2024 Chapter 12 Lecture Notes.docx

Chapter 12 State and Local Taxes LECTURE NOTES Learning Objectives 12-1. Describe the primary types of state and local taxes. 12-2. Determine whether a business has sales tax nexus and calculate its sales tax withholding responsibilities. 12-3. Identify whether a business has income tax nexus and de...

Chapter 12 State and Local Taxes LECTURE NOTES Learning Objectives 12-1. Describe the primary types of state and local taxes. 12-2. Determine whether a business has sales tax nexus and calculate its sales tax withholding responsibilities. 12-3. Identify whether a business has income tax nexus and determine its state income tax liabilities. Lecture Notes State and Local Taxes Company subject to a state’s taxing regime based on: Commercial domicile Nexus____________ Sales and Use Taxes Sales tax _Nexus_ Sales tax _nexus__ is the sufficient connection between a business and a state that allows a state to require an out-of-state business to collect sales taxes and remit them to the state. Sales tax _nexus__ was traditionally established through physical presence of salespeople or property in a state. The Wayfair decision creates economic sales tax nexus for online sellers with more than $_100,000_ or _200_ sales transactions within a state on an annual basis. Sales tax liability If the seller doesn’t have nexus, then the customer is responsible for remitting a _use__ tax (at the same tax rate as sales tax) to the state in which the property is used. Income Taxes Businesses must pay income tax in their state of __domicile_. Four criteria for determining whether states can tax nondomiciliary companies and to what extent: Sufficient connection or nexus must exist between the state and the business. A state may tax only a _fair_ portion of a business’s income. Businesses must be able to divide or _ commercial domicile__ income among the states where nexus exists. The tax cannot be constructed to discriminate against _nonresident_ businesses. The taxes paid must be fairly related to the _services_ the state provides. Income tax nexus is created through physical or economic nexus within a state. Public Law 86-272 Businesses with income tax nexus are protected from an income tax liability if, and only if, all the following apply: The tax is based on _net income__ (not gross receipts or revenue). The taxpayer sells only _tangible _ personal property in that state. The taxpayer’s in-state activities are limited to _solicitation_ of sales (see below for the definition of _solicitation_). The taxpayer participates in _interstate_ commerce. The taxpayer is __nondomiciliary__. The taxpayer approves orders __outside__ the state. The taxpayer delivers goods from _outside_ the state. Solicitation The Supreme Court determined the following activities meet the definition of solicitation: Soliciting by any form of _advertising__. Carrying samples and promotional materials for display or distribution _without____________ charge. Passing _ inquiries _ or _ complaints _ to the home office. Checking customer’s __ inventory _ for reorder. Maintaining a sample room for two weeks or less; this is known as the_ trade show rule __. Recruiting, training, and evaluating _salespeople_ using homes or hotels. Owning or furnishing _personal property__ and _autos__ used in sales activities. The Supreme Court held the following activities _do not __ meet the definition of solicitation and, therefore, create income tax nexus with the state in which they take place: Making _repairs__. _Collecting __ delinquent accounts. Investigating _________________. Installing or supervising the _installation_ of property. _Training__ for employees other than sales representatives. Approving or accepting _orders_. Repossessing _property___. Securing _deposits__. Maintaining an _office__ (other than in-home). Entities included on income tax return Separate tax returns Separate-return states require a separate return for each entity that has income tax nexus in the state. Unitary tax returns Unitary states require members of a unitary group to file a __unitary__ tax return reflecting the combined income of the unitary group. Any of three factors determine a unitary group: _Functional Integration_, _Centralization of Management_, and _Economies of Scale__. State taxable income _____________ taxable income—starting point for computing state taxable income Identify federal/state _______________ (differences) for each specific state. Dividing state tax base among states Business income Apportionment formula Historically, most states determined the apportionment formula for income by relying on a three-factor test: _sales_, _payroll_, and _property_. Most states have shifted to either a single-factor _single-factor_ formula or a factor that super-weights the sales factor. Businesses determine the factors as the ratio of: Total sales, payroll, or property in a specific state. Total sales, payroll, or property everywhere. The general rules for determining the amount of sales to include in the sales factor calculation are: Tangible personal property sales are sourced (included) in the _destination_ state (the location the property is delivered and used). If the business does not have nexus in the destination state, sales are generally “_thrown back_” to the state from which the property is shipped; this is called the _throwback_ rule. Payroll factor Payroll includes salaries, commissions, bonuses, and other forms of compensation. Payroll does not include amounts paid to independent contractors_. Payroll for each employee is apportioned to a single state (payroll for employees who work in more than one state is sourced to the state where they perform the majority of services). Property Use the _average_ property values for the year [(beginning + ending)/2]. Value property at _historical_ cost rather than adjusted basis (do not subtract accumulated depreciation in determining value). Include property in transit (such as inventory) in the state of _origin_. Include only business property (values of rented investment properties are excluded). Include rented or leased property by multiplying the annual rent by _8_ and adding this value to the average owned-property factor. Nonbusiness income Common types of nonbusiness income and the rules for allocating them to specific states: Allocate interest and dividends to the state of __commercial domicile_ (except interest on working capital, which is business income). Allocate rental income to the state where the property generating the rental income is _located____________. Allocate royalties to the state where the property is _used_ (if the business has nexus in that state; if not, allocate royalties to the state of commercial domicile). Allocate capital gains from investment property to the state of _commercial domicile_. Allocate capital gains from selling rental property to the state where the rental property was _located______________. State income tax liability Business income is apportioned based on some combination of the following factors: _Sales___________ _Payroll___________ _Property___________ Nonbusiness income is allocated. Investment income is allocated to the state of _domicile__________________. Rents and royalties are generally allocated to the state where the property is _located___________.