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Business Tax Topics > Chapter 24 > Flashcards

Chapter 24 Flashcards

1
Q

Overview

A

• 46 states and District of Columbia impose a tax based on a C corp’s taxable income
– Majority of states “piggyback” onto Federal income tax base
• Essentially, they have adopted part or all of the Federal tax provisions
• In more than 40 of those states, the starting point in computing the tax base is taxable income as reflected on the Federal corporate income tax return (Form 1120)

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2
Q

State Modifications

A

• Federal taxable income generally is used as the starting point in computing the state’s income tax base
– State adjustments or modifications often are made to Federal taxable income to:
• Reflect differences between state and Federal tax statutes
• Remove income that a state is constitutionally prohibited from taxing

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3
Q

Common State Additions (slide 1 of 3)

A

• Interest income on state/municipal obligations and other interest income exempt from Federal income tax
– May exclude interest income on obligations within that state to encourage investment in in-state bonds

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4
Q

Common State Additions (slide 2 of 3)

A

• State income taxes deducted on Federal return
– Includes franchise taxes based on income
• Federal depreciation in excess of amount allowed by state (if depreciation systems differ)

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5
Q

Common State Additions (slide 3 of 3)

A
  • State gain in excess of Federal gain on assets; Federal loss in excess of state loss on assets
  • Adjustments to amounts under Federal elections
  • Federal net operating loss deduction
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6
Q

Common State Subtractions(slide 1 of 3)

A

• Interest on U.S. obligations to extent included in Federal taxable income
– States cannot impose income tax on income from U.S. obligations, but may assess income-based franchise tax
• State depreciation in excess of Federal (if depreciation systems differ)

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7
Q

Common State Subtractions(slide 2 of 3)

A
  • Federal gain in excess of state gain on assets; State loss in excess of Federal loss of assets
  • Adjustments to amounts under Federal elections
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8
Q

Common State Subtractions(slide 3 of 3)

A
  • State Net Operating Loss Deduction
  • Dividends received from certain out-of-state corps to extent included in Federal return
  • Federal income taxes paid
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9
Q

UDITPA and the Multistate Tax Commission

A
  • Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to assignment of income among states for multistate corps
  • Many states have adopted UDITPA either by joining the Multistate Tax Compact or modeling their laws after UDITPA
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10
Q

Nexus for Income Tax Purposes (slide 1 of 2)

A

• Nexus is the degree of business activity which must be present before a state can impose tax on an out-of-state entity’s income
• Sufficient nexus typically exists if:
– Income is derived from within state
– Property is owned or leased in state
– Persons are employed in state
– Physical or financial capital is located in state

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11
Q

Nexus for Income Tax Purposes (slide 2 of 2)

A
  • No nexus if only “connection” to state is solicitation for sale of tangible personal property, with orders sent outside state for approval and shipping to customer (Public Law 86-272)
  • Sales tax can still apply
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12
Q

Independent Contractors

A 
•  May generally engage in the following activities without establishing nexus for the company:
– Solicit sales
– Make sales
– Maintain sales office
•  Source: Public law 86-272
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13
Q

Allocation and Apportionment of Income (slide 1 of 3)

A

• Apportionment is the means by which business income is divided among states in which it conducts business
– Corp determines net income for the company as a whole and then apportions some to a given state, according to an approved formula

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14
Q

Allocation and Apportionment of Income (slide 2 of 3)

A
  • Allocation is a method used to directly assign specific components of a corp’s income, net of related expenses, to a specific state
  • Allocable income generally includes:
  • Income or loss from sale of nonbusiness property
  • Income or losses from rents or royalties from nonbusiness real or tangible personal property
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15
Q

Allocation and Apportionment of Income (slide 3 of 3)

A

• Typically, allocable income (loss) is removed from corporate net income before the state’s apportionment formula is applied
– Nonapportionable income (loss) assigned to a state is then combined with income apportionable to the state to arrive at total income subject to tax in the state

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16
Q

Apportionment Procedure

A

•Business incomeis assigned to states using an apportionment formula
– Business income arises from the regular course of business
• Integral part of taxpayer’s regular business
•Nonapportionable incomeis allocated to the state in which the income-producing asset is located. It generally does not relate to the entity’s business activities.

