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Current Corporate Income Tax Developments (Part II) This two-part article discusses a variety of recent state tax activity in the corporate income tax area. Part I, in the last issue, addressed nexus, tax base and entity-classification conformity; Part II examines apportionment, administration, amnesty and other developments.
Karen
J. Boucher, CPA
For more information about this article, contact Ms. Boucher at karen.j.boucher@us.arthurandersen.com.
Executive Summary
During 2001, an overwhelming number of state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn. Because it is impractical to summarize all of these activities, Part I of this article, in the last issue, focused on some of the more interesting items in the corporate income tax areas of nexus, tax base and entity-classification conformity. Part II, below, discusses apportionment, filing methods, unitary groups and other significant income tax and nonincome tax developments.
Apportionment A multistate corporation's business income is apportioned among the states in which it does business, using an apportionment percentage for each state with jurisdiction to tax the corporation. To determine the apportionment percentage, a ratio is established for each of the factors included in the state's formula; each ratio is calculated by comparing the corporation's level of a specific business activity in the state to the total corporate activity of that type everywhere. The ratios are then summed, weighted (if required) and averaged to determine the corporation's apportionment percentage for the state; the apportionment percentage is then multiplied by total corporate business income to determine the income subject to tax by the state. Although apportionment formulas vary among jurisdictions, most states use a three-factor formula that includes sales, payroll and property. However, over the past several years, legislative changes to the apportionment formula have become common; more than half of the states now accord more weight to the sales factor than to payroll and property. Use of a double-weighted sales factor tends to pull a larger percentage of an out-of-state corporation's income into the state's jurisdiction, but generally provides tax relief for in-state corporations. Changes in the apportionment formula may also be used to provide special relief or tax benefits to specific industries or to properly reflect the operations of a special industry. Recent apportionment formula developments are summarized below.
Alabama The chief administrative law judge (ALJ) decided49 that a taxpayer is entitled to either a payroll factor or an alternative "compensation" factor under Ala. Code Section 40-27-1, Art. IV, 18. The taxpayer's sole purpose is to hold a 50% interest in a partnership doing business in the state; it has no employees nor owns any property. The partnership also has no employees of its own; it pays an administrative fee to related entities for services provided by those companies' employees. When filing its Alabama returns, the taxpayer computed its payroll factors based on the annual amounts the partnership paid for the services the related entities provided. On audit, the DOR eliminated the payroll factor from the returns, because the partnership had no employees, and thus did not have a payroll within the scope of Ala. Admin. Code Regulation 810-27-1-4-.13. The ALJ agreed that the taxpayer did not have a payroll factor under the regulation, because it required amounts to be paid to "employees," and the partnership had none; however, he found that the regulation was inconsistent with the statute, which defines the payroll factor to include compensation paid (a term not limited to amounts paid to employees). Consequently, the amounts paid by the partnership for the services provided by the employees constituted "compensation paid" within the scope of the statute, and had to be included in the payroll factor. The regulations were rejected to the extent they conflicted with that finding. The ALJ also decided that, even if the payroll-factor regulations are followed and the taxpayer's payroll factor eliminated, the taxpayer would be entitled to relief under Section 40-27-1, Art. IV, 18. Use of only the property and sales factors would not fairly reflect the partnership's in-state activities, because the employees' income-producing activities would be ignored. Consequently, the partnership should be allowed an alternative factor pursuant to 18 based on the compensation it paid for those employees. The net effect would be an alternative factor identical to the one the DOR rejected.
Arizona The DOR explained50 when to include computer software in the property-factor numerator and denominator. Computer software treated as tangible personal property and capitalized for Federal tax purposes is similarly treated for state tax purposes. Ariz. Rev. Stats. Section 43-1140 provides that the property-factor numerator includes real and tangible personal property used in-state; thus, computer software is includible in the numerators of the states in which the software is actually used, not where the original program disk or tape is located.
Arkansas Effective for tax years beginning after 2000, a taxpayer will be "taxable in another state" under HB 1462 (enacted as Act 1228), and thus entitled to apportion income (and not required to throw back sales), if it is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business or a corporate stock tax in another state and files the requisite tax return in the other state.
California Effective March 1, 2001, the Franchise Tax Board (FTB) amended Regulation Section 25137(c), alternative apportionment. Among the amendments was the expansion of the substantial-amount special-sales-factor rule to include certain intangible assets and provide guidance in defining "substantial." The amended regulation provides that, when substantial gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of a taxpayer's trade or business, such receipts must be excluded from the sales factor. For example, gross receipts from the sale of a factory, patent or affiliate's stock are excluded if substantial. For purposes of this subsection, sales of assets to the same purchaser in a single year are aggregated to determine whether the combined gross receipts are substantial. Further, a sale is substantial if its exclusion results in a 5%-or-greater decrease in the taxpayer's sales-factor denominator or, if the taxpayer is part of a combined reporting group, a 5%- or-greater decrease in the group's sales-factor denominator. A sale is occasional for this purpose if the transaction is outside of the taxpayer's normal course of business and occurs infrequently.
