1. Taxation of Business Entities C13-1 Chapter 13 Multijurisdictional Taxation Copyright ©2010 Cengage Learning Taxation of Business Entities

2. C13-2 U.S. International Tax Provisions (slide 1 of 2) Concerned primarily with two types of potential taxpayers: –U.S. persons earning income from outside the United States, and –Non-U.S. persons earning income from inside the United States Concerned primarily with two types of potential taxpayers: –U.S. persons earning income from outside the United States, and –Non-U.S. persons earning income from inside the United States

3. Taxation of Business Entities C13-3 U.S. International Tax Provisions (slide 2 of 2) Can be organized in terms of: –Outbound taxation Refers to the U.S. taxation of foreign-source income earned by U.S. taxpayers –Inbound taxation Refers to the U.S. taxation of U.S.-source income earned by foreign taxpayers Can be organized in terms of: –Outbound taxation Refers to the U.S. taxation of foreign-source income earned by U.S. taxpayers –Inbound taxation Refers to the U.S. taxation of U.S.-source income earned by foreign taxpayers

4. Taxation of Business Entities C13-4 Sources of Law (slide 1 of 3) U.S. individuals and companies –Subject to both U.S. law and laws of other jurisdictions in which they operate or invest The Internal Revenue Code addresses the tax consequences of earning income anywhere in the world Must also comply with the local tax law of the other nations in which they operate For non-U.S. persons, U.S. statutory law is relevant to income they earn that is connected to U.S. income-producing activities U.S. individuals and companies –Subject to both U.S. law and laws of other jurisdictions in which they operate or invest The Internal Revenue Code addresses the tax consequences of earning income anywhere in the world Must also comply with the local tax law of the other nations in which they operate For non-U.S. persons, U.S. statutory law is relevant to income they earn that is connected to U.S. income-producing activities

5. Taxation of Business Entities C13-5 Sources of Law (slide 2 of 3) Tax treaties exist between the U.S. and many other countries –All tax treaties are organized in the same way Include provisions regarding the taxation of: –Investment income –Business profits from a permanent establishment (PE) –Personal service income, and –Exceptions for certain persons (e.g., athletes, entertainers, students, and teachers) Tax treaties exist between the U.S. and many other countries –All tax treaties are organized in the same way Include provisions regarding the taxation of: –Investment income –Business profits from a permanent establishment (PE) –Personal service income, and –Exceptions for certain persons (e.g., athletes, entertainers, students, and teachers)

6. Taxation of Business Entities C13-6 Sources of Law (slide 3 of 3) Tax treaty provisions generally override the treatment otherwise called for under the Internal Revenue Code or foreign tax statutes

7. Taxation of Business Entities C13-7 Authority to Tax (slide 1 of 2) The U.S. taxes U.S. taxpayers on “worldwide” income –The U.S. allows a foreign tax credit to be claimed against the U.S. tax to reduce double- taxation (U.S. and foreign) of the same income The U.S. taxes U.S. taxpayers on “worldwide” income –The U.S. allows a foreign tax credit to be claimed against the U.S. tax to reduce double- taxation (U.S. and foreign) of the same income

8. Taxation of Business Entities C13-8 Authority to Tax (slide 2 of 2) Foreign persons may be subject to tax in the U.S. –Generally, subject to tax only on income earned within U.S. borders Foreign persons may be subject to tax in the U.S. –Generally, subject to tax only on income earned within U.S. borders

9. Taxation of Business Entities C13-9 Sourcing of Income Determining the source of income is critical in calculating the U.S. tax consequences to both U.S. and foreign persons –Numerous tax provisions address the income- sourcing rules for all types of income These sourcing rules generally assign income to a geographic source based on the location where the economic activity producing the income took place Determining the source of income is critical in calculating the U.S. tax consequences to both U.S. and foreign persons –Numerous tax provisions address the income- sourcing rules for all types of income These sourcing rules generally assign income to a geographic source based on the location where the economic activity producing the income took place

