SALT, Dormant Commerce Clause, 754 State Tax, Tax Chapter 15
Common State Modifications for State Personal Income Tax
- deduction for state income tax is not allowed some states allow - deduction for federal income tax - exemption of other state's muni bond interest usually not allowed - states have different CC rules - states have different carry forward/back rules - common to "de-couple" from certain temporary provisions (e.g. bonus depreciation)
Allocable income usually includes:
- income/loss from sale of nonbusiness property - income or losses from rents or royalties from nonbusiness real or tangible property - interest and dividends usually allocated to "home office"
Unitary business- constitutional test 3 factors
1. Functional integration 2. Centralized Management 3. Economies of Scale
Dealing with Privileges and Immunities and Dormant Commerce Clause Issues
1. If facts mention harm to interstate commerce, lead with Dormant Commerce Clause and mention Privileges and Immunities as an alternative. 2. If facts mention discrimination based on residency or citizenship, lead with Privileges and Immunities and mention Dormant Commerce Clause as an alternative. 3. Remember that corporations are protected by the Dormant Commerce Clause, but not Privileges and Immunities. 4. Market participant exception only applies to Dormant Commerce Clause.
Types of Discrimination against Interstate Commerce
1. Requiring business to be performed in state 2. Protecting local business 3. Discrimination as to in state resources 4. Transportation restrictions 5. Interstate mobility of persons
4 main categories of business entity recognized by tax system
1. Taxable corporation (separate taxpaying entity, income reported on Form 1120) 2. S corporation (flow-through entity, income reported on Form 1120S) 3. Partnership (flow-through entity, income reported on Form 1065) 4. Sole Proprietorship (flow-through entity, income reported on Form 1040, schedule C)
C Corporations tax form
1120
S Corporation tax form (flow through entity)
1120S
Public Law 86-272
1959 response to Supreme court case States may not impose taxes on measure of net income derived from interstate commerce if the "only business activities carried on within the state" are: - solicitation of orders for sales of tangible personal property, AND - orders are sent outside the state for approval/rejection AND - orders are filled by shipment or delivery from point outside state
Streamlined sales tax(SST), 1 state didn't conform
24 states. NY didn't conform
CA min tax
$800 min tax. also requires unitary reporting not separate
Exemptions from True object test
- Sale for resale - Casual or occasional sales - Sales of items used or consumed in manufacturing, processing, or fabrication - Sales of machinery or equipment - Essential items - Sales to religious, charitable or educational organizations - Real property repairs and improvements - Donations - Must obtain exemption certificate in many cases
Double taxation
C Corporations pay the first level of tax on their taxable income. The most profitable corporations are taxed at a flat 35 percent rate. Corporate shareholders are subject to double taxation because they pay a second level of tax on corporate income. Distributions to shareholders of C corporations are taxes as dividends to the extent they come from the "earnings and profits" (similar to economic income) of corporations. The applicable rate for the second level of tax depends on whether corporations retain after-tax earnings and on the type of shareholders.
S corp tax year
Calendar year
Taxable corps accounting period
Can choose a tax year that ends on the last day pf any month of the year - year end of owners is not relevant
Privileges and Immunities Clause
Citizens of each state shall be entitled to all privileges and immunities in the several states "secures and protects right of a Citizen of on state to pass into any other state...for the purposes of engaging in lawful commerce, trade, or business without molestation" *only applies to people not corporations*
Commerce Clause
Congress shall have the power to regulate commerce with Foreign Nations, and among Several States and with the Indian Tribes
DMA v. Brohl
DMA, a trade association of retailers, filed claimed against director of Colorado DoR who imposed a law that required retailers to notify purchasers that use tax is due, send a report of purchasers, and send statement to DOR listing customers *Supreme court reversed judgement of Court of Appeals but remands case for further proceedings regarding comity doctrine*
Delaware Holding Company
Delaware tax code exempts corporations from income tax if activities in state are confined to - maintenance and management of intangibles and collection and distribution of income from such investments or from tangible property physically located outside the state DHC must provide "sufficient substance" within Delaware in order to minimize possibility of taxation in another state
True object test
Determines whether something is property or service
Direct/Indirect Impact on Interstate Commerce
Direct burdens are viewed as being more harmful to interstate commerce than indirect burdens. Direct: if law passed primarily to regulate something in another state. Indirect: if law passed primarily to regulate something in state with incidental impact on other states. Court will be more wary of states directly trying to control other states than of states indirectly impacting interstate commerce by regulating a local problem. Not an independent test (it is part of the unreasonable burdens balancing test), but should be considered if the facts make relevant (If they emphasize local aspect over another state). McGoldrick doesn't like this test!
