Closing State Corporate Tax Loopholes

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Closing State Corporate Tax Loopholes

• Michael Mazerov (mazerov_at_cbpp.org)
• Center on Budget Policy Priorities
• AFL-CIO Workers Voice Conference
• San Francisco, California
• July 20, 2003

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Why address state corporate tax loopholes (and
giveaways)?
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Why address state corporate tax loopholes (and
giveaways)?
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Why address state corporate tax loopholes (and
giveaways)?
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Why address state corporate tax loopholes (and
giveaways)?
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First, DO NO HARMStop New Revenue Losses From

• State corporate income tax coupling to federal
  deduction for bonus depreciation in 2002 and
  2003 federal tax cut bills
• States can decouple their laws 31 have already

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States that Need to Decouple from Federal
Bonus Depreciation
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First, DO NO HARMStop New Revenue Losses From

• New economic development giveaways.
• Still proliferating (e.g., single sales factor
  corporate tax formula enacted this year in
  Wisconsin)

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First, DO NO HARMStop New Revenue Losses From

• Proposed federal legislation restricting state
  corporate tax powers
• Known as business activity tax (BAT) nexus
  bill
• Would require a corp. to have a substantial
  physical presence in a state before that state
  could tax its profits
• Higher nexus threshold than required at present,
  so states would lose rapidly
• Opens up all kinds of new tax shelters

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First, DO NO HARM Block Proposed BAT Nexus Bill
to Avoid Revenue Losses

• NCSL considering resolution to endorse proposed
  BAT nexus bill
• Corporate America demanding this bill as quid pro
  quo for empowering states to tax Internet sales
• NCSL (rightfully) wants this but too high a
  price to pay
• Need to block any NCSL resolution on BAT nexus at
  this time

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Closing Corporate Tax Loopholes Delaware Holding
Companies

• Public Enemy 1
• A-k-a Passive Invest. Co. (PIC) or Intangibles
  Holding Co. (IHC)
• Most often set up in DE, NV, MI
• Most famous DHC is Geoffrey Giraffe DE
  subsidiary of Toys R Us
• Are essentially shell corporations set up by
  banks and accounting firms HQs of 500 DHCs
  are in a single DE building

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How the DHC game works

• Step 1 Parent corporation sets up DHC in state
  without corporate income tax (NV) or that doesnt
  tax corps whose only income is from intangible
  assets (DE, MI)
• Step 2 Parent transfers to DHC its patents,
  trademarks, know-how, etc.
• Step 3 DHC licenses back to parent the right to
  use patents, trademarks, etc. in exchange for
  tax-deductible royalties
• Result payment of royalties reduces (perhaps
  eliminates) taxable profit of parent, while DHC
  is not subject to tax on its profit

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Documented DE Holding Companies(see Glenn
Simpson, A Tax Maneuver in Delaware Puts Squeeze
on Other States, Wall Street Journal, 8/9/02,
page 1)
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States Still Losing Revenue to the DE Holding
Company Tax Shelter
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Shutting Down DHC-sStrategy 1 Quick Fix

• Amend state law to deny deductions for
  royalty/interest payments to DHC subsidiaries in
  tax haven states
• Already enacted in AL, CT, MA, MS, NC, NJ, OH
• Proposed and still alive in DC, PA
• Business killed in MD, MO, TX
• MA and NJ laws best model business community has
  pushed through ineffective/weak versions in AR
  NY

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Shutting Down DHC-sLong-term Solution

• Switch state corporate income tax to combined
  reporting by amending law
• Treats parent and subsidiaries as one corp. for
  tax purposes therefore, no benefit to shifting
  income to DHC
• Also nullifies other strategies for shifting
  income to out-of-state subsidiaries
• 16 states already use
• Govs, legislators, or activists pushed this
  session in IA, MD, MA, NY, WI (no success)

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States that Need to Adopt Combined Reporting
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Closing Corporate LoopholesNowhere Income

• Problem Corporations can make sales in states in
  which they dont cross taxability threshold
  have nexus
• Solution enact throwback or throwout rule
• Ensures that corps. are taxed on profits they
  earn in states where they arent taxable home
  state taxes profit instead
• NJ enacted 2002 MD 2003 (Gov vetoed)

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States that Need to Adopt Throwback Rule
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Eliminate Unwarranted Corporate Tax Giveaways

• Repeal single sales factor formula
• Giveaway to corps. that sell most of what they
  produce out of state especially manufacturers
• Big business still actively seeking in AZ, CA,
  NJ, NY, PA, RI (be on guard)
• Repeal being pushed in IL, MA, MO

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States that Need to Repeal Single Sales Factor
Formula (and Similar Giveaway)
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Eliminate Unwarranted Corporate Tax Giveaways

• Repeal ability of corporations to carry back
  current losses to years in which they were
  profitable and obtain refunds of taxes paid in
  those years
• Only minority of states still allow

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States that Need to Repeal NOL Carrybacks
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Other Current Corporate Tax Reform Efforts

• Legislation was introduced in TX to close
  Delaware Sub loophole (use of limited
  partnerships to avoid franchise tax). Gov.
  supported business killed.
• NV Gov. Quinn proposed business gross receipts
  tax OK, but CIT better. Business killed.

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Other Corporate Tax Reform Options Enact
Corporate Minimum Taxes

• Enact a second corporate tax not based on
  profits corp. pays higher of profits tax or tax
  on other base
• NJ enacted alternative minimum tax last year
  based on gross receipts
• Another good model is NHs alternative tax based
  on value added

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Other Corporate Tax Reform Options Stop Tax
Avoidance from Limited Liability Companies

• LLCs are businesses whose profits are taxed on
  the owners tax returns whether owners are
  individuals or other businesses
• Growing evidence that corps are using LLCs to
  avoid state profits taxes
• Need to pass laws requiring LLC to withhold and
  pay tax due from out-of-state owners unless
  owners agree in writing to pay tax due on their
  pro-rata share of LLC income

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Chipping Away at the Internet/ Catalog Sales Tax
Loophole

• Need federal law to ensure sales taxation of all
  Internet/catalog sales
• But states can require their vendors to collect
  sales taxes (e.g. Dell Computer). AR, NC, SD do.
• States can amend and then enforce laws to compel
  dot-com subsidiaries of retail store chains to
  charge sales tax (e.g. Barnes Noble.com)

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A recent column headline (and accompanying
cartoon)

• Its Time to Curb Corporate Tax Shenanigans
• From
• The Nation?
• Mother Jones?

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• No!
• The Wall Street Journal (9/19/02)

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Closing Corporate Tax Loopholes Repealing
Unwarranted Giveaways

• Time is ripe take advantage of current anger
  about phony financial reporting and aggressive
  tax sheltering to push reform
• Can raise meaningful amounts of revenue now and
  help preserve state programs from budget cuts
• Lays the groundwork for revitalization of corp.
  income tax as state revenue source without it,
  CIT will steadily decline