10. Taxation of Business Entities C13-10 Allocation and Apportionment of Deductions (slide 1 of 2) Deductions and losses must be allocated and apportioned between U.S.- and foreign- source income –Deductions directly related to an activity or property are allocated to classes of income –Then, deductions are apportioned between statutory and residual groupings Deductions and losses must be allocated and apportioned between U.S.- and foreign- source income –Deductions directly related to an activity or property are allocated to classes of income –Then, deductions are apportioned between statutory and residual groupings

11. Taxation of Business Entities C13-11 Allocation and Apportionment of Deductions (slide 2 of 2) Interest expense is allocated and apportioned to all activities and property regardless of the specific purpose for incurring the debt –Allocation and apportionment is based on either FMV or tax book value of assets Interest expense is allocated and apportioned to all activities and property regardless of the specific purpose for incurring the debt –Allocation and apportionment is based on either FMV or tax book value of assets

12. Taxation of Business Entities C13-12 Foreign Tax Credit Foreign tax credit (FTC) provisions are designed to reduce the possibility of double taxation –Allows a credit for foreign taxes paid Credit is a dollar-for-dollar reduction of U.S. income tax liability –FTC may be “direct” or “indirect” The FTC is elective for any particular tax year –If FTC is not elected, § 164 allows a deduction for foreign taxes paid or incurred Cannot take a credit and deduction for same foreign taxes In most situations the FTC is more valuable to the taxpayer Foreign tax credit (FTC) provisions are designed to reduce the possibility of double taxation –Allows a credit for foreign taxes paid Credit is a dollar-for-dollar reduction of U.S. income tax liability –FTC may be “direct” or “indirect” The FTC is elective for any particular tax year –If FTC is not elected, § 164 allows a deduction for foreign taxes paid or incurred Cannot take a credit and deduction for same foreign taxes In most situations the FTC is more valuable to the taxpayer

13. Taxation of Business Entities C13-13 Direct Foreign Tax Credit Available to taxpayers who pay or incur a foreign income tax –Only person who bears the legal burden of the foreign tax is eligible for the direct credit Direct credit is not available to a U.S. corporation operating in a foreign country through a foreign subsidiary Available to taxpayers who pay or incur a foreign income tax –Only person who bears the legal burden of the foreign tax is eligible for the direct credit Direct credit is not available to a U.S. corporation operating in a foreign country through a foreign subsidiary

14. Taxation of Business Entities C13-14 Indirect Foreign Tax Credit (slide 1 of 5) The indirect credit is available to U.S. corporations for dividends received (actual or constructive) from foreign corporations –Foreign corp pays tax in foreign jurisdiction –When foreign corp remits dividends to U.S. corp, the income is subject to tax in the U.S. The indirect credit is available to U.S. corporations for dividends received (actual or constructive) from foreign corporations –Foreign corp pays tax in foreign jurisdiction –When foreign corp remits dividends to U.S. corp, the income is subject to tax in the U.S.

15. Taxation of Business Entities C13-15 Indirect Foreign Tax Credit (slide 2 of 5) –Foreign taxes are deemed paid by U.S. corporate shareholders in same proportion as dividends bear to the foreign corp’s post-1986 undistributed E & P –Corporations choosing the FTC for deemed- paid foreign taxes must “gross up” dividend income by the amount of deemed-paid taxes –Foreign taxes are deemed paid by U.S. corporate shareholders in same proportion as dividends bear to the foreign corp’s post-1986 undistributed E & P –Corporations choosing the FTC for deemed- paid foreign taxes must “gross up” dividend income by the amount of deemed-paid taxes

16. Taxation of Business Entities C13-16 Indirect Foreign Tax Credit (slide 3 of 5) Example – Wren Inc, a domestic corp, receives a $120,000 dividend from Finch Inc, a foreign corp. Finch paid $500,000 of foreign taxes on post-1986 E & P totaling $1,200,000 (after taxes) Example – Wren Inc, a domestic corp, receives a $120,000 dividend from Finch Inc, a foreign corp. Finch paid $500,000 of foreign taxes on post-1986 E & P totaling $1,200,000 (after taxes)

