State and Local

Allocation

Allocable income generally includes: Income or loss from sale of nonbusiness property Income or losses from rents or royalties from nonbusiness real or tangible personal property Lack of consistency in state apportionment formulas can cause a corporation to be subject to state income tax on more or less than 100% of its income Some states don't distinguish between business and nonbusiness income

Apportionment

Business determines net income for the company as a whole and then apportions some to a given state, according to an approved formula. 3 factors - Sales, Property, Payroll

Allocation and Apportionment

Business income is apportioned Nonbusiness income is allocated

Sales and Use Tax Nexus

Federal law requires a state to have "substantial nexus" to a seller to require that seller to collect sales and use tax. "Substantial nexus" is not defined in the code Generally, however, it means having a physical presence in the state , whether by salesperson, contractor, location or a number of different events The Quill Standard: Sales tax Nexus is created once a substantial physical presence is established Owning or leasing tangible personal property or real property in the state is usually considered to establish sales-and-use-tax nexus.

Nexus

Generally, a corporation is subject to state tax only if nexus has been established.  Nexus is the degree of business activity which must be present before a state can impose tax on an out-of-state entity's income Once nexus is established, a corporation's income is taxable in the state. Sufficient nexus typically exists if: Income is derived from within state Property is owned or leased in state Persons are employed in state Physical or financial capital is located in state

Tax Effects of the Unitary Theory

Higher income apportioned to states where compensation, property value and sales prices are higher relative to other states. (numerator) Effect is favorable when unprofitable affiliate's losses may be offset against profitable affiliate's gains or where there are large differences in the marginal tax rates that apply among the nexus states. Unfavorable when income is pulled from a low tax state to a high tax state

Throwback Rule

If adopted by state, requires that out-of-state sales not subject to tax in destination state be pulled back into origination state Treats such sales as in-state sales of the origination state

Sales and Use Tax Exemptions

Nature of the taxed product - services, occasional sale (garage sale, sale of business), sale for resale, groceries/medicines/back to school. Nature of the purchaser - exempt organization (charity, church), government or agency Nature of sale - casual/occasional sale, amnesty or holiday Nature of the process - manufacturer/farmer, packaging and shipping, ingredient part/consumed in process (not fuel or electricity)

The Unitary Theory

Under the unitary approach, a corporation files a combined return including the results from all operations of its related corporations, not just those with business within the state. This forces the use of the apportionment factor on a unitary business's nationwide or worldwide income even if that income is generated by a separate legal entity that may not itself have nexus in the state. Subsidiary's income is included as part of the unitary group if it is an integral part of the unitary business. Unitary theory considers a "business" as an integrated, operating unit that cannot be separated into divisions. It ignores legal existence of separate entities. Apportionment is applied to the combined income of the unitary business.  Application of the theory is based on subjective observations about the business whereas Federal controlled and affiliated group status is based on objective tests: 3 prong test: Unity of ownership (more than 50%), Unity of operation (centralized purchasing, marketing, finance, etc.), Unity of use (centralized executive function and system of operation)

Economic Nexus

Even if an out-of-state seller has no physical presence in a state, if the out-of-state seller is reaping substantial economic benefits from sales to in-state customers, then the out-of-state seller is establishing a sufficient enough connection to the taxing state to be subject to the state's sales and use tax laws.  Per Quill vs. North Dakota, a state could not impose its tax collection requirements on an out-of-state seller unless the seller had a substantial physical presence in the state.  On June 21, 2018, the U.S. Supreme Court held in favor of the state in South Dakota v. Wayfair and overturned the physical presence standard - opening the door for other states to adopt economic nexus rules. The number of states that adopted economic nexus prior to and since the Wayfair decision, has grown exponentially.