California A court of appeal affirmed51 a trial court's findings that there is nothing arbitrary or unconstitutional about assigning a taxpayer's South Dakota credit-card sales and transactions to California based on Finnigan.52 The court also affirmed classifying the gain on the sale of four properties as business income.
California The U.S. Supreme Court rejected Deluxe Corp.'s53 petition for certiorari in its case on the application of Finnigan in typical inbound sales for tax years before Huffy.54
California The SBE held against Toys "R" Us.55 The company maintains a treasury department in New Jersey responsible for working capital and maintaining liquid assets for inventory control purposes. For years ending 1991–1994, it included in its income gross receipts from that department's investment activities for sales-factor purposes. The gross receipts from such activities were disproportionate to the net income generated. Toys "R" Us argued that there was insufficient distortion to invoke Regulation Section 25137 relief; accordingly, the investment receipts had to be included in the sales factor. The SBE decided against the company and denied its petition for rehearing.
Connecticut The superior court ruled56 that a taxpayer properly computed its corporation business tax using the three-factor apportionment method. The taxpayer used computers, telephones and other tangible personal property to produce market reports that ultimately resulted in revenue. The taxpayer contended that it was required to use the state's three-factor apportionment formula, because its revenue was derived from the use of personal property, as provided in Conn. Gen. Stat. 12-218(b) (current version 12-218(c)). The state argued that the taxpayer provided a service; because the taxpayer's use of tangible personal property was not essential in providing the service, it had to use the single-factor apportionment formula. The court ruled that by deriving income from its use of tangible personal property, the taxpayer could apply the three-factor formula; such use fell within the express language of Conn. Gen. Stat. 12-218(b).
Florida The DOR proposed amendments to several corporate tax rules (Fla. Regulation, Rules 12C-1.003, -1.013, -1.0153, -1.0155, -1.016, -1.023 and -1.034). The proposed amendment to Rule 12C-1.0153 (Property Factor for Apportionment) provides a definition for the term "unsecured loans." The proposed amendment to Rule 12C-1.0155 (Sales Factor for Apportionment) provides that interest received from loans made to customers located in-state (other than loans secured by real or tangible personal property located out-of-state) is included in the sales-factor numerator for apportionment purposes. Rule 12C-1.016 is being amended to change the title to "Business/Nonbusiness Income—Definitions and Examples" and to provide a definition and examples of "business income."
Idaho The state supreme court found57 that proceeds from the sales of receivables should not be included in the sales factor under a provision allowing the state tax commission to deviate from the general apportionment provisions if they did not fairly represent the extent of the taxpayer's business in the state. The court found that the inclusion in the sales factor of freight sales and proceeds from selling the receivables therefrom did not fairly represent how the taxpayer earned its income. The court remanded the case for consideration of an alternative method on this issue.
Illinois The DOR determined58 that a financial institution and a bank holding company that lacked nexus with any other state could apportion interest income earned from customers in other states; the entities would be deemed nonresidents and, thus, be able to apportion income as long as it was not derived solely from Illinois. According to the DOR, this standard is not the same as the "taxable in another state" standard construed in 86 Ill. Admin. Code Section 100.3200 for purposes of allocating nonbusiness income and applying the throwback rule in Ill. Income Tax Act (IITA) Section 304(a)(3)(B)(ii). A person may derive business income from a state and yet not be taxable by that state.
Illinois The DOR proposed an amendment to the apportionment regulation that would require flow-up of apportionment factors in a tiered partnership structure. Currently, second-tier partnerships are not deemed unitary; thus, the income is treated as allocable income and the apportionment factors from such partnerships do not flow up to the partners. This proposed amendment could significantly change the liability for taxpayers with tiered partnerships. The DOR is still gathering public comments; it may decide not to pursue the amendment. If adopted, the amendment will not be effective until the year after adoption.
Maryland Legislation enacted in 2001 altered the apportionment formula for manufacturers. Under the new law, effective for tax years beginning after 2001, a multistate manufacturer's income is apportioned to the state based solely on its percentage of in-state sales. A "manufacturer" is defined for this purpose as a corporation (except for petroleum refiners) that would fall under Section 11 or 31-33 of the North American Industrial Classification System of the U.S. Office of Budget and Management. Specified manufacturing corporations using the new apportionment method must submit specified reports as part of their income tax returns; the comptroller must prepare and submit a report each year to the governor and the general assembly detailing the information from these reports.
