State and Local Tax Considerations for the Banking Industry

Nick Smetana: Hi everyone. Welcome to issues of interest, BNN’s podcast for the banking and financial services industry. I’m Nick Smetana, tax manager at Baker Newman Noyes, specializing in state and local tax. And today I’m sitting down with Leanne Scott, State and Local Tax Principal at BNN.

Hi Leanne.

Leanne Scott: Hi Nick. And hello to our listeners. Thank you for joining.

Nick Smetana: So, as we are aware, banks and other financial institutions are subject to very specific tax regimes on the income tax side.

But today we’re going to talk about sales and use tax matters for the banking and broader financial institutions industry. Before we get into that, can you remind our listeners of your role at BNN?

Leanne Scott: Sure. I lead our state and local, or SALT as we call it, practice here at the firm. This involves working with all types of clients in all industries on various tax types across the country.

I’m based in Boston, but I work with issues all around the country and all the states and often team up with our financial institutions practice on issues in this area.

Prior to joining BNN, I worked in a state tax role for an insurance company, so we definitely have some familiarity with the industry.

I’m excited to be back on the podcast today and I think we have some really interesting things to cover.

Nick Smetana: To get us started, one thing that we’ve discussed before is that unlike a lot of our client base, these tax types are not a big area of focus for most in this industry.

Why would you say that?

Leanne Scott: Sure, a lot of times it’s because, as you mentioned, there’s specific rules in this area for income tax. That’s where most of the focus is, I think for banks and other financial institutions because most of them are not selling tangible personal property or software.

They usually don’t think about collecting and remitting sales tax, which is normally where this comes up in more traditional, say sellers of tangible personal property. This is because most states impose their tax on sales of TPP and also potentially software or certain specified or so called enumerated services, but not on the types of services that banks provide.

Why does that matter? As I mentioned, it’s just really has to do with the tax base and the fact that only a few states might tax things a bit more broadly.

None of those are in our neck of the woods. So you really don’t see sales tax a lot here in terms of financial institutions because none of them are really obligated to charge it for their day to day business.

Nick Smetana: And I do want to say for our listeners, just at a fundamental level, service providers such as banks are generally required to pay sales tax on any applicable inputs that they use to provide your services.

So whereas the service itself might not be taxable broadly, as you mentioned, Leanne, any taxable goods or services that the bank purchases for its operations or to provide its services would be subject to sales or use tax.

And I think that’s kind of where we’re going with a lot of our conversation today is really talking about some of the purchases that a bank might make and how they might need to assess use tax on those.

Leanne Scott: Great point. Yeah, that’s a really good one. People often refer to this area as sales and use tax. If you’ve come near it at all, you’ve probably heard that phrase. So I think that’s a really important distinction to draw.

So maybe Nick, you could talk a little bit about what is the difference between a sales tax and a use tax, both in terms of general use or how states might use the term.

Nick Smetana: Certainly, I think we could spend all day talking about this. But really, sales and use tax can be considered different sides of the same coin. Meaning very basically, if a seller did not include sales tax on a taxable transaction, the buyer is generally required to assess and remit use tax on that transaction.

You know, there’s some nuances and exceptions to that which we can get into later, but that’s a general concept. Fundamentally, sales tax is considered a trust tax, whereby the seller will collect the tax from the buyer at the time of the sale and remit it to the taxing authority.

And at the same time, the states generally hold both the seller and the buyer jointly liable for the tax, although the tax needs only to be remitted once. So that’s a concept that listeners should keep in mind just because you might be the seller or you might be the buyer in a particular transaction, but just understand that the taxing authority has the right and the ability to come after either of you for the tax.

So just something to keep in mind, from an administrative perspective, it’s certainly easier. I think we’d all say it’s easier to require a seller to collect sales tax than try to make sure that each and every purchaser remits use tax.

Leanne Scott: Definitely.

Nick Smetana: And states have recognized this and broadly responded to the US Supreme Court’s ruling in the Wayfair case back in 2018 to roll out sales and use tax collection requirements for remote sellers based on the concept of an economic nexus determination.

