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Evaluating New State Forms of Taxing Business

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LeAnn Luna of the University of Tennessee, Knoxville discusses alternatives to the traditional corporate income tax, such as the gross receipts tax, the margins tax, the subtraction method value-added tax and the credit invoice value-added tax

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Evaluating New State Forms of Taxing Business

  1. 1. Evaluating New State Forms of Taxing Business LeAnn Luna, Professor of Accounting December 4, 2015
  2. 2. What’s Wrong with the Corporate Income Tax? • Are profits the appropriate tax base? • Complicated, high administrative and compliance costs • Volatile • Shrinking tax base • Shift of business activity to LLCs and other pass through entities • State level erosion from changes in Federal tax base • State economic incentives • Sophisticated tax planning
  3. 3. Connecticut’s Revenue Performance CIT versus Total Taxes 1,000.0 3,000.0 5,000.0 7,000.0 9,000.0 11,000.0 13,000.0 15,000.0 17,000.0 19,000.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 900.0 1,000.0 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 TotalStateTax(thous) CorporateNetIncomeTax(thous) CIT Total State Taxes
  4. 4. Tax Base Examples Description Gross Receipts Tax Ohio, Washington, Nevada Gross receipts Margins Tax Texas, Kentucky - Gross receipts minus labor - Gross receipts minus COGS - 70% of gross receipts Subtraction Method Vat Proposed in California Gross receipts minus purchases from other firms Credit Invoice VAT Europe Gross receipts minus labor, depreciation, interest, purchases from other firms Corporate Income Tax Imposed on U.S. C-corps in 45 states Gross receipts minus labor, depreciation, interest, purchases from other firms, other operating exp. Broad Base Narrow Base Taxonomy of Business Taxes Low Rate High Rate
  5. 5. Gross Receipts Tax • Imposed on all forms of business, including partnerships and LLCs. • Period tax on the value of total sales. • Often exclude interest, dividends, proceeds from the sale of stock. • No deduction for business inputs. • Generally imposed on a destination basis. • Sometimes functions as a form of minimum tax (e.g. the New Jersey AMA on out of state corporations with NJ receipts).
  6. 6. GRT Advantages • Low rate, broad base; rates are below 1%. • Tax return fits on a post card. • Typically a privilege tax and can be imposed on every firm doing business in the state without regard to nexus. • Not subject to P.L. 86-272 • More stable than CIT across business cycles. • Decouple from federal tax law changes. • Tax planning is difficult.
  7. 7. GRT Disadvantages • Imposed on firms losing money, startups, etc. • Disadvantages high volume, low margin businesses such as grocers, wholesalers, discount retailers, etc. • Pyramiding • Study of Washington State’s B&O tax indicated it pyramided from 1.5 times for services to over 6 times for food manufacturing. • Encourages vertical integration • Low rates mitigate pyramiding and vertical integration problem. • “Above the line” deduction for financial reporting purposes.
  8. 8. Gross Margins Tax • Similar to the GRT, but allows deductions for some business inputs, such as cost of goods sold. • Raw materials, parts, direct labor • Eliminates some of the pyramiding. • Allowing deductions for purchased inputs moves the tax closer to a tax on consumption ultimately. • Deductions open the door for tax planning. • Treated as an income tax for GAAP purposes • Deduction from operating income (“below the line”).
  9. 9. Value Added Taxes • Imposed on all business regardless of form. • The VAT can be accomplished using a subtraction or addition VAT. • Addition VAT = payroll + rent +interest +firm profit • Subtraction VAT = gross receipts – all purchases from other businesses. No deduction for in-house labor. • Types • Income variant – capitalized and deducted when sold (inventory) or depreciated (capital assets). • Consumption variant – all items fully deductible in the year purchased, no inventory, no depreciation deductions.
  10. 10. Alternative Taxes in NE Region • Delaware GRT • Annual exclusion starts at $100,000 per month • Rates range from 0.1006% to 0.7543% • New Hampshire BET • Base = Wages + interest + dividends • Rate = 0.75% • BET paid is credited against the business profits tax • New Jersey AMA • Applies only to taxpayers not subject to income tax • Tax on gross profits • Alternative minimum taxes in general • Most AMT regimes will fall on the continuum between GRT and the income tax.
  11. 11. Other Considerations • Apportionment • Combined reporting • Transitional rules and treatment of various tax attributes. • Financial accounting considerations.

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