ACCT 570 - Ch 12: State & Local Taxes

Business Income

All revenues earned in the ordinary course of business; Sales less cost of goods sold and other expenses; Fairly apportioned across states with nexus

What is included in payroll?

Salaries, commissions, bonuses, and other forms of compensation

Solicitation

Selling activities or activities ancillary to selling that are protected under Public Law 86-272

What is the primary difference between separate and unitary state?

Separate states tax the entire apportioned income of each separate business unit with nexus while unitary state tax the entire unitary group using a smaller apportioned percentage

Who is not protected under Public Law 86-272?

Service providers, sellers of real property, or businesses licensing intangibles; These sellers establish nexus through physical presence of sales personnel or property

Nonbusiness Income

All income except for business income - generally investment income and rental income; Allocated to a specific state - usually the state of commercial domicile

Who is included on a unitary tax return?

All members meeting the unitary criteria - whether they have nexus or not

Sales Tax

A tax imposed on the retail sales of goods (plus certain services); Retailers are responsible for collecting and remitting the tax; Typically collected at the point of sale

4 Criteria for Determining Whether States can Tax Nondomiciliary Businesses

1 - A sufficient connection or nexus must exist between the state and the business 2 - A state may tax only a fair portion of a business's income 3 - The tax cannot be constructed to discriminate against nonresident businesses 4 - The taxes paid must be fairly related to the services the state provides

State Tax Base

The federal taxable income plus or minus required state tax adjustments

5 Rules for Allocating Common Types of Nonbusiness Income

1 - Allocate interest and dividends to the state of commercial domicile (except interest on working capital, which is business income) 2 - Allocate rental income to the state where the property generating the rental income is located 3 - Allocate royalties to the state where the property is used 4 - Allocate capital gains from investment property to the state of commercial domicile 5 - Allocate capital gains from selling rental property to the state where the rental property was located

3 Factors to Determine Whether a Group of Businesses is Unitary

1 - Functional integration - vertical or horizontal integration or knowledge transfer 2 - Centralization of management - interlocking directors, common officers, or rotation of management between companies 3 - Economies of scale - group discounts or other efficiencies due to size

4 Questions to Determine State Income Tax Liability

1 - In which states does it have nexus? 2 - If the business is related to other entities, should it file separate state tax returns, or should it include the activities of the related entities on its state tax returns? 3 - What adjustments to federal taxable income must the business make to determine state taxable income for each state in which it is required to file? 4 - If income is taxable (nexus exists) in more than one state, how is income divided among the various state in which the business is required to file tax returns?

3 Types of State Tax Law

1 - Legislative law - state constitution and tax code 2 - Administrative law - regulations and rulings 3 - Judicial law - state and federal tax cases

What are the 3 primary factors in determining apportionment?

1 - Sales 2 - Payroll 3 - Property

3 Primary Revenue Sources for State Governments

1 - Sales and use tax 2 - Income or franchise tax 3 - Property tax

5 General Rules for Determining the Amount of Sales to Include in the Sales Factor Calculation

1 - Sales of tangible personal property are sourced (included) to the destination state 2 - Throwback Rule - If the business does not have nexus in the destination state, sales are generally "thrown back" to the state from which the property is shipped 3 - Dock sales should be sourced to the good's ultimate destination 4 - Sales of services are sourced in the state where the services are performed 5 - Government sales are sourced in the state from which they were shipped

2 Ways a Business May Have Physical Presence in a State

1 - Salespeople enter a state to obtain sales 2 - Tangible property is located within a state

5 General Rules for Determining Property Factors

1 - Use the average property values for the year [(beg+end)/2] 2 - Value property at historical cost rather than adjusted basis 3 - Include property in transit (such as inventory) in the state of destination 4 - Include only business property (values of rented investment properties are excluded) 5 - Include rented or leased property by multiplying the annual rent by 8 and adding this value to the average owned-property factor

Formula for Sales Factor in a State

= (Total sales in state X)/(Total sales in all states)

What activities do not meet the definition of solicitation, and, therefore, create income tax nexus?

