Importance of State and Local
Tax Planning
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Various Types of Taxes Levied on Business
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Various Business Transactions Subject to
Taxation
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Review Table 1.1
Review Illustration 1.1
Disparity of Tax Rates Across Jurisdictions
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Tax Liabilities Among Multiple Jurisdictions
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“Today’s entrepreneurs and managers thus must be well
versed in the basics of state and local tax planning…”
Types of Taxes
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Corporate Income and Franchise Taxes
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Simplified Formula: [(Federal taxable income +/- state
adjustments) X State rate] – State Credits and Estimated
Taxes
Key Issues
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When is a business subject to a state’s taxing
jurisdiction?
How should the corporation split income in a multistate operation?
Compliance Procedures and Tax Controversies are some
what similar to Federal.
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4 year statute of limitations.
Amendments filed 90 days of Federal Amendment
Appeals process less friendly than federal, use regular
courts rather than tax court.
Individual Income Taxes
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Residency
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Calculation of base
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Resident—Physically present in the state for other than a
temporary or transitory purpose. Taxed on world wide income.
Non Resident—An individual who is not a resident. Taxed only on
income sourced within the state.
Part year resident—A resident who moves into (out of the state)
during the tax year. Taxed on income received while a resident.
Starts with Federal Taxable Income or AGI, adjustments, tax rates
and credits similar to corporate formula
Sourcing of Income
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Generally sourced where earned.
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Rents—By jurisdiction where the property is located
Royalties—Where the intangible is being used
Services—Where the service is rendered.
Flow Through Entities
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Generally not taxed on the state level
Resident partners/shareholders taxed on their
distributive share of income regardless of jurisdiction
Non resident partners/shareholders taxed (1) in the
state of their residence and (2) in the state where
the income is earned. The state of residence
generally allows a credit for taxes paid to another
state.
Non resident partners/shareholders are often
permitted to file a composite (group) return.
Many states have withholding or other arrangements
to collect taxes owed from non-residents.
Sales and Use Taxes
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Imposed on the Consumer
Rates set at the state level; cities and
counties may levy an additional tax.
Based on a percentage of purchase price.
Definitions are very important
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Certain types of sales are exempt
Tax rate depends on the nature of the product
sold.
Definitions determine the difference between
products and services.
Property Taxes
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Assessed against realty, in many
settings also personalty
Local government assesses the tax in
most cases.
Valuation methods, tax rates and
Assessment dates vary
Other Taxes
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Payroll (unemployment compensation) and excise taxes—very
important
Capital stock taxes
License taxes—important
Estate (Inheritance) and Gift Taxes
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Estate tax structure was generally uniform until 2001, not varies
considerably
Gift taxes are rare
Additional Taxes
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Transfer Tax
Incorporation
Severance
Telecommunications
Tourism
Highway Use
Sources of Law
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U.S. Constitution
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State Constitutions
Legislative Law Sources
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Statutes are the highest authority
Administrative Law Sources
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Jurisdiction and Nexus are important issues. See next slide.
Commerce Clause
Due Process
State revenue agency administers the law. The agency issues regulations
and rulings, letter rulings.
Counties and cities assess and collect property taxes
Specialized agencies collect capital stock taxes, employment taxes, and
public utility taxes.
Judicial Law Sources
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Only bind states over which the court has jurisdiction.
Trial, intermediate appellate, and final appeal courts--> US Supreme Court
Multistate Law Sources
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Multistate Tax Commission
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Encourages states to adopt tax laws that apply to
multistate and multinational enterprises
Over ½ of the states are full or associate
members of MTC
UDITPA
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“Seeks to properly and consistently determine the
state and local tax liability of multistate taxpayers.
Applies primarily to apportionment methods.
Most states have adopted UDITPA in whole or in
part.
Generic State and Local Tax Planning
Strategies
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Shifting and Splitting (Examples 1.1 &
1.3)
Location (Example 1.4)
Transformation (Example 1.6)
Timing (Example 1.7)
Apportionment (Example 1.10)
State and Local Tax Research
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Scanning the changing state and local
tax environment for (1) non tax
changes in the business environment
and (2) changes in tax rates and tax
credits
Tax Management in Action 1.1 Web
Sites
Appendix A
Corporate Income/Franchise
Tax
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Effective and Statutory Rates (Table
3.1)
Nexus
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Definition and judicial history differs from
sales tax
Four tests for franchise tax purposes.
Domestic corporations have nexus with
state of incorporation; foreign corporations
must meet the nexus rules.
Definitions
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Jurisdiction
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A State’s Power to
Impose a Tax
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Nexus
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A Taxpayer’s Contact
with a State
Elements of Public Law 86-272
If a seller from state B has only the following
business activities in state A:
 Solicitation
 By an employee or representative
 Of orders for tangible personal property
 Sent outside the state for approval, and
 Filed by shipment or delivery from a point outside the
state.
Then the seller from state B owes no income tax to
state A.
Wisconsin Department of Revenue vs.