So because of the state responses to that, we’ve seen fewer use tax implications since 2018.

Yet there’s still areas of concern as we’re discussing today.

Leanne Scott: Yeah. And that’s because more companies are collecting sales tax. So. Yeah. Less for people to think about self-assessing on. But I would say self-assessing is definitely one of the biggest questions we get from banks.

So. Yeah. So Nick, how many, how many states have a sales and use tax?

Nick Smetana: Right. So, I think if we’re speaking to our clients, most of our banking client base is generally located in the Northeast, New England and it extends into the Mid-Atlantic region. And obviously all the states up in New England in the Northeast have a sales tax, except for New Hampshire, a general sales tax, that is.

And understand that 45 states across the country do have a sales tax. So, to the extent that operations extend or revenues extend out into across the U.S. that’s something to be considered by banks and financial institutions across the country.

One thing I do want to mention just about that is really the idea that banks and financial institutions should more and more be contemplating, “Where are we using this product or service or software that we’re buying?”

Right. Typically, when a seller going to look at the headquarters, location of that bank or that customer and invoice them for sales tax based on where that customer’s headquarters are, location, or where they’re sending the bill.

Right. Makes sense. But what we want to talk about here is really just as a bank, as a financial institution that might be purchasing something to really think about where you’re using that product or service, the onus is really on the buyer to push back on the seller.

Let’s think hypothetically. If you’re a regional bank in New England, maybe you’re headquartered in Massachusetts, but you’ve got a few branches in New Hampshire and maybe in Maine, and you’re purchasing a piece of software from a vendor that might be based somewhere outside of the region, not familiar with New England’s tax rules, or might not have nexus or an obligation to collect tax in your state in any of those New England states, or even they may be a vendor from outside the US who still has an obligation to collect tax if they have nexus.

And so, you may look and say, all right, well, we’re using this piece of software 100% in all of our Massachusetts branches, or maybe we’re only using it 50% in Mass and 50% in New Hampshire.

You know, the onus is really on purchaser, the bank, to push back on their vendor and say, look, please invoice us. We’ve got 20 licenses. We’re using 10 of them in New Hampshire and 10 of them in Massachusetts.

So, to bifurcate that, the taxability, the tax on those services to locations where you’re actually using it. And so, if there’s anything that we want to take away from today’s podcast is to take the time to evaluate and think, where are we using this that we’re buying?

Leanne Scott: Yeah, I think that’s a great point. And banks in general, and I think most financial institutions and companies in this area are conservative bunch in terms of wanting to be in compliance and watching the bottom line and everything.

So this is a really important area to watch in that regard.

Nick Smetana: So fortunately, in New England, as you get down in say New York and Pennsylvania, they have local tax rates, but New England is broadly, broadly has a single tax rate at the state level without local taxes, with the exception being Vermont, that has the local option tax there.

So not only do you need to contemplate where on the state level you’re using something, but also potentially in the instance of Vermont and then Pennsylvania, New York on the local level, making sure that you’re evaluating where you might be using something at the local level.

Leanne Scott: Right, yeah.

And all of this, you know, as you mentioned, it’s a trust fund type tax. So, for those who are listening who are not familiar with it, I would equate it to the other one in that area is a payroll tax.

Just think of these taxes as they’re the state’s money. You’re collecting it on their behalf. That’s why it often comes up. Any audits and questions in this area can be a lot.

You want to try to get it right the first time to avoid that down the road and having to pay more in terms of interest and penalties and everything else.

Nick Smetana: So, Leanne, I’ll throw this one back to you. We’re speaking somewhat generally now, but specifically with regard to banks, what are some areas that banks might need to pay attention to in this for sale and use tax purposes?

Leanne Scott: Yeah, so we’ll highlight a general one again and then give a couple of state specific examples Given our region first. You know, as we’ve mentioned a couple times, the concept of use tax self-assessments.