Flow-through entities
Do not pay taxes because income flows through to business owners who are responsible for paying tax on their income
Due Process Clause
Due process nexus requires some sort of "minimum contacts" between the TP and the taxing state. "Has the state given anything for which it can ask return?"
Instrumentalities in Transit (Non-Discriminatory State Tax)
Each state can tax the value of the instrumentality but the tax has to be fairly apportioned to contacts within the state. - State must work out ratio of how much of instrumentality belongs to it. Test for fair apportionment: rational basis.
Partnership accounting method
May use cash method unless they have a taxable corp as a member or partner
S corp accounting method
May use cash or accrual
Texas Margin Tax- 3(4?) mutually exclusive deductions
Modified GI tax Take federal return items of gross income (total revenue excluding pship income) less one of the following: - Total rev-$1 million - Total rev*70% - Total rev-COGS - Total rev- compensation paid to employees
S Corps ownership
Most restrictive - no more than 100 shareholders and cannot have shareholders that are corporations, partnerships, nonresident aliens, or certain types of trusts
Entities taxed as partnerships (LLC, GP, LLPs)
Must have at least 2 partners Partnerships - no restriction on owner type Limited partnerships - must have at least one general partner
States w/o sales and use tax
NOMAD- NH, OR, MT, AK, DE
States w/o corp. income tax
Nevada, Ohio, SD, WA, WY
Import/Export Clause
No State shall, without the consent of Congress, *lay any Imposts or Exports, except what may be absolutely necessary for executing it's inspections Laws:* and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be used by the Treasury of the United States: and all such Laws shall be subject to the Revision and Control of the Congress.
Can corporations avoid the second level of tax entirely by not paying dividends?
No for 2 reasons 1. Corporations that retain earnings may be required to pay a penalty tax in addition to income tax on their earnings. Unless corporations have a business reason to retain earnings, they are subject to a 20 percent accumulated earnings tax on the retained earnings. Also, personal holding companies (closely held corporations) are subject to a 20 percent personal holding company tax on their undistributed income. These penalty taxes remove the tax incentives for corporations to retain earnings. 2. shareholders also pay a second level of tax when corporations retain their after-tax earnings. Shareholders should experience an increase in the value of their shares to reflect any undistributed earnings (increase in assets). Individual shareholders pay the second tax at capital gains rates on this undistributed income when they realize appreciation in their stock by selling their shares. These long-term capital gains are generally taxed at 15 percent. Taxpayers with modified AGI in excess of a threshold amount pay an additional 3.8 percent net investment income tax on dividends. The threshold amount is $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers. Because shareholders defer paying this second tax until they sell their shares, taxes on capital gains must be discounted to reflect their present value.
Unreasonable Burdens Balancing Test
On exam: do not list all factors (only the ones that a relevant for the facts). Most important factors: (1) state's interest and (2) harm to interstate commerce. Factors: 1. State's interest - Life, health, and safety are all important. - Safety regulations must actually improve safety. 2. Harm to interstate commerce 3. Degree to which burden falls in state or out of state - court more likely to uphold regulation whose burden falls primarily out of state (if burden falls on other states won't be self correcting). - if burden falls primarily in state, court may let political process correct it. 4. Adequate, reasonable alternatives 5. Direct/Indirect impact on interstate commerce 6. Dangers of multiple state regulations - state regulations that conflict with other state's regulations. (mud flaps on trucks that would have to be switched at state borders). 7. Need for uniformity vs. diversity 7. Disproportionate impact 8. Least discriminatory way of addressing
Non-Discriminatory (even handed) State Taxes
Each tax has its own rule. If the tax is fairly apportioned between in state and out of state, it's usually Constitutional. 1. Goods in transit 2. Instrumentalities in transit 3. State income tax 4. Sales tax 5. Use tax 6. Services rendered If tax does not fit into one of the categories below default to the Brady Test: 1. How substantial is nexus with the state? 2. How fairly is it apportioned? 3. How fairly does it relate to services rendered?
