2009 was a significant year for state taxation issues. As states
grappled with unprecedented economic problems, their legislatures
and, in some cases, their judicial systems, searched for additional
revenue from residents and companies doing business within their
jurisdictions. With Congress and the U.S. Supreme Court continuing
their "hands-off" approach to state taxation, states expanded their
efforts to tax companies with minimal nexus, and reached into other
states to tax sales made to their residents. Here are some of the
highlights in Massachusetts.
1. Combined reporting
Forty-six states and the District of Colombia impose some sort
of corporate income, franchise or excise tax based on income (only
Nevada, South Dakota, Washington and Wyoming do not). Historically,
Massachusetts has been a separate filing state - every company with
nexus in Massachusetts has filed a state tax return and apportioned
its income among its activities in all states where it does
In 2008 (effective in 2009), Massachusetts adopted "combined
reporting," which is designed to address questionable income
shifting, abusive tax shelters and other intercompany transactions
among members of a corporate group. With combined reporting, the
income of a unitary group of affiliates is combined and then
apportioned among the members of the entire group. This includes
all members of the unitary group, whether or not they have
nexus in the taxing state (although some states do exclude members
In general, combined reporting under certain circumstances
apportions to Massachusetts the multistate income of a unitary
business (whether conducted through several divisions or affiliated
corporations), not just the multistate income of a single corporate
entity. All activities constituting a single business are viewed as
a whole, rather than as separate activities conducted in the
Combined reporting was developed in the late 1800s as Western
states sought to impose property taxes on railroad companies. The
general idea is to fairly tax a company's entire unitary business.
For some companies, their overall tax burden will decrease, but for
most, it will increase, as each state has different rules.
Massachusetts expects to bring in as much as $400 million in new
Combined reporting differs from consolidated return filings in
several ways (50 percent versus 80 percent ownership, apportionment
methodology, unitary business requirement, worldwide/water's-edge
combinations, etc.) and has generated much more litigation in other
states than disputes involving consolidated returns, primarily in
So far, about 20 states have mandatory combined reporting; 15
other states generally allow separate filing, but also require or
permit a combined unitary report if certain conditions are
satisfied. In 2009, 10 states considered and then rejected
mandatory combined reporting.
The issues involved are complex. They range from defining the
unitary group, understanding and applying the various tests used by
courts to define the group, deciding whether to report on a
worldwide basis or on a "water's-edge" basis, understanding the
difference between business and non-business income, analyzing
nexus issues, etc. As other states have experienced, we can expect
much litigation involving these issues.
2. Geoffrey and Capital One cases - Nexus without a
For many years, taxpayers have argued, mostly without success,
that the "physical presence" test of Commerce Clause nexus that was
mandated by the Supreme Court in its Quill
decision2 should apply to all taxes, not just
sales and use taxes. Congress and the Supreme Court have
consistently refused to address this issue (see #3 below discussing
HR 1083, which has been sitting in the House for over a year). The
Supreme Court insists that Congress should address this issue,
since it has broad power under the Commerce Clause to do so.
Congress' failure to act has resulted in litigation in many states,
Following the precedents set by several other states, the
Massachusetts Supreme Judicial Court in its Geoffrey
decision upheld the imposition of income tax on an out-of-state
intangible holding company that received royalty income from
affiliates in Massachusetts but had no physical presence
in the state.
Following its holding in the Capital One case, the
Court held that physical presence is not required for an entity to
be subject to a state tax based on income. Instead, a taxpayer must
only have established substantial nexus with the state. In the
Capital One case, the Court noted that significant,
purposeful economic activity in a state is enough to establish
significant nexus required by prior Supreme Court decisions. In the
Geoffrey case, the Court noted that substantial nexus can
be established through the licensing of intangible property to a
Massachusetts business that generates income for the licensing
An analysis of Geoffrey might be helpful. Geoffrey was
a Delaware company wholly owned by Toys "R" Us, Inc. Geoffrey did
not own any real or tangible personal property in Massachusetts,
nor did it have any employees or offices located in Massachusetts.
Geoffrey had never used state or federal courts in Massachusetts.
Geoffrey held all trademarks, trade names and service marks
associated with Toys "R" Us and its related companies, and licensed
the intangible property to various Toys "R" Us affiliates
throughout the United States, including Massachusetts. These
affiliates made market-rate royalty payments to Geoffrey.
The DOR assessed Geoffrey with unpaid corporate taxes, interest
and penalties. Geoffrey protested the assessment, but the Appellate
Tax Board upheld the department's findings.
