[Editor's note: This article is part two of an overview of various tax issues. The first portion of the article appeared in the March 2002 Lawyers Journal. The full article appears on the MBA Web site here.]
Multistate corporate income tax principles (continued) Payroll factor The payroll factor is determined by comparing the compensation paid for services rendered within a state to the total compensation paid by the corporation. The payroll factor is a fraction: the numerator is the total amount that a corporation has paid or accrued in a state during the tax period for compensation; the denominator is the total amount paid or accrued by the corporation for compensation during the period.
Payments made to an independent contractor or any other person who is not properly classifiable as an employee generally are excluded from the numerator and denominator of the payroll factor.
Some states exclude the compensation paid to executive officers from the payroll factor.
The payroll factor denominator is the total compensation paid everywhere during the tax period. Thus, compensation paid to employees whose services are performed entirely within a state where a taxpayer is immune from taxation under P.L. 86-272 is included in the denominator of the payroll factor.
Sales factor The sales (or receipts) factor is a fraction: the numerator is the total sales or gross receipts of the corporation in the state during the tax period; the denominator is the total sales or gross receipts of the corporation everywhere during the tax period.
Sales or gross receipts for this purpose are generally net of returns, allowances and discounts.
With respect to the sale of assets, some states require that the gross proceeds, rather than the net gain or loss, be included in the fraction.
In determining the numerator of the sales factor for a corporation that sells tangible personal property, most states follow the "ultimate destination concept." Under this concept, sales are assumed to take place at the point of delivery, as opposed to the location at which the shipment originates. Consequently, in-state sales are defined as sales to purchasers with a destination point in that state; sales delivered to out-of-state purchasers are included in the sales factor of the destination state.
Filing options States take varying approaches to state income taxation. Some states (e.g., Massachusetts) generally view each corporation as its own separate entity and require filing on a separate-entity basis. Other states (e.g., California) allow or require taxpayers that are members of a unitary group to calculate their income using a combined report that includes the income and apportionment factors of all such corporations. Additionally, some states allow entities to file as part of an affiliated group, similar to a federal consolidated return. These elective consolidations are typically an alternative to either separate reporting or combined reporting.
In states implementing a separate filing regime each taxpayer files its own tax return and reports only its own income and apportionment factors. In states using a unitary combined reporting methodology, taxpayers that are engaged in a unitary business compute their taxable income as if all members of the group were one entity.
Additionally, some states allow for elective consolidated or combined reporting. For example Massachusetts allows post-apportionment combination. Each taxpayer with a taxable presence in the state computes its own taxable income and then combines this with the taxable income of other entities. Such an approach allows one taxpayer to offset it income against the loss of another. Another approach is to allow for pre-apportionment combination. Under this option, each taxpayer with a taxable presence in the state adds its income together to arrive at consolidated net income. This income is then allocated and apportioned based on the combined apportionment factors (i.e., total numerators over total denominators) of the group.
Massachusetts corporate excise tax Tax base Massachusetts' corporate excise tax has both an income measure and a non-income measure to the tax. The income measure of the tax is imposed at a rate of 9.5 percent of net income attributable to Massachusetts. The non-income measure of the tax is imposed at a rate of .26 percent of a corporation's tangible property or of a corporation's net worth. The taxpayer must pay the total of these amounts.20 As the non-income measure is not based on federal taxable income, taxpayers that do not have federal taxable income (i.e., are in a loss position) will have a Massachusetts corporate excise tax liability. Taxpayers are frequently surprised by this unfortunate news. Therefore, it is critical to advise a client of this possibility.
The computation of the Massachusetts income tax base begins with net income per line 28 of the taxpayer's federal income tax return. After certain modifications and the subtraction of the applicable dividend received deduction, a taxpayer will arrive at a subtotal for its income tax base. The taxpayer next modifies this base to account for loss carryover and the resulting figure is the income subject to apportionment. The taxpayer will multiply this net income measure by the Massachusetts apportionment percentage and then by the 9.5 percent rate to arrive at the portion of the tax due relating to the net income measure of the tax.
Massachusetts offers a limited amount of credits to further reduce the income (or non-income) tax obligation.
Massachusetts business trusts, financial institutions, utilities and security corporations do not have to pay a non-income measure of the tax. S Corporations are subject to the non-income measure of the tax.21 The Department of Revenue estimates that the non-income measure of the tax is about 10 percent of the total corporate excise tax revenue generated by the commonwealth.
The computation of the non-income measure of the tax begins with the taxpayer determining whether it will be considered a tangible property corporation or an intangible property corporation. The Massachusetts statute provides for two different, yet similar methods of determining whether a corporation is a tangible property corporation or an intangible property corporation. However, based on a recent decision22, a taxable can choose either calculation. Prior to this decision, domestic corporations were required to use one calculation and foreign (non-Massachusetts) corporations were required to use a different calculation. Tangible property corporations pay on the basis of their tangible property and intangible property corporations pay on their net worth. Generally, a corporation will be classified as a tangible property corporation if its ratio of tangible assets (not subject to local tax) in Massachusetts on the last day of the taxable year is at least 10 percent of: the total of the corporation's assets multiplied by the net income apportionment percentage. If the result is less than 10 percent then the corporation will be deemed to be an intangible corporation.