So that really means having a process in place within your organization usually falls to accounts payable or depending upon how large you are somewhere in your finance function. But to review invoices when they come in, have a general sense of what you might be purchasing that could be subject to tax and if there’s not sales tax showing up on an invoice, and perhaps it should, should have been having a process in place to do what’s called self-assessing use tax and remitting that to the states that it might belong to.

We most often see this with software purchases. A lot of states tax software. Massachusetts is a great example that imposes tax on SAS if used in the state, as Nick alluded to.

But that’s a big area. If you happen to purchase anything else tangible like say office furniture, books or something, if tax was not applied and should have been, that’s something that technically you need to be self-assessing and reporting to the state that obviously to report it would require registering for that tax type and filing and certainly can provide more guidance there as needed.

But that’s probably the biggest thing we see is just needing to have a process in place to evaluate those items as they come in. One item we’ve gotten a lot of questions on in recent months is there was a recent Vermont law change.

So, in the past, I feel like most of our questions were in Massachusetts, given our geography and the aggressive stance that the state takes on a lot of things. But Vermont had a law change in July of 2024 that impacts certain software purchases.

We could do a whole podcast on that. But I would just say if you have users or branches in Vermont, that’s a good one to make sure you’re paying attention to, to make sure you’re adequately complying and also, as Nick said, you don’t want to be overpaying tax either.

Make sure you’re only remitting things on things that were actually used in Vermont. So those are things that we see a lot.

Nick Smetana: I was going to jump in here too, just because you start to think of what types of things might a bank purchase that could be subject to tax. And obviously you think, right, you get your furniture and fixtures and then you’ve got your software.

But in between, just thinking of some of the different types of things that states tax differently, even in, even just in the New England region. So we say services are generally exempt, but there’s a number of services that are taxed.

Collection services, credit check services, advertising services, data processing services, monthly subscriptions to industry information, information services. If you’re purchasing custom reports, those are looking at differently than if you’re purchasing say canned industry reports.

Things like that, loan application software that you might purchase, digital goods, apps, things like that that you might be purchasing and using. All of those are sort of, I would say, more mainstream things that a bank purchases.

But just branching out a little bit. There’s certain services like snow removal, landscaping and lawn care, commercial property cleaning services.

A broad swath of states tax those types of services, personal services like that. And sometimes we think, okay, well these are hyper local service providers. They have to have a handle on the taxability of the services they sell in the immediate region.

But oftentimes those providers are smaller and not sophisticated and might not be aware of the manner in which the states tax their services. So to the extent that your bank procures those types of services to your physical brick and mortar plant facilities, certainly it’s a good idea to spot check those just to see if they’re being taxed appropriately in states that do tax those types of services.

Leanne Scott: Yeah, and I guess a couple other points there, as Nick said. Yeah, every state’s going to be different on that. That’s kind of the standard state and local tax responses depends.

So please don’t take any of that as that those taxes would apply in every state. But it’s always a determination of the rules in that particular state and how they apply.

And then I will say too, I’ve also gotten questions from banks over the years involving build outs or constructions of branches, things they’re buying for their lobby. I know everybody has their own kind of signature style and how they decorate things.

So there may be purchases there that depending upon how you buy them are not being taxed. So I guess the point is yeah, the rules can vary by state and it’s also going to be fact specific depending upon your location.

Nick, I think a couple of things. We’ve talked a little bit about Massachusetts, a little bit about Vermont, but for a lot of our main based clients, is there anything recently we should be alerting people to in terms of changes in that state?

Nick Smetana: Definitely. And I will talk a little bit about software and with some of the changes in Maine, but I’ll step back first and just I do want to talk a little bit about the word software and what that means.

Sometimes people hear software is taxable on state X, software is exempt and statewide, but I want to just give a little context to that and make people aware that when we say quote unquote software, it should be understood that not all software is the same.

States generally view pre written or canned software for intended sale to multiple customers differently than custom built software or custom built portions of pre written software. So if you’re getting sort of a ground up build of say an enterprise level software or bolt ons or configurations of something standard versus something that’s sort of pre written, that’s often looked at differently at the state level.