17. Taxation of Business Entities C13-17 Indirect Foreign Tax Credit ( slide 4 of 5) Example (cont’d)- Wren’s deemed-paid foreign taxes for FTC purposes are $50,000 Cash dividend from Finch$120,000 Deemed-paid foreign taxes $500,000 × $ 120,000. 50,000 $1,200,000 Gross income to Wren$170,000 Wren must include $50,000 in gross income for the gross up adjustment if FTC is elected Example (cont’d)- Wren’s deemed-paid foreign taxes for FTC purposes are $50,000 Cash dividend from Finch$120,000 Deemed-paid foreign taxes $500,000 × $ 120,000. 50,000 $1,200,000 Gross income to Wren$170,000 Wren must include $50,000 in gross income for the gross up adjustment if FTC is elected

18. Taxation of Business Entities C13-18 Indirect Foreign Tax Credit (slide 5 of 5) –Only available if domestic corp owns 10% or more of voting stock of foreign corp Credit is available for 2nd and 3rd tier foreign corps if 10% ownership requirement is met at the 2nd and 3rd levels Credit is also available for 4th through 6th tier foreign corps if additional requirements are met –Only available if domestic corp owns 10% or more of voting stock of foreign corp Credit is available for 2nd and 3rd tier foreign corps if 10% ownership requirement is met at the 2nd and 3rd levels Credit is also available for 4th through 6th tier foreign corps if additional requirements are met

19. Taxation of Business Entities C13-19 Foreign Tax Credit Limitations (slide 1 of 3) Limit is designed to prevent foreign taxes from being credited against U.S. taxes on U.S.-source taxable income –FTC cannot exceed the lesser of: Actual foreign taxes paid or accrued, or U.S. taxes (before FTC) on foreign-source taxable income, calculated as follows: U.S. tax × Foreign-source taxable income before FTC Worldwide taxable income Limit is designed to prevent foreign taxes from being credited against U.S. taxes on U.S.-source taxable income –FTC cannot exceed the lesser of: Actual foreign taxes paid or accrued, or U.S. taxes (before FTC) on foreign-source taxable income, calculated as follows: U.S. tax × Foreign-source taxable income before FTC Worldwide taxable income

20. Taxation of Business Entities C13-20 Foreign Tax Credit Limitations (slide 2 of 3) Limitation can prevent total amount of foreign taxes paid in high-tax jurisdictions from being credited –Generating additional foreign-source income in low, or no, tax jurisdictions could alleviate this problem –However, a separate limitation must be calculated for certain categories (baskets) of foreign source income Limitation can prevent total amount of foreign taxes paid in high-tax jurisdictions from being credited –Generating additional foreign-source income in low, or no, tax jurisdictions could alleviate this problem –However, a separate limitation must be calculated for certain categories (baskets) of foreign source income

21. Taxation of Business Entities C13-21 Foreign Tax Credit Limitations (slide 3 of 3) For tax years beginning after 2006, there are only two baskets: –Passive income, and –All other (general) Any FTC carryforwards into post-2006 years are assigned to one of these two categories For tax years beginning after 2006, there are only two baskets: –Passive income, and –All other (general) Any FTC carryforwards into post-2006 years are assigned to one of these two categories

22. Taxation of Business Entities C13-22 Controlled Foreign Corporations (slide 1 of 3) Pro rata share of Subpart F income generated by a controlled foreign corporation (CFC) is currently included in income of U.S. shareholders

