1

State and Local Tax TopicsState 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 TaxSales 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 TaxUse 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 TaxationState 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-Level Taxation of Multi-State BusinessesState 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 continuedState-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 IncomeState-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 Example 1: State-Level Taxable IncomeIncome

Santa Fe Corporation’s 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 Fe’s operations are in one state with a

7% income tax rate, calculate federal taxable income and federal tax liability

9

Defining State Taxable IncomeDefining 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 FormulaApportionment 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 Example 2: Apportionment Weighting AlternativesWeighting 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 CSales 33% 40% 27%Payroll 20 65 15Property 10 80 10 If all 3 states use equal weighting, determine income taxable

in each state If state A’s income tax rate is 7%, state B’s is 5% and state

C’s 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 FactorsDefining 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 Example 3: Sales Factor with and without Throwbackand without Throwback

Amsalu Corporation sells products in 3 states with the following sales information:

State AState BState 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 Amsalu’s activities there do not establish nexus. State C assesses no income tax.

14

Example 3 continuedExample 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 continuedDefining 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 Example 4: Apportionment Factors - PayrollFactors - 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 Example 5: Apportionment Factors - PropertyFactors - Property

Wave Inc. previously operated only in state A. This year it expanded into state B. It’s property information is as follows:

State A State BBeg. Yr. End Yr. Beg. Yr. End Yr.

Land $100,000 $100,000 $0 $200,000Depr. Assets 500,000 600,000 0 400,000Accum. 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 Wave’s property factors in each state. If Wave

undertakes no further expansion, would you expect next year’s property factors to be comparable?

18

Unitary ReportingUnitary 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 ReportingExample 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 900,000 400,0001,300,000

20

Example 6 continuedExample 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 IssuesInternet 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 ProgramsState 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 RequirementsIncentive 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