William F. Wrigley, Jr. Co. (1992)_
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Solicitation of chewing gum orders
Stock of display racks and gum
Distribution of gum samples
Replacement of stale gum
Retail display racks
Rental of storage space
Administrative and personnel-related issues
Wrigley Decision
The U.S. Supreme Court:
 Rejected a narrow construction of
“solicitation”
 Concluded de minimus exception is
applicable under Public Law 86-272
 Decided Wrigley’s non-immune activities
were neither ancillary to requesting
orders or de minimus.
Wrigley Decision
The U.S. Supreme Court:
 Rejected a narrow construction of
“solicitation”
 Concluded de minimus exception is
applicable under Public Law 86-272
 Decided Wrigley’s non-immune activities
were neither ancillary to requesting
orders or de minimus.
Multistate Tax Commission—
Interpretation of PL 86-272
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Only solicitation to sell personal property is
protected
Intangibles are not protected
Sale or delivery and their solicitation are not
protected unless it is either:
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Ancillary to solicitation
From the protected list
In-state activity limited to solicitation
(exceptions; de minimus and independent
contractor activities)
Multistate Tax Commission—
Interpretation of PL 86-272
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Only solicitation to sell personal property is
protected
Intangibles are not protected
Sale or delivery and their solicitation are not
protected unless it is either:
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Ancillary to solicitation
From the protected list
In-state activity limited to solicitation
(exceptions; de minimus and independent
contractor activities)
State C Corporation Income Tax
Formula
Federal corporate income tax base
±
=
=
X
=
+
=
X
=
=
State adjustments
Total corporate income tax base
Non-business income
Total apportionable state income
State apportionment percentage
State apportioned business income
Allocated non-business income
State income tax base
Statutory Income tax rate
State income tax
Credits
Net State Tax
State C Corporation Income Tax
Formula
Federal corporate income tax base
±
=
=
X
=
+
=
X
=
=
State adjustments
Total corporate income tax base
Non-business income
Total apportionable state income
State apportionment percentage
State apportioned business income
Allocated non-business income
State income tax base
Statutory Income tax rate
State income tax
Credits
Net State Tax
State Adjustments
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Interest income on Federal general obligations
State and local interest income (same state)
Federal income tax (AL,IA,LA,MO,ND)
State income taxes (usually an add-back)
Foreign income taxes (1/2 of the states)
NOL’s (tax management in action 3.1)
Dividends received deduction (0 or limited to domicile)
Depreciation (non conformity, disallowance of bonus & § 179) ,
depletion and amortization
Foreign Dividends and Subpart F income
Deductions foregone because of a federal credit
Charitable contributions (different limits)
Business v. Non-business
Income
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Business income—apportioned
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Transactional test—”transactions and activities in
the regular course of the tax payer’s trade or
business”
Functional test—”acquisition, management, and
disposition of the property constitute integral parts
of the regular trade or business.”
MTC Compact examples
Non-business income—allocated
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Example 3.6
Allocating Non-business
Income
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Non-business income sourced to a
particular state
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Examples 3.7 & 3.8
Table 3.2
Shannon Properties—business and nonbusiness income components
Apportionment Rules for
Business Income
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Taxable in Another State
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Net income tax
Franchise tax measured by net income
Franchise tax for privilege of doing
business
Corporate stock tax in another state
Apportionment Rules for
Business Income--Continued
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Unitary Taxation
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Generally states west of Mississippi river.
Tax management in action 3.3 provides a list of unitary and
separate reporting states.
Combined returns available
 Similar to consolidated returns but with foreign affiliates
 Business income partitioned among the jurisdictions in which
the group operates based on a rough approximation of the
companies’ presence there.
 Usually uses a three factor formula: sales, property and
payroll.
 States only apportion the business income of a unitary
business or part of a multistate business that constitutes a
unitary business (all activities of a single business entity)
 Parts of the same groups of companies—whether incorporated
or not—are usually considered unitary if they are consolidated
for GAAP purposes.
 Review Example 3.10
Apportionment Rules for
Business Income--Continued
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Separate Accounting
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Each corporation doing business in a state files a
separate return even if it a member of a group
that files a federal consolidated return.
However states do allow consolidated returns for
corporations domiciled in that state and in some
instances for foreign corporations that are
members of an domestic affiliated group.
Review Tax Management in Action 3.4 & footnotes
Three-Factor Apportionment
Formula
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Table 3.3 Apportionment Factor Weighting by State
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Review IA & MN apportionment factors
Property Factor
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Property included if it is owned or rented and used by the
taxpayer during the tax period.
Usually does not include intangibles
Mobile property is sourced to each state based on a ratio of either
time spent or miles traveled.
Property in transit is sourced to the buyer’s destination state.
Owned property is generally valued at original cost usually
averaged at the beginning and end of the year.
The net rental cost of the property rented for the year multiplied
by eights becomes the property factor component.
Businesses may reduce state income taxes by shifting property or
payroll to a low income tax state. Citibank example.
