State and Local Tax Topics

1
State and Local Tax Topics

• Sales and use taxes
• Income taxes
• Internet taxation
• Other state and local taxes (property taxes,
  franchise taxes, employment taxes)
• State tax incentive programs

2
Sales Tax

• Assessed on purchases of tangible personal
  property (and services in some jurisdictions)
• Owed by purchaser, collected by seller and
  remitted to government
• Jurisdiction to assess sales tax exists only if
  seller has nexus within the taxing jurisdiction
• Traditionally requires a physical presence by the
  seller
• Sales via mail or independent shipper do not
  create nexus

3
Use Tax

• Complementary to sales tax systems
• Assessed on purchaser of goods brought into a
  state without paying sales tax
• Would apply to Internet and mail-order purchases
• Self-compliance system
• Out-of-state venders cannot be required to
  collect use tax from purchasers, so many
  transactions escape taxation

4
State Income Taxation

• Issues for multi-state business operations
• State-level definition of taxable income
• States in which business has nexus
• Apportionment of total taxable income to each
  state
• 46 states and the district of Columbia currently
  impose the equivalent of an income tax on
  corporate business operations

5
State-Level Taxation of Multi-State Businesses

• Each state has jurisdiction to tax
• corporations incorporated within the state
• corporations incorporated outside the state with
  sufficient activity in the state to establish
  nexus
• definition of nexus varies by state and may
  differ from sales tax nexus
• generally requires a physical presence
• a manufacturing or sales facility
• company personnel working within the state

6
State-Level Taxation continued

• Some income tax nexus issues
• PL 86-272 solicitation of orders for tangible
  personal property shipped from outside the state
  does not create nexus for income taxation
• Does not apply to income from services
• Economic nexus
• Some states have taken the position that use of
  intangible assets (such as licenses or
  trademarks) within a state creates nexus

7
State-Level Taxable Income

• Common approach
• Federal taxable income before special
  deductions federal deduction for state income
  tax tax exempt interest income- federal bond
  interest income/- differences for differing
  depreciation methods at state level versus
  federal level/- other state-specific
  modifications state-level taxable income

8
Example 1 State-Level Taxable Income

• Santa Fe Corporations federal TI is 2.1 million
  before its deduction for state income taxes. Its
  books and records also reveal
• Tax-exempt muni bond income 15,000
• Interest income on federal bonds 25,000
• MACRS depreciation (federal) 400,000
• Straight-line depreciation (state) 320,000
• Calculate state-level taxable income
• If all of Santa Fes operations are in one state
  with a 7 income tax rate, calculate federal
  taxable income and federal tax liability

9
Defining State Taxable Income

• Direct accounting (tracing of sources income and
  deductions)
• Apportionment of business income
• Uniform Division of Income for Tax Purposes Act
  (UDIPTA)
• 3-factor apportionment formula
• sales factor sales in state A/Total sales
• payroll factor payroll in state A/Total payroll
• property factor property in state A/Total
  property

10
Apportionment Formula

• Portion of total taxable income taxed in state A
  ws sales factor wpay payroll factor
  wprop property factor
• where ws, wpay, and wprop are the weights
  assigned to each factor, and ws wpay wprop 1
• Traditionally, ws wpay wprop 1/3
• Recent changes in state tax legislation have lead
  28 states to double-weight the sales factor, so
  that ws 1/2, wpay wprop 1/4
• 3 states use ws 1, wpay wprop 0

11
Example 2 Apportionment Weighting Alternatives

• Triad Inc. operates in 3 states. State-level
  taxable income before apportionment is 3 million
  and its apportionment factors are
• State A State B State C
• Sales 33 40 27
• Payroll 20 65 15
• Property 10 80 10
• If all 3 states use equal weighting, determine
  income taxable in each state
• If state As income tax rate is 7, state Bs is
  5 and state Cs is 10, determine state tax
  liability
• How would your answers change if state B uses
  double-weighting of the sales factor to apportion
  income?

12
Defining the Factors

• Sales factor
• gross sales less returns, allowances and
  discounts
• sales of inventory and services (not occasional
  sales of business property)
• Inclusion in numerator based on point of
  ultimate destination
• Throw-back rule sourced in state of origination
  if not taxed in destination state

13
Example 3 Sales Factor with and without Throwback

• Amsalu Corporation sells products in 3 states
  with the following sales information
• State A State B State C
• Gross sales 400,000 300,000 200,000
• Returns and (10,000) (5,000)
  (1,000)discounts
• Amsalu ships all products from state A, the
  location of 100 of its property and payroll.
  Total state-level taxable income is 300,000.
  State A assesses 10 income tax state B assesses
  5 income tax but Amsalus activities there do
  not establish nexus. State C assesses no income
  tax.