From there, states differentiate between software delivered on tangible medium such as a disk or a USB drive. We don’t see as much of that anymore versus software that you download and it resides say locally on your computer or your mainframe and then software accessed remotely via the cloud, such as software provided under the SaaS model.

So there’s sort of a couple of different ways to transfer the software, how it has to get to you. And unsurprisingly states view those differently and tax those differently. So it’s really not a matter of saying software is taxable, it’s software in X, Y and Z formats are taxable or exempt.

So keep that in mind as you evaluate. I’m just circling back on what Leanne mentioned earlier. Massachusetts taxes all types of prewritten software in all formats, but similar. Vermont’s law that just recently passed in 2024 taxes all types of prewritten software, but doesn’t tax custom software right and certain software related services.

So, to recap, Maine rolled out a new piece of legislation with an effective date of 11/25. At a high level, this relates to a complete overhaul to the manner in which Maine treats leases or rentals of tangible personal property, not real property.

This has no impact on real property. But until now, lessors would pay sales tax in Maine when purchasing tangible personal property for subsequent lease and the recurring lease stream would be exempt from tax.

This treatment was unique. It made Maine an outlier compared to most other states across the country. So that was a little tough to deal with being an outlier. This change really brings Maine into alignment with certainly the states of New England and most of the states across the country, meaning that lessors, when they purchase the property, it’s under a resale certificate and exempt from tax.

But then it must charge sales tax on the lease stream, assuming another exemption does not apply. So, how’s this relevant for banks? Certainly, it applies to what we might consider as traditional tangible personal property, business equipment, computers, furniture and fixtures, et cetera.

But it also applies to prewritten software delivered or downloaded electronically.

Again, for banks here, the impact to this legislative change is really probably on the lessee side, where, you know, banks may be leasing equipment or licensing downloaded software and start to see sales tax now be included on invoices.

On the other side of the coin, banks or financial institutions with leasing arms will need to be charging Maine sales tax on lease streams of tangible personal property used in Maine, again, unless an exemption applies.

This brings up a critical point of planning and diligence that should not be ignored. Banks with operations in Maine should be carefully evaluating whether they might be using particular pieces of software or other rented property in Maine or outside of ME.

One of the things that we’ve encountered is banks with offsite backup servers in, say, New Hampshire, for instance.

In a situation like that, banks would want to look internally and review records and determine where that software is actually being used and confirm that vendors are appropriately citising any on premise or downloaded software at the place of use, potentially being outside of Maine or even in New Hampshire where there’s no sales tax to avoid incorrectly paying sales tax in Maine.

All this being said, this is an evolving area and we can certainly assist with discussions around internal best practices and compliance as banks look to adapt to this legislative change.

Leanne Scott: Thanks for that. We think we’re out of time for today. But before we close out, is there anything you want to touch on in terms of gross receipts taxes? That’s kind of a different bucket than we’ve talked about before, which was income tax and sales tax.

We always just like to kind of mention that the other kind of tax as well, that we see a lot with financial institutions and really all of our clients.

Nick Smetana: Yeah, I’m glad you mentioned that, Leanne. I do want to talk about those gross receipts taxes because they can sneak up on banks and financial institutions that might just be focused on the areas where they have a physical or brick and mortar location.

If you’re, say, based regionally in the Northeast and you’re not really dialed into a gross receipts tax. And typically, gross receipts taxes are not a compliance obligation that are handled as part of an income tax engagement.

If you have an income tax provider, they may not inform you of your gross receipts tax obligations because those are typically handled by the entity themselves and not your tax provider.

So oftentimes that can sneak up on businesses, including banks and financial institutions that might not be aware of those obligations. Gross receipt taxes are unique in that they are a tax upon a seller or provider, but are not passed along directly to the customer like a traditional sales tax.

The Northeast, fortunately we don’t have any gross receipts tax regimes at the state level, but banks may encounter these to the extent that they have qualifying activities or presence further west.

Washington, Ohio and Oregon are examples of states that have gross receipts tax regimes that do apply to banks and financial institutions.

So how might you be caught up in one of these? If you’re maybe based on out on the east coast, remote employees could trigger a physical presence nexus. But also, the ownership or title to property within those states can cause that or even just general economic thresholds.

Where we see it is would be say loans secured by property in states with gross receipts tax regimes or credit card receivables. Those types of revenue streams coming from a state where maybe a financial institution holds a property under loan or something similar has title to a state can, depending on the dollar value and the thresholds of those revenue streams, you could be subject to that and kind of catch you off guard.

I will say last point on that is just that there are some gross receipts taxes, are generally taxes on any income earned, gross income earned received by the financial institution.

So that can include interest commissions, dividends, fees, carrying charges, data processing fees, sales of repossessed merchandise, lease streams, even sales of personalized checks. So, it gets that broad. But there are certain specific deductions and exclusions that you’ll want to make sure you’re incorporating when you’re examining what your taxable base might be for that kind of thing.

Leanne Scott: Great.

So, in terms of I know we’ve thrown a lot at folks and a lot of these topics could be full podcast episodes of their own. But I think one final thing I wanted to mention as a key point is what’s your action step here?

If you get a notice or a questionnaire in the mail from a state or locality, how should you deal with it? Obviously, if you are a BNN client, or even if you’re not, feel free to reach out to us.

The really important thing with notices, I think a couple of things. One, I do think it’s important to respond to them and not ignore them. Second, it’s important to respond carefully.

These are areas that you’re not familiar with or your organization is not familiar with. You want to make sure you’re really fully understanding the potential implications of how you’re answering questions.

A lot of times notices are generated because states might be comparing different tax type records or they’ve gotten some other information that you might have activity in the state often if you have a remote employee and you got a payroll account, it’s an automated thing for a state to ask, why aren’t you filing sales tax?

Why aren’t you filing, you know, whatever type of tax they have? So just make sure you really understand what you’re doing before you respond to those. You certainly don’t want to get on record with a response that either isn’t complete or accurate and then have to try to unwind that later.

So message there is really, if you’re not sure, reach out to your contact. And also, it’s important during the year to keep your tax advisors up to date on new activities so they can help you plan for these things.

If you’re going to be hiring people in new states or maybe branching out into a new state, whatever it is you’re doing, it’s good to have an active dialogue with your advisor so we can best give you an idea of the consequences that might occur.

Nick Smetana: One additional item to keep in mind is that just with the regulatory environment that banks and financial institutions exist in, some things such as say, having title to a mortgaged property in a certain state, those are registered with certain local authorities or other national authorities, that can be an additional touch points beyond what, say, a typical operating company might encounter.

So just be aware that owning or having title to a property or something in another state could tip off those taxing authorities as well.

Leanne Scott: Good point.

Nick Smetana: While we’re here, I do want to make a quick comment about credit unions.

Listeners should be aware that not all states treat credit unions uniformly for sales tax purposes.

Federally charted credit unions are protected by federal law from sales or use tax at the state level. However, states have varying treatments for state-chartered credit unions, and we’ve encountered this with some of our clients in the past who provided software and related services to credit unions across the country.

And this is something that’s come up on several occasions. But for example, Massachusetts and Rhode Island do not extend a sales tax exemption to state chartered credit unions, although other states do.

So just one thing to keep in mind if you’re operating in that space, that it’s not uniform like you might see, say for a 501 chartered organization where it might be much more broadly offered an exemption.

So state chartered credit unions just had differing state treatments for sales tax purposes.

Leanne Scott: Good point. There’s a lot that falls under that financial institution’s umbrella.

Nick Smetana: Leanne, it was great to chat with you today, and I think we covered some great points for our listeners to watch out for.

Leanne Scott: Absolutely, Nick, thanks for sitting down with me and thank you to our listeners for tuning in. I hope you found this information helpful.

Nick Smetana: Yes, and we are always monitoring and sharing updates and developments, so stay tuned for more articles, podcasts and resources from our team. Thanks all. Goodbye.