23. Taxation of Business Entities C13-23 Controlled Foreign Corporations (slide 2 of 3) Examples of Subpart F income include: –Passive income such as interest, dividends, rents, and royalties –Sales income where neither the manufacturing activity nor the customer base is in the CFC’s country and either the property supplier or the customer is related to the CFC – Service income where the CFC is providing services on behalf of its U.S. owners outside the CFC’s country Examples of Subpart F income include: –Passive income such as interest, dividends, rents, and royalties –Sales income where neither the manufacturing activity nor the customer base is in the CFC’s country and either the property supplier or the customer is related to the CFC – Service income where the CFC is providing services on behalf of its U.S. owners outside the CFC’s country

24. Taxation of Business Entities C13-24 Controlled Foreign Corporations (slide 3 of 3) A CFC is any foreign corp in which > 50% of total voting power or value is owned by U.S. shareholders on any day of tax year –U.S. shareholder is a U.S. person who owns (directly or indirectly) 10% or more of voting stock of the foreign corp A CFC is any foreign corp in which > 50% of total voting power or value is owned by U.S. shareholders on any day of tax year –U.S. shareholder is a U.S. person who owns (directly or indirectly) 10% or more of voting stock of the foreign corp

25. Taxation of Business Entities C13-25 Inbound Issues Generally, only the U.S.-source income of nonresident alien individuals and foreign corporations is subject to U.S. taxation –A person is treated as a resident of the U.S. for income tax purposes if he or she meets either: The green card test, or The substantial presence test –If either test is met, the individual is deemed a U.S. resident for the year –A foreign corp is one that is not domestic Generally, only the U.S.-source income of nonresident alien individuals and foreign corporations is subject to U.S. taxation –A person is treated as a resident of the U.S. for income tax purposes if he or she meets either: The green card test, or The substantial presence test –If either test is met, the individual is deemed a U.S. resident for the year –A foreign corp is one that is not domestic

26. Taxation of Business Entities C13-26 U.S. Taxation of Nonresident Aliens (slide 1 of 3) Non-resident alien income not “effectively connected” with U.S. trade or business –Includes dividends, interest, rents, royalties,etc –30% tax must be withheld by payor of income, unless this rate is reduced by treaty with the payee’s country of residence No deductions can offset this income Non-resident alien income not “effectively connected” with U.S. trade or business –Includes dividends, interest, rents, royalties,etc –30% tax must be withheld by payor of income, unless this rate is reduced by treaty with the payee’s country of residence No deductions can offset this income

27. Taxation of Business Entities C13-27 U.S. Taxation of Nonresident Aliens (slide 2 of 3) Example: German resident earns $1,000 dividend from U.S. corporation –Absent a U.S.-German treaty, $300 U.S. tax is withheld, and the German resident receives $700 Treaties frequently reduce the withholding rates on dividends and interest –The payor corporation remits the tax to the IRS Example: German resident earns $1,000 dividend from U.S. corporation –Absent a U.S.-German treaty, $300 U.S. tax is withheld, and the German resident receives $700 Treaties frequently reduce the withholding rates on dividends and interest –The payor corporation remits the tax to the IRS

28. Taxation of Business Entities C13-28 U.S. Taxation of Nonresident Aliens (slide 3 of 3) Non-resident alien income effectively connected with U.S. trade or business –This income is taxed at the same rates as are applicable to U.S. citizens –Deductions for expenses related to the income may be claimed Non-resident alien income effectively connected with U.S. trade or business –This income is taxed at the same rates as are applicable to U.S. citizens –Deductions for expenses related to the income may be claimed

29. Taxation of Business Entities C13-29 State Income Taxation 46 states and District of Columbia impose a tax based on corp’s taxable income –Majority of states “piggyback” onto Federal income tax base Essentially, they have adopted part or all of the Federal tax provisions 46 states and District of Columbia impose a tax based on corp’s taxable income –Majority of states “piggyback” onto Federal income tax base Essentially, they have adopted part or all of the Federal tax provisions

30. Taxation of Business Entities C13-30 UDITPA and the Multistate Tax Commission Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to assignment of income among states for multistate corps Many states have adopted UDITPA either by joining the Multistate Tax Commission or modeling their laws after UDITPA Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to assignment of income among states for multistate corps Many states have adopted UDITPA either by joining the Multistate Tax Commission or modeling their laws after UDITPA