Maryland The comptroller adopted amendments to Regulations .02 and .03 under COMAR 03.04.08, Banks and Similar Institutions. The amendments include in the definition of "banking institution" organizations that, for tax years beginning before 2001, were subject to the financial institutions franchise tax (e.g., savings and local associations, mortgage companies, certain savings banks, etc.). The amendments also provide that a decision by a former administrator of the financial institution franchise tax that an entity was not required to file a franchise tax return, is not a factor in determining whether an entity has to file an income tax return or apportion in-come to the state. Further, as required by law passed in 2000, the amended regulation provides that a financial holding company allocates interest income received from financial subsidiaries using the apportionment formula of the subsidiary that pays the interest.
Massachusetts The DOR issued59 a technical information release (TIR) in response to Combustion Engineering.60 According to the TIR, the Commissioner treats the sales-factor receipts from an Internal Revenue Code (IRC) Sec. 338(h)(10) transaction as belonging to the parent that sells the stock; because "sales" do not include receipts from the disposition of securities, such receipts are not included in the parent's sales factor. Further, the commissioner will recognize the Combustion Engineering decision as applicable for all open tax years. The DOR also amended 830 CMR 63.38.1(9)(b)7 to reverse its position on a specific rule pertaining to a corporation's sale of a subsidiary when the parent elects to treat the sale as a sale of assets (and not stock) for sales-factor purposes. The amendment makes an analogous change, reversing the DOR's position on the treatment of certain distributions of appreciated assets by a subsidiary to its parent.
New Jersey The state supreme court held61 that a New Jersey manufacturer had to include all sales to its retailer-subsidiary in the numerator of its receipts factor, regardless of where it drop-ships the product. The court affirmed a lower court's holding that the taxpayer's sales of orthopedic products to its retailer-subsidiary constituted other business receipts earned within the state.
New York An ALJ concluded62 that the taxpayers properly included in the property factor their business allocation percentage (BAP) rent paid for storage space at a warehouse in New Jersey. New York regulations provide that gross rents do not include amounts payable for storage if payable for space not designated nor controlled by the taxpayer. The ALJ found that the taxpayers' sharing of space set aside for them, as related corporations under one warehousing agreement, did not defeat a finding that the space was designated. As to whether the space was under the taxpayers' control, the ALJ agreed that the quality and dominance of the taxpayers' owner's authority over the storage space had to be considered. Accordingly, the ALJ determined that the space was under the taxpayers' control and that the rent paid for the storage space was properly included in the BAP property factor.
New York City The Department of Finance amended a rule to allow manufacturing corporations to elect to use a double-weighted receipts factor to apportion income for tax years beginning after June 30, 1996.63
Oklahoma According to SB 1300, effective July 1, 2000, the apportionment factors for income of a unitary multistate business may be calculated using 25% property and payroll factors, with a 50% sales factor for corporations that expand their property or facilities in the state (with a minimum investment of $200 million over a less-than-three-year period) commencing before Jan. 2, 2000.
Oregon Under Rule 150-314.665(6), effective Dec. 31, 2000, a taxpayer's primary business activity determines whether it has to include gross receipts or net gains from the disposition of intangible assets in its sales factor. Under this rule, taxpayers must determine their primary business activity on a unitary basis when filing a consolidated state excise tax return. If the taxpayer's primary business activities include dealing in intangible assets (as well as the production or sale of tangible personal property), greater weight will be given to criteria reflecting the corporation's actual activities during the tax year.
Oregon According to HB 2281, Laws 2001, effective for tax years beginning after April 30, 2003, the weighting of the sales factor will increase to 80% for all taxpayers (other than public utility companies, which will be allowed to elect to continue using the current double-weighted sales-factor apportionment formula).
Oregon The state tax court held64 that the DOR did not have the authority to modify the corporate excise tax income-apportionment method required by its regulations. The DOR had assessed additional taxes for 1984–1992 attributable to the inclusion of intangible property in the apportionment formula. Although the DOR adopted a rule at the end of 1995 allowing it to require an alternative apportionment method in any case in which it determined that the usual method was not accurate, the rule was not expressly made retroactive; thus, the court did not apply it to the years in question.
Washington An ALJ ruled65 that the DOR had incorrectly apportioned income from the taxpayers' lending activities (i.e., interest, late-payment and pre-payment penalties, servicing fees and gains from interest-rate swaps and loan sales). The ALJ overruled earlier determinations holding that, in using the cost-apportionment method, the location in which costs are incurred determines whether they are treated as in-state or out-of-state costs. The ALJ held that costs are included in the numerator (regardless of where incurred) when they relate to the in-state taxable activity.
Filing Methods and Unitary Groups Alabama For tax years beginning after 2001, HB 4, Laws 2001, limited the use of consolidated returns to members of a Federal affiliated group that have nexus with the state; doubled the annual consolidated-return election fee; and increased from eight to 10 years the period that consolidated filing is required (unless permission to deconsolidate is obtained). The new law also limited the benefits of consolidated filing by requiring company-by-company apportionment factors and gave the commissioner the power either to deconsolidate the entire group or a particular member. In addition, the new law gave the 93 consolidated groups presently filing state consolidated returns the right to opt out, if the election to do so was filed no later than March 15, 2002; if the election was not filed, those group members with nexus would be deemed to have begun a new 10-year election.