14
Example 3 continued

• Assuming that state A does not apply throwback
• Calculate the state A sales factor
• Assuming equal weighting, calculate taxable
  income apportioned to state A and state A tax
  liability
• How would your answers change if state A requires
  throwback?
• How would your answers change if Amsalu had nexus
  in state B?
• Calculate state B taxable income and tax
  liability using equally weighted apportionment,
  assuming Amsalu establishes nexus in state B

15
Defining the Factors continued

• Payroll factor
• Wages, salary, commissions, other compensation
  paid to employees
• Inclusion in the numerator based on state in
  which employee primarily performs services
• Property factor
• Real and tangible personal property owned or used
  by the business
• Historical cost of owned property
• 8 times rental value of leased property

16
Example 4 Apportionment Factors - Payroll

• Chimera Inc. operates in 2 states, with the
  following payroll information
• State A State B
• Officer compensation 200,000 100,000
• Other compensation 800,000 700,000
• Calculate payroll factors for both states,
  assuming both include officer compensation
• How would your answers change if state B does not
  include officer compensation in the payroll
  factor?

17
Example 5 Apportionment Factors - Property

• Wave Inc. previously operated only in state A.
  This year it expanded into state B. Its
  property information is as follows
• State A State B
• Beg. Yr. End Yr. Beg. Yr. End Yr.
• Land 100,000 100,000 0 200,000
• Depr. Assets 500,000 600,000 0
  400,000
• Accum. Depr. (50,000) (60,000) 0
  (20,000)
• Inventory 200,000 250,000 0
  200,000
• Wave also leases property in state A for 25,000
  annually
• Calculate Waves property factors in each state.
  If Wave undertakes no further expansion, would
  you expect next years property factors to be
  comparable?

18
Unitary Reporting

• For affiliated groups of corporations, most
  states require reporting only by those
  corporations with nexus in the state
• Typically separate returns for each corporation,
  although some states allow consolidated reports
• Unitary reporting (a few states) includes in a
  combined return the income, sales, payroll and
  property (in denominator) of all members of
  group, including those without nexus

19
Example 6 Unitary Reporting

• Parenti Inc. operates entirely in state A its
  subsidiary, Sub Corp. operates entirely in state
  B. 2001 state-level taxable income for Parenti
  was 400,000 and for Sub was 250,000. Other
  information
• Parenti Sub Total
• Sales 2,000,000 1,200,000
  3,200,000
• Payroll 400,000 300,000 700,000
• Property 900,000 400,000 1,300,000

20
Example 6 continued

• If state A requires unitary reporting, uses
  double-weighting of sales, and has a 7 tax rate,
  calculate state A taxable income and tax
  liability
• If state B requires separate (non-unitary)
  reporting, uses equal-weighting, and has a 10
  tax rate, calculate state B taxable income and
  tax liability
• How would your answers change if both states
  required unitary reporting? Both separate
  reporting?

21
Internet Taxation Issues

• Nexus issues
• Location of warehouses retail stores
  establishes physical presence for sales and
  income taxation
• Most bricks-and-mortar retailers have established
  separate legal entities for their Internet sales
  divisions
• Economic nexus notion for income tax could extend
  to computer software
• Other sales tax issues is downloadable,
  digitally transmitted music or software a
  tangible product?
• Internet Tax Freedom Act imposes moratorium on
  new Internet taxes

22
State Tax Incentive Programs

• Vary from jurisdiction to jurisdiction
• Some examples of types of incentives offered
• Investment tax credits, property tax abatements
• Jobs credits, payroll tax credits
• State enterprise zones
• Low-interest financing via industrial development
  bonds
• Apportionment exclusions
• Exemption from sales throwback
• Exclusions of certain property additions
• Tax increment financing

23
Incentive Program Requirements

• Many substantial state incentive packages require
  advance negotiation directly with the taxing
  authority or state development agency
• Legislative caps restrict overall funds available
  but do not specify allocation
• Certification and documentation requirements are
  often voluminous, and failure to comply fully can
  result in loss of negotiated benefits
• Specialized tax consultants can be of great
  assistance in negotiations and meeting compliance
  requirements