State Business Activity Taxes:Where are businesses and their owners required to file and pay taxes?

June 23, 2020

• State Tax Nexus Overview

• Public Law 86-272 Protections

• Common state income tax structure- Federal Conformity

- COVID-19 Extensions

- Pass-through entities

• Non-Income Based Taxes

• Market-Based Sourcing

Agenda

Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

• Due Process Clause requires: (1) “some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax”; and (2) income must be rationally related to the values connected with the state.

• Commerce Clause prohibits states from imposing undue burdens on interstate commerce.

U.S. Constitutional Considerations

4 Prong Test:

• Taxpayer and activity must have substantial nexus with the state

• Not discriminate against interstate businesses

• Be fairly apportioned

• Fairly relate to services provided by the State

Commerce Clause Protection

South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (June 21, 2018)

• Physical presence is not necessary to establish substantial nexus for sales / use tax collection.

• Did Quill’s physical presence requirement apply to other state taxes?

Kimberly Rice Kaestner 1992 Family Trust v. N.C. Dep’t of Rev., 588 U.S. ____ (June 19, 2019).

• Presence of in-state beneficiaries alone did not allow state to tax trust income.

• Contingent beneficiaries did not receive distributions and could not compel future distributions.

Quill is Killed!

All states with sales/use tax have implemented economic nexus, except FL and MO.

• Effective dates for enforcement

• Sales / transactions thresholds

• Registration may trigger inquiry for other state taxes

Expansion of Sales Tax Collection Obligations

Substantial nexus exists for business activity taxes (i.e. non-sales/use taxes) if any of the following are present:

• $50,000 of property in the state;

• $50,000 of payroll in the state;

• $500,000 of sales in the state; or

• 25% of total property, payroll or sales are in the state.

Multistate Tax Commission (MTC)

Factor Presence Standard

• California• Connecticut• Colorado• Kansas• Michigan• New York• Ohio• Oregon• Texas• Washington

Economic Nexus Standards

KFC subject to Iowa Corporate Income taxes based upon income generated from licensing KFC’s trade marks and systems to franchisees in the state. 792 N.W. 2d 308 (Dec. 30, 2010).• First, KFC’s economic presence (receiving royalties from the licensing of

intangibles in Iowa) was “the functional equivalent of ‘physical presence’ under Quill.”

• Alternatively (and more reasonably in my opinion), Quill bright-line physical presence standard did not apply to income-based taxes.

• Consistent with a South Carolina case involving the licensing of Toys-R-Us’ trade marks and other intellectual property. Geoffrey, Inc. v. S.C. Tax Comm’n, 437 S.E.2d 13 (S.C., 1993), cert. denied, 510 U.S. 992 (1993).

• U.S. Supreme Court recently denied certiorari.

KFC Corp. v. Iowa Dept. of Rev.

• A state may not tax income from the sale of tangible personal property if the only in-state activities are solicitation of sales with orders being sent outside the state for acceptance and the products are delivery via U.S. Mail or common carrier. - Only net-income based taxes.

• Does not apply to gross-receipts based taxes.

- Does not apply to service providers.

Public Law 86-272 Safeharbor

• MTC Work Group Proposed Revisions to State Guidance- Pre-sale vs. Post-sale activities

- Static vs. Interactive websites

- Use of “cookies”

- Digital goods

P.L. 86-272 in the Internet Era

• Starting Point: Federal AGI

• Conformity- Fixed: AZ, FL, GA, HI, IN, IA, ID, KY, ME, MI, MN, NE, NH, NC, OR,

SC, TX, VT, VA, WV, WI

- Rolling: AL, AZ, CO, CT, DE, DC, IL, KS, LA, MA, MD, MO, MT, NE, ND, NY, NM, OK, RI, TN, UT

- Selective: AR, CA, MS, PA

State Income Tax Structure

• Bonus Depreciation

• IRC 163(j) Interest Expense Limitation

• NOL Carryback / Limitations Provisions

• Pass-through Entity Deduction – IRC 199A

• GILTI – IRC 250 & 951A

Common Decoupling Areas

• Deadlines extended - Does this include sales / use, property, employer withholding?