>Making repairs >Collecting delinquent accounts >Investigating creditworthiness >Installing or supervising the installation of property >Training for employees other than sales reps >Approving or accepting orders >Repossessing property >Securing deposits >Maintaining an office other than in-home

Passive Investment Companies (PICs)

A company simply creates a subsidiary and transfers ownership of its trademarks and patents to a state that does not tax royalties, interest, and other similar types of intangible income

Trade Show Rule

A rule that permits businesses to have physical presence at conventions and trade shows, generally up to two weeks a year, without creating nexus

Separate Tax Return

A state tax return methodology requiring that each related entity with nexus files a separate tax return

Unitary Tax Return

A state tax return methodology requiring the activities of a group of related entities to be reported on a single tax return. The criteria for determining whether a group of entities must file a unitary tax return are functional integration, centralization of management, and economies of scale

Use Tax

A tax imposed on the retail price of goods owned, possessed, or consumed within a state that were not purchased within the state

Which 5 states do not impose sales and use taxes?

Alaska Delaware Montana New Hampshire Oregon

How is federal interest income treated for state tax returns?

All states require a negative adjustment (reduction in federal income in adjusting to state income) because states cannot tax federal interest income

Federal/State Adjustments

Amounts added to or subtracted from federal taxable income when firms compute taxable income for a particular state

What is not included in payroll?

Amounts paid to independent contractors

How can nexus be limited?

Because nexus is determined on a legal entity basis, nexus can be limited by creating a separate legal entity

Why is food often exempt from sales tax?

Because taxing food is considered to be regressive; that is, it imposes a proportionally higher tax burden on lower-income taxpayers that spend a greater proportion of their income on food and other necessities

Interstate Commerce

Business conducted between parties in two or more states

Nondomiciliary Businesses

Businesses not domiciled or headquartered in a state; These are subject to tax only where they have nexus

Sales and Use Taxes

Excise taxes levied on the sale or use of tangible personal property within a state

When might physical presence not create nexus for sellers of tangible personal property with regard to income tax?

If their activities within a state are limited to "protected" activities as described by Public Law 86-272

Under Public Law 86-272, when are businesses protected from income tax nexus in a particular state?

If, and only if, all of the following apply: 1 - The tax is based on net income (not gross receipts or revenue) 2 - The taxpayer sells only tangible personal property in that state 3 - The taxpayer's in-state activities are limited to solicitation of sales 4 - The taxpayer participates in interstate commerce 5 - The taxpayer is nondomiciliary 6 - The taxpayer approves orders outside the state 7 - The taxpayer delivers goods from outside the state

How is state and local bond interest income treated for state tax returns?

Most states require a positive adjustment for state and local bond interest income if the bond is from another state (they tax out-of-state bond interest income)

How are state income taxes treated for state tax returns?

Most states require a positive adjustment for state income taxes because they do not allow business to deduct state income taxes

How is state income tax liability calculated?

Multiply business income by the apportionment factor and then add any non business income allocated to the state

Which 4 states do not impose an income tax on corporations?

Nevada South Dakota Washington Wyoming

Is sales tax imposed on purchases of inventory for resale?

No, inventory is exempt

When does a use tax occur?

Only when a seller in one state ships goods to a customer in a different state and the seller is not required to collect the sales tax; The seller does not have sales and use tax nexus in the state in which the goods are shipped to

How is payroll apportioned for state tax returns?

Payroll for each employee is apportioned to a single state - the state where they perform the majority of services

Public Law 86-272

Places limits on state's power to impose income taxes on nondomiciliary businesses

Which states are unitary return states?

Primarily states west of the Mississippi River, plus Illinois, Massachusetts, Michigan, New York, Ohio, Texas, Vermont, and Wisconsin

What happens if a buyer is charged sales tax in another state?

The buyer will have a use tax liability for an incremental amount if the state where the property is used has a higher sales tax rate

Economic Nexus

The concept that businesses without a physical presence in the state may establish income tax nexus in the state through an economic presence there

Apportionment

The method of dividing business income of an interstate business among the states where nexus exists, based on the extent of the business's activities and property in various states

Allocation

The method of dividing or sourcing nonbusiness income to specific states

Commercial Domicile

The state where a business is headquartered and directs its operations; This location may be different from the place of incorporation; A business must always collect sales tax and pay income tax in the state where it is domiciled

Nexus

The sufficient (or minimum) connection between a business and a state that subjects the business to the state's tax system; The requirement for establishing nexus with a state depends on whether the tax is a sales and use tax, an income tax, or a nonincome-based tax

How is state taxable income calculated for states in which the business has nexus?

The sum of the business income apportioned to that state plus the nonbusiness income allocated to that state

How is sales tax nexus established?

Through physical presence of salespeople or property within a state