid on coal burned in its Southern Nevada power plant.  Edison argued that because coal could be subject to Nevada's net proceeds of minerals tax it would be unconstitutional to also subject it to Nevada's use tax.  The coal at issue was mined in Arizona, mixed with water to form a coal slurry, and piped into Nevada where the water was removed and the pulverized coal powder was burned in Edison's power plant.

The Nevada Department of Taxation denied the refund claim and a hearing officer upheld the denial.  The case was appealed to the Nevada Tax Commission.  The Commission reversed the decision of the hearing officer and ordered a refund.  Thereafter, the Nevada Attorney General filed an open meeting law complaint, alleging that the Commission reached its decision in violation of Nevada's open meeting law.  That complaint went up to the Nevada Supreme Court, who agreed with the Attorney General and voided the Commission's decision to grant a refund.  

The case was remanded to the Commission for further deliberation in compliance with the open meeting law.  On February 27, 2009, the Commission changed course and voted to deny the refund.  The Commission held that because coal is not mined in Nevada and because Edison was therefore not subject to Nevada's net proceeds of minerals tax on the coal, it was appropriate to subject Edison to the use tax.  The Commission also held that Edison's refund request was time-barred and that Edison was not entitled to any offset for taxes paid in Arizona.  Edison appealed the Commission's decision to the courts, where the case is currently pending. 

The refund case caught the attention of the Nevada Legislature, who created a supplemental account in the state's rainy day fund with over $30 million in the event a refund was ordered.  However, that supplemental account was drained (along with the rest of the rainy day fund) in a 2008 special session to plug holes in the state budget, leaving no contingency plan for a refund should Edison prevail in the courts. 

The financial impact of a potential refund would be significant as interest on refunds accrues at 6% per year, and would run for over 10 years as the initial refund period claimed by Edison began in early 1998.  Moreover, Edison is not the only power company to import and burn coal in Nevada, and other power producers are surely watching this case closely to determine whether further refunds may be justified.

Baptism by Fire

The Associated Press ran a story yesterday called "Rookies will be  big factor in 2011 Legislature."  The article notes that newcomers will hold at least 17 of the 42 spots in the Assembly, and at least 8 of the 21 spots in the Senate (with some allowances for legislators who avoid term limits and remain in the Legislature by swapping houses).  The story notes that the 2011 Legislature will be confronted with at least two enormous challenges:  the growing gap between government expenses and revenues; and reapportionment of Nevada's legislative districts. 

The challenges in tackling those issues will be exacerbated by several factors.  The last year saw the retirement of the two most senior fiscal analysts at the Legislative Counsel Bureau (although their replacements are experienced veterans in their own right).  The amount Nevada spends on Medicaid continues to climb as unemployment remains high.  The unemployment insurance trust fund is depleted and the state is borrowing money from the federal government to cover unemployment benefits.  On top of that, there are some major tax refund cases pending dealing with complimentary casino meals and the taxability of coal, both of which could further upset the already tenuous budget outlook.  Furthermore, the largest counties in the state are beginning to experience significant downturns in revenue as property tax assessments decline in response to foreclosures and falling home values, which could trigger additional state expenses in order to hold education harmless by maintaining basic school support levels.

These challenges may leave many of the rookie legislators wondering just what they got themselves into come February 2011 when the Legislature convenes for its 120 day biennial session.  Of course, while the challenges will be daunting, there will also be plentiful opportunities for positive and imaginative reform.