Apportionment Rules for
Business Income--Continued
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Payroll Factor
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Exclude payroll related to non-business income
Payroll Sourcing Rules (employee services within state)
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Source wages to the state where a majority of the services are
performed, if only incidental services are performed outside
the state.
If the services outside the state are more than incidental
sources wages to the state that is the base of operations for
the employee
If the employee has no base of operations, source wages to
the state from which the employer exercises direction and
control, but only as long as some services are performed in
that state.
If the employee’s wages cannot be sources under the first
three criteria, use state of residence.
Payroll Formula: Payroll nexus state/Total compensation
everywhere
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Planning: Locate management in states that do not
include executive compensation in the payroll factor.
Apportionment Rules for
Business Income--Continued
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Sales Factor
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All gross receipts from transactions and activities
conducted in the regular course of the taxpayer’s
business.
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Gross receipts = gross sales – returns and all. + interest
charges + service charges + federal and state excise
(sales) taxes + commissions + rental income + royalties
+ proceeds from disposition of tangible and intangible
assets (business income)
Non business income is excluded
Sales of a significant asset are included
Apportionment Rules for
Business Income--Continued
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Sourcing Rules for Sales
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Tangible Personal Property
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Sourced at state of destination
State of origin for purchaser is US government or
taxpayer is not taxed at state of destination (throwback
rule)
Review Table 3.4, Throwback rule creates “nowhere
states’
Planning technique—create warehouse or production
facility in a state that does not have the throwback rule
Double throwback rule applied in some states for drop
shipments
Foreign sales—general rule is if purchaser pay income
tax in foreign country, sale is foreign source
Apportionment Rules for
Business Income--Continued
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Receipts Other Than Tangible Personal
Property
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Includes employee services, rentals, licensing
or other use of intangible personal property
Sourced to location of income producing
activity
If activity takes place in more than one state,
apportionment is based on the cost of
performance.
Apportionment and Consolidated
or Combined Tax Returns
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Combined Returns
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Mandatory
Includes the pooled information of the corporation and other
members of the unitary group
Members of the unitary group are treated as a single corporate
entity for purposes of apportionment. The combined factor is
applied to the unitary group’s combined income
Consolidated Returns in a Unitary State
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The Unitary group and the affiliated corporations may be the
same.
However, a consolidated group may include corporations that are
not members of the same unitary group. To apportion income the
group may use one of two methods:
 Separate method—company by company basis
 Consolidated method apportions the groups aggregate
income.
Combined Returns: Sales Factor
Sourcing and the Throwback Rule
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The separate entity approach
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Each unitary group member’s sales are subjected
to the throwback rules before the numerator of
the group’s combined sales factor is determined.
The unitary approach
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All sales into the state are sourced to it regardless
of the status of the members.
Sales into other states that would be thrown back
are not thrown back if any member of the unitary
group is taxable in the other state.
Combined Returns and Unitary
Taxation
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What constitutes a unitary business?
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The three unities test
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The functional integration test
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Contributions to income result from functional integration,
centralization of management, and economies of scale.
Contribution dependency test
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Unity of ownership
Unity of operation
Unity of centralized executive force and system of operation
The member makes a contribution to, or depends on,l other members
of the unitary group./
Multistate Compact Unitary Business Regulations
Unitary Checklists (TMA 3.5)
Worldwide Unitary Business
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Water’s edge unitary group—domestic corporations and foreign
corporations with more than 20% of their activity in the U.S.
Water’s edge election available in many unitary states
Apportionment and Consolidated or
Combined Tax Returns--Continued
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Consolidated Returns
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Voluntary
Pools the operations of affiliated corporations
operating in a non-unitary state or non-unitary
corporations operating in a unitary state.
Beneficial if affiliates having NOL’s are combined
with profitable affiliates
Used in both unitary and non unitary states.
A group of affiliated corporations that files a
consolidated return is called a consolidated group.
Alternative Apportionment
Formulas
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Single factor sales
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Two Factor Election
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Detrimental to out-of state business
Used in Iowa/Texas
Missouri election
Colorado, Hawaii
Industry specific formulas
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Railroads, Financial Institutions, Radio,TV
broadcasting
Taxation of Flow-Through Entities
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Partnerships
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For corporate partners
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Partnership must separate business and non-business income
based on the relationship between the asset-yielding income
and the partnership income.
The partner must then also separate business and nonbusiness income based on the relationship between the
partnership’s business and the corporate partner’s business
Apportionment Methods for corporations
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On the partnership level—allocated to the specific partner
Flow through methods—flows through to the corporation and
is combined with other corporate activities.
Corporate level—stand alone factors are multiplied by the
distributive share of partnership income
Example 3.32
Taxation of Flow-Through Entities
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Limited Liability Companies
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Florida, Texas and Pennsylvania tax as
corporations
Can use check the box regulations to elect flow
through status (partnership, Subchapter S or in
some cases proprietorship)
Subchapter S Corporations
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Not taxed in most states, five states have a “toll
charge”