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17
Q

Apportionment Factors

A

• Apportionment formulas vary among states
– Traditionally, states use a three-factor formula that equally weights sales, property, and payroll
– Many states use a modified formula where sales factor receives a larger weight
• Tends to pull larger amount of out-of state corporation’s income into the state
• May provide tax relief to corps domiciled in the state

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18
Q

Sales Factor (slide 1 of 3)

A

• Sales factor is a fraction
– Numerator is corp’s sales in the state
– Denominator is corp’s total sales everywhere
• Most states follow UDITPA’s “ultimate destination concept”
– Tangible asset sales are assumed to take place at point of delivery, not where shipping originates
• About 20 states have adopted market-sourcing rules, where the sale of services is sourced to the customer’s state

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19
Q

Sales Factor (slide 2 of 3)

A

– Sales to the US Government –
• Because the U.S. government is present in every state, the ultimate destination concept becomes difficult to use.
• Accordingly, sales to the Federal government are assigned to the sales factor numerator of the state from which the sale occurs
– Dock sales occur when delivery is taken at seller’s shipping dock
• Most states apply the destination test to dock sales
– If purchaser has out-of-state location to which it returns with the product, sale is assigned to purchaser’s state

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20
Q

Sales Factor (slide 3 of 3)

A

– Throwback rule
• If adopted by state, requires that out-of-state sales not subject to tax in destination state be pulled back into origination state
• Treats such sales as in-state sales of the origination state
• Also applies if purchaser is U.S. government

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21
Q

Payroll Factor (slide 1 of 4)

A

• Payroll factor is a fraction
– Numerator is compensation paid within a state
– Denominator is total compensation paid by the corporation

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22
Q

Payroll Factor (slide 2 of 4)

A

• Compensation includes wages, salaries, commissions, etc
– Amounts paid to independent contractors are excluded
– Some states exclude amounts paid to corporate officers
– Some states require that deferred compensation amounts be included in the payroll factor (e.g., 401(k) plans)

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23
Q

Payroll Factor (slide 3 of 4)

A

• Compensation of an employee is usually not split between states (unless employee is transferred or changes positions)
– Usually allocated to state in which services are primarily performed
• If more than one state, attribute to:
– Employee’s base of operations, or, if none,
– Place where work is directed or controlled, or, if none,
– Employee’s state of residency

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24
Q

Payroll Factor (slide 4 of 4)

A

• Only compensation related to production of apportionable income is included in payroll factor
– In states that distinguish between apportionable and nonapportionable income, compensation related to nonapportionable income is not included
– Compensation related to both business and nonapportionalbe income is prorated between the two

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25
Q

Property Factor (slide 1 of 3)

A

• Property factor generally includes average value of real and tangible personal property owned or rented
– Numerator is amount used in the state
– Denominator is all of corp’s property owned or rented

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26
Q

Property Factor (slide 2 of 3)

A

• Property includes:
– Land, buildings, machinery, inventory, etc
– May include offshore property, outer space property (satellites), and partnership property
• Property in transit is included in numerator of destination state

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27
Q

Property Factor (slide 3 of 3)

A

• Property is typically valued at average original or historical cost plus additions and improvements
– Some states allow net book value or adjusted basis to be used
• Leased property, when included in the property factor, is valued at eight times its annual rental payments

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28
Q

Unitary Taxation (slide 1 of 2)

A

• Theory: operating divisions are interdependent so cannot be segregated into separate units
– Each unit deemed to contribute to overall profits
– Unitary theory ignores separate legal existence of companies: all combined for apportionment

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29
Q

Unitary Taxation (slide 2 of 2)

A

• For multistate apportionment, all divisions or entities are treated as single unitary base:
– Larger apportionment base (all companies’ activities)
– Smaller apportionment factors (each state’s %)

30
Q

Other Multi-Entity Considerations (slide 1 of 2)

A

• Multinational operations: If state uses Unitary system, it may require inclusion of worldwide activities in determining apportionment
• Most unitary states allow Water’s Edge election so only U.S. operations are included
– Cost of election may include:
• Specified number of years before revocation
• Additional tax for privilege of excluding foreign entities

31
Q

Other Multi-Entity Considerations (slide 2 of 2)

A

• Combined reporting
– Filed in every unitary state in which one or more unitary members have nexus
• The computations reflect apportioned and allocated income of the unitary members
• Consolidated returns
– Some states allow (or require) consolidated return if filed for Federal

32
Q

Taxation of S Corporations(slide 1 of 2)

A

• Majority of states with corporate income tax have special provisions that govern S corporations
– Only a few states do not provide special treatment for S corps
• There, S corps are taxed the same as C corps
– Must have valid S election at federal level to get S corp treatment in states

33
Q

Taxation of S Corporations (slide 2 of 2)

A

• Multistate S corps must apportion and allocate income in same manner as regular corp
– Must file a state tax return in each state with nexus
– Must inform shareholders of their share of income for each state so their tax returns can be prepared
• S corp may be allowed to file a single return and pay tax for all shareholders

