Multistate Income Tax

Transcription

1 Multistate Income Tax Marion Kopin, CPA Kopin & Company, CPA, PC Multistate Income Taxation Overview Forty-seven states and the District of Columbia impose some type of income or franchise tax on corporations. Nevada, South Dakota, and Wyoming do not impose corporate income taxes. While they do not have a corporate income tax, Ohio, Texas and Washington do have a gross receipts tax. Most other states piggyback off federal taxable income. Unfortunately, while the concepts of dividing a company s taxable income among the states in which it is doing business are few in number, the application and methods of applying those concepts are varied and often contradictory. States generally apportion a multistate corporation s income based upon a formula intended to reflect the company s presence and income in each state. The formula traditionally has relied on factors such as sales, property, and payroll. The basic outline of state income tax begins with federal taxable income, adds and subtracts certain state modifications and allocable non-business income, and then multiplies the apportionable income based on some combination of sales, property, and payroll factors. There are several states that have more than one element to their corporate income tax. Alabama, Arkansas, Connecticut, Delaware, Illinois, Louisiana, Massachusetts, Mississippi, Missouri, Nebraska, New York, North Carolina, and Oklahoma all have capital stock taxes. New York corporations calculate their tax using four different measures a tax measured by net income, a tax measured by the company s capital base, a tax measured by the minimum taxable income, and a fixed dollar minimum base. To calculate tax on capital, a company must divide its capital into several components investment capital, business capital, and subsidiary capital. Nexus Nexus is the contact that must be established with a taxing jurisdiction before that jurisdiction can require a business o collect its tax or otherwise subject it to its taxing authority. Nexus may be different for different taxes. In analyzing income tax issues, do not confuse nexus for sales and use tax purposes with nexus for income tax purposes. Most businesses are concerned with three types of nexus when doing business in surrounding states or states outside their domicile s taxing jurisdiction. Most common are nexus for sales and use tax purposes, nexus for income and franchise tax purposes, and nexus for purposes of registering or qualifying with the Secretary of state s office to do business in a state. Nexus conditions for all three of these are generally different. 1

2 Income Tax Nexus While physical presence is the bright-line test for sales tax nexus, it does not determine income tax nexus. A company can have numerous employees in a state creating considerable physical presence and yet not have an income tax filing obligation. This is because federal law, Public Law , creates a safe harbor from income tax nexus, even when there is physical presence. Public Law states that No state shall have the power to impose an income tax if the only business activities within such state are the solicitation of orders for sales of tangible personal property, which are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from outside the state. Sales of services are not protected by this law. Therefore, if training, seminars, computer classes are offered in a state, those activities would generate the requirement to file income tax returns in that state. Examples of activities within a state that could establish nexus for income tax purposes include: Repairs and maintenance; Collections on accounts; Credit investigations: Installation and supervision of installation; Non-solicitation training; Non-solicitation technical advice; Handling or processing customer complaints; Approving or accepting orders; Securing deposits on sales; Picking up or replacing damaged or returned property; Hiring, training or supervising personnel other than those involved only in solicitation; Carrying samples for sale, exchange, or distribution in any manner for value; Owning, leasing, using, or maintaining a repair shop, parts dept., warehouse, etc. Maintaining an office or place of business of any kind; Any advertising literature listing a specific address within the state or a telephone/fax within the state Entering or selling franchises or licenses. Any other non-protected, non-ancillary activity. Modifications to State Taxable Income Most states begin with federal taxable income. A few states are prohibited from automatically following changes in the federal tax code because their judiciaries have ruled that such delegation is unconstitutional. Many states tax bases, such as New York s do not tie directly to federal taxable income. Every state has additions and subtractions that must be made before arriving at state taxable income and before allocation and apportionment. 2