Georgia The DOR proposed new Regulation 560-7-3-.13 to allow multistate corporations to request permission to file a post-apportionment nexus consolidated filing for tax years beginning after Jan. 1, 2002. Once permission is received, the corporations are required to continue filing consolidated returns, except in limited circumstances. The proposed rule allows the commissioner to eliminate one or more eligible corporations from the consolidated return if necessary to clearly and equitably reflect income attributable to the state. The proposed rule also provides that, if any member of the group of corporations filing a Georgia consolidated return has incurred interest expense or other deductions in connection with the ownership of one or more corporations not included in such return, the commissioner may (as a condition of granting permission to file a state consolidated return) require that such interest or deductions be excluded in calculating state income.
Illinois A taxpayer had excluded a foreign sales corporation (FSC) and some royalty companies from its unitary return as 80/20 companies (i.e., 80% or more of their business activities occurred outside the U.S.). A state circuit court rejected66 this classification and included the companies in the unitary return. The FSC and the royalty companies were created abroad and had one employee abroad. The court, however, disregarded the form of the royalty companies and looked to where the work for the intangibles was actually being done. Because such work was done in the U.S. and there were no intercompany agreements or service charges, the court held that the royalty companies had no measurable activity outside of the U.S. The court engaged in a similar analysis as to the FSC. The taxpayer is appealing.
Illinois The DOR announced that it will settle pending FSC cases involving open tax years ending after 1989 and beginning before 1998. The issue is whether an FSC's foreign property and payroll apportionment factors should be considered in determining whether the FSC qualifies as an 80/20 company properly excluded from a unitary business group. The DOR's decision to settle pre-1998 years was prompted by the fact that it had issued inconsistent guidance on the 80/20 calculation for FSCs prior to 1998. The settlement offer extends to cases pending in administrative hearings and in court, in addition to matters pending in the Audit Bureau. The DOR will concede 70% of the tax liability related to the issue during each tax year and abate any associated penalties.
Illinois An appellate court affirmed67 a trial court's summary judgment for a taxpayer. The lower court had ruled that a subsidiary was not part of a unitary business group with its parent holding company and the parent's upper-tier majority shareholder. As a result of an audit indicating that the taxpayer had paid $105 million in loan interest to its parent, the DOR argued that a unitary business group existed through functional integration of the three entities; this was based on the substantial loans the parent and upper-tier majority shareholder made to the taxpayer. The appellate court disagreed; because the trial-court record indicated the loans were based on market conditions, the facts failed to establish "functional integration through the exercise of strong centralized management," as required by the state's definition of a unitary business group.
Indiana HEA 1578, Laws 2001, modified the "unitary business" definition for purposes of the financial institutions tax, by adding the following language: "[H]owever, the term does not include an entity that does not transact business in Indiana."
Kentucky In a September 2001 Tax Alert, the Revenue Cabinet (RC) provided guidance on the election to file state consolidated returns. Ky. Rev. Stats. (KRS) 141.200(3) allows an affiliated group to elect to file a consolidated income tax return. KRS 141.200(1)(a) defines "affiliated group" by reference to IRC Sec. 1504(a) and the related regulations. The election to file a consolidated return is binding on both the affiliated group and the RC for eight years. Regulation 103 KAR 16:200 provides procedures to make the election. The common parent must make the election on behalf of all affiliated group members on Form 722, Election to File Consolidated Kentucky Corporation Income Tax Return. The election form must be submitted to the RC with a timely filed Form 720, Corporation Income and License Tax Return, for the first tax year for which the election is made.
Maine Revenue Services adopted new Rule No. 810, "Maine Unitary Business Taxable Income, Combined Reports and Tax Returns," to establish standards for (1) determining state income tax for unitary businesses and (2) filing combined reports and related returns.
Missouri The administrative hearing commission (AHC) held68 that several taxpayers could not file state consolidated returns prior to 1998. Before the state supreme court's decision in General Motors Corp.,69 affiliated-group members that did not derive at least 50% of their income from in-state sources could not be included in a state consolidated return (MoRS Section 143.431.3 (1)). After General Motors, several taxpayers filed amended state consolidated returns. The DOR denied these refund requests on the grounds that the companies did not timely elect to file a state consolidated return, as required by 12 CSR 10-2.045 (15); several taxpayers are litigating the issue. In addition, the DOR stated that General Motors was an "unexpected decision" that did not have to be applied retroactively. The AHC denied the taxpayers' refund requests, because the election to file a state consolidated return has to be made on an originally filed return. However, the AHC acknowledged that the state supreme court might find that due-process considerations outweigh the procedural analysis. The AHC does not have jurisdiction over constitutional issues; every taxpayer has the right to have an AHC decision heard by the state supreme court. It is likely that taxpayers will appeal the AHC's decision to the high court.
