State
Income Tax
State
income tax is levied in addition to federal
income tax, except in certain cases noted below
in which all or part of federal income tax paid
is allowed to be set off against state income
tax. See Forms of
Company for details of structures (LLCs,
'S' Corporations etc) that allow a 'pass-through'
tax situation, in which federal income tax (and
therefore, state income taxes) apply to the
owners of the organization rather than to the
organization itself. For most incorporated commercial
organizations (known as 'C' corporations) and
foreign companies, federal income taxes will
apply to income earned from business activity
in the US, and state income taxes will apply
in all of the states where a business has qualifying
activity.
Business
activity in a state will attract taxation there
if the organization concerned has 'nexus' in
that state. Nexus for income tax purposes is
normally established when a corporation derives
income from sources within the state, owns or
leases property there, employs personnel there
or has capital or property in the state. However,
the exact definition varies from state to state.
Congress
has however established some exemptions from
state taxation. Law 86-272 provides immunity
from state taxation if a business merely solicits
orders for the sales of tangible personal property
that are sent outside the state for approval
or rejection and, if approved, are filled and
shipped by the business from a point outside
the state. The law does not cover leases, rentals,
transfers of real property and the sale of services.
The statute does not define solicitation; therefore,
each state defines it differently.
Nexus
is usually not created by the following activities:
-
Advertising campaigns or sales activities
and incidental and minor advertising;
-
Carrying free samples only for display or
distribution;
-
Owning or furnishing automobiles to salespersons;
- Passing
inquires or complaints to the home office;
-
Maintaining a sample or display room for less
than 14 days; or
-
Soliciting sales by an in-state resident employee,
provided that the employee does not maintain
a place of business in the state, including
an office in the home.
The
situation regarding intellectual property is
confused. In some states the licensing of a
trademark is sufficient to establish nexus;
in others, not.
Some
states attempt (often unsuccessfully) to 'attribute'
nexus to an entity based on the activities of
related (eg subsidiary or affiliated) entities.
Nexus is attributed using the concept of agency,
the 'alter ego' theory, or the concept of unitary
taxation (most famously in California against
multinationals, where it failed).
State
taxation is relatively simple if a company is
doing business in just one state, but if a business
operates in multiple states, income will have
to be apportioned according to sometimes complex
formulae, and there is plentiful room for dispute.
The Uniform Division of Income for Tax Purposes
Act (UDITPA) was established to provide uniformity
among the states with respect to the taxation
of multistate corporations, and it has been
adopted, at least in part, by most states. UDITPA
provides that a business is considered to be
taxable in another state when:
- The
corporation is subject to the other state's
net income tax, franchise tax measured by
net income, franchise tax for the privilege
of doing business, or corporate stock tax;
or
-
The other state has jurisdiction to impose
a net income tax on the corporation, whether
or not the state actually does so.
Most
of the states that impose a corporate income
tax begin the computation of state taxable income
with taxable income as reflected on the federal
corporate income tax return (Form 1120). Those
states use either taxable income before the
net operating loss and special deductions (Line
28) or taxable income itself (Line 30). Those
states whose computation of state taxable income
is not coupled to the federal tax return could
adopt their own state-specified definitions
of gross and taxable income. Nevertheless, even
those states typically adopt the majority of
federal income and deduction provisions.
In
May, 2004, a poll conducted by Bloomberg’s Wealth
Management magazine, found that the state of
New York ranked 49th in a league table measuring
the tax burden in each state, with only Wisconsin
and “tax hell” Rhode Island producing worse
results.
By using an identical set of six tax parameters,
the survey found that the most wealth-friendly
state was Wyoming, where these parameters produced
a tax bill of $7,259. By comparison, the same
tax calculations resulted in a bill of $56,419
in Rhode Island.
A
analysis of state corporate income tax figures
produced in March, 2005, claimed that America’s
largest 250 corporations have managed to reduce
their state income tax contributions to around
one-third of the actual average state corporate
tax rate.
The
report, released by the liberal-leaning think
tank, Citizens for Tax Justice (in association
with the Institute on Taxation and Economic
Policy) was a follow-up to a September 2004
study of the federal income taxes paid by 275
Fortune 500 corporations, of which 252 disclosed
their state and local income tax payments.
According
to the CTJ study, by 2003, these 252 companies
had reduced their state income tax payments
to an average of 2.3% of their US profits, which
compares to an average statutory state corporate
tax rate of around 6.8%, resulting in a decline
in the total contribution of state corporate
income taxes to the economy of almost 40% since
1989.
The
study claimed that 71 of the 252 companies managed
to pay no state income tax at all in at least
one year from 2001 through 2003, while 25 of
the firms enjoyed multiple no-tax years. In
addition, 35 companies paid no state income
tax in 2003, and another 138 paid less than
half the statutory state corporate tax rate
in the same year.
