State Income Tax Nexus


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Concerned about state income tax liability for your business? View this presentation for tips on how to minimize state income taxes.

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State Income Tax Nexus

  1. 1.  Speaker: Ryan P. Giolitto, CPA, CFP® ◦ Ryan is a tax manager at CDH with several years of experience in working with a variety of businesses of all sizes. His area of specialty includes financial planning and tax planning for businesses and high net worth individuals, including business owners. Phone Contact: 630-285-0215 x8214 Email Contact:
  2. 2.  Basic Principles of State Income Tax Calculation of Apportionment Factors General Nexus Principles History of Nexus Types of Nexus Future of Nexus Compliance Suggestions Planning Suggestions
  3. 3.  Federal taxable income is modified for state adjustments and multiplied by a state apportionment factor to determine state taxable incomeFederal taxable income+ State modificationsState modified taxable incomex apportionment factorState taxable income
  4. 4.  State modifications result from differences in federal vs. state law Common modifications in adjusting federal taxable income to state taxable income are as follows: ◦ Bonus depreciation ◦ State taxes ◦ Other items
  5. 5.  State apportionment factors determine the portion of federal taxable income that will be taxed by each state State apportionment factors refer to the combination of 3 individual apportionment factors weighted differently by each state Each factor is composed of a numerator (total within state) and denominator (total everywhere)
  6. 6.  The 3 individual apportionment factors are as follows: ◦ Payroll ◦ Property ◦ Sales These factors are weighted differently by each state, with the following weightings being most common: ◦ One factor sales ◦ Three factor ◦ Three factor with double weighted sales
  7. 7.  Payroll Factor includes: ◦ Officer’s compensation ◦ Wages related to cost of sales ◦ Operating/administrative wages Payroll Factor does not include: ◦ Independent contractor payments ◦ Management fees
  8. 8.  Property Factor includes: ◦ Original cost of owned property (most states) ◦ Net book value of owned property (few states) ◦ Rented property x 8 (most states) Property Factor does not include: ◦ Construction in progress
  9. 9.  Sales Factor includes: ◦ Gross Receipts ◦ Interest (most states) ◦ Dividends (most states) ◦ Gains from sales of property (most states)
  10. 10.  Sales factor is based on several approaches depending on the state: ◦ Destination of end user ◦ Where services performed (income-producing activity or cost of performance sourcing) ◦ Defined by state law (market based sourcing based on where market for services really exists)
  11. 11.  Throwback – requires “throwing back” sales sourced to a state in which the taxpayer is not taxable to the taxpayer’s home state for inclusion in the sales apportionment numerator Throw-out – requires “removal” of sales sourced to a state in which the taxpayer is not taxable from the sales apportionment denominator Most states have a throwback rule Very few states have a throw-out rule, including New Jersey and West Virginia
  12. 12. Most Some States Few States StatesAirlines XAthletics XBroadcasting XConstruction XFinancial XManufacturing XMotor Carriers XPipelines XPublishing XRailroads XShipping XTelecommunications XUtilities X
  13. 13.  Definition of Nexus – sufficient/substantial connection Sales Tax/Income Tax Nexus applied different standards This class focuses on Income Tax Nexus only
  14. 14.  Payroll ◦ Defer to filed payroll tax returns Property ◦ Defer to records of property location Sales ◦ Subjective, based on determination of end user location, cost of performance/income producing activity location, or market source location ◦ But are we really required to file and pay in all these locations? Maybe not.
  15. 15.  PL 86-272 – Interstate Income Act of 1959 ◦ Limits ability of states to tax interstate commerce ◦ Limits nexus for mere solicitation of orders in a state if the orders are filled or approved out of the state ◦ Only limits income tax nexus (not franchise tax nexus) ◦ Only applies to sales of tangible property (does not apply to service companies) ◦ Only covers solicitation in state (other activities may disqualify, sales orders must be approved out of state)
  16. 16.  Several states have enacted taxes not based on income, which are not subject to protection by P.L. 86-272 and could cause substantial tax burden These taxes are known as franchise or gross receipts based taxes, which exist in the following states: ◦ Michigan (Single Business Tax/Michigan Business Tax changed to Corporate Income Tax, no longer receipts based) ◦ Ohio (Commercial Activity Tax) ◦ Texas (Margin Tax) ◦ Washington (Business & Occupation Tax)
  17. 17.  Traditionally required physical presence ◦ Quill Corp vs. North Dakota ◦ National Bellas Hess vs. Department of Revenue Now changing to focus more on true economics of transactions
  18. 18.  Physical Presence ◦ Requires Traditional Presence Economic Nexus ◦ Based on Facts/Circumstances Factor-Based Nexus ◦ Based on Exceeding Set Thresholds
  19. 19.  Nexus based on physical presence is triggered upon entering the state physically for a period of time Some states have defined de-minimus physical presence rules, while others have not Since P.L. 86-272 was enacted to cover only solicitation of sales situations, any amount of physical presence, although limited, will most likely trigger income tax nexus
  20. 20.  The following activities may create income tax nexus in various states: ◦ Occasional training seminars for customers ◦ Occasional business meetings ◦ Occasional attendance at technical/training seminars sponsored by unrelated parties ◦ Occasional board of director’s meetings ◦ Solicitation of sales ◦ Attendance at trade shows for less than 14 days per year