New York The Division of Tax Appeals ruled70 that a taxpayer could not be forcibly combined with its two trademark-protection-company affiliates for corporate franchise tax purposes. The taxpayer had very well-documented business purposes; the issue was the presumption of distortion, which the taxpayer and its expert witnesses successfully rebutted. The state will appeal this nonprecedential decision.
Administration Amnesty Programs Los Angeles The City of Los Angeles enacted an amnesty program from Oct. 1, 2001– Dec. 31, 2001. During this period, businesses could register and/or pay any delinquent business tax, while avoiding the imposition of penalties. Following the amnesty period, the Tax and Permit Division announced that it would vigorously pursue a range of enforcement efforts to local nonfiling taxpayers.
Louisiana The Tax Delinquency Amnesty Act of 2001, Act 136 (HB 992), authorized the DOR to establish a tax amnesty program for all taxpayers who owed any tax imposed by (or pursuant to) a state law and collected by the DOR. The 60-day amnesty period ran from Sept. 1, 2001–Oct. 30, 2001.
Maryland HB 828, signed into law as Chapter 275, required the comptroller to declare an amnesty period for delinquent taxpayers from Sept. 1, 2001–Oct. 31, 2001, for penalties attributable to nonpayment, nonreporting or underreporting of state or local income tax, withholding tax, sales and use tax, and admissions and amusement tax paid during the amnesty period. The new law also increased specified criminal penalties from $5,000 to $10,000 under various tax laws, effective at the end of the amnesty period.
Michigan HB 5036 established an amnesty period to run from May 15, 2002–June 30, 2002. Tax amnesty will generally apply to all taxes administered under the revenue act and due before June 1, 2001. The amnesty will provide for a waiver of penalties if a taxpayer pays all tax and interest due with the amnesty application.
New Hampshire Chapter Law 158 of 2001, Section 29, provided an amnesty from the assessment or payment of all penalties and interest greater than 7% annually. The amnesty period ran from Dec. 1, 2001– Feb. 15, 2002, inclusive, and applied to all taxes administered by the DOR Administration.
Ohio A state amnesty program under HB 94, Laws 2001, ran from Oct. 15, 2001–Jan. 15, 2002; it provided for a waiver of the penalty and half of the interest otherwise imposed on such a delinquency.
Other Issues Alaska The state supreme court held71 that restricted Federal statute of limitations (SOL) waivers extend the state SOL only for the issues covered in the Federal waivers. The taxpayer filed refund claims for 1988–1991, thinking that it had used an incorrect apportionment fraction. The state argued the refund claims were untimely filed, because they were filed more than three years after the original returns. The taxpayer responded that the SOL was stayed by waiver agreements it had reached with the IRS. The court concluded that a restricted waiver is effective only for state adjustments reasonably related to the issues covered by a restricted Federal waiver. Thus, while the state SOL was extended based on the Federal waivers, the taxpayer could not claim refunds on issues other than those specified in the Federal waivers.
Arizona The DOR clarified72 the corporate income tax filing extension. If a taxpayer is granted one or more extensions to file a Federal income tax return for any tax year, the taxpayer is automatically deemed to have been granted the same extension for state return filing purposes, if at least 90% of the tax liability disclosed by the taxpayer's return for the reporting period is paid by the original due date. The extension is the number of months the filing date is extended, not the extended due date. Thus, a six-month Federal extension for a corporate taxpayer that extends a March 15 due date to September 15 would extend the taxpayer's state due date from April 15 to October 15. Alternatively, a taxpayer may file an application for a state extension on or before the return due date.
Arkansas HB 1931, signed into law as Act 1549, prohibits filing with the secretary of state any form or document related to a corporation or limited liability company (LLC) that owes past-due state franchise taxes.
Colorado Effective Aug. 8, 2001, under HB 01-1304, Laws, 2001, the deadline to file claims for refund or credit of income tax is the period provided for filing a Federal income tax refund claim plus one year, and is extended by any Federal extension granted. Further, the new law clarifies that the state will not pay any refund for which a claim is filed after this deadline.
Colorado Under HB 1179, Laws 2001, taxpayers are required to file an amended state corporate or personal income tax return within 30 days of an IRS final determination changing the taxpayer's Federal taxable income originally reported on the state return. Previously, taxpayers were required to report any change in Federal taxable income to the state; an amended state return was required only if the taxpayer had filed an amended Federal return.
Illinois The DOR established73 the Informal Conference Board (ICB), which allows taxpayers to resolve audit disagreements before formal protest procedures start. The ICB cannot compromise tax, nor are ICB decisions subject to administrative review. At the conclusion of an audit, the DOR will send a notice of proposed liability or claim denial to a taxpayer, containing the grounds for a proposed tax deficiency or claim denial. The taxpayer has 60 days to request an ICB hearing. Within 45 days, the ICB will hear the case and reach a decision. The ICB is meant to expedite agreements between taxpayers and the DOR pursuant to adverse audit decisions. During the informal conference protest, a taxpayer may be represented by itself or someone else.