The calculation for determining the tangible property base is identical for domestic and foreign corporations.
In calculating the net-worth base, the taxpayer is again allowed to choose whether to use the domestic or foreign calculation. Note here that this election can be made without regard to whether the corporation chose to use the domestic or foreign calculation earlier. The major difference between the two formulae is the option to back out the investment in foreign subsidiaries not doing business in Massachusetts from the denominator. This calculation will increase the chance that a taxpayer will be deemed to be a tangible property corporation.
Directive 99-1 provides further guidance as to the method for determining whether a corporation is a tangible or intangible property corporation and for calculating an intangible property corporation's net worth.
Combined reporting As discussed above, Massachusetts allows taxpayers to determine its income tax liability on a combined basis.23 Under this option, corporations that participate in the filing of a consolidated federal income tax return may calculate combined net income by: (1) determining the taxable net income for each member of the group on a separate basis (2) apportioning that income to Massachusetts, and (3) assigning the apportioned net income to the group members. This method allows for members of the same affiliated group to offset income of one member with current year losses of another member.
Sales and use tax principles Sales tax All states except Alaska, Delaware, Montana, New Hampshire and Oregon (NOMAD) levy some form of sales and use tax. In addition, thousands of local jurisdictions levy sales and use taxes. Massachusetts imposes a state-level sales tax. No counties, cities or towns currently impose a sales tax.
Local governments may either follow the state's treatment of transactions or develop their own approach. The local tax rates may differ considerably. Also, local jurisdictions may administer the tax independently of the state.
A sales tax is typically imposed on the sale, transfer or exchange of a "taxable" item or service, unless an exemption applies. The tax applies to the sale or transfer to the end user or consumer and generally is added to the sales price and charged to the purchaser. The seller remits the sales tax to the state. As such, sales taxes are trustee taxes and become the property of the state once they are collected from the purchaser. However, in the event that no sales tax is collected, a state may seek collection from either the purchaser or the seller. The tax generally applies to the sale of tangible personal property and, in some states (e.g., Connecticut), to selected services.
Use tax The use tax was enacted as a complementary tax to the sales tax in order to protect in-state sellers from inequitable competition from out-of-state sellers. The use tax is imposed on the storage, use, or consumption of the taxable item or service for which no sales tax has been paid. The use applies to purchases made outside the state but used within the state. Use tax should be self-assessed by the purchaser and paid directly to the state. States typically provide a credit to the sales tax, so that only one tax applies to a transaction. Accordingly, a use tax is generally due only when no sales tax is collected or when the sales tax charged by one state is at a lower rate than the tax in the state where the product is used.
Nexus As with income tax, a state can only require a seller to collect sales tax if the seller has nexus with the state. Nexus standards and requirements for sales and use taxes are similar to those for income taxes, however there are no federal statutory limitations to the imposition of sales and use taxes that are comparable to P.L. 86-272 limitations with respect to state income taxation.
The history of what constitutes sufficient nexus for the imposition of sales and use practically mirrors that of the nexus standards for taxing interstate commerce in general. As indicated infra, the Supreme Court has held that there must be some sort of physical presence within a state in order for that state to impose a sales tax filing obligation.24
General issues Sales tax issues associated with any sale include: (1) whether the product sold or service provided is of a type that is subject to tax, (2) do any exemptions apply - including exemptions for the type of product, the use of the product, or the status of the end-user, (3) does the seller have nexus, and (4) in what state did the sale occur25.
Sales tax is typically sourced to the state of ultimate destination of the product. Sales and use tax is a generally regarded as a consumption tax, hence the tax is sourced to state of consumption or use.
Exemptions from sales tax generally fall within three categories (1) exempt products, (2) exempt transactions, (3) exempt purchasers or users.
Massachusetts sales and use tax Massachusetts imposes a 5 percent sales tax on the sale or lease of tangible personal property. Typically the sales tax is paid by the purchaser to the vendor. The vendor acts as a trustee of the commonwealth and remits the tax to the commonwealth.
Massachusetts also imposes a use on the sale or lease of tangible personal property where no sales tax (or a sales tax at a rate of less than 5 percent) is charged. The purchaser self-assesses the use tax and pays it directly to the commonwealth. Example: A consumer purchases a television in tax-free New Hampshire for use in the taxpayer's Massachusetts home. The taxpayer is obligated to self-assess a use tax and remit the appropriate funds to the commonwealth. Likewise, businesses purchasing non-exempt property and equipment must self-assess the tax if these companies are not paying sales tax or are paying sales tax of less than 5 percent. Frequently, the Department of Revenue will perform both a sales and use tax audit contemporaneously (or even at the same time).
Exemptions Massachusetts provides exemptions for sales for certain types of products. These products include clothing, newspapers, tickets to events, utilities to certain customers, telephone service to residential users, personal or professional services, and sales of transportation.
Massachusetts also provides exemptions for certain types of sales. Such sales include casual sales and sales for resale. A casual sale is an infrequent and nonrecurring sale made by a person not regularly engaged in the business of making such a sale. The sale for resale exemption is provided based on the theory that the tax will be collected from the end user, rather than from every purchaser in the chain.
