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

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