Louisiana In a change from previous policy, the DOR will begin to enforce interest and penalty assessments on individual and corporate taxpayers that fail to make estimated income tax payments for the 2001 tax year. The estimated payments are due quarterly for corporations that expect to owe $1,000 or more in income tax for the tax year. Individuals who expect to owe $200 or more ($400 if filing a joint return) must now also make estimated payments.
Massachusetts According to a Nov. 5, 2001 memorandum from the acting commissioner, the DOR's administrative appeals process has been streamlined. A new Office of Appeals (OA) combines the functions of the Office of Dispute Resolution (ODR) and the Appeal and Review Bureau (ARB) and reports directly to the acting commissioner. The OA will conduct all pre- and post-assessment hearings and act on all "Requests for Settlement Consideration." According to the memorandum, the streamlining should increase efficiency and facilitate decisionmaking, while applying consistent tax policy to effect the DOR's goal of fair and reasonable tax law administration. The OA will be staffed by the ARB's and ODR's current members.
Massachusetts The DOR issued74 a TIR in response EMC Corp.75 According to the TIR, effective immediately, the two-year SOL for applying for a tax abatement begins to run from the date printed on the Notice of Assessment form as the "Notice Date." The date(s) listed under "Assessment Date" will no longer be the date(s) from which the two-year SOL will begin to run, but will still be the date(s) on which the tax was actually assessed for all other purposes.
Massachusetts To encourage voluntary compliance, a TIR76 reduced from seven to three years the lookback period for a nonfiling taxpayer that voluntarily discloses its noncompliance. The rule applies to nonresident individuals and foreign corporations with state nexus. Generally, the lookback period for a taxpayer that voluntarily discloses its nonfiling includes the three most recent tax years. However, if the DOR determines (independent of any voluntary disclosure) that a taxpayer with a filing obligation has not filed returns, a seven-year lookback period will generally apply. In cases in which a taxpayer has not filed returns for a specific tax type, the commissioner will assess such taxpayer for all tax periods for which a return is due.
New York City The state supreme court ruled77 that the Department of Finance cannot offset a refund claim by reauditing the taxpayer and reallocating certain of its expenses to its controlled foreign corporations.
Other Important Developments Flowthrough Entities Alabama Act 2001-1105 (HB 5) requires subchapter K entities to file a composite return and make a composite tax payment on behalf of their nonresident members or partners for the 2001 tax year by April 15, 2002, without regard to extensions. The composite payment is determined by applying the highest marginal Alabama income tax rate applicable (6.5% for corporate partners, 5% for noncorporate partners) to the partners distributive share of the entity's net income apportioned or allocated to the state. Payments made by the entities will be deemed made by the owners. For tax years after 2001, subchapter K entities may be relieved of this reporting and payment requirement if nonresident partners or members file a consent agreement with the DOR and agree to file and timely pay Alabama taxes. Should a nonresident partner or member fail to file the return or pay the tax, the tax liability would pass to the subchapter K entity.
Alabama The DOR addressed78 whether a single-member LLC (SMLLC) that had not elected to be treated as a corporation could separately calculate, report and pay its state income tax withholding obligations independent of the single member. According to the ruling, the DOR adopts the tax procedures in IRS Notice 99-6.79 Thus, an SMLLC may separately calculate, report and pay to the DOR its state income tax withholding obligations under its own name and taxpayer identification number (TIN); or the owner can compute, report and pay them under its own name and TIN. If the SMLLC reports its withholding tax liabilities under its own name and TIN, its owner will retain ultimate responsibility for tax payments. If the owner reports, it retains ultimate responsibility for employment tax obligations incurred on employees of the disregarded entity.
Georgia Under HB 582, Laws 2001, LLCs are treated for state income tax purposes in the same manner as for Federal income tax purposes. Previously, LLCs were classified for all state taxes in the same manner as for Federal income tax purposes.
Illinois A circuit court ruled80 that a corporate partner of a unitary partnership had to combine its distributive share of partnership income with its own in apportioning the partner's income.
Indiana Gross income received by a partnership that "checked the box" to be taxed as a corporation was not subject to state gross income tax.81
Mississippi HB 1695, Laws 2001, required that assets of certain flowthrough entities be included in the ratio of their owners used to determine the value of capital employed in the state for franchise tax purposes.
New Jersey Under ACS 3045, Laws 2001, for a limited partnership (LP) or LLC to avoid an entity-level tax, the entity must obtain each corporate owner's consent that the state has the right and jurisdiction to tax the owner's LP or LLC state income. An LP or LLC that does not have such consent must pay a 9% corporation business tax on behalf of nonconsenting members. The nonconsenting members' share of the entity's entire net income is determined by multiplying the entity's income by an allocation factor (consisting of flowing through the entity's apportionment factors to the nonconsenting members) if the relationship between the member and the entity is unitary. If the relationship is not unitary, the entity's allocation factors are applied to the members' distributive share of the entity's income. Entities listed on a U.S. stock exchange or "qualified investment partnerships" are exempt from the new law. The new law is retroactively effective for privilege periods beginning after 2000. However, the tax for privilege periods beginning in calendar-year 2001 is 45% of the tax otherwise due; no estimated payments are required.