Distributions Partnerships
Entities taxed as partnerships do not recognize gain or loss when they distribute property (appreciated or depreciated) to owners. distributions to owners of entities taxed as partnerships are treated as a nontaxable return of capital to the extent of the owner's basis. Amounts in excess of basis are generally treated as capital gain to the owners.
Quill Corp. v. ND
Established that physical presence was need to collect tax under commerce clause- having customers in the state isn't enough
Converting to other entity types
Existing corporations have only two options for converting into flow-through entities. First, shareholders of C Corporations could make an S election to treat the corporation as an S corporation (a flow through entity). The only other option is for shareholders to liquidate the corporation and form the business as a partnership or LLC.
Commerce Clause
Fed. govt. regulates interstate commerce A tax is constitutional under the Commerce Clause if the four following criteria are met: 1. The tax must be applied to an activity that has aeswq in the state. 2. The tax must be fairly apportioned to activities carried on by the taxpayer in the state. 3. The tax must not discriminate against interstate commerce. 4. The tax must be fairly related to services provided by the state. "Fairly related" test significantly limited and is dead letter.
State Modifications
Federal and Munit Bond interest State income taxes Depreciation methods NOL Deduction Dividends Received
Services Rendered
Fee for services must fairly relate to services (very lenient standard). ex: LAX charging tax for each plane that lands.
Articles of organization
Filed to form LLC with the state
Articles of incorporation
Filed to legally form corporation with the state
4 Part Complete Auto Test
For commerce clause: 1. The tax must be applied to an activity that has substantial nexus in the state. 2. The tax must be fairly apportioned to activities carried on by the taxpayer in the state. 3. The tax must not discriminate against interstate commerce. 4. The tax must be fairly related to services provided by the state. (dead letter)
General partnerships
Formed by written agreement among the partners (partnership agreement) or formed informally without a written agreement when 2 or more owners join together in an activity to generate profits
Requiring Business to be Performed In-State
Generally per se invalid unless: 1. Law actually protects reputation of particular in state products; or 2. State is market participant preferring to buy in state products (distinguish between government owned and private entities). Example: public contractor case where city could not give subsidy to private contractor to which law gave monopoly. - Held to be discriminatory and per se invalid. - State can favor public entities more than it can private entities. - But city could give subsidy to a public contractor.
Goods in Transit (Non-Discriminatory State Tax)
Goods in transit are immune from state taxation. Once goods are moving or are committed to common carrier for purpose of moving, they are exempt from taxation until transit ends.
Dormant Commerce Clause
If Congress is given commerce power, then states have power taken from them and cannot discriminate or impose an unreasonable burden on interstate commerce and foreign commerce.
FICA and Self Employment Tax for partnerships
If owner is a general partner - income allocation is subject to self employment tax Limited partner - not subject to self employment tax
Discrimination towards Interstate Commerce
If state law is discriminating against interstate commerce, then it is per se invalid. 1. It is discriminatory if state favors in-state commerce over out-of-state commerce for no reason. 2. If treated differently because it's different, it is not discriminatory.
Unreasonable Burden on Interstate Commerce
If state law is even-handed, the state cannot impose an unreasonable burden on interstate commerce. Triggered when law is even-handed between in and out-of-state commerce, but harms interstate commerce. Balance competing interests to determine if burden to interstate commerce is justified by the state's interest.
Market Participant Exception
If state, city, or county is a market participant, then it can discriminate against interstate commerce and impose unreasonable burdens. The state can prefer in state over out of state. Taxing power does not fit within the market participant exception. 3 ways for a state to act like a private enterprise: 1. State as a buyer. 2. State as a seller (exception only applies for first sale, doesn't extend "downstream"). 3. State as an employer. (State's refusal to hire out of state employees would not violate the dormant commerce clause but it would violate the Privileges and Immunities Clause).