At
a state corporate tax rate rate of 6.8%, the
CTJ calculated that the 252 corporations would
have paid $67.1 billion in state corporate income
taxes over the 2001-03 period on the $1 trillion
in U.S. profits that they reported. In reality,
the firms paid $25.4 billion in state income
taxes, the report stated.
Condemning
the findings, Robert S. McIntyre, director of
Citizens for Tax Justice and author of the study
observed that: “The data in our report show
in stark terms just how successful large, corporations
have become at shirking their tax responsibilities
to state and local governments.”
He
went on to add that: “As a result, individual
taxpayers and purely in-state (usually smaller)
businesses are paying a heavy price, in the
form of higher taxes, reduced public services
and unfair competition.”
However,
Merrill
Lynch & Co. and Lexmark International Inc, two
firms reportedly singled out as major culprits
in the study, refuted the CTJ’s conclusions.
"The
study is absolutely incorrect as it relates
to Merrill Lynch," remarked company spokesman
Bill Halldin, dismissing the allegation that
the firm paid no state income tax from 2001
through 2003 despite reporting profits in those
periods.
"We
paid state and local taxes in each of the three
years referenced," stated Mr Halldin.
Meanwhile,
a Lexmark spokeswoman explained that the firm
had paid $15 million in state corporate income
taxes during the same period, in addition to
a number of other taxes such as state and local
property, payroll, insurance and sales tax.
"Lexmark
is committed to complying with all tax laws
in every jurisdiction around the world where
we do business," the spokeswoman stated.
In
July 2007, Senators Mike Crapo (R-Idaho) and
Charles E. Schumer (D-New York) announced the
introduction of new legislation that would remove
from affected businesses the burden of double
taxation which results from a varying mix of
state tax laws.
Crapo
and Schumer introduced the bill following the
Supreme Court’s refusal the week prior
to hear two cases relating to multiple layers
of tax on multi-state businesses.
At
issue was whether companies, in addition to
being taxed in the state where they are physically
located, should also be subject to business
activity taxes where they solicit business or
have customers, even if they do not have employees
or a physical location in the state.
The
Schumer-Crapo legislation, known as the Business
Activity Tax Simplification Act (BATSA), codifies
the physical presence standard, which is common
practice for the imposition of sales and use
taxes but not for income taxes. This bill would
thus eliminate one type of double taxation and
its resulting effect on interstate commerce.
“Businesses
should not be punished with double taxation
simply because their products reach beyond state
borders,” stated Schumer. “At a
minimum, this is a huge administrative burden.
In the worst case scenario, these differing
state tax treatments will drive businesses to
states with more favorable laws. Either way,
the effect on commerce is debilitating.”
Crapo
added: “This effort by a large number
of states to impose business activity taxes
based on economic presence has the potential
to open a Pandora’s Box of negative implications
for businesses. Without clarification by Congress,
states will be free to enact revenue-raising
nexus legislation and policies that, by definition,
will not and cannot take into account the national
impact of such activities.”
The
Senators said that in recent years, states which
impose taxes based on economic presence have
caused widespread litigation and stifled commerce.
With a dizzying maze of state and local tax
rules – some enacted by legislatures and
others imposed by state revenue authorities
and upheld by state courts – simplification
is desperately needed, they added.
According
to Crapo and Schumer, the legislation will have
positive benefits for companies big and small.
For smaller businesses facing different taxing
standards in different states, BATSA would eliminate
costly litigation and administrative issues.
For larger companies that have customers throughout
the country, the legislation creates clarity
and reduces the likelihood of double taxation.
For the states, the bill creates a uniform taxing
standard that permits them to compete on a level
playing field for business activity and jobs,
while establishing a predictable and relatively
easily discernable tax base.
On
June 18, 2007, the Supreme Court denied certiorari
in two cases which challenged the constitutionality
of taxing companies with no physical presence
in a state. In addition to ignoring the tax
imbalance, Crapo and Schumer argue that the
court’s inaction has emboldened at least
one state to introduce new legislation that
would allow it to levy taxes based on economic
presence – and other states could follow
suit if Congress doesn’t act.
“In
short, this is no longer a theoretical discussion,”
Schumer stated. “I believe that Congress
has a duty to prevent some states from impeding
the free flow and development of interstate
commerce and to prevent double taxation.”
The
Schumer-Crapo legislation updates current law
by codifying the physical presence standard,
requiring a business to have a physical presence,
such as employees or property, in the state
before it can be subject to state business activity
taxes. The bill establishes a bright-line standard
that will eliminate any confusion for both state
tax administrators and businesses as to the
circumstances under which businesses are subject
to state business activity tax (BAT). Under
BATSA, mere economic activity – such as
in-state customers – would be insufficient
for a state to impose income and other business
activity taxes on out of state businesses. Firm
guidance on what activities can be conducted
within a state that will trigger that state’s
taxing power is expected to provide certainty
for tax administrators and business, reduce
multiple taxation of the same income, and reduce
compliance and enforcement costs for states
and businesses alike.
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