Answers to Five Questions on the Continuing Tax-Based Competitive Give and Take Among the States

JEFF SAVIANO is a Principal and leader of Ernst & Young LLP’s Americas Indirect & State/Local Tax practice. STEVE WLODYCHAK is a Principal and Ernst & Young LLP’s Center for State Tax Policy Leader. The views expressed are those of the authors and do not necessarily represent the views of Ernst & Young LLP or the global Ernst & Young organization.

In this first in a series from Ernst & Young LLP on today’s most Taxing Issues, Jeff Saviano and Steve Wlodychak tackle five key questions on a vital issue of state tax policy and practice.

Why isthere so much tax-based competitionamongthe states?
Jeff Saviano: Fundamentally, states are competing with one another to attract businesses. Meanwhile, there’s also a continuing struggle among states and companies: states want to maximize tax revenue; corporations want lower tax bills.

Understanding how this became so contested requires a bit of commercial history. A hundred years ago, companies operating in multiple states were often subjected to double taxation. A product might be manufactured in one state then sold to a buyer in a second state, but both states would claim all or a portion of the income from that sale for state income tax purposes. So the company would be taxed twice on the same income.

Steve Wlodychak: Apportionment of multistate income for individual state tax purposes remained contentious for many years. Then in 1965, Congress, at the behest of American industry, established the Willis Commission to study ways to harmonize interstate tax rules and practices.

The Commission’s proposal was to create a special division of state taxation in the U.S. Department of Treasury, the Federal State Income Tax Division (FSITD ). Instead of filing multiple state returns, multistate taxpayers would file a single form with the FSITD using federal taxable income as a starting point and applying uniform rules of apportionment to each state based on two factors: property and payroll.

In this way, all investment and income generated by each corporation nationwide would be accounted and apportioned to each state under uniform rules. There would be no opportunity by either the companies (to avoid taxation) or the states (to compete based on tax characterizations). Of course, each state would be free to adjust its tax rate on the income so apportioned, but not the rules for measuring property or payroll or for determining taxable income.

Saviano: But resistance to this idea was widespread. Many states were against new limits on their sovereignty. So-called “market” states realized that under a property/payroll formula, they would be unable to tax the income of out-of-state companies selling into their state if those companies did not have a local presence. Also, the fact that the proposed FSITD would act as the sole collection agent further diminished states’ control of their own revenues.

The states universally rejected this proposal but instead offered their own solution to the problem of multistate taxation. They created the Multistate Tax Commission (MTC) and the Uniform Division of Income for Tax Purposes Act (UDITPA), which essentially provided taxpayers with two options to report and apportion their income to the states:

One, a taxpayer could now elect to use a standard, three-factor apportionment formula. That is, in addition to property and payroll, there were also rules to evaluate revenues to determine income-serving to obviate the objections of market states.

Two, a taxpayer in any given state could simply elect to follow the state’s own apportionment rules. What all of this accomplished was that it began forcing more states to adopt more uniform practices. And by the late 1970’s, nearly all the states did just that.

So whydo problems and challenges still persist today?
Saviano: Today, we have states working incredibly hard to compete with one another to attract and retain businesses. So they’re engaging in economic development activity which includes all types of tax incentives-some more direct than others. For example, states can legislatively adopt a single sales factor approach and then tell companies: “Locate here, invest, employ and build and you won’t need to worry about your corporate income tax bill rising because of the property or employees located within our state.” Companies can pass on electing application of the standard three factor apportionment formula (option one above) and instead take option two, adopting an apportionment formula with a more heavily weighted sales factor. While this is good for the state and in-state company in question, it penalizes companies from out of state.

Another problem, 50 years ago, when today’s rules were being formulated, you could touch and feel the things we bought and sold, making it easier to determine where something was made and where the earnings should be taxed. No one had ever heard of software, or imagined that the bulk of a product’s value could be based on intellectual property (IP). Enormous growth in payments for things like royalties and service fees increase the likelihood that significant amounts of income will not be taxed at all.

Wlodychak: For a good illustration, think about the emergence of the Delaware Holding Company in the 1990s. Companies could set up a Delaware Holding Company that would perform services on behalf of other related companies operating outside of Delaware. They would also transfer a good portion of the company’s IP to this new entity, which could now charge royalties or fees for logistics, risk, intellectual property usage or insurance services to other companies which they deducted in computing their separate return taxable income. This increased profits in Delaware, reducing taxable income in other states.

But Delaware imposes no taxes on this income-part of the attraction of the structure. So for state tax purposes, this had the effect of creating non-taxed income. Ironically, we’ve moved from a focus on avoiding double taxation to now making sure that all income is subject to state tax-somewhere.

How are states dealing with these challenges? Click here to continue reading…Answers_to_Five_Questions_on_the_Continuing_Tax_Based_Competitive_Give_and_Take_Among_the_States__Jo

Tax Base: States, Local Agencies Pushing the Envelope On Pass-Throughs, Nexus, Practitioners Say

Tax Base

States, Local Agencies Pushing the Envelope
On Pass-Throughs, Nexus, Practitioners Say

By Michael Kerman

Dec. 10 — Taxpayers need to pay close attention to states’ increased willingness to seek additional sources of revenue, determine nexus and apply their tax laws retroactively, prominent attorneys and accountants told attendees at New York University’s 33rd Institute on State and Local Taxation Dec. 8 and 9 in New York City.