3 Additions include: Decoupling from depreciation, depletion, and amortization; State and municipal interest income; State income taxes. Federal net operating loss; Cancellation of indebtedness income; Domestic Production Activities Deduction; Subtractions include: Deduction for federal income tax paid Alabama, Iowa, Louisiana and Missouri; State income tax paid for other states Arkansas, Colorado, Illinois, Iowa, Louisiana, Rhode Island and Tennessee. Gains and losses on asset dispositions. Different basis from federal due to depreciation decoupling. Interest income earned on federal or US obligations Expenses related to nontaxable state and municipal interest Separate, Consolidated, or Combined Filing Separate filing means that each company with nexus in the state must file its own separate return regardless of whether it is part of an affiliated or consolidated group. There are many states that require separate filing irrelevant whether the corporation is a standalone entity or a member of a controlled, affiliated, or consolidated group. Those states include Arkansas, Delaware, Georgia, Louisiana, Maryland, New Jersey, Pennsylvania, and Tennessee. Separate filing has the disadvantage in that a company is prohibited from offsetting profitable subsidiaries with subsidiaries with losses. The advantage in separate filing is that a multistate taxpayer can arrange its legal structure to isolate high-profit margin activities in low or no tax states, and its low-profit margin activities in states with higher tax rates. Consolidated filing is a method of reporting the taxable income of multiple corporations on a single return. It is used generally where the same stock ownership (80 percent) requirements as that of the federal consolidated rules are met. In addition, a state may require that only the affiliated entities that have nexus with the state be part of the consolidated return. Consolidated filing may also be allowed or even required where separate filing does not fairly reflect a company s income or economic activities. Combined reporting requires the members of a unitary group to calculate their taxable income on a combined or unitary basis. A combined report ignores the legal structure of a corporation or affiliated group in order to focus on the entities underlying economic reality. If a group of companies are interrelated in certain specific ways, and function as one economic unit, they will be taxed as one entity, and any legal or geographic divisions will be ignored. To be in a combined report the entities must meet one of several unitary tests including the contribution and dependency test, or the tests of functional integration, economies of scale 3

4 and centralization of management. The combined or unitary reporting states include Alaska, Arizona, California, Colorado, Hawaii, Idaho, Illinois, Kansas, Maine, Massachusetts, Michigan, Minnesota, Montana, Nebraska, New Hampshire, New Mexico, New York, North Dakota, Oregon, Texas, Utah, Vermont, Wisconsin, and West Virginia. Allocation and Apportionment Allocation refers to income that is specifically assigned to a particular state. Apportionment is the sourcing of income based upon some formula, usually a combination of the company s payroll, property and sales. For most states business income is subject to apportionment while nonbusiness income is allocable to a specific state, usually the taxpayer s state of commercial domicile. However, some states specifically allocate certain identified types of income, and other states apportion all income. Business income generally includes the following: Income from investments that were made in stocks, bonds, and loans for securing a supply source or market. Income from either short-term or long-term investments of working capital. Income from patents, copyrights, and trademarks that have been either developed or purchased by the taxpayer and used in the business. Income traceable to reserves for the seasonal cycling or fluctuations of the business Income from investments in either horizontal or vertical business expansion, such as the creation of subsidiaries, partnerships, or joint ventures that are linked to the same line of business or industry. Income from commonly owned and controlled corporations. Income from the disposition of investments that produced business income while held by the taxpayer. Nonbusiness income generally includes: Income from surplus funds invested in activities or businesses unrelated to that of the taxpayer. Income from business activities that are unrelated to the taxpayer s core business. Income from farm land owned by a manufacturer. Income from the disposition of investments that produced nonbusiness income while held by the taxpayer. UDITPA (Uniform Division of Income for Tax Purposes Act) provides for the allocation of five types of nonbusiness income to specific states. They are rents, royalties, capital gains, interest and dividends. 4

5 Payroll, Property, and Sales Factors These factors are calculated by determining their in-state amount to their total amounts. Each of these three factors is used to represent fairly a business s activity in a state. However, each state has its own formula and interpretations thereof. Additionally, change is continual. 5