31. Taxation of Business Entities C13-31 Nexus for Income Tax Purposes (slide 1 of 2) Nexus is the degree of business activity which must be present before a state can impose tax on an out-of-state entity’s income Sufficient nexus typically exists if: –Income is derived from within state –Property is owned or leased in state –Persons are employed in state –Physical or financial capital is located in state Nexus is the degree of business activity which must be present before a state can impose tax on an out-of-state entity’s income Sufficient nexus typically exists if: –Income is derived from within state –Property is owned or leased in state –Persons are employed in state –Physical or financial capital is located in state

32. Taxation of Business Entities C13-32 Nexus for Income Tax Purposes (slide 2 of 2) No nexus if only “connection” to state is solicitation for sale of tangible personal property, with orders sent outside state for approval and shipping to customer (Public Law 86-272) Sales tax can still apply No nexus if only “connection” to state is solicitation for sale of tangible personal property, with orders sent outside state for approval and shipping to customer (Public Law 86-272) Sales tax can still apply

33. Taxation of Business Entities C13-33 Computing Corporate State Income Tax Liability (slide 1 of 2) Starting point in computing taxable income** ± State modification items State tax base ± Total net allocable income/(loss) (nonbusiness income) Total apportionable income/(loss) (business income) ×State’s apportionment percentage Income apportioned to the state **Most states use either line 28 or line 30 of the Federal corp tax return (Form 1120). In other states, the corp must identify and report each element of income and deduction on the state return. Starting point in computing taxable income** ± State modification items State tax base ± Total net allocable income/(loss) (nonbusiness income) Total apportionable income/(loss) (business income) ×State’s apportionment percentage Income apportioned to the state **Most states use either line 28 or line 30 of the Federal corp tax return (Form 1120). In other states, the corp must identify and report each element of income and deduction on the state return.

34. Taxation of Business Entities C13-34 Computing Corporate State Income Tax Liability (slide 2 of 2) Income apportioned to the state ± Income/(loss) allocated to the state State taxable income/(loss) × State tax rate. Gross income tax liability for state – State’s tax credits. Net income tax liability for the state Income apportioned to the state ± Income/(loss) allocated to the state State taxable income/(loss) × State tax rate. Gross income tax liability for state – State’s tax credits. Net income tax liability for the state

35. Taxation of Business Entities C13-35 Common State Additions (slide 1 of 3) Interest income on state/municipal obligations and other interest income exempt from Federal income tax –May exclude interest income on obligations within that state to encourage investment in in- state bonds Interest income on state/municipal obligations and other interest income exempt from Federal income tax –May exclude interest income on obligations within that state to encourage investment in in- state bonds

36. Taxation of Business Entities C13-36 Common State Additions (slide 2 of 3) State income taxes deducted on Federal return –Includes franchise taxes based on income Federal depreciation in excess of amount allowed by state (if depreciation systems differ) State income taxes deducted on Federal return –Includes franchise taxes based on income Federal depreciation in excess of amount allowed by state (if depreciation systems differ)

37. Taxation of Business Entities C13-37 Common State Additions (slide 3 of 3) State gain in excess of Federal gain on assets; Federal loss in excess of state loss on assets Adjustments to amounts under Federal elections Federal Net Operating Loss deduction State gain in excess of Federal gain on assets; Federal loss in excess of state loss on assets Adjustments to amounts under Federal elections Federal Net Operating Loss deduction

38. Taxation of Business Entities C13-38 Common State Subtractions (slide 1 of 3) Interest on U.S. obligations to extent included in Federal taxable income –States cannot impose income tax on income from U.S. obligations, but may assess income- based franchise tax State depreciation in excess of Federal (if depreciation systems differ) Interest on U.S. obligations to extent included in Federal taxable income –States cannot impose income tax on income from U.S. obligations, but may assess income- based franchise tax State depreciation in excess of Federal (if depreciation systems differ)