North Carolina HB 1157, Laws 2001, applied the franchise tax equally to assets held by corporations and corporate-affiliated LLCs. Under the new law, if a corporation is an LLC member and the LLC's governing law provides that 70% or more of its assets (after payments to creditors) must be distributed on dissolution to the member-corporation (or to includible corporations of an affiliated group that includes the member-corporation), a percentage of the LLC's income, assets, liabilities and equity will be attributed to that member-corporation and have to be included in its franchise tax computation. Further, the member-corporation's LLC investment is not included in the franchise tax computation. The attributable percentage equals the percentage of the LLC's assets (after payments to creditors) distributable to the member corporation under the LLC's governing law if the LLC dissolved as of the last day of the member corporation's tax year. In all other cases, none of the LLC's income, assets, liabilities or equity is attributed to a member-corporation for franchise tax purposes. A taxpayer who (because of fraud with intent to evade tax) underpays the franchise tax on assets attributable to it under this provision is guilty of a Class H felony.
Oregon A new regulation provides that a corporate LLC member taxed as a partnership has to include its distributive share of the LLC's property, payroll and receipts in the computation of its apportionment factor for state tax purposes. The regulation also provides that transactions between the corporate member and the LLC must be eliminated to the extent of the corporation's percentage interest in the LLC.
Pennsylvania HB 334 (enacted as Act 23) amended the definition of a "corporation" for state purposes to include "a business trust, limited liability company, or other entity, which for Federal income tax purposes is classified as a corporation...." Prior to this law change, significant Pennsylvania tax could be saved if an entity converted to a partnership and then "checked the box" to be taxed as a corporation for Federal tax purposes. The new law is retroactively effective to 2001.
Texas SB 1125, Laws 2001 clarified that for earned-surplus purposes, a corporation that is a partner in a partnership or joint venture has to include that entity's gross receipts apportioned to the state as though the corporation had earned them directly (including receipts from business done directly with the corporation).
Wisconsin Effective for tax years beginning after 2000, the definition of "doing business" has been expanded by Act 16 (the Budget Act) to include "owning, directly or indirectly, a general or limited partnership interest in a partnership that does business in Wisconsin, regardless of the percentage of ownership; and owning, directly or indirectly, an interest in a limited liability company that does business in this state, regardless of the percentage of ownership, if the LLC is treated as a partnership for Federal income tax purposes." In addition, the new law provides that an LP's or LLC's apportionment factors are attributed to its partners or members in computing their state tax liability. Because the "doing business" rules were expanded retroactively to 2001, the DOR provided that affected corporations that indicate "New Law—Doing Business as Owner in Partnership or LLC" on top of Form 4U, Wisconsin Corporate Franchise or Income Tax Return, will not be subject to estimated tax penalties.
Two-Year Internet Tax Moratorium Extension P.L. 107-75 enacted a two-year extension of the moratorium on Internet access taxes and multiple and discriminatory taxes on electronic commerce through Nov. 1, 2003. In addition, the grandfather provision permitting Internet access taxes imposed prior to Oct. 1, 1998 was retained. The original three-year Internet tax moratorium expired on October 21, 2001.
Miscellaneous Alabama HB 2, Laws 2001, restored the calculation of a corporation's Federal income tax deduction to pre-1999 law; changed the basis for calculating a multistate corporation's nonbusiness interest expense from the book value of its assets to historical cost; adopted the Federal estimated tax penalty rules for corporations (and retained the current quarterly filing threshold for corporations with annual taxable income of $5,000); imposed new penalties on tax advisers and return preparers who charge a fee based on the tax savings resulting from the planning idea recommended by the adviser's firm, if they violate AICPA contingent-fee-engagement standards; and changed the computation of interest to charge interest not only on the tax deficiency, but also on the interest accrued until the date the final assessment is issued.
Arizona HB 2637, Laws 2001, created triggered appropriations and tax cuts based on state revenues exceeding current forecasts. If revenues exceed the forecast in either fiscal year (FY) 2001 by $79.7 million or FY 2002 by $73.5 million, the lowest state individual income tax rate will be reduced from 2.87% to 2.84% in FY 2003 after numerous additional appropriations. If revenues exceed the forecast by $104.13 million in FY 2001 or by $91.4 million in FY 2002, the lowest rate will be further reduced to 2.81% in FY 2003 after additional appropriations. Finally, if revenues exceed the forecast by $138.13 million in FY 2001 or $125.4 million in FY 2002, the state corporate tax rate will be reduced from 6.968% to 6.8%; corporations will be able to chose the current apportionment formula or one that weights the sales factor at 65% in determining corporate income subject to state tax in FY 2003.