34
Q

Taxation of Partnerships and LLCs (slide 1 of 2)

A

• Most states treat partnerships, LLCs, and LLPs in a manner that parallels Federal treatment
– Entity is a tax-reporting, not a taxpaying, entity
– Income, loss, and credit items are allocated and apportioned among the partners according to the terms of the partnership agreement

35
Q

Taxation of Partnerships and LLCs (slide 2 of 2)

A

• Some states:
– Require entity make estimated tax payments for out-of-state partners
– Allow composite returns to be filed for out-of-state partners
• Generally, an in-state partner computes the income tax resulting from all of the flow-through income from the entity
– Partner is allowed a credit for income taxes paid to other states on this income

36
Q

Sales and Use Taxes(slide 1 of 3)

A

• Sales tax: Consumers’ tax on tangible personal property acquired for use or consumption
– In several states, selected services are subject to tax
– Vendor acts as collection agent
– Generally, not assessed on goods purchased for shipment out-of-state
• Use tax complements sales tax
– Consumers bringing purchased goods into state pay tax to state in which property is used
– States have difficulty enforcing use tax

37
Q

Sales and Use Taxes(slide 2 of 3)

A

• A majority of states exempt certain sales including, for example:
– Sales for resale
– Casual or occasional sales
– Most purchases by exempt organizations
– Sales of targeted items
– Sales to manufacturers, producers, and processors

38
Q

Sales and Use Taxes(slide 3 of 3)

A

• Solicitation by independent brokers is sufficient nexus for sales tax purposes
– Turns “use” tax into “sales” tax for that state
– Seller required to collect tax
– Facilitates collection by state

39
Q

Other Taxes

A

• States may impose a variety of other state & local taxes on corporations, including
– Incorporation or entrance fees or taxes
– Gross receipt taxes
– Stock transfer taxes
– Realty transfer and mortgage recording taxes
– License taxes, and
– Franchise taxes based on net worth or capital stock outstanding

40
Q

If there is no income tax in the state to which a sale otherwise would be apportioned, the sale is exempt from state income tax, even though the seller is domiciled in a state that levies an income tax.

A

Throwback rule

41
Q

A U.S. state may have the right to acquire property that has been made available to an individual or legal entity for a fixed period of time, where the claimant has not taken possession of the property after a notice period.

A

Unclaimed property

42
Q

Sales, property, and payroll of related corporations are combined for nexus and apportionment purposes, and the worldwide income of this entity is apportioned to the state.

A

Unitary theory

43
Q

A fraction whose numerator is the corporation’s total receipts in the state during the tax period. The denominator is the corporation’s total receipts generated everywhere during the tax period.

A

Sales factor

44
Q

Permits a multinational corporation to elect to limit the reach of the state’s taxing jurisdiction over out-of-state affiliates to activities occurring within the boundaries of the United States.

A

Water’s edge

45
Q

This Act develops criteria by which the total taxable income of a multistate corporation can be assigned to specific states.

A

UDITPA

46
Q

Most states have their own state-specific definitions of gross and taxable income that is used in computing the tax base rather than using taxable income from the Federal 1120 form.

A

False

47
Q

Most states piggyback onto the IRS’s audit process.

A

true

48
Q

State tax credits typically are designed to encourage increased hiring and investment in local facilities.

A

True

49
Q

The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to the _____ among the states for corporations that maintain operations in more than one state (multistate corporations). ____ states have adopted the provisions of the UDITPA, either by joining the Multistate Tax Compact or by modeling their laws after the provisions of the UDITPA.

A
  • assignment of income

- Many

50
Q

Property owned by the corporation typically is valued at its carrying value or adjusted basis.

A

False

51
Q

The property factor generally is a fraction whose numerator is the average value of the corporation’s real property and its tangible personal property owned and used or rented and used in the state during the taxable year.

A

True

52
Q

In the case of property that is in transit between locations of the taxpayer or between a buyer and seller, the assets are included in the numerator of the destination state. True

A

True

53
Q

Megan is an accountant for KnoxCo. She is a telecommuter and works most days from her home in Tennessee. Twice a month, she travels to Georgia for a staff meeting at the employer’s Atlanta headquarters.
In which state’s payroll factor should Megan’s compensation be included under the following scenarios?
a. Megan is an employee and is covered by the qualified retirement plan of her Atlanta employer.
Megan’s compensation should be assigned _____
b. Megan works as an independent contractor for several clients, including the Atlanta-based firm.
Megan’s compensation should be assigned _____
Megan is an employee and for one day each month she provides accounting services for KnoxCo’s Memphis rental properties.
The rental properties constitute a _____ activity for KnoxCo, so the cost of Megan’s time on these days _____.