39. Taxation of Business Entities C13-39 Common State Subtractions (slide 2 of 3) Federal gain in excess of state gain on assets; State loss in excess of Federal loss of assets Adjustments to amounts under Federal elections Federal gain in excess of state gain on assets; State loss in excess of Federal loss of assets Adjustments to amounts under Federal elections

40. Taxation of Business Entities C13-40 Common State Subtractions (slide 3 of 3) State Net Operating Loss deduction Dividends received from certain out-of-state corps to extent included in Federal return Federal income taxes paid State Net Operating Loss deduction Dividends received from certain out-of-state corps to extent included in Federal return Federal income taxes paid

41. Taxation of Business Entities C13-41 Allocation and Apportionment of Income (slide 1 of 3) Apportionment is the means by which business income is divided among states in which it conducts business –Corp determines net income for the company as a whole and then apportions some to a given state, according to an approved formula Apportionment is the means by which business income is divided among states in which it conducts business –Corp determines net income for the company as a whole and then apportions some to a given state, according to an approved formula

42. Taxation of Business Entities C13-42 Allocation and Apportionment of Income (slide 2 of 3) Allocation is a method used to directly assign specific components of a corp’s income, net of related expenses, to a specific state Allocable income generally includes: Income or loss from sale of nonbusiness property Income or losses from rents or royalties from nonbusiness real or tangible personal property Allocation is a method used to directly assign specific components of a corp’s income, net of related expenses, to a specific state Allocable income generally includes: Income or loss from sale of nonbusiness property Income or losses from rents or royalties from nonbusiness real or tangible personal property

43. Taxation of Business Entities C13-43 Allocation and Apportionment of Income (slide 3 of 3) Typically, allocable income (loss) is removed from corporate net income before the state’s apportionment formula is applied –Nonapportionable income (loss) assigned to a state is then combined with income apportionable to the state to arrive at total income subject to tax in the state Typically, allocable income (loss) is removed from corporate net income before the state’s apportionment formula is applied –Nonapportionable income (loss) assigned to a state is then combined with income apportionable to the state to arrive at total income subject to tax in the state

44. Taxation of Business Entities C13-44 Apportionment Procedure Business income is assigned to states using an apportionment formula –Business income arises from the regular course of business Integral part of taxpayer’s regular business Nonbusiness income is apportioned or allocated to the state in which the income- producing asset is located Business income is assigned to states using an apportionment formula –Business income arises from the regular course of business Integral part of taxpayer’s regular business Nonbusiness income is apportioned or allocated to the state in which the income- producing asset is located

45. Taxation of Business Entities C13-45 Apportionment Factors Apportionment formulas vary among states –Traditionally, states use a three-factor formula that equally weights sales, property, and payroll –Many states use a modified formula where sales factor receives a larger weight Tends to pull larger amount of out-of state corporation's income into the state May provide tax relief to corps domiciled in the state Apportionment formulas vary among states –Traditionally, states use a three-factor formula that equally weights sales, property, and payroll –Many states use a modified formula where sales factor receives a larger weight Tends to pull larger amount of out-of state corporation's income into the state May provide tax relief to corps domiciled in the state

46. Taxation of Business Entities C13-46 Sales Factor (slide 1 of 3) Sales factor is a fraction –Numerator is corp’s sales in the state –Denominator is corp’s total sales everywhere Most states follow UDITPA’s “ultimate destination concept” –Tangible asset sales are assumed to take place at point of delivery, not where shipping originates Sales factor is a fraction –Numerator is corp’s sales in the state –Denominator is corp’s total sales everywhere Most states follow UDITPA’s “ultimate destination concept” –Tangible asset sales are assumed to take place at point of delivery, not where shipping originates

