2024 Chapter 12 PPT.pptx

TAXATION OF BUSINESS ENTITIES 2024 Edition Chapter 12 State and Local Taxes © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. TAXATION OF BUSINESS ENTITIES 2024 EDITION Chapter 12 State and Local Taxes Lesson 1 12-2 © McGraw...

TAXATION OF BUSINESS ENTITIES 2024 Edition Chapter 12 State and Local Taxes © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. TAXATION OF BUSINESS ENTITIES 2024 EDITION Chapter 12 State and Local Taxes Lesson 1 12-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 1. Describe the primary types of state and local taxes. 2. Determine whether a business has sales tax nexus and calculate its sales tax withholding responsibilities. 3. Identify whether a business has income tax nexus and determine its state income tax liabilities. LEARNING OBJECTIVES © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-3  Purpose  Raise revenue to finance state governments STATE AND LOCAL TAXES (1 OF 3)  Subject to taxes if:  Taxpayer’s commercial domicile  State where a business is headquartered and directs operations  Taxpayer has nexus  Nexus is the sufficient (or minimum) connection between a business and a state that subjects the business to the state’s tax system. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-4  Sales of tangible personal property are generally subject to the sales tax.  Taxable items vary from state to state. SALES TAXES (1 OF 2)  Sales Tax Nexus  Businesses create sales tax nexus when they have a physical presence in the state.  The Wayfair decision adds economic nexus for online sellers when they reach certain sales thresholds.  A business is required to collect sales tax from customers in a state only if it has sales tax nexus with that state. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-5  Businesses that establish sales tax SALES TAXES (2 OF 2) nexus with a state but fail to properly collect sales tax can create significant liabilities that need to be disclosed for financial reporting purposes.  Sellers with sales tax nexus collect and remit sales tax.  When a seller doesn’t have sales tax nexus, the customer is responsible for paying a use tax to the state in which the property is used. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-6 SALES TAXES: EXAMPLE 1  Kay Bailey Corporation is a Texas corporation engaged in the business of selling rare books. The only activity that Kay Corporation performs in New Mexico is the solicitation of sales through representatives who visit residents of New Mexico to sell the company’s products.  Does Kay have New Mexico sales tax nexus? 12-7 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. SALES TAXES: EXAMPLE 2  Perry Corporation is a Texas corporation principally engaged in the sale of flyfishing equipment. Perry’s only activity in Colorado is the solicitation of orders for their sporting equipment through catalogs and flyers. Perry delivers the sporting equipment via USPS to its customers in Colorado.  Does Perry have Colorado sales tax nexus? 12-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. SALES TAXES: EXAMPLE 3  Hatch Corporation is a Virginia corporation engaged in the business of selling sporting goods. Hatch Corporation has nexus in Washington and has $210,000 of taxable sales. Assuming the (hypothetical) sales tax rate is 8.2 percent, what is the sales tax Hatch should collect and remit? 12-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Businesses must pay income tax in their state of commercial domicile.  The Supreme Court spelled out four INCOME TAXES (1 OF 21) criteria for determining whether states can tax nondomiciliary companies and to what extent.  Sufficient connection or nexus exists between the state and the business.  State may tax only a fair portion of a business’s income.  Tax cannot be constructed to discriminate against nonresident businesses.  Taxes paid must be fairly related to the services the state provides. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-10  Income Tax Nexus  Businesses must file income tax returns in states where they have income tax nexus. INCOME TAXES (2 OF 21)  Rules for determining income tax nexus are not necessarily the same as those for determining sales and use tax nexus.  Physical presence creates income tax nexus for all businesses—but sellers of tangible personal property may be protected by Public Law 86272. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-11  Physical presence creates income INCOME TAXES (3 OF 21) tax nexus for sellers of tangible personal property, but if their instate activities are limited to “protected” activities as described by Public Law 86-272 they are protected from an income-based tax.  Public Law 86-272  Businesses are protected from an income tax liability if (and only if) all the following apply:  Tax is based on net income (not gross receipts or revenue). © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-12  Taxpayer sells only tangible personal property.  Taxpayer’s in-state activities are limited to solicitation of sales.  Taxpayer participates in interstate INCOME TAXES (4 OF 21) commerce.  Taxpayer is nondomiciliary.  Taxpayer approves orders outside the state.  Taxpayer delivers goods from outside the state.  Providing services along with the sale of tangible personal property violates the criteria and creates an income tax liability. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-13  Solicitation  Public Law 86-272 protects the solicitation of tangible personal property.  Supreme Court determined the following activities meet the definition of solicitation:  Soliciting by any form of advertising  Carrying samples and promotional INCOME TAXES (5 OF 21) 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 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-14  Supreme Court held the following activities do not meet the definition of solicitation and, therefore, create an income tax liability within the state in which these activities take place: INCOME TAXES (6 OF 21)  Making repairs  Collecting delinquent accounts  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 office © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-15 INCOME TAXES: EXAMPLE 1 (1 OF 2)  Mark Corporation, incorporated in Colorado, engages in the sale and distribution of copiers and fax machines across several states. Mark also has a copy center design team that provides comprehensive services to large clients. A description of Mark’s activities in the following states follows: 12-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. INCOME TAXES: EXAMPLE 1 (2 OF 2)  Mark sells copiers in Utah through its local sales force. Mark maintains no public sales office and maintains no inventory in Utah. All orders are approved in Colorado and delivered via common carrier. To be competitive with a local copier company, Mark has its sales agents on site to supervise installation and perform a twoday seminar on proper use of the equipment.  