• Ease compliance burdens- E-filing

- Wet signatures required?

• Employer withholding – working from home- Does teleworking create nexus?

• Extend appeal deadlines

COVID-19 Relief

• PTE must withhold tax on distributive share income attributable to nonresident individuals.- Imposes obligation based upon PTE’s nexus.

• Business income subject to apportionment formula. - 3-factor formula - property, payroll, and sales

- More states heavily weight sales factor

• Nonresident owners still have filing obligation unless entity files a composite return on their behalf.

Pass-Through Entity Withholding Tax

Residents: All income (i.e., modified federal AGI).

• Credit for income subjected to another state’s income tax.

Nonresidents: Only income earned in the state.

• Determined by allocation or apportionment.

• Intangible / investment income allocated where taxpayer is domiciled.

Individual Income Tax Base

• Ohio Commercial Activity Tax

• Oregon Corporate Activity Tax

• Texas Franchise Tax

• Washington Business & Occupation Tax

• Kentucky Limited Liability Entity Tax

• Other state minimum / franchise taxes

Non-Income Taxes

• Imposed on gross receipts, not income / profit

• $1 M exclusion

• Market-based sourcing

• Broad based, low rate- OH: 0.26%

- TX: 0.4875% (retailer)

- OR: 0.57%

- WA: 0.471% (retailer)

Common Features

• Ohio CAT imposed on “gross receipts” sitused to Ohio.

- “Total amount realized by a person without deduction for the cost of goods sold or other expenses incurred, that contributes to the production of gross income of the person...” O.R.C. 5751.01(F).

• Does federal income tax treatment matter?

- “Amount realized” is defined in IRC § 1001(b).

- “Gross income” is defined in IRC § 61.

- O.R.C. 5751.01(K)

Definition of “commercial activity”

Tangible personal property – the location received by the purchaser after all transportation is complete. • Common Issues:

- When is “all transportation completed”?- Is a subsequent shipment relevant?

• To the purchaser’s own retail locations• To the purchaser’s customer

- Does the vendor know the ultimate destination?

• Greenscapes Home & Garden Prods., Inc. v. Testa, 2019-Ohio-384 (10th Dist. Ct. of App.)

• VVF Intervest, Inc. v. McClain, BTA Case No. 2019-1233 (pending)

Market-Based Sourcing of Gross Receipts

Services – the location where the purchaser receives the benefit• Generally, based upon the purchaser’s physical location or employees. • Issues arise when no specific property or employees benefit from service.• Election available to situs receipts to principal place of business.

• Defender Security Co v. Testa, 2019-Ohio-725 (10th Dist. Ct. of App.) pending at Ohio S. Ct.

• Hegar v. Sirius XM Radio, Inc., No. 03-18-00573-CV (Tex. Ct. App. May 1, 2020) (sourced to where service is performed).

Market-Based Sourcing of commercial activity

Imposed on the lowest of the following apportioned tax bases:

• Revenue minus COGS

• Revenue minus compensation (with limitations)

• Revenue x 70%

• Revenue minus $1 M

Texas Franchise Tax

Starting point: “Commercial Activity” sourced to Oregon

Subtraction: 35% of the greater of COGS or labor costs--apportioned

Tax base: “Taxable Commercial Activity”

Oregon CAT Overview

• Identify states where required:- Do you exceed state economic nexus threshold?

- Administrative burden

• Most states require online registration and filing returns

• Filing frequency

• Other Taxes?- Sales & Use Taxes

- Employer Withholding Taxes

State Tax Registration

• What to do if you discover a delinquent state tax liability?• State administered programs whereby a taxpayer generally receives a

limited look-back period and waiver of penalties in exchange for the taxpayer voluntarily coming forward and paying its liability.- If no returns have been filed, statute of limitations may be unlimited.

• Can be requested on an anonymous basis through the taxpayer’s representative (i.e. the taxpayer’s attorney or accountant).

• Multistate Tax Commission has a nexus program where the taxpayer works through the MTC to enter into voluntary disclosure agreements with states where it has nexus but has not been paying taxes.

Voluntary Disclosure Programs

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