47. Taxation of Business Entities C13-47 Sales Factor (slide 2 of 3) –Dock sales occur when delivery is taken at seller’s shipping dock Most states apply the destination test to dock sales –If purchaser has out-of-state location to which it returns with the product, sale is assigned to purchaser’s state –Dock sales occur when delivery is taken at seller’s shipping dock Most states apply the destination test to dock sales –If purchaser has out-of-state location to which it returns with the product, sale is assigned to purchaser’s state

48. Taxation of Business Entities C13-48 Sales Factor (slide 3 of 3) –Throwback rule If adopted by state, requires that out-of-state sales not subject to tax in destination state be pulled back into origination state Treats such sales as in-state sales of the origination state Also applies if purchaser is U.S. government –Throwback rule If adopted by state, requires that out-of-state sales not subject to tax in destination state be pulled back into origination state Treats such sales as in-state sales of the origination state Also applies if purchaser is U.S. government

49. Taxation of Business Entities C13-49 Payroll Factor (slide 1 of 3) Payroll factor is a fraction –Numerator is compensation paid within a state –Denominator is total compensation paid by the corporation Payroll factor is a fraction –Numerator is compensation paid within a state –Denominator is total compensation paid by the corporation

50. Taxation of Business Entities C13-50 Payroll Factor (slide 2 of 3) Compensation includes wages, salaries, commissions, etc –Some states exclude amounts paid to corporate officers –Some states require that deferred compensation amounts be included in the payroll factor (e.g., 401(k) plans) Compensation includes wages, salaries, commissions, etc –Some states exclude amounts paid to corporate officers –Some states require that deferred compensation amounts be included in the payroll factor (e.g., 401(k) plans)

51. Taxation of Business Entities C13-51 Payroll Factor (slide 3 of 3) Only compensation related to production of apportionable income is included in payroll factor –In states that distinguish between business and nonbusiness income, compensation related to nonbusiness income is not included –Compensation related to both business and nonbusiness income is prorated between the two Only compensation related to production of apportionable income is included in payroll factor –In states that distinguish between business and nonbusiness income, compensation related to nonbusiness income is not included –Compensation related to both business and nonbusiness income is prorated between the two

52. Taxation of Business Entities C13-52 Property Factor (slide 1 of 3) Property factor generally includes average value of real and tangible personal property owned or rented –Numerator is amount used in the state –Denominator is all of corp’s property owned or rented Property factor generally includes average value of real and tangible personal property owned or rented –Numerator is amount used in the state –Denominator is all of corp’s property owned or rented

53. Taxation of Business Entities C13-53 Property Factor (slide 2 of 3) Property includes: –Land, buildings, machinery, inventory, etc –May include construction in progress, offshore property, outer space property (satellites), and partnership property Property in transit is included in numerator of destination state Property includes: –Land, buildings, machinery, inventory, etc –May include construction in progress, offshore property, outer space property (satellites), and partnership property Property in transit is included in numerator of destination state

54. Taxation of Business Entities C13-54 Property Factor (slide 3 of 3) Property is typically valued at average historical cost plus additions and improvements –Some states allow net book value or adjusted basis to be used Leased property, when included in the property factor, is valued at eight times its annual rental payments Property is typically valued at average historical cost plus additions and improvements –Some states allow net book value or adjusted basis to be used Leased property, when included in the property factor, is valued at eight times its annual rental payments

55. Taxation of Business Entities C13-55 Allocation, Apportionment Example Total allocable income (State A) $100,000 Apportionable income (States A and B) 800,000 Total income $900,000 All sales, payroll, and property is divided equally between states A and B. Both states use identical apportionment formulas. Taxable income:State AState B 1/2 Apportionable income $400,000 $400,000 Allocable income 100,000 -0- Total state taxable income $500,000 $400,000 Total allocable income (State A) $100,000 Apportionable income (States A and B) 800,000 Total income $900,000 All sales, payroll, and property is divided equally between states A and B. Both states use identical apportionment formulas. Taxable income:State AState B 1/2 Apportionable income $400,000 $400,000 Allocable income 100,000 -0- Total state taxable income $500,000 $400,000