The Supreme Judicial Court, saying basically that "everyone else
is doing it," disagreed with Geoffrey's argument that physical
presence was required for a state to impose an income-based tax on
an out-of-state taxpayer. The Court maintained that Geoffrey
engaged in business activities having a substantial nexus with
Massachusetts, including entering into contractual relationships
with Toys "R" Us in Massachusetts and marketing to consumers in
Massachusetts. These activities generated substantial income for
Geoffrey, and the Court concluded that they established a
substantial nexus with Massachusetts.
The effect of these cases on future tax litigation in
Massachusetts is unclear, since the new combined reporting
requirements certainly will affect the issues involved in nexus
determinations and tax reporting. However, their effect on pre-2009
tax years is significant.
3. Limits on states' taxation powers
50th anniversary of Northwestern States Portland Cement
case and 50th anniversary of Public Law 86-2723
Northwestern States Portland Cement Co. v.
Minnesota4 upheld a state's power to tax income
generated from interstate activities. This case held, arguably for
the first time, that the Commerce Clause does not prohibit a state
from imposing a "fairly apportioned" direct corporate income tax on
an out-of-state business carrying on an exclusively interstate
business within the state.
In 1959, seven months after the Northwestern States
decision, P.L. 86-272 was adopted by a panicked Congress as a
"temporary stopgap measure," designed to address several
issues that were raised by that decision and its broad opinion. It
offers a very limited safe harbor from the imposition of state
income taxes by preventing state income taxation of out-of-state
corporations if their only in-state activity is the solicitation of
orders for sales of tangible personal property that are sent
outside the state for approval or rejection and are filled from
outside the state.
This safe harbor applies only to income taxes (not sales taxes
or franchise taxes based on net worth or capital), protects only
the sale of tangible personal property (not leasing, not services,
not intangibles and not real estate), and offers no protection if
the soliciting employees do anything other than solicit orders
(make repairs, approve orders, provide customer training, etc.).
This "temporary" measure was designed to last until Congress
addressed the overall power of states' taxation rights. Despite
many failed attempts to expand or limit its reach, P.L. 86-272
remains intact 50 years later, and is the major federal statutory
limit to state corporate income taxation.
HR 1083 (introduced Feb. 13, 2009, and still in committee), the
"Business Activity Tax Simplification Act of 2009," would expand
the federal prohibition against state taxation of interstate
commerce to: (1) include within the protection of P.L. 86-272 all
transactions involving services and all forms of property,
including intangible personal property (currently, only sales of
tangible personal property are protected); and (2) prohibit state
taxation of an out-of-state entity unless that entity has a
physical presence in the taxing state. It also sets forth criteria
for determining whether a business has a physical presence in a
4. State transfer pricing case5
This case is one of the country's few state tax transfer pricing
cases (almost all these cases are from New York), so it's had much
national attention. IDC Research charged its out-of-state
affiliates for concentrated services such as accounting and
marketing. The charges to its affiliates were deemed to be "not at
arms-length" (i.e. too low) by the Department of Revenue. However,
this ruling by the Appellate Tax Board determined that the prices
IDC charged its affiliates were at arms-length, although it did
apply the "sham transaction" doctrine to certain royalty
Although the case's significance is limited in Massachusetts by
the new combined reporting rules, it is still relevant for years
prior to 2009, and for all related party transactions that are not
eliminated by combined reporting because the parties are not in the
same unitary group. Also, the IRS and federal courts may take note
of it, since it addresses issues raised by Massachusetts' version
of IRC Section 482.
This case is a reminder that intercompany arrangements can no
longer be expected to escape the attention of state taxing
authorities, and that the "sham transaction" doctrine will be used
aggressively by the DOR.
5. Economic nexus legislation in other
Several states (California, Wisconsin, Connecticut, Ohio and
Michigan) have adopted economic nexus legislation basing their
power to impose income taxes on companies simply because they have
a threshold level of sales in the state. These states' goal is to
broadly tax out-of-state companies that derive any income from
their state. Obviously, these statutes are heading to federal
court, where there is no clear precedent for whether a physical
presence in a state is required to impose an income tax (see #2
above). Despite much case law, the Supreme Court has only required
a physical presence for the imposition of a sales tax6
but has not ruled on this requirement for income taxes. See also
the H.R. 1083 discussion in #3 above.
6. New York City case involving post-9/11 rent on World
Trade Center buildings7
After 9/11, the master entities controlling the World Trade
Center buildings were obligated to continue to make payments to
their landlord, the Port Authority, even though the buildings were
destroyed. These payments were funded primarily by insurance
proceeds. New York City attempted to collect $35 million of NYC
commercial rent tax, penalties and interest for the years after
9/11, but the NYC Tax Appeals Tribunal decided that those payments
did not constitute "base rent" because New York City (and later,
the Port Authority) had taken over the site, the master lessees had
no right to rebuild on the same site, and no one else had the right
to occupy any space on the site.