Does Mark have a Utah income tax liability? 12-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. INCOME TAXES: EXAMPLE 2  Mark sells copiers in Arizona through its sales force. For the past 25 years all orders are approved in Colorado and delivered via common carrier. One local sales representative won a large contract in the current year. To help facilitate the sale, Mark reduced its normal fee for its copy center design team by 50 percent and had them do an on-site visit to customize and integrate the client’s new center and equipment.  Does Mark have Arizona income tax liability? 12-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Entities Included on Income Tax Return  Separate tax return  Require only those businesses with INCOME TAXES (7 OF 21) nexus in a state to file an income tax return  Unitary tax return  Companies not filing a federal consolidated tax return can become a unitary group.  Unitary tax return group includes all members meeting the unitary criteria —whether they have nexus or not.  States west of the Mississippi River (and Illinois) are unitary return states. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-19  Supreme Court identified three factors that can be used to determine whether a group of businesses is unitary:  Functional integration (vertical or horizontal integration or knowledge transfer) INCOME TAXES (8 OF 21)  Centralization of management (interlocking directors, common officers, or rotation of management)  Economies of scale (group discounts or other efficiencies due to size)  Unitary concept pervades activities in the entire income tax system, including computing taxable income, computing apportionment percentages, and determining tax return filing requirements. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-20  State Taxable Income  Businesses must calculate state taxable income for each state in which they must file tax returns.  Federal taxable income is generally INCOME TAXES (9 OF 21) the starting point for computing state taxable income.  Businesses must reconcile from federal taxable income to state taxable income.  Requires them to identify federal/state adjustments (differences) for each specific state before apportioning the income to a particular state where they have income tax nexus. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-21  Because states do not tax federal INCOME TAXES (10 OF 21) interest income, all states require a negative adjustment for federal interest income.  Most states require a positive adjustment for state income taxes, as they do not allow businesses to deduct state income taxes, and they require a positive adjustment for state and local bond interest income if the bond is from another state. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-22 INCOME TAXES (11 OF 21) 12-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Dividing State Tax Base among States  All state taxable income is taxed in INCOME TAXES (12 OF 21) the state of commercial domicile unless the business is taxable in more than one state.  An interstate business must separate its business income from nonbusiness income.  A business must apportion its business income among the states in which it conducts business, whereas it allocates nonbusiness income. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-24  Business Income  Includes all revenues earned in the INCOME TAXES (13 OF 21) ordinary course of business—sales less cost of goods sold and other expenses  Fairly apportioned or divided across the states where nexus exists  Business may apportion if it has nexus with a state, even if the state does not actually impose tax. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-25  Apportionment formula  States determine the apportionment formula for income, and most rely on three factors:  Sales  Payroll INCOME TAXES (14 OF 21)  Property  Business determines the factors as the ratio of: © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-26  Sales factor includes:  All gross business receipts net of returns INCOME TAXES (15 OF 21)  Allowances  Discounts  The general rules for determining the amount of sales to include in the sales factor calculation are:  Tangible personal property sales are sourced (included) to the destination state (the location the property is delivered to and used in). © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-27  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. INCOME TAXES (16 OF 21)  Dock sales (sales picked up by the customer) are generally sourced in the destination state rather than the state where they are picked up.  Sales of services are sourced to the state where the services are performed (California and Illinois are exceptions to this rule).  Government sales are sourced in the state from which they were shipped. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-28  Payroll  Defined as total compensation paid to employees  Includes salaries, commissions, INCOME TAXES (17 OF 21) bonuses, and other forms of compensation  Does not include amounts paid to independent contractors  Payroll for each employee is apportioned to a single state.  Property  Includes both real and tangible personal property, but not intangible property © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-29  General rules for determining the property factors are:  Use the average property values for the year [(beginning + ending)/2]. INCOME TAXES (18 OF 21)  Value property at historical cost rather than adjusted basis.  Include property in transit in the state of destination and also business property (values of rented investment properties are excluded).  Include rented or leased property by multiplying the annual rent by eight and adding this value to the average owned-property factor. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-30  Nonbusiness Income  Common types of nonbusiness INCOME TAXES (19 OF 21) income and the rules for allocating them to specific states are:  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. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-31  Allocate royalties to the state where INCOME TAXES (20 OF 21) 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. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-32 INCOME TAXES (21 OF 21)  State Income Tax Liability  State taxable Income = (Business income × Apportionment factor) + Nonbusiness income allocated to the state © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 12-33 END OF PRESENTATION 12-34 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.