A
  • only to Tennessee
  • to neither state
  • nonbusiness
  • offsets the allocable income from the rent income.
54
Q

Definition: The Uniform Division of Income for Tax Purposes Act has been adopted in some form by many of the states. The Act develops criteria by which the total taxable income of a multistate corporation can be assigned to specific states.

A

UDITPA

55
Q

A regulatory body of the states that develops operating rules and regulations for the implementation of the UDITPA and other provisions that assign the total taxable income of a multistate corporation to specific states.

A

Multistate Tax Commission (MTC)

56
Q

The degree of activity that must be present before a taxing jurisdiction has the right to impose a tax on an outof- state entity. The rules for income tax nexus are not the same as for sales tax nexus.

A

nexus

57
Q

A congressional limit on the ability of the state to force a multistate corporation to assign taxable income to that state. Under P.L. 86–272, where orders for tangible personal property are both filled and delivered outside the state, the entity must establish more than the mere solicitation of such orders before any income can be apportioned to the state.

A

Public Law 86–272

58
Q

The assignment of income for various tax purposes. A multistate corporation’s nonbusiness income usually is allocated to the state where the nonbusiness assets are located; it is not apportioned with the rest of the entity’s income. The income and expense items of an estate or a trust are allocated between income and corpus components. Specific items of income, expense, gain, loss, and credit can be allocated to specific partners if a substantial economic nontax purpose for the allocation is established.

A

allocate

59
Q

Definition: The assignment of the business income of a multistate corporation to specific states for income taxation. Usually, the apportionment procedure accounts for the property, payroll, and sales activity levels of the various states, and a proportionate assignment of the entity’s total income is made using a three-factor apportionment formula. These activities indicate the commercial domicile of the corporation relative to that income. Some states exclude nonbusiness income from the apportionment procedure; they allocate nonbusiness income to the states where the nonbusiness assets are located.

A

apportion

60
Q

The proportion of a multistate corporation’s total sales that is traceable to a specific state. Used in determining the taxable income that is to be apportioned to that state.

A

sales factor

61
Q

A purchaser uses its owned or rented vehicles to take possession of the product at the seller’s shipping dock. In most states, the sale is apportioned to the operating state of the purchaser, rather than the seller.

A

Dock sales

62
Q

If there is no income tax in the state to which a sale otherwise would be apportioned, the sale essentially is exempt from state income tax, even though the seller is domiciled in a state that levies an income tax. Nonetheless, if the seller’s state has adopted a throwback rule, the sale is attributed to the seller’s state and the transaction is subjected to a state-level tax.

A

throwback rule

63
Q

The proportion of a multistate corporation’s total payroll that is traceable to a specific state. Used in determining the taxable income that is to be apportioned to that state.

A

payroll factor

64
Q

The proportion of a multistate corporation’s total property that is traceable to a specific state. Used in determining the taxable income that is to be apportioned to that state.

A

property factor

65
Q

Sales, property, and payroll of related corporations are combined for nexus and apportionment purposes, and the worldwide income of the unitary entity is apportioned to the state. Subsidiaries and other affiliated corporations found to be part of the corporation’s unitary business (because they are subject to overlapping ownership, operation, or management) are included in the apportionment procedure. This approach can be limited if a water’s-edge election is in effect.

A

unitary theory

66
Q

In multistate taxation, a group of unitary corporations may elect or be required to file an income tax return that includes operating results for all of the affiliates, not just those with nexus in the state. Thus, apportionment data is reported for the group’s worldwide or water’s-edge operations.

A

combined return

67
Q

A limitation on the worldwide scope of the unitary theory. If a corporate waters’-edge election is in effect, the state can consider in the apportionment procedure only the activities that occur within the boundaries of the United States.

A

water’s edge

68
Q

In multistate taxation, an S corporation may be allowed to file a single income tax return that assigns pass-through items to resident and nonresident shareholders. The composite or “block” return allows the entity to remit any tax that is attributable to the nonresident shareholders.

A

return

69
Q

A U.S. state may have the right to acquire property that has been made available to an individual or legal entity for a fixed period of time, where the claimant has not taken possession of the property after a notice period. Examples of such property that a state could acquire are an uncashed payroll check or an unused gift card.

A

Unclaimed property

70
Q

A means by which a multistate corporation can reduce the overall effective tax rate by isolating investment income in a low- or no-tax state.

A

passive investment company

Business Tax Topics (7 decks)

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