FICA and Self Employment Tax for S Corp
If you receive a salary from an S Corp as well as income from being an owner the income allocation is not subject to FICA or self employment tax
Individual shareholders
Individual shareholders receiving distributions from corporations pay the second tax on the dividends they receive, usually at a 15 percent tax rate. Also, taxpayers with modified AGI in excess of a threshold amount pay an additional 3.8 percent net investment income tax on dividends. The threshold amount is $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers.
Pros/Cons to state conformity w/ IRC
Pros to conformity: - Simplicity - Reduction in compliance costs Cons to conformity: - Loss of control over tax revenues - Loss of control over policy making
Property Factor
Real and tangible personal property o Inventory o Owned property o Leased property Property must be rented and used by the taxpayer o Sourced to location of property Exclusions o Intangible property o Property producing non-business income In-state property/Total property
States without Retail Sales Tax
Alaska, Delaware, Montana, New Hampshire, and Oregon
Partnerships liability
All general partners are ultimately responsible for the liabilities of the partnership
Entity-level taxes S-corp. Exceptions
Almost all states will conform to federal S election: treat as pass-through entity Exceptions: CA, IL, MA, LA, NH, TN, TX
Basis Computation Flow through
An owner's tax basis in a flow through entity interest is increased for contributions to the entity and income allocated from the entity to the owners. The tax basis of the interest is decreased by distributions to owners and losses allocated from the entity to the owner.
Sales Tax
Seller's state always has first dibs (always has the right to charge sales tax).
Shareholder tax
Shareholders generally pay the second tax immediately when they receive dividends or in the future when they sell their stock and pay capital gains tax. For individual shareholders, the tax rate applicable to both dividend income and long-term capital gain is generally 15 percent under current tax law.
3 major movements in MTS towards:
Single Sales Factor Combined reporting to avoid shifting tax consequences Market sourcing
LLC liability
Solely responsible
Alabama Reg.
Targets out of state retailers with substantial sales in the state Sellers without an Alabama presence must pay state tax when making retail sales of tangible personal property into the state - must exceed $250,000 and perform "certain activities" AL trying to push back, contradicts physical presence requirements in Quill Corp. North Dakota
Ohio Commercial Activity Tax
Tax on the privilege of doing business in Ohio Gross receipts tax Not an income or sales tax
Accounting method for taxable corp
Taxable corps are required to use accrual method but can use cash method if annual gross receipts do not exceed 5 million for the three previous tax years
Unincorporated entities with more than one owner tax rule
Taxed as partnerships - form 1065
Unincorporated entities with only one individual owner
Taxed as sole proprietorship - schedule C form 1040
Gamble vs. SC
Taxpayers claimed they were owed a refund of $14,172 due to their status as nonresidents. The department determined that the taxpayers were residents of SC for the 2012 pursuant to SC Code Section 12 which states that a "resident individual" is an "individual domiciled in the state". Concluded the taxpayers are residents of the state of SC fro the tax year 2012 because ti was their state of domicile
Contributions of Property and Services
When a business owner contributes appreciated property to an entity in exchange for an ownership interest, the business owner realizes a gain in the amount of the value of the ownership interest received in excess of the basis of the property transferred. Shareholders of taxable corporations and S corporations are allowed to defer this gain as long as the shareholders contributing property to the corporation "control" the corporation after the exchange (defined as 80 percent ownership). In contrast, members of LLCs and partners in partnerships are allowed to defer the gain no matter their level of ownership in the business entity.
Unincorporated entities with only one corporate owner
Typically a single member LLC - Disregarded for tax purposes - income reported as if it had originated from a division of the corporation and is reported directly on the single member corporation's return
Converting partnerships/sole proprietorships to Corps
Typically, converting entities taxed as partnerships and sole proprietorships can be accomplished in a tax-deferred transaction without any special tax elections. For this reason, many businesses that plan to eventually go public will operate for a time as entities taxable as partnerships to receive the associated tax benefits and the convert to C Corporations when they finally decide to go public.
