For State Corporate Tax Policy, It's Alphabet Soup
“Alphabet soup,” a phrase observers used to describe President Roosevelt’s anti-Great Depression programs, might well fit in the case of corporate tax policy. Like the New Deal, a number of acronyms, abbreviations, and other shorthand expressions characterize today’s corporate and business tax policies. Here is a sample, drawn from recent developments at the state and federal level.
Nexus is neither an acronym, nor a name or indicator of a “recent policy development” per se. However, it is a central term in corporate tax policy. The word nexus indicates a link between a business entity and a taxing jurisdiction (i.e. a state). Hypothetically, a business is subject to taxation in a given jurisdiction if it meets or exceeds a nexus threshold. For an entity residing and operating in one place (such as the state in which it is incorporated), the nexus determination is straightforward. But things can get more complicated. Suppose, for example, an entity is incorporated in one state, but sells goods in several others. How should its activities be apportioned among the several states for tax purposes?
The U.S. Supreme Court took up this question in Quill Corp. v. North Dakota in 1992, reaffirming a “physical presence” standard with respect to excise taxes. As its name suggests, the physical presence standard holds that entities are only obligated to remit excise taxes to jurisdictions in which they have a physical presence. While physical presence lacks a precise definition, it can generally be construed as the presence of offices or other real property, non-transient employees, and the like. Advertising or the presence of transient employees, such as traveling sales people, generally does not establish physical presence.
Implications of the physical presence standard for government revenues prompted expansions of nexus thresholds in many jurisdictions, leading remote entities to reach nexus on the basis of “economic presence.” On the one hand, economic presence standards ensure states collect a fair share of sales and income tax revenue from out-of-state entities doing significant business within their borders. On the other, economic presence creates higher tax compliance costs for multi-state companies. Furthermore, while physical presence is a relatively unambiguous concept, to some it is not clear what constitutes “economic presence.” A report from the Tax Foundation shows that in nine states, a phone listing is enough to achieve nexus. Tax Foundation staff recently filed an amicus brief with the Supreme Court, urging justices to adhere to the physical presence standard should they consider a nexus question in Lamtec Corp. v. Department of Revenue of the State of Washington.
Business Activity Tax Simplification Act. This refers to federal legislation which would, among other actions, mandate states return to a physical presence standard for the purposes of determining nexus. By implication, corporations would no longer be obligated to pay applicable state and local business activity taxes in jurisdictions where they have no physical presence, as defined in the bill.
The Congressional Budget Office (CBO) estimated a 2005 version of BATSA would cost states and municipalities about $3 billion in tax revenue over an ensuing five year period (if enacted at that time). Legislators introduced a new version of BATSA in April of the current Congressional session. To date, CBO has not estimated the bill’s fiscal impact. To view the 2006 cost estimate, click here. To read the new BATSA legislation, click here.
Single Sales Factor Apportionment. Apportionment formulas determine the share of profits on which a multi-jurisdictional entity is obligated to pay taxes, provided nexus exists. Traditional formulas contain three factors that determine the level of profit subject to a tax, each of which receives an equal weight – property, payroll, and sales. In some instances, weights have been shifted to impose a lower (or higher) implicit tax on one factor. Shifting weight away from property or payroll and toward sales, for instance, imposes a lower implicit tax on production. Such a shift would benefit, as an example, entities that produce a high volume of goods in one state but sell most in another, by reducing their in-state tax burden. However, it would impose greater tax burdens on entities with large in-state sales. The burden faced by the latter would grow under an SSFA rule, where all the weight in the apportionment formula would be placed upon sales.
In a recently updated report, the Center on Budget and Policy Priorities (CBPP) indicated that federal BATSA legislation could interact with SSFA rules in a manner that lowers state and local tax revenue. The argument is as follows. The return to a physical presence standard mandated by BATSA would limit states’ ability to tax out-of-state corporations’ profits. Meanwhile, SSFA would limit state corporate income tax collections from in-state corporations focused heavily on production. In such a scenario, according to CBPP, states could no longer appreciably tax the incomes of corporations with a heavy in-state production presence but a heavy out-of-state sales presence.
It should be noted that since BATSA has not been passed, no data exists to validate or disprove the argument. To read the full CBPP report, click here.
Mandatory Unitary Combined Reporting. As noted above, the case of multi-jurisdictional entities can make tax burden calculations complex. Mandatory Unitary Combined Reporting (MUCR) aims to simplify the math. Under MUCR, a business with related entities in several states would combine its profits with that of the out-of-state subsidiaries. It would then file a single report listing all this income for tax purposes. States would tax a share of the reported income (generally in proportion to the amount of activity occurring within state borders).
Proponents note that combined reporting requirements limit corporations’ ability to “hide away” profits in out-of-state tax havens. Opponents claim it makes the determination of profit subject to tax arbitrary, and imposes an undue administrative burden on businesses. For a view from each side, see 1) a 2009 report from the Institute on Taxation and Economic Policy (ITEP) (in favor of MUCR), and 2) a statement from the Council on State Taxation (COST)(opposed to MUCR).