In his February 2016 State of the State address, Governor Malloy announced that his administration would be adopting a new approach to state budgeting in light of what he characterized as “the new economic reality” facing Connecticut and the nation.  The Governor’s proposed changes to the biennial budget, including significant rescissions, funding reductions and state employee layoffs, touched off a firestorm.  Each of the Governor, the Democratic legislative leadership and the Republican legislative leadership submitted one or more budget proposals, and the 2016 legislative year eventually required an extended special session before a revised budget, budget implementation bill and bond authorization legislation could be enacted.  Although the Governor largely remained true to his pledge not to increase state taxes, the reduction in state grants, PILOT payments and other financial support for municipalities likely will result in increased municipal property taxes.  Despite these efforts, the state finished the fiscal year ended June 30, 2016, with a projected deficit of $279.4 million, requiring a draw on the Budget Reserve Fund (i.e. the state’s “rainy day fund”).

The 2016 legislative session did witness the passage of significant tax legislation that, in particular, should be of assistance to Connecticut-based businesses which provide services and/or sell goods to out-of-state customers.  After last year adopting a general single-factor apportionment formula for the Connecticut corporation business tax, the General Assembly this session enacted market-based rules for the sourcing of business income, retroactively effective for income years commencing on or after January 1, 2016.  For businesses operated as Subchapter S corporations, limited liability companies, partnerships and other pass-through entities, the Legislature adopted a general single-factor apportionment formula and market-based sourcing effective for income years commencing on or after January 1, 2017.  Unfortunately, the austerity budget did result in a partial roll back of the limitation on the property tax mill rate for motor vehicles, but a number of new property tax relief provisions were enacted, including one for homeowners who are suffering from defective concrete foundations.  Finally, the General Assembly established the Connecticut Retirement Security Exchange, a new state-administered retirement savings program that, commencing in 2018, generally will be available to for-profit and non-profit employers in Connecticut.

Despite its attempt to address “the new economic reality,” Connecticut will continue to face significant budgetary challenges.  The state’s general obligation bond rating was cut from “AA” to “AA-” by three ratings agencies in May and July, thus increasing the cost of state borrowing.  A study released in June, 2016 for the Mercatus Center at George Mason University ranked the state’s fiscal condition, based on short- and long-term debt and other key fiscal obligations, as the worst in the country.  The Pew Charitable Trusts ranked the state’s debt, as a share of its personal income, as the fifth worst in the nation, and a new data survey from LERETA, a national real estate tax and flood service provider, characterized Connecticut’s property taxes as the second highest in the country.  On November 15, 2016, the nonpartisan Office of Fiscal Analysis announced that it is projecting a deficit for the current fiscal year of $77.5 million.  The Office of Policy and Management subsequently announced that the State was cutting $20 million in educational cost-sharing and freezing $65 million for construction projects in the Local Capital Improvement Program. Of greater concern, OFA also projected a deficit of almost $1.2 billion for the 2018 fiscal year, and over $1.0 billion in each of the next two succeeding fiscal years.  The return of large projected deficits is attributable largely to a dramatic $898.7 million increase in fixed costs commencing in the 2018 fiscal year, including debt service payments, Teachers’ Retirement Systems contributions and state employee pension and retiree health contributions. Put simply, there is a growing recognition that much more work will need to be done during next year’s legislative session for the state to respond adequately to “the new economic reality”.

This alert summarizes Connecticut tax legislation enacted, court decisions rendered and administrative guidance published by the Connecticut Department of Revenue Services (“DRS”) during the first ten months of 2016.  Please contact a member of our State and Local Tax Practice Group if you have questions regarding the new tax law changes or how they may affect you and your business.