Property is valued at...
average historical cost plus additions and improvements some states use net book value or adjusted basis
Wrigley v. Wisconsin
U.S. Supreme Court defined "solicitation" De minimis level of non-solicitation activity establishes only a trivial connection with the taxing state-does not forfeit protection of P.L. 86-272
Congressional Authorization Exception
Under the Commerce Clause, Congress has the power to permit states, cities, or counties to violate dormant commerce clause rules. It takes an express federal law permitting them to discriminate or impose unreasonable burdens. Permission is narrowly construed. (ex: allowing discrimination against banks does not allow discrimination against investment advisors).
Business Income- 2 tests
Used for apportionment Transactional Test- Income arising from transaction and activities in the regular course of the taxpayer's trade or business Functional Test-Income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations
Tax Commissioner of WV s. MBNA
WV's imposition of its business franchise and corporation net income tax on MBNA for 1998 and 1999 did not violate the commerce clause based on substantial nexus and economic precedes test (empowers states to tax corporations that conducted business within the state without having physical presence)
Distributions Taxable Corp and S Corp
both taxable and S corporations recognize gain when they distribute appreciated property to shareholders. However, they are not allowed to recognize loss when they distribute property with a value less than its basis (depreciated property). shareholders of taxable corporations generally recognize dividend income in the amount of the fair market value of the distributions they receive. Distributions to S corporation shareholders are treated as a nontaxable return of capital to the extent of the owner's basis.
Losses generated by flow through entities
generally available to offset the owners' personal income. Note: The owner of a flow-through entity may only deduct losses from the entity to the extent of the owner's basis in the flow-through entity. In addition, deductibility of losses from flow-through entities may be further limited by the "at-risk" and passive activity loss limitations.
Property Factor
generally includes average value of real and tangible personal property owned or rented *Amount used in the state divided by all of corp's property owned or rented*
Washington B&O tax
gross receipts tax 40 cities impose, no city east of cascades
Phillips vs. NY
had little supporting evidence to confirm the fact that his home office was a necessity, his compensation was omission or salary and the location of the transaction (argued all commissions from years were based on sales to customers located out of NY but there is not proof)
Throwback Rule
if adopted by state, requires that out-of-state sales not be subject to tax in destination state be pulled back into origination state sales are treated as in-state sales of origination state
How to treat income and apportionment percentages for unitary basis
if partner and pship act on unitary basis, combine income and apportionment percentage, if not pship level apportionment- 2 levels
"Dormant" Clause
imposing an implicit restriction on ability of states to regulate interstate commerce
Interstate Mobility of Persons
Restrictions to interstate mobility are per se invalid because they violate the Privileges and Immunities Clause (and the Commerce Clause).
Income/ loss allocation
S - allocated based on stock ownership percentages
Property included in Property Factor
land, buildings, machinery, inventory, etc. may include CIP, offshore property, outer space property, partnership property if leased property is included it is valued at 8x annual rental payments
Apportionment
means by which business income is dividend among state in which it conducts business (has nexus) corporate determines net income for the company as a whole based on each state's income tax rues, the apportions some to each state, according to a mandated formula
Allocation
method used to directly assign specific components of a corporations income, net of related expenses, to a specific state typically income (loss) is removed from corporate net income before the state's apportionment formula is applied
Uniform Division of Income for Tax Purposes (UDITPA)
model law (1957) relating to assignment of income among state for multistage corporations many states have adopted by joining Multi-state Tax Compact or meddling their law
Provisions for S Corps
must have a valid S corp election at federal level to get S corp treatment in states
Losses generated by taxable C Corps
net operating losses (NOLs). While NOLs provide no tax benefit to a corporation in the current year the corporation experiences the NOL, they may be used to reduce corporate taxes in other years. Taxable C corporations with a NOL for the current year can carry back the loss to offset the taxable income reported in the 2 preceding years and carry it forward for up to 20 years. Losses from taxable corporations are not available to offset their shareholders' personal income.
