The Corporation Rules• The old law—Arizona had its own independent corporate tax code• Now—Arizona taxable income “piggy backs” from federal income—the federal “flows through” to the state – Federal taxable income equals Arizona gross income
The Corporation Rules• Make the statutory additions and subtractions• The result at this point is Arizona taxable income• Apply the corporate income tax rate of 6.968% of the taxable income• Apply the applicable corporate state tax credits• Be aware of special state rules for certain types of corporations
Who Is Subject To Taxation? • Generally if you are residing or engaged in business • In Arizona: – Nonresident individuals and corporations are taxable on their Arizona source income – Resident individuals are taxable on all of their income • A state is subject to the limitations imposed by the Due Process and Commerce Clauses of the U.S. Constitution – Quill says there must be physical presence (for Commerce Clause purposes) • If a corporation is subject to tax in more than one state, it must apportion the tax burden among the states
Arizona Apportionment Rules They are generally based on the following formulas: – These are the current Arizona versions of the traditional UDITPA three factor formula
Apportionment Is Based On Two Concepts• Business Income – Business income arises “from transactions and activity in the regular course of the taxpayers business . . .”• Non Business Income – Non business income is “all income other than business income”
Apportionment Is Based On Two Concepts• Business income is apportioned among the states where the taxpayer engages in business• Non business income is generally allocated to the one state where the income is generated
Non Business Income• Non business income consists of: – Rents – Royalties – Capital Gains – Patent Royalties – Copyright Royalties – Dividends – Interest
Business Income• Business income consists of all income arising from the taxpayer’s regular business activity• It is apportioned among all of the states where the taxpayer is doing business based on the percentage of three factors from the above formula: – The property factor – The payroll factor – The sales factor
The Property Factor• The percent of the taxpayer’s total property that is in Arizona – Does not include intangible property – The value of the property is its original cost as adjusted for improvements and dispositions but not depreciation – If leased, the value is eight times the annual rent – Property used to produce nonbusiness income is nonbusiness
The Payroll Factor• The percent of the taxpayer’s total payroll that is in Arizona – Only what is paid to employees, not independent contractors – Applies to services performed entirely or mostly in Arizona
The Sales Factor• The percent of the taxpayer’s total sales that are in Arizona• Sales includes sales but also: – Services – Leasing – Licensing – Etc.
Different Rules--Sales of Tangible and Intangible Property • Tangible Personal Property – Arizona uses the “destination” rules for sourcing TPP – A sale is Arizona source if it is shipped into Arizona – The “throwback” rules have been repealed • Intangible Personal Property – It is Arizona source if: • The income producing activity is in Arizona, or • Most of the income producing activity is in Arizona • See Heller Western
Miscellaneous• There are rules that allow alternative methods or factors to be used• Many states, although not Arizona (with one exception), have special apportionment formulas for certain industries (banks, railroads, publishing)
The Unitary Concept• Even though, for example, only one corporation may be physically present or doing business in Arizona, related entities may contribute to the income produced in Arizona.• Under the unitary theory, Arizona may tax the total (apportioned) income of all of the related entities.• The related entities must be unitary—effectively operating as a single unit (an “organic whole’) for business purposes.• In Arizona, the test is “operational integration” – Contrast with California’s “functional integration”• Arizona has a big regulation on point.
The Unitary Concept• In Arizona, the limit on taxing is “water’s edge”• Contrast with California’s “world wide” combined reporting• Unitary businesses subject to tax in Arizona must file a combined report• Arizona also has consolidated reporting• R.R. Donnelley, Home Depot appeals
Must the TPT Be Apportioned? • The Commerce Clause allows Congress to regulate interstate commerce. – Dormant Commerce Clause • Historically, there was no state taxation of interstate commerce • Complete Auto Transit v. Brady – Four factor test • Later Supreme Court cases
Recent Apportionment Decisions • There have been many recent apportionment cases • Philadelphia, Pennsylvania (external consistency) • Upper Moreland, Pennsylvania (external consistency) • Modesto, California (external consistency) • Los Angeles, California (internal consistency) • Los Angeles, California (equal protection) • San Francisco, California (internal consistency)
The Arizona Court of Appeals has Ruled on this Issue • So. Pacific Trans. Co. v. State and Town of Clifton, 202 Ariz. 326, 44 P.3d 1006 (Ct. App. 2002) • “Arizona Revised Statutes § 42-5062(A) cannot constitutionally be applied to tax Southern Pacific’s gross receipts from shipping goods . . . .
Southern Pacific Also Ruled On the Model City Tax Code • Southern Pacific also ruled on the Town of Clifton transportation for hire tax • MCTC § 475 • EMC v. City of Phoenix
Arizona Multistate Taxation Overview Presented by Mike Galloway Member Bancroft Susa & Galloway, PC www.arizonatax.com Bancroft Susa & Galloway A PROFESSIONAL CORPORATION