Finally, Massachusetts provides exemptions based on the type of purchaser. Exempt purchasers include governmental agencies and purchasers using the product in manufacturing (and in some instances research and development).
Bad debts A taxpayer may reply for reimbursement for tax remitted on bad debts.26 This request can only be made on annual basis on Form ST-BDR (Claim for Bad Debt Reimbursement). The form must be filed by the due date, including extensions, of the seller's federal income tax return.
State employment tax principles Employment taxes are generally broken into two categories: those that are imposed on the employer and the employee or individual. The employer-level tax is the state unemployment tax. This tax was created to fund the unemployment reserve of states to compensate individuals who are temporarily unemployed. The employee-level tax is withheld from the employee's wages. The employer does not contribute to this amount.
As is the case for income and sales taxes, an employer's state unemployment tax rate will vary from state to state. The rate also varies based upon the company's employment history. In general, the employer will receive a lower rate if few claims have been filed against the employer's account.
Both unemployment taxes and withholding taxes should be paid to the jurisdiction where the services are performed. Taxpayers frequently make payments based on the employee's state of residence. While in rare circumstances this may be correct, this practice may lead to assessment in those states where the services are performed.27
Scott M. Gilefsky is a manager in the tax and business-advisory services practice of Andersen's national office, where he works exclusively in the state and local tax area 1. U.S. Bureau of the Census, State Governments - Revenue by State: 1999 (Washington, D.C.: U.S. Bureau of the Census, 2000); U.S. Bureau of the Census, State Governments-Summary of Finances: 1980 to 1998 (Washington, D.C.: U.S. Bureau of the Census, 2000).
2. See e.g., Massachusetts Department of Revenue, Monthly Report of Tax Collections through December 31, 2001 (Boston, Massachusetts, 2001).
3. Wisconsin v. J.C. Penney Co., 311 U.S. 435 (1940).
4. Mobil Oil Corp v. Comm'r of Taxes of Vermont, 445 U.S. 425 (1980).
5. See, e.g., Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (1993).
6. See Mass. DOR Dir. 96-2.
7. Complete Auto Transit v. Brady, 430 U.S. 274 (1976).
9. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
10. Additionally, registering to do business in a state may be enough to establish nexus in some states. Note that the South Carolina Supreme Court in Geoffrey agreed that the taxpayer had due process and commerce clause nexus based on its licensing of intangibles in the state.
11. 15 USC section 381-384. Although formally codified as the part of the United States Code, Public Law 86-272 is frequently referred to as the Public Law or P.L. 86-272.
13. For example, Michigan's Single Business Tax and Washington's Business and Occupation Tax. Also note that sales taxes (discussed infra) and franchise taxes are beyond the scope of Public Law 86-272.
14. For recent Massachusetts treatment see e.g., National Private Truck Council v. Commissioner of Revenue, 688 N.E.2d 936 (1997); Kennametal, Inc. v. Commissioner or Revenue, A.T.B. Nos. 170029, 183527, 186703, (1996) affirmed 686 N.E.2d 436 (1997); Amgen, Inc. v. Commissioner of Revenue, A.T.B. 218135, 236076, 236077.
15. 15 USCS section 383
16. One way to think of this division of income is to think of the business income of a corporation as a pie and as apportionment as determining each states slice of the pie. Pomp, Richard D. and Oldman, Oliver, State & Local Taxation, Third Ed. 1998, vol III, ch. 10.
17. Business income is typically net income derived from the ordinary course of a taxpayer's business activities. Nonbusiness income is, as one might imagine, typically income generated outside of the taxpayer's regular business activities. While business income is apportioned among all of the states where the taxpayer has a filing obligation, non-business income is allocated to one specific state. Generally, non-business income will be assigned to the state of commercial domicile or the state where the income-producing asset is located.
18. States adopting this method will add the property factor, the payroll factor, and twice the sales factor and then divide by four to determine the apportionment percentage.
19. These states will ignore the payroll and property factors. Such a structure rewards a taxpayer for having high payroll and property within a state (or at least does not punish a taxpayer for this business model). For example, to the extent that two taxpayers have the same percentage of sales to a state, a taxpayer with minimal payroll and property within a state will have the same apportionment percentage as a taxpayer with significant payroll and property with the state.
20. Some states have taxing regimes where a taxpayer need only pay on the higher of the income measure or the non-income measure.
21. Some S corporations are subject to the income measure of the tax as well. S corporations with greater than $6 million in gross receipts must pay a tax at the rate of 3 percent. S corporations with greater than $9 million in gross receipts pay a tax at the rate of 4.5 percent.
22. Perini Corp. v. Commissioner of Revenue, 647 N.E.2d 52 (1995).
23. M.G.L., c. 63, section 32B.
24. Quill Corp. v. North Dakota 25. This final question is critical when services are provided in more than one state or where a product is used in more than one state.
26. See TIR 00-3.
27. Some states do allow for reciprocity. In this instance, the state where the work is performed relinquishes its right to tax the wages earned in the state.