New Mexico Taxation vs. barnesandnoble.com
nexus was sustained in NM because bn.com's competitors did not receive customer date, gift cards were usable online/in stores; loyalty programs were used by both; trademarks and logos were used; etc.
Separate taxpaying entities
pay tax on their own income
Sales/Use Tax Nexus
require suppliers to collect sales tax and remit it to the state
Mobil Oil test
set up factors of probability test for unitary business- functional integration, centralized management, economies of scale
S Corp basis computation
shareholders of S corporations are not allowed to increase the basis in their S corporation stock by liabilities of the S corporation. receive nontaxable distributions to the extent of the basis in their ownership interest, and they are not allowed to deduct losses allocated to them in excess of their tax basis.
State Personal Income Tax
starting point is federal income tax and adjusted for common state modifications
Use Tax
substitution for sales tax for online retailers that do not collect sales tax
State Taxation of Non-Residents
supreme court asserted states' right to tax nonresidents on income from property owned within the state and their business, trade, or profession carried on in the state Issues with professional athletes, work from home, interstate transport, and reciprocity agreements
Ultimate Destination Concept
tangible asset sales are assumed to take place at point of deliver, not where shipping originates
Geoffrey v. South Carolina Tax Commission
taxation of Geoffrey's royalty income is not prohibited by the due process clause or the commerce clause of the US constitution Geoffrey must be taxed and must pay the corporate license fee
Selective Sales Tax
taxes on specific items not as visible as retail sales tax including alcohol, tobacco, and gasoline
Cons of liquidating Corp
the taxes imposed on liquidating corporations with appreciated assets can be very punitive. Liquidating corporations are taxed on the appreciation in the assets they distribute to their shareholders as part of the liquidation. Further, shareholders of liquidating corporations are also taxed on the difference between the fair market value of the assets they receive form the liquidating corporation and their basis in their stock.
Apportionment Factors
three-factor formula that equally weights sales, property, and payroll states may modify formula where sales favor receives a larger weight
Compensation included in Payroll Factor
wages, salaries commissions EXCLUDES: amounts paid to independent contractors; some states exclude amounts paid to corporate officers Some states require deferred compensation amounts be included
How to opt out of including foreign income in in combined return for four states that include it
water's edge election
Sales Factor
*Corp's sales in the state divided by corp's total sales* everywhere must follow UDIPA's "ultimate destination" concept
Payroll Factor
*compensation paid within a state divided by total compensation paid by the corporation*
Common State Income Modifications
- Depreciation (IRC Sec 179) - Domestic Production Activities Deduction-Sec 199 - State Income Taxes-IRC Sec. 164 - Dividends received deduction-IRC Sec 243 - NOL carryback/carryforward - Section 78 Gross Up - Subpart F Income - Interest on Federal Obligations - Federally Tax Exempt Interest - Intangible and Interest Expense incurred with related entity transactions - Fed. int. income - Fed. income taxes
To retain limited liability protection for shareholders
1. Create, update, and comply with bylaws 2. Have a BOD and hold regular Board meetings 3. Annual shareholder meeting 4. Issue shares of stock to owners 5. Comply with annual filing requirements specified by the state of incorporation 6. Pay any required corporate taxes
State Taxation of Interstate Commerce
1. Discriminatory state taxes 2. Non-discriminatory (even handed) state taxes
2 objectives accomplished by making tax-deductible payments to shareholders
1. It shifts income away from (relatively) high tax rate corporations to (relatively) lower tax rate shareholders. 2. The deduction shields income from the corporate level tax. Strategies that shift income from corporations to shareholders include: • Paying salaries to shareholders (salaries are deductible to the extent they are reasonable) • Paying fringe benefits to shareholders (common fringe benefits include medical insurance, group-term insurance, dependent care assistance, tuition benefits). • Leasing property from shareholders • Paying interest on loans from shareholders.
If state treats out-of-state commerce differently because it is actually different
1. Law must actually advance a legitimate policy reason for discriminating. 2. If facts do not support state's justification, then apply virtually per se invalid rule.