This was a bold and obviously controversial attempt by NYC to
tax some of the insurance proceeds, but it does raise interesting
questions about rent and other payments made after a building's
destruction, whether by fire, storm or otherwise, if the
destroyed building cannot be rebuilt on the same site.
7. W.R. Grace Appellate Tax Board
W.R. Grace continued its ongoing battles with the DOR about
payments to its out-of-state affiliates. This case involved
dividend and interest payments that Grace made to an affiliate that
Grace contended was not part of its "unitary" business. This case
applies pre-2009 law that deals with the issues of unitary
businesses and applicable constitutional principles such as
functional integration, centralization of management, economies of
scale, and an investment/operational analysis. The board held in
favor of Grace, but this case's relevance for future combined
reporting unitary issues is unclear.
8. Work product doctrine
U.S. v. Textron, Inc.9 held that certain tax
work papers prepared by Textron's Tax Department were not protected
from IRS scrutiny by the work product doctrine, which protects
documents prepared in anticipation of litigation. The opinion seems
to create a troubling new standard dealing with whether documents
were prepared "because of" litigation or with the "primary purpose"
In Commissioner of Revenue v. Comcast
Corporation,10 the court held that tax accrual
papers shared between in-house counsel and outside tax consultants
were protected because they were prepared in anticipation
of litigation, but were not protected by the
These two cases may be in conflict, and Textron is seeking
Supreme Court review, although any effect of that Court's ruling on
Rule 26(b)(3) of the Massachusetts Rules of Civil Procedure is
unclear. At least the Supreme Court could resolve the conflicting
decisions among the circuits. At this point, many tax litigators
worry that providing work papers in one jurisdiction might result
in a waiver of protection in other jurisdictions.
9. Sales tax increase
On Aug. 1, 2009, the sales tax rate in Massachusetts increased
to 6.25 percent from 5 percent. The state's alcohol, satellite
television, meals and hotel taxes also were increased.
10. State income tax credit for donated conservation
Effective in 2011, this is an effort to "encourage private
landowners to make lasting contributions to our natural and
cultural heritage." Eligible lands include those that protect
drinking water supplies, wildlife habitat and scenic vistas, and
those that boost the tourism, agricultural and forest product
industries. The incentive requires that gifts of land be
permanently protected. The credit (up to $50,000) is valued at 50
percent of the appraised fair market value of the land, and the
credit cannot exceed the donor's tax liability, although it can be
11. Streamlined sales tax project
Massachusetts is not yet a full member of the project
(Massachusetts is an "advisor state"), which seeks to simplify
interstate sales tax collection by participating retailers in the
member states. In February 2009, the project's governing board
amended its "essential clothing" rules to make it possible for
Massachusetts, New York and Connecticut to join. If these states
don't join, the board has announced that it "may" repeal its
amendment in April 2010, which probably would end any near-term
full participation by Massachusetts.
12. New Hampshire update
New Hampshire's reaction to Town Fair Tire
The Massachusetts DOR's failed attempt to assess sales/use tax
collection duty on a New Hampshire retailer's sales in New
Hampshire to Massachusetts customers generated an angry legislative
response from New Hampshire.
Town Fair Tire Centers, Inc. v. Commissioner of
Revenue,11 was a narrow decision testing whether
Massachusetts has the right to compel the tire company, which also
has stores in Massachusetts and has nexus in Massachusetts, to
collect Massachusetts use tax on tires sold and installed in New
Hampshire on vehicles bearing Massachusetts license plates and
registrations. Instead of applying constitutional principles, as
the Appellate Tax Board had done, the Supreme Judicial Court
decided this case on narrow grounds, prohibiting the DOR from
making a presumption that an out-of-state purchase is for use in
Massachusetts, and stated that:
"There is no Massachusetts statutory presumption of use in
the Commonwealth where personal property is sold to a Massachusetts
resident outside the Commonwealth, even where the goods purchased
out of State may be affixed to property registered in
Massachusetts. We will not recognize a presumption that the
Legislature has not established."
The Court went on to say that Massachusetts could
create a statutory presumption, but that it had not done so, and
therefore it did not exist. Since there was no other proof that the
tires were used in Massachusetts, the Court reversed the Appellate
Tax Board's decision in favor of the commissioner.