  21. 21. ◦ Providing company car for salesperson◦ Inventory inspection by salesperson◦ Sale of real estate◦ Setup of promotional items by salesperson◦ Maintenance of a security interest in property sold until contract price has been paid
  22. 22.  The following activities may create income tax nexus in various states: ◦ Employees repairing and maintaining products ◦ Maintaining telephone answering service ◦ Leasing employees to another company ◦ Non-salesperson employee working from home ◦ Employees providing in state consulting services ◦ Having a website in and/or located on a server in a state ◦ Employee presence for less than 20 days to purchase goods from vendors
  23. 23. ◦ Employees inspecting customer installations of products◦ Company listing in phone book◦ Providing engineering or design functions related to sales of customized products◦ Hiring unrelated parties to repossess property◦ Hiring unrelated parties to install products◦ Holding inventory at fulfillment company◦ Hiring unrelated parties to collect accounts◦ Hiring unrelated parties for warranty repair
  24. 24.  In response to the flexibility of P.L. 86-272 with regard to physical presence, most states have responded by enacting economic nexus provisions Economic nexus is a subjective concept focused on determining whether the company is “doing business” in a state Enforcement has been unsuccessful to some degree, so the states have increased enforcement and some have passed factor- based nexus laws
  25. 25.  The following states have enacted factor-based nexus standards with the following thresholds: California/Colorado/Ohio ◦ Property $50,000 ◦ Payroll $50,000 ◦ Sales $500,000 Connecticut ◦ Sales $500,000 Virginia ◦ Any apportionment factor is positive
  26. 26.  States are moving away from traditional nexus rules in the following ways: ◦ 3 factor apportionment is switching to single factor sales apportionment or double weighted sales apportionment to capture lost revenue from increasing move toward decreased physical presence ◦ Nexus rules changing from based on physical presence or economic nexus to factor-based nexus ◦ Enforcement of economic nexus is increasing
  27. 27.  Evaluating nexus for a pure ecommerce company is challenging. The following factors are used to determine nexus risk for these types of businesses: ◦ Internet/Telecommunications provider location ◦ Server location (for website and other data) ◦ Location of intangible property ◦ Location and significance of customers ◦ Physical location of affiliate ◦ Location of advertising/telephone listing ◦ Location of product repairs/support assistance
  28. 28.  Filing related returns will most likely result in a state income tax reporting requirement Therefore, be aware of where you file the following to address nexus exposure: ◦ Company registrations ◦ Annual reports ◦ Sales tax returns ◦ Withholding tax returns ◦ Payroll tax returns ◦ Property tax returns
  29. 29.  States often send nexus questionnaires to taxpayers they suspect of having unreported activity It is acceptable to prepare your own responses to a nexus questionnaire However, make sure to seek a review of your responses by a state tax expert prior to submitting to state taxing authorities
  30. 30.  Voluntary Disclosure programs are available in virtually all states to report unreported state tax filings prior to receiving a notice from a state taxing authority Voluntary Disclosure often guarantees a shorter look back period for unfiled returns and ability to ask for abatement of penalties due to reasonable cause
  31. 31.  Amnesty programs offer the ability to file unfiled state tax returns without any penalty charges These programs are often opened and closed quickly, so it is important to be on the lookout for specific states where risk exists
  32. 32.  Kentucky – Through June 30, 2013 Ohio – Through May 1, 2013 Rhode Island – Through November 15, 2012
  33. 33.  If none of the previously suggested courses of action are possible, you may be forced to file a state tax return by a state taxing authority In this event, attempt to negotiate look back periods and penalties to the highest extent possible Some states will allow a 3 year look back period and will abate penalties in certain circumstances
  34. 34. 1. Identify states with potential nexus2. Discover state nexus rules, apportionment factors, and tax rates3. Develop and implement plan for moving nexus and apportionment factors to states with lower tax rates
  35. 35.  If a large apportionment fraction is desired in a low tax state, consider forming a separate company to hold that state’s activity (if profitable) If avoiding overall company exposure to a state with a gross receipts based tax is desirable, consider forming a separate company to be exposed to the gross receipts tax on its own Be aware of consolidated reporting rules
  36. 36.  State modified taxable income may not be flexible so focus planning efforts on changing apportionment factors Make necessary adjustments to source items to low tax states while keeping apportionment factors low in high tax states
  37. 37.  If state tax exposure is significant, consider CDH nexus study to identify risk and recommend strategies for improvement Nexus study can be customized in scope of states and can include both income and sales tax if necessary
  38. 38.  State nexus is a very complicated topic due to varying state law With proper planning, state taxes can be minimized It is important to stay current on state tax risk and exposure to maximize company profits
  39. 39.  Thank you for your attendance Please complete the course evaluation worksheets