Examples of Discrimination against Interstate Commerce
1. Law: no out of state milk. - State interest: protecting WI milk quality. - Court bought claim, but McG does not. 2. Law: AZ cantaloupes must be packed in AZ. - State interest: protecting reputation of AZ cantaloupes. - Failed balancing test because reputation not actually advanced by packing. 3. Law: no importation of out of state cattle. - State interest: protecting in state cattle from disease. - Court bought claim, but it did not know that in state cattle were already diseased. Therefore, we would decide that the law fails balancing test. 4. Law: refineries could not sell their own franchises. - State interest: protecting independent gas stations. - Court upheld law because state interest outweighed harm to commerce.
Discrimination as to In-State Resources
A state cannot prefer itself for its resources (per se invalid). (Example: prohibiting out of state waste). A state can discriminate if there is an actual, valid state concern: 1. If state alleges a legitimate state interest, use balancing test. 2. Cannot place entire burden of state concern on other states. 3. More likely to be valid if there are in state regulations advancing the state concern (ex: in state water regulation laws when it burdens other states). Reciprocal agreements are per se invalid. Exception: state can prefer itself over over states if it is a market participant. (ex: state can choose to buy only from in state manufacturers).
States without Individual Income Tax
Alaska (oil), Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming
States that include worldwide income in combined income
CA, ID, MT, ND
Reverse Credit States
CA, OR, VA, AZ, Indiana
Corporate shareholders
Corporate shareholders receiving dividends are not entitled to the reduced dividend tax rate (15 percent) available to individual shareholders. Rather, the dividends are subject to the corporate shareholder's ordinary rates. Further, dividends received by a corporation are potentially subject to another (third) level of tax when the corporation receiving the dividend distributes its earnings as dividends to its shareholders. This potential for more than two levels of tax on the same earnings prompted Congress to allow corporations to claim the dividends received deduction (DRD). A corporation receiving a dividend is allowed to deduct a certain percentage of the dividend from its taxable income to offset the potential for additional layers of taxation on the dividend when the corporation distributes the dividend to its shareholders. The dividends received deduction percentage is 70, 80 or 100 percent depending on the extent of the recipient corporation's ownership in the dividend paying corporation. Thus, the DRD partially mitigates the tax burden associated with more than two levels of tax on corporate income.
Corporation liabilities
Corporation is solely liable
Legal classifications of a business entity
Corporation, limited liability company, general partnership, limited partnership, sole proprietorship under state law
Joyce vs. Finnegan state
Joyce: (TX & OR) separate entity approach- each corp. in the unitary group is evaluated separately when determining whether it is taxable in each state Finnegan: (AZ & CA) Combined group approach- each unitary group evaluated as a whole, if one corp. in a group entire unitary business is taxable for apportionment
Discrimination against Interstate Commerce on Exam
Lead with per se invalid, but then recognize that the Court has balancing test when state offers justification for discrimination. Court tends to accept state's justification. Factors to balance: 1. state interest (law must actually advance that interest); 2. harm to interstate commerce; 3. degree to which burden falls in-state or out-of-state; 4. reasonable, adequate alternatives; 5. direct/indirect impact on interstate commerce; 6. danger of multiple state regulations.
Taxable Corporations
Least restrictive ownership requirements - can have between 1 and infinity shareholders
Limited liability companies (LLC)
Legal entities separate from owners (members)
Limited partners liability
Limited partners are not responsible for liabilities but they also cannot participate in the activities of a business
Equal Protection
No state shall deny to any person within its jurisdiction the equal protection of law Supreme Court - state tax classifications require only a rational basis to satisfy and in taxation legislator possesses greater freedom in classifications laws that discriminate in favor of non-residence are allowed but laws that favor residents violate
Fifth Amendment
Nor shall any person...be deprived of life, litter or property without due process of law
Fourteenth Amendment
Nor shall any state deprive any person of life, liberty, or property without due process of law Supreme Court - state cannot assert personal jurisdiction over someone unless that person has "minimum contacts" with the state
Sole proprietorships
Not considered separate legal entity from owner
Transportation Restrictions
Not discriminatory if it actually improves safety. (ex: mudflaps improved safety, but outweighed by harm to interstate commerce).
