McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Principles of Taxation: Advanced Strategies Chapter 9 Chapter 9 Multistate Business Expansion Multistate Business Expansion Slide 9-1

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Sale Taxes 45 states impose a sales tax on sales of tangible personal property within their jurisdiction 45 states impose a sales tax on sales of tangible personal property within their jurisdiction Many local governments also impose a sales tax Many local governments also impose a sales tax Slide 9-2

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Nexus Slide 9-3 Business must have some physical relationship with jurisdiction before being required to collect sales tax Business must have some physical relationship with jurisdiction before being required to collect sales tax Such a relationship is referred to as nexus Such a relationship is referred to as nexus

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Use Tax Tax imposed on goods purchased out of state but used in state Tax imposed on goods purchased out of state but used in state Imposed to prevent people going out of state to buy goods and not paying sales tax Imposed to prevent people going out of state to buy goods and not paying sales tax Typically only imposed if sales tax not collected on original sale Typically only imposed if sales tax not collected on original sale Slide 9-4

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Use Tax Collection Generally a voluntary system for out of state or mail order purchases Generally a voluntary system for out of state or mail order purchases Tax must be collected by out of state businesses only if they have nexus Tax must be collected by out of state businesses only if they have nexus Slide 9-5

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Sales and Use Tax Exemptions Many states exempt food and drugs from sales tax Many states exempt food and drugs from sales tax Sales of raw materials intended for resale generally exempt Sales of raw materials intended for resale generally exempt Slide 9-6

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State and Local Income Tax Imposed on corporations by 46 states and District of Columbia Imposed on corporations by 46 states and District of Columbia Only imposed on corporations that have nexus Only imposed on corporations that have nexus Imposed on income attributable to state Imposed on income attributable to state Slide 9-7

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Nexus for Income Tax Must have some sort of physical presence in state Must have some sort of physical presence in state Federal law prohibits states from taxing corporations if only connection with state is selling tangible personal property in state if orders shipped from outside state Federal law prohibits states from taxing corporations if only connection with state is selling tangible personal property in state if orders shipped from outside state Slide 9-8

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Economic Nexus Some states take position that earning income from intangible assets within state creates nexus even if no physical presence Some states take position that earning income from intangible assets within state creates nexus even if no physical presence Slide 9-9

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Impact of State Income Tax on Federal Tax State income tax deductible for federal tax State income taxes on individuals are generally an itemized deduction Slide 9-10

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State Taxable Income Generally starts with federal taxable income Generally starts with federal taxable income Common modifications: Common modifications:  Deduction for state income tax added back  Add municipal bond interest  Subtract any interest from federal bonds  Adjust depreciation Slide 9-11

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Multistate Businesses States may only tax income earned within their borders States may only tax income earned within their borders Methods: Methods:  Direct allocation  Apportionment Slide 9-12

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Allocation Slide 9-13 Generally just used for nonbusiness income such as interest, dividends, rents and royalties Generally just used for nonbusiness income such as interest, dividends, rents and royalties Income is taxed directly to state where earned Income is taxed directly to state where earned

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Apportionment Some states apportion all income, some just business income Some states apportion all income, some just business income Uniform Division of Income for Tax Purposes(UDIPTA) used by many states apportions based upon three factors Uniform Division of Income for Tax Purposes(UDIPTA) used by many states apportions based upon three factors  Sales  Payroll  Property Slide 9-14

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Apportionment Factors May states weigh factors evenly May states weigh factors evenly Some double weight sales Some double weight sales Some do not use payroll Some do not use payroll Some states use a one factor formula based upon sales Some states use a one factor formula based upon sales Slide 9-15

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Sales Factor Based upon state of final product delivery Based upon state of final product delivery Throwback rule Throwback rule  Used by many but not all states  If corporation does not file in state in which product is delivered, sale is attributed to state in which sale originates Slide 9-16

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Property Factor Includes all real and tangible personal property Includes all real and tangible personal property  Generally based on original cost Leased property also considered by capitalizing lease costs by some factor Leased property also considered by capitalizing lease costs by some factor Slide 9-17

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State Net Operating Loss Carryovers Determined by state rules based upon loss allocated to state Determined by state rules based upon loss allocated to state Slide 9-18

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Affiliated Corporations Slide 9-19 Filing rules vary greatly depending on state Filing rules vary greatly depending on state Some states do not allow consolidated returns. Some allow consolidated returns for members which have nexus with that state Some states do not allow consolidated returns. Some allow consolidated returns for members which have nexus with that state

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Unitary Businesses Many states require all members of a unitary business to report on a combined return Many states require all members of a unitary business to report on a combined return Definition of unitary business is somewhat unclear but based upon corporations whose operations are integrated and interdependent Definition of unitary business is somewhat unclear but based upon corporations whose operations are integrated and interdependent Some states include world wide operations while others allow a “water’s edge elections” that only includes US operations Some states include world wide operations while others allow a “water’s edge elections” that only includes US operations Slide 9-20

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State Taxation of Passthrough Entities Entity is not subject to state income tax but partners, members and S corporation shareholders are Entity is not subject to state income tax but partners, members and S corporation shareholders are Partners, members and S corporation shareholders must file and pay tax in states in which entity has operations Partners, members and S corporation shareholders must file and pay tax in states in which entity has operations Slide 9-21

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Internet Operations Difficult to apply traditional nexus rules Difficult to apply traditional nexus rules  Often companies establish separate entities for internet operations to shield the internet sales Internet Tax Freedom Act prohibits new taxes on internet sales Internet Tax Freedom Act prohibits new taxes on internet sales Slide 9-22

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Other State Taxes Property Property Taxes on property transfers Taxes on property transfers Franchise taxes Franchise taxes Slide 9-23

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State Incentives Many states provides credits, tax rebates and other incentives to locate business within them Many states provides credits, tax rebates and other incentives to locate business within them Incentives must be considered when determining effect tax rate Incentives must be considered when determining effect tax rate Slide 9-24