1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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?

12. 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

13. 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.

14. 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

15. 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

16. 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?

17. 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?

18. 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

19. 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

20. 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?

21. 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

22. 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

23. 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