Common State Additions

Interest income on state/municipal obligations and other interest income exempt from Federal income tax May exclude interest income on obligations within that state to encourage investment in in-state bonds Expenses related to Federal obligations State income taxes deducted on Federal return Federal depreciation in excess of amount allowed by state (if depreciation systems differ) Sale of assets: State gain in excess of Federal gain; Federal loss in excess of state loss Adjustments to amounts under Federal elections Federal net operating loss deduction

Common State Subtractions

Interest on U.S. obligations to extent included in Federal taxable income Expenses related to state and local obligations State and local tax refunds State depreciation in excess of Federal (if depreciation systems differ) Dividends received from certain out-of-state corps to extent included in Federal return Sale of assets: Federal gain in excess of state gain; State loss in excess of Federal loss Adjustments to amounts under Federal elections State Net Operating Loss Deduction Federal income taxes paid

Incentives to do Business in a State

Investment Tax Credits Job Tax Credits Research and Development Credits Favorable political environment State level deductions Low state tax rate

Property Factor

Property factor generally includes average value of real and tangible personal property owned or rented Numerator is amount used or rented in the state Denominator is all of corp's property owned or rented, regardless of location Real property is land and buildings Tangible personal property is machinery, inventory, equipment, etc Includes property regularly used in the trade or business Does NOT include cash, intangible assets, or investments/property that generate non-business income Only property used to produce apportionable (business) income is included in the property factor. Idle property, property under construction, and property that is used in producing non-apportionable income generally are excluded Property in-transit is assigned to the destination state, and mobile property (trucks/equipment) are prorated using total time in each state The value of the property usually is determined using average historical cost of the assets (plus additions/improvements, but without depreciation adjustments) Some states allow a downward adjustment for accumulated depreciation, the use of monthly (rather than yearly) average values, or the use of income tax basis.

Public Law 86-272

Public Law 86-272 limits the states' ability to impose a tax on income:"State cannot impose an income tax on income derived within the state by any person from interstate commerce if the only business activities within the state is: The solicitation of orders for sales of tangible personal property, which orders are sent outside the state and will be filled by shipment from a point outside of the state" Solicitation is defined as: Speech or conduct that explicitly or implicitly invites an order; and, Activities that neither explicitly nor implicitly invite an order, but are entirely ancillary to requests for an order Ancillary activities are defined as: Those activities that serve no independent business function for the seller apart from their connection to the solicitation of orders. Activities that a seller would engage in apart from soliciting orders shall not be considered as ancillary to the solicitation of orders. A de minimis rule also may allow a transaction to stay immune under the statute

UDITPA

The Uniform Division of Income for Tax Purposes Act (UDITPA) is an attempt by numerous states to create a model law that standardizes the assignment of income among the states. Many states have adopted UDITPA either by joining the Multistate Tax Compact or modeling their laws after UDITPA

Payroll Factor

The payroll factor is a fraction whose numerator is compensation paid or accrued for services rendered (wages, salaries, commissions) within a state, and its denominator is the total compensation paid by the corporation everywhere Some states include the value of certain employee benefits  Some states exclude executive's salaries, and some exclude contributions to and earnings on qualified retirement plans. An employee's payroll is generally assigned to only one state, even if they travel regularly. Exception: a permanent transfer mid-year This is for purposes of the company's payroll factor, not for the employee's personal income reporting Fees paid to independent contractors usually also are excluded from the factor. Only compensation related to production of apportionable income is included in payroll factor In states that distinguish between business and nonbusiness income, compensation related to nonbusiness income is not included

Sales Factor

The sales factor is a fraction whose numerator is the corporation's total sales in the state and the denominator is the corporation's total sales everywhere Sales are net of returns, allowances, and discounts Only includes sales that generate business income Sales often gets a higher weighting Manipulation of the sales factor often yields the greatest planning opportunities. Most states follow UDITPA's ultimate destination concept: Sales are assumed to take place at point of delivery, rather than the shipment point In a dock sale, where the buyer picks up the item from the seller (or arranges to have it delivered themselves), the sale is (generally) assigned to the purchaser's home state and not the location of the dock.