California The FTB stated82 that sales and use tax payment determinations made under SBE audits will be accepted to the extent necessary to meet manufacturers' investment credit requirements. However, taxpayers must still retain necessary underlying documentation.
Idaho HB 377, Laws 2001, permanently reduced all individual income tax rates and the corporate income tax rate by 0.4% The new law also provides for an income tax credit for research and development expenditures for five years.
Illinois The DOR added 86 Ill. Adm. Code 100.9710, which sets forth the definition of "financial organization" contained in IITA Section 1501(a)(8). The rulemaking clarifies and provides standards for the application of various terms in the statutory definition of "financial organization."
Massachusetts The Appellate Tax Board (ATB) addressed83 the application of accounting principles to the determination of the nonincome measure of the corporate excise tax. G.L. c. 63, 30(9) measures a foreign corporation's net worth by referring to the "book value" of its tangible and intangible assets. Additionally, 30(11), defining "intangible property corporation," specifies that corporate assets should be valued at book value. In 30(7), "book value" is defined as "the original cost of such property, less the depreciation or amortization taken against such property on the books of the corporation maintained for making financial reports to shareholders." (Emphasis added.) Thus, based on 30(7), the ATB determined that the cost method (not the equity method) should have been used to calculate the value of the taxpayer's interest in Viacom. The ATB noted that the assessments had to be consistent with accounting principles taxpayers actually use. To require taxpayers to maintain two separate sets of books (one for financial accounting purposes and one for tax accounting purposes) would create an undue compliance burden and be inconsistent with the statutory language.
Michigan A court of appeals reversed84 a circuit court decision and held that the site-based capital acquisition deduction of the Single Business Tax scheme does not violate the Commerce Clause.
New Hampshire Legislation enacted during 2001 (1) increased the business enterprise tax from 0.50% to 0.75%, retroactive to 2001; (2) increased the business profits tax from 8% to 8.5%, retroactive to 2001; (3) increased the telecommunications tax from 5.5% to 7%; (4) decreased the statewide property tax from $6.60 per $1,000 to $5.80 per $1,000 in FY 2003; and (5) repealed the legacies and succession tax starting in January 2003.
New York A supplemental budget bill (S 5828/A 9459, enacted as Chapter 383 of 2001) enacted spending and revenue enhancement provisions that included the authorization of new forms of gambling. The bill also extended through Dec. 31, 2002 the current provisions of the Article 32 bank tax; extended to the 2001 and 2002 tax years the applicability of the state's transitional provisions enacted in response to the Federal Gramm-Leach-Bliley Act; authorized eight new Empire Zones; and created a Resurgence Zone and a Liberty Zone in lower Manhattan, which would offer benefits to businesses locating within their geographic boundaries.
Ohio HB 405, Laws 2001 created a nonrefundable credit for certain financial institutions, starting with the 2002 tax year. The credit will be available to financial institutions that own a related qualifying dealer in intangibles and will be limited to the lesser of the amount of dealer intangibles tax paid or an imputed credit amount. For a financial institution to obtain the credit, the related qualifying dealer in intangibles had to submit a written statement to the tax commissioner by Jan. 15, 2002 irrevocably agreeing not to seek a refund for certain taxes for the 2000 and 2001 tax years, as well as agreeing to continue to pay certain taxes in the 2002 tax year. Additionally, the alternative-franchise-tax apportionment-factor election for financial institutions has been made permanent; the percentage-of-deposit rule related to the definition of a financial institution was reduced from 10% to 9%.
Pennsylvania The supreme court concluded85 that the capital-stock-tax manufacturing exemption was unconstitutional and required a "retrospective" remedy. It held that, for the tax year at issue, the exemption had to be severed from the tax in its entirety. Because the language of the exemption remained virtually unchanged from 1983–1998, presumably the court's decision applies to all of those years. The court set forth a number of potentially acceptable retrospective remedies: (1) refunding the difference between the tax paid and the tax had the taxpayer been granted the unlawful exemption (i.e., taxpayers with manufacturing operations outside Pennsylvania); (2) assessing and collecting back taxes (to the extent consistent with other constitutional restrictions) from those who benefited from the unlawful exemption during the contested period; or (3) applying a combination of a partial refund and a partial retroactive assessment, as long as the resultant tax actually assessed during the contested tax period reflects a scheme that does not discriminate against interstate commerce. The court left it to the Commonwealth to decide which remedy to employ.
Tennessee Tenn. Code Ann. 67-4-2107(b) provides a franchise tax deduction for the value of stock held by a taxpayer in an entity doing business in the state and subject to its franchise tax. However, no deduction is permitted for investments in entities not doing business, but subject to tax in the state. This provision has been challenged86 as unconstitutional in at least three lawsuits pending in state chancery courts. |