56. Taxation of Business Entities C13-56 Apportionment Example (slide 1 of 2) Americo, Inc. operates in three states with the following apportionment systems: W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only State: W X YTotal Sales:$400,000 $100,000$500,000 $1,000,000 Factor 40%10% 50% Payroll: 90,000 150,000 60,000 300,000 Factor 30%50% 20% Property: 120,000 240,000 40,000 400,000 Factor 30%60% 10% Americo, Inc. operates in three states with the following apportionment systems: W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only State: W X YTotal Sales:$400,000 $100,000$500,000 $1,000,000 Factor 40%10% 50% Payroll: 90,000 150,000 60,000 300,000 Factor 30%50% 20% Property: 120,000 240,000 40,000 400,000 Factor 30%60% 10%

57. Taxation of Business Entities C13-57 Apportionment Example (slide 2 of 2) Taxable income for year (all states)$100,000 State: W X Y Sales 40% 10%50% Sales 40% N/AN/A Payroll 30% 50%N/A Property 30% 60%N/A Total140%120%50% Average 35% 40%50% Taxable income to each state $35,000 $40,000 $50,000 Total taxed in all states:$125,000 N/A=not applicable Taxable income for year (all states)$100,000 State: W X Y Sales 40% 10%50% Sales 40% N/AN/A Payroll 30% 50%N/A Property 30% 60%N/A Total140%120%50% Average 35% 40%50% Taxable income to each state $35,000 $40,000 $50,000 Total taxed in all states:$125,000 N/A=not applicable

58. Taxation of Business Entities C13-58 Apportionment Example Revisited (slide 1 of 2) Americo, Inc. moves most personnel and property to state Y. State: W X Y Total Sales: $400,000$100,000 $500,000 $1,000,000 Factor 40% 10% 50% Payroll: 30,000 30,000 240,000 300,000 Factor 10% 10% 80% Property: 40,000 40,000 320,000 400,000 Factor 10% 10%80% W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only Americo, Inc. moves most personnel and property to state Y. State: W X Y Total Sales: $400,000$100,000 $500,000 $1,000,000 Factor 40% 10% 50% Payroll: 30,000 30,000 240,000 300,000 Factor 10% 10% 80% Property: 40,000 40,000 320,000 400,000 Factor 10% 10%80% W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only

59. Taxation of Business Entities C13-59 Apportionment Example Revisited (slide 2 of 2) Taxable income for year (all states)$100,000 State: W X Y Sales: 40%10%50% Sales 40% N/AN/A Payroll: 10%10%N/A Property: 10%10%N/A Total100%30%50% Average 25%10%50% Taxable income to each state $25,000 $10,000 $50,000 Total taxed in all states: $85,000 N/A = not applicable Taxable income for year (all states)$100,000 State: W X Y Sales: 40%10%50% Sales 40% N/AN/A Payroll: 10%10%N/A Property: 10%10%N/A Total100%30%50% Average 25%10%50% Taxable income to each state $25,000 $10,000 $50,000 Total taxed in all states: $85,000 N/A = not applicable

60. Taxation of Business Entities C13-60 Unitary Taxation (slide 1 of 2) Theory: operating divisions are interdependent so cannot be segregated into separate units –Each unit deemed to contribute to overall profits –Unitary theory ignores separate legal existence of companies: all combined for apportionment Theory: operating divisions are interdependent so cannot be segregated into separate units –Each unit deemed to contribute to overall profits –Unitary theory ignores separate legal existence of companies: all combined for apportionment

61. Taxation of Business Entities C13-61 Unitary Taxation (slide 2 of 2) For multistate apportionment, all divisions or entities are treated as single unitary base: –Larger apportionment base (all companies’ activities) –Smaller apportionment factors (each state’s %) For multistate apportionment, all divisions or entities are treated as single unitary base: –Larger apportionment base (all companies’ activities) –Smaller apportionment factors (each state’s %)

62. Taxation of Business Entities C13-62 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta