miller nash llp | Fall 2011 brought to you by the tax law practice team NW Tax Wire ™ Cloudy With a Chance of Tax • On-demand self-service : The user allows the resource provider to scale can use computer resources (e.g., server a particular consumer’s computer time and network storage) as needed resources in and out to the consumer’s by Valerie H. Sasaki without requiring human interaction computer usage. From the consumer’s valerie.sasaki@millernash.com with the service’s provider. perspective, the resources appear to be 503.205.2510 unlimited and can be purchased in any • Broad network access : The computer It is a truth universally acknowl- quantity at any time. resources may be accessed over the edged, that an emerging business user’s network in a variety of different • Measured service : As noted above, model in a lucrative area must be in ways, including in ways (cell phones one of the advantages of the cloud want of a new taxing model. 1 Business- and laptops) that promote use by a mix model is the scalability of resources to es are increasingly outsourcing their of thin (depending heavily on some usage. Providers and consumers have information technology requirements other server) and thick (stand-alone) greater visibility to the consumer’s to the “cloud.” State legislatures and client platforms. actual usage of the resources. Thus, the policymakers are struggling to adopt resources can be monitored, controlled, • Resource pooling : The cloud provid- taxing mechanisms to capture the and reported in methods appropriate to er’s computer resources are pooled to new model of business activity. This the type of resource. This lends itself to serve many consumers using a multi- article discusses common questions a “metered” model, typically pay-per- tenant model, with different physical about state taxation of cloud computing use. and virtual resources dynamically as- activity and concludes with an analysis signed and reassigned based on variable of the current status of state tax laws These characteristics are typi- consumer demand. These resources surrounding cloud taxation. cal of cloud systems that our clients may include storage, memory, process- have adopted in industries as diverse Query: What is cloud computing? ing, network bandwidth, and virtual as healthcare, manufacturing, and In order for us to determine tax- machines. Location independence is electronic retailing. As computer re- ability of cloud transactions, we need increased in this model. This is the idea sources increase in cost and complexity, to be able to identify them. Broadly that the consumer has no control or (continued on page 4) stated, cloud computing is a model knowledge over the exact location of the for “enabling ubiquitous, convenient, provided resources. Information tech- on-demand network access to a shared inside this issue nology outsourcing agreements may or pool of computing resources.” 2 The may not specify that the location may 2 The Tax Man Cometh . . . National Institute of Standards and be a particular data center or located in 3 Is the Fox Guarding the Technology (“NIST”), a division of the Henhouse? . . . a particular state. Commerce Department, has identified elasticity : Computer re- • Rapid five essential characteristics of the sources can be rapidly and elastically cloud model: reallocated between consumers. This 1 Apologies to Jane Austen. 2 Peter Mell and Timothy Grance, “The NIST Definition of Cloud Computing (Draft): Recommendations of the National Institutes of Standards and Technology,” Special Publication 800-145 (Draft) (Jan. 2011). www.millernash.com
The Tax Man Cometh, and He’s Got His Eyes on Your Investment (2) the amount by which the individual’s vidual to be subject to the new Medicare total income exceeds the threshold. For tax. example, a single individual taxpayer Although the new Medicare tax by Jeneé Hilliard who has $150,000 of investment income applies to individuals, for investment jenee.hilliard@millernash.com and $125,000 of other income will pay income earned by a partnership (includ- 503.205.2505 the new Medicare tax on $75,000 (the ing a limited liability company that is It’s not news that the current Social amount by which the individual’s in- taxed as a partnership rather than a cor- Security and Medicare programs are not come exceeds the $200,000 threshold). poration), each partner will be treated as sustainable. In fact, with the first wave Because the threshold amounts for the having investment income equal to his of baby boomers already eligible for So- new Medicare tax are not indexed for or her share of the partnership’s invest- cial Security and first becoming eligible inflation, more taxpayers will be subject ment income. Additionally, although a for Medicare in 2011, the outlook is bleak to the new Medicare tax over time. corporation won’t be subject to the new for each program unless significant re- Medicare, any dividends paid to an in- For purposes of the new Medicare forms are made. In an attempt to bolster dividual shareholder will be investment tax, net investment income will include the Medicare program, as part of the income to the shareholder. This means interest, dividends, annuities, royalties, over-1,000-page and much-publicized that creating an entity to hold “Health Care and Education investment-income-producing “. . . each partner will be treated as Reconciliation Act of 2010,” assets for a taxpayer is unlikely having investment income equal to his or Internal Revenue Code to effectively avoid the new Section 1411 was enacted. her share of the partnership’s investment Medicare tax. This provision will cause income. ” Individuals who anticipate investment income of many being subject to the new individuals to be subject to rents, income from passive activities, 3.8 percent Medicare tax may want to a 3.8 percent Medicare tax beginning and gain from the sale of assets. But in- engage in some advance tax planning in the year 2013 (the new Medicare tax vestment income that is not recognized before the tax becomes effective. For also applies to trusts and estates, but for federal income tax purposes will not example, if an individual desires to sell this article focuses on the application to be subject to the new Medicare tax, in- an industrial rental property in the next individuals). cluding income from tax-exempt bonds, few years and expects to have $1 million Traditionally, Medicare has ap- tax-free distributions from qualified re- of taxable gain as a result of the sale, plied only to an individual’s wages or tirement accounts, gain from the sale of the taxpayer could avoid $38,000 of self-employment income earned in the a principal residence to the extent that Medicare tax if he or she sold the prop- operation of a trade or business. Cur- Section 121 applies, gain from the sale of erty before January 1, 2013. Addition- rently, and in general terms, Medicare property to the extent that Section 1031 ally, a taxpayer might consider selling tax is a payroll tax equal to 2.9 percent applies, increases in the value of a life investment-income-producing assets of wages paid, and the cost of the tax is insurance policy, and gain in a quali- before 2013 and investing the proceeds shared equally by employers and em- fied IRA or other retirement account. in tax-exempt bonds or a whole-life in- ployees (each paying 1.45 percent of the Additionally, taxable distributions from surance policy, thereby avoiding the new tax). Individuals who are self-employed qualified retirement accounts, income Medicare tax on any gain generated by pay both the employer and the employee from a trade or business (other than a the sale of the asset and avoiding the new portions of the Medicare tax. passive trade or business or trading in Medicare tax on the income produced financial instruments or commodities), Beginning on January 1, 2013, the by the investment. A taxpayer might and income subject to self-employment new Medicare tax will apply at a rate of also consider transferring investment- taxes are exempt from the new Medi- 3.8 percent on the investment income income-producing assets to a qualified care tax, but any such amounts will be of individuals with a modified adjusted retirement account, or, after 2013, sell- included in the individual’s modified gross income of $200,000 ($250,000 ing assets on an installment-sale basis, adjusted gross income and could push for couples filing jointly) or more. The if doing so could help keep the taxpayer the taxpayer over the threshold, causing tax applies to the lesser of (1) the total under the new Medicare tax threshold. other investment income of the indi- investment income for the year, and 2 | miller nash llp | NW Tax Wire
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