Why might state tax administrators be getting more aggressive than in past years? Perhaps because state corporate income tax collections are still at pre-recession levels, said Steve Wlodychak, principal with Ernst & Young LLP in Washington. Plus, more than 90 percent of businesses are now structured as pass-through entities, said Bruce Ely, a partner with Bradley Arant Boult Cummings LLP in Birmingham, Ala. With business income flowing through and being reported on individual income tax returns, states could be losing out on a valuable revenue source.

Pass-Through Entities

States have become more aggressive in applying the business tax concept of nexus to pass-through entities. It is unclear whether a taxpayer can trigger income tax nexus in a state by owning an interest in a pass-through entity that operates within the jurisdiction’s borders, said Wlodychak. While the U.S. Supreme Court has held that merely holding stock in a corporation is not enough to create nexus, the court has never addressed the question as it applies to pass-through entities.

State court decisions haven’t provided much clear guidance either. “It’s like watching a pinball bounce back and forth; there’s no clear answer,” said Wlodychak. For example, in Swart Enterprises Inc. v. Cal. Franchise Tax Bd., No. 13CECG02171 (Cal. Super. Ct. 2014), a California Superior Court held that an Iowa hog farmer with a 0.02 percent interest in a California pass-through did not have nexus through such a small ownership interest.

However, in another case, BIS LP Inc. v. New Jersey Div. of Taxn., 26 N.J. Tax 489 N.J. Super. Ct. App. Div. 2011), New Jersey found a U.K. company to not have ()nexus despite having a 99 percent ownership interest in a New Jersey company. There, the court said that despite the large ownership interest, the U.K. company was a limited partner with no management control. In another New Jersey case, Village Super Market of PA Inc. v. New Jersey Div. of Taxn., 27 N.J. Tax 394 (N.J. Tax Ct. 2013), nexus was found for a limited partner because it had the same officers and directors and shared a mailing address. Thus, decisions cannot always be predicted based solely on the level of ownership or on whether the owner is a limited or general partner, Wlodychak explained.

Don’t Mess With Nexus

Corporate entities subject to business taxes continue to struggle with nexus issues. Click here to continue reading…Tax Base – States, Local Agencies Pushing the Envelope On Pass-Throughs, Nexus, Practitioners Say

What Businesses Really Pay in State and Local Taxes, and Why the Sales Tax Shouldn’t be #1

FERDINAND HOGROIAN serves as Tax & Legislative Counsel at the Council On State Taxation (COST). The views expressed here are his own and do not necessarily reflect the views of COST or its member companies.

Each year, the Council On State Taxation issues its study on the total state and local business tax burden. 1 From my experience in conferences and seminars and from observing coverage in the tax press, the study seems to spark surprise anew each year. Why is that? One reason is the prominence of the corporate income tax in corporate tax departments and state departments of revenue, consuming an outsized portion of private and public sector resources.

Another reason is the ease with which corporate income taxes can be employed in corporate “shaming” campaigns. It is this latter reason which sparked the COST business tax burden study in 2002, as then-New Jersey Governor Jim McGreevey was waging a war on corporate tax “cheats” amidst declining corporate profits and recession.

The total business tax burden.

COST’s study serves to remind policymakers, as it did in 2002, that businesses actually pay a relatively constant share of total state and local taxes. Click here to continue reading…What_Businesses_Really_Pay_in_State_and_Local_Taxes__and_Why_the_Sales_Tax_Shouldn_t_be__1__Journal_

Best practices for obtaining and evaluating credits and incentives.

Over the past several decades, more and more states have been offering tax credits and incentives to encourage economic development in their jurisdictions. Accordingly, a business should prepare an incentives analysis every time it considers making a capital investment or growing jobs. This applies to every material capital outlay in any type of real estate, machinery or equipment. That is, the business should investigate and evaluate whether the federal, state and local governments where the investment will be located (or could be located) will partner with them by providing financial and other incentives to encourage the businesses to locate (or relocate) within their boundaries. Oftentimes, businesses can overlook these opportunities because the proposed acquisition has to be kept confidential, or time is of the essence and there is not sufficient leeway to negotiate incentives. Even so, factoring the potential for obtaining financial assistance from state and local governments could prove worth the time and trouble.

Click here to continue reading: Credit and Incentives

News Release: Rauschenberger Announces Online Release of 2014 State and Local Taxes Comparative Guide

Rauschenberger Announces Online Release of 2014 State and Local Taxes Comparative Guide
BISMARCK, N.D. – Tax Commissioner Ryan Rauschenberger announces an online release of the 2014 State and Local Taxes Overview and Comparative Guide, better known to some as the “Red Book.”
The State and Local Taxes Comparative Guide has a section for each North Dakota tax type explaining current law and historical overview along accompanying tables, graphs and/or charts. “The oil and gas taxes section has an abundance of information,” explains Rauschenberger. “This publication is proving to be a timely resource as it also explains oil tax incentive ‘trigger’ provisions.”

The State and Local Taxes Comparative Guide is a bi-annual publication of the Office of the State Tax Commissioner that is published in concurrence with the North Dakota Legislative session.

“The 2014 State and Local Taxes Comparative Guide has a new look this year, which includes an additional color on the inside,” said Rauschenberger. “This makes the information easier to read. We also added property tax graphs showing ad valorem and special taxes by property class and taxing district as well as taxable value by property class and average mill levies by taxing district.”

The online version of the 2014 State and Local Taxes Overview and Comparative Guide may be found on the Office of State Tax Commissioner’s website at http://www.nd.gov/tax. Printed copies will be available mid-January.