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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
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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
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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
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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
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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
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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
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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
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8 Example 1: State-Level Taxable Income 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
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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
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10 Apportionment Formula Portion of total taxable income taxed in state A = w s * sales factor + w pay * payroll factor + w prop * property factor where w s, w pay, and w prop are the weights assigned to each factor, and w s + w pay + w prop = 1 Traditionally, w s = w pay = w prop = 1/3 Recent changes in state tax legislation have lead 28 states to double-weight the sales factor, so that w s = 1/2, w pay = w prop = 1/4 3 states use w s = 1, w pay = w prop = 0
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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 AState BState C Sales33%40%27% Payroll206515 Property108010 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?
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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
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13 Example 3: Sales Factor with and 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.
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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
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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
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16 Example 4: Apportionment Factors - Payroll Chimera Inc. operates in 2 states, with the following payroll information: State AState 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?
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17 Example 5: Apportionment Factors - Property Wave Inc. previously operated only in state A. This year it expanded into state B. It’s property information is as follows: State AState 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 Wave’s property factors in each state. If Wave undertakes no further expansion, would you expect next year’s property factors to be comparable?
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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
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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: ParentiSubTotal Sales $2,000,000 $1,200,000 $3,200,000 Payroll 400,000 300,000 700,000 Property 900,000 400,0001,300,000
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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?
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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
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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
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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
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