Limited partnerships
Organized by written agreement and must file a certificate of limited partnership to be recognized by state law
Flow through entity tax year
Owner's tax year
Shareholders
Owners of a company - separate legal entity from corporation
Basis computation partnership
Owners of entities taxed as a partnership are allowed to increase the tax basis in their ownership interest by their share of the entity's liabilities. receive nontaxable distributions to the extent of the basis in their ownership interest, and they are not allowed to deduct losses allocated to them in excess of their tax basis.
General rule for taxation of tangible property vs. sale of services
Sale of tangible personal prop subject to sales tax unless exempt Sale of services presumed to be exempt unless identified as taxable
Exceptions to Dormant Commerce Clause
State can discriminate or impose unreasonable burdens on interstate commerce if: 1. it is a market participant; or 2. there is congressional authorization.
State Income Tax
State may impose income tax on any interstate business as long as it is fairly apportioned. - Determine ratio of goods and services rendered in state vs. out of state.
Protecting Local Business (Quarantine Laws)
State quarantine and inspection laws are allowed as long as the burden on interstate commerce is outweighed by valid health and safety reasons. Balance state's alleged interest against reasonable adequate alternatives and harm to interstate commerce. Triggered when state does not accept out of state goods. Difficult to determine if they're actually discriminating.
Discriminatory State Taxes
State taxation laws that discriminate against interstate commerce are per se invalid. ex: MD had county tax that gave credit to in state people but not out of state people. This is discriminatory, thus per se invalid. Out of state people were being taxed more because they're out of state. ex: tax rebates to only in state manufacturers.
Discriminatory Law is Virtually Per Se Invalid
States are allowed to treat out-of-state commerce differently if it is actually different. However, states cannot impose customs duties for goods imported from other states.
Use Tax
States can always impose a use tax on state residents for purchases in other states. If seller has substantial nexus with in state buyer's state, the seller has to collect tax. (Substantial nexus: retail outlet, warehouses, substantial amount of employees).
Supremacy Clause
The Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every state shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.
Quill Corp. v. North Dakota
The lack of a physical nexus in a state is sufficient grounds to exempt a corporation from having to pay sales and use taxes to a state.
Rational Basis Test and Commerce Clause
There must be a rational basis for Congress to believe there is a substantial impact on interstate commerce, allowing Congress to intervene.
Payroll Factor
Total amount paid for compensation: o Includes paid directly to employees or third party (leased employees) o Generally payments made to contractors are not included In-state payroll/Total payroll
Reducing the Corporate Level Tax
When a corporation's marginal tax rate exceeds its individual shareholder's marginal tax rates, the overall tax rate on corporate income will exceed the flow-through rate even if shareholders can defer the second level of tax indefinitely. In these situations, it makes sense for closely held corporations and their shareholders to consider strategies to shift income from the corporation to shareholders. These strategies are all designed to move earnings out of the corporation and to shareholders with payments that are deductible (dividends are not deductible payments) by the corporation.
Partnership tax year
Year end consistent with the year end of partners
Residents for purposes of personal income tax
defined by different states as one or more of the following concepts: - domicile - presence in state for other than temporary or transitory purpose - presence in state for specified period of time - maintenance of permanent place of abode or a place of abode for a specified period of time - combination of the above
Kraft v. Iowa
eliminated discriminatory taxation of foreign dividends
Protected Activities- PL 86-272
o Soliciting orders for sales by any type of advertising. o Carrying samples and promotional materials only for display or distribution without charge or other consideration. o Providing cars to sales personnel for their use in conducting protected activities. o In-home office
Unprotected Activities- PL 86-272
oMaking repairs or providing maintenance or service to the property sold or to be sold. o Collecting current or delinquent accounts, even if using 3 rd party. o Installation or supervision of installation at or after shipment or delivery. o Training courses for personnel other than solicitation personnel. o Approving or accepting orders.
Unitary Taxation
operating divisions are interdependent so shouldn't be segregated into separate legal entities each unit is deemed to contribute to overall profits ignores separate legal existence of corporations