In response, the commissioner of revenue has recently (Feb. 11,
2010) issued Sales and Use Tax TIR 10-2, which makes clear
"Absent evidence of actual storage or use in the
Commonwealth, the Commissioner will not assess a use tax against an
out of state registered vendor on sales to a Massachusetts resident
where a Massachusetts resident purchases and takes possession of
tangible personal property entirely outside the
The TIR also reminds taxpayers that a use tax return must be
filed and the tax must be paid by a purchaser storing, using or
consuming tangible personal property in the state:
"The Town Fair Tire decision does not exempt
purchasers who purchase property elsewhere and bring it into
Massachusetts from their use tax filing or payment
The TIR leaves open two approaches by the DOR. First, the DOR
could seek evidence of actual use in Massachusetts. Second, the DOR
could ask the Legislature to adopt a statutory presumption of
In reaction to the DOR's aggressive position in the Town
Fair Tire case, New Hampshire passed S.B. 5 (NH RSA 78-D),
which restricts a New Hampshire retailer from providing any
information to other states in connection with sales completed in
New Hampshire. This appears to be a unique statutory provision,
subject to attack on constitutional grounds, but New Hampshire
argues that its retailers may cooperate as long as other states
adopt appropriate legislation and the New Hampshire Department of
Justice approves. As a practical matter, no state's laws are
appropriate, so everyone is waiting for Massachusetts to take the
next shot - either litigation or legislation. This law has
attracted much national attention, since it could be the start of a
free-for-all among neighboring states that can't behave
Distributions from New Hampshire LLCs and
The other big news in New Hampshire has been the state's efforts
to tax distributions from LLCs and partnerships. Effective Jan. 1,
2009, New Hampshire's tax law was amended to tax certain
distributions from limited liability companies and partnerships to
New Hampshire owners. The law requires the recipient of the
distribution to report it as a dividend under the New Hampshire
Interest and Dividends Tax, which imposes a tax on interest and
dividend income at the rate of 5 percent.
The law is not a new tax; rather, the change is
intended to subject "distribution income" that resembles dividend
income to an existing tax, New Hampshire's Interest and Dividends
The tax is intended to place businesses that operate as
corporations on a par with businesses that operate as limited
liability companies or partnerships. More precisely, the objective
of the law was to tax distributions made by limited liability
companies and partnerships to their owners to the same degree - and
only to the same degree - that dividends paid by corporations to
shareholders are taxed as dividends.
The tax will apply to recipients of LLC or partnership
distributions who are New Hampshire residents, regardless of where
the LLCs or partnerships making the distributions are located or
under which state's laws they are formed. Payments made to
owner-employees of LLCs and partnerships that constitute
compensation for the services of the owner-employees of the
business are not intended to be taxed, any more than compensation
paid to shareholder-owners is taxed.
My thanks to Steven M. Burke, Esq., and Donna L. Killmon,
Esq., of McLane, Graf, Raulerson & Middleton Professional
Association, for their help with the New Hampshire sections of this
outline. Killmon and Burke are members of the MBA's State Tax
Practice Group, and they encourage others to join. If you're
interested in becoming a member, contact Rick Stone at (617)
848-9360 or [e-mail rick].
1. Geoffrey, Inc. v. Commissioner of Revenue,
453 Mass. 17 (2009), cert. denied 6/22/09; Capital One Bank v.
Commissioner of Revenue, 453 Mass. 1 (2009), cert. denied
2. Quill Corp. v. North Dakota, 504 U.S. 298
(1992), based on National Bellas Hess, Inc. v. Department of
Revenue of Illinois, 386 U.S. 753 (1967).
3. 15 U.S.C. §381.
4. 358 US 450 (1959).
5. IDC Research, Inc. v. Commissioner of
Revenue; (MA Appellate Tax Board Findings of Fact and
6. Quill Corp. v. North Dakota 504 U.S.
7. In the Matter of the Petition of 1
World Trade Center LLC, TAT(H) 07-34(CR), et al. (New York City Tax
Appeals Tribunal 12/03/09).
8. W.R. Grace & Co.-Conn. V.
Commissioner of Revenue (MA Appellate Tax Board Findings of Fact
and Report, 2009-261).
9. 577 F.3d 21 (1st Cir. 2009).
10. 453 Mass. 293 (2009).
11. 454 Mass. 601 (2009).
Richard M. Stone is a tax attorney in
Boston (www.rickstonelaw.com) where
he focuses on state and federal tax matters. He is a member of the
MBA's Taxation Law Section Council, chair of its State Tax Practice
Group and served on the faculty for the MBA 2010 Annual Conference.
He has served as general counsel of two major multi-national U.S.
companies. He is a graduate of the University of Pennsylvania Law