Concerned about state income tax liability for your business? View this presentation for tips on how to minimize state income taxes.

2.  Speaker: Ryan P. Giolitto, CPA, CFP®
◦ Ryan is a tax manager at CDH with several years of
experience in working with a variety of businesses
of all sizes. His area of specialty includes financial
planning and tax planning for businesses and high
net worth individuals, including business owners.
 Phone Contact: 630-285-0215 x8214
 Email Contact: rgiolitto@cdhcpa.com

3.  Basic Principles of State Income Tax
 Calculation of Apportionment Factors
 General Nexus Principles
 History of Nexus
 Types of Nexus
 Future of Nexus
 Compliance Suggestions
 Planning Suggestions

4.  Federal taxable income is modified for state
adjustments and multiplied by a state
apportionment factor to determine state
taxable income
Federal taxable income
+ State modifications
State modified taxable income
x apportionment factor
State taxable income

5.  State modifications result from differences in
federal vs. state law
 Common modifications in adjusting federal
taxable income to state taxable income are as
follows:
◦ Bonus depreciation
◦ State taxes
◦ Other items

6.  State apportionment factors determine the
portion of federal taxable income that will be
taxed by each state
 State apportionment factors refer to the
combination of 3 individual apportionment
factors weighted differently by each state
 Each factor is composed of a numerator (total
within state) and denominator (total
everywhere)

7.  The 3 individual apportionment factors are as
follows:
◦ Payroll
◦ Property
◦ Sales
 These factors are weighted differently by
each state, with the following weightings
being most common:
◦ One factor sales
◦ Three factor
◦ Three factor with double weighted sales

8.  Payroll Factor includes:
◦ Officer’s compensation
◦ Wages related to cost of sales
◦ Operating/administrative wages
 Payroll Factor does not include:
◦ Independent contractor payments
◦ Management fees

9.  Property Factor includes:
◦ Original cost of owned property (most states)
◦ Net book value of owned property (few states)
◦ Rented property x 8 (most states)
 Property Factor does not include:
◦ Construction in progress

10.  Sales Factor includes:
◦ Gross Receipts
◦ Interest (most states)
◦ Dividends (most states)
◦ Gains from sales of property (most states)

11.  Sales factor is based on several approaches
depending on the state:
◦ Destination of end user
◦ Where services performed (income-producing
activity or cost of performance sourcing)
◦ Defined by state law (market based sourcing based
on where market for services really exists)

12.  Throwback – requires “throwing back” sales
sourced to a state in which the taxpayer is not
taxable to the taxpayer’s home state for
inclusion in the sales apportionment numerator
 Throw-out – requires “removal” of sales sourced
to a state in which the taxpayer is not taxable
from the sales apportionment denominator
 Most states have a throwback rule
 Very few states have a throw-out rule, including
New Jersey and West Virginia

13. Most Some States Few States
States
Airlines X
Athletics X
Broadcasting X
Construction X
Financial X
Manufacturing X
Motor Carriers X
Pipelines X
Publishing X
Railroads X
Shipping X
Telecommunications X
Utilities X

14.  Definition of Nexus – sufficient/substantial
connection
 Sales Tax/Income Tax Nexus applied
different standards
 This class focuses on Income Tax Nexus only

15.  Payroll
◦ Defer to filed payroll tax returns
 Property
◦ Defer to records of property location
 Sales
◦ Subjective, based on determination of end user
location, cost of performance/income producing
activity location, or market source location
◦ But are we really required to file and pay in all these
locations? Maybe not.

16.  PL 86-272 – Interstate Income Act of 1959
◦ Limits ability of states to tax interstate commerce
◦ Limits nexus for mere solicitation of orders in a
state if the orders are filled or approved out of the
state
◦ Only limits income tax nexus (not franchise tax
nexus)
◦ Only applies to sales of tangible property (does not
apply to service companies)
◦ Only covers solicitation in state (other activities may
disqualify, sales orders must be approved out of
state)

17.  Several states have enacted taxes not based on
income, which are not subject to protection by
P.L. 86-272 and could cause substantial tax
burden
 These taxes are known as franchise or gross
receipts based taxes, which exist in the following
states:
◦ Michigan (Single Business Tax/Michigan Business Tax
changed to Corporate Income Tax, no longer receipts
based)
◦ Ohio (Commercial Activity Tax)
◦ Texas (Margin Tax)
◦ Washington (Business & Occupation Tax)

18.  Traditionally required physical presence
◦ Quill Corp vs. North Dakota
◦ National Bellas Hess vs. Department of Revenue
 Now changing to focus more on true
economics of transactions

19.  Physical Presence
◦ Requires Traditional Presence
 Economic Nexus
◦ Based on Facts/Circumstances
 Factor-Based Nexus
◦ Based on Exceeding Set Thresholds

20.  Nexus based on physical presence is
triggered upon entering the state physically
for a period of time
 Some states have defined de-minimus
physical presence rules, while others have not
 Since P.L. 86-272 was enacted to cover only
solicitation of sales situations, any amount of
physical presence, although limited, will most
likely trigger income tax nexus

21.  The following activities may create income
tax nexus in various states:
◦ Occasional training seminars for customers
◦ Occasional business meetings
◦ Occasional attendance at technical/training
seminars sponsored by unrelated parties
◦ Occasional board of director’s meetings
◦ Solicitation of sales
◦ Attendance at trade shows for less than 14 days per
year

22. ◦ Providing company car for salesperson
◦ Inventory inspection by salesperson
◦ Sale of real estate
◦ Setup of promotional items by salesperson
◦ Maintenance of a security interest in property sold
until contract price has been paid

23.  The following activities may create income
tax nexus in various states:
◦ Employees repairing and maintaining products
◦ Maintaining telephone answering service
◦ Leasing employees to another company
◦ Non-salesperson employee working from home
◦ Employees providing in state consulting services
◦ Having a website in and/or located on a server in a
state
◦ Employee presence for less than 20 days to
purchase goods from vendors

24. ◦ Employees inspecting customer installations of
products
◦ Company listing in phone book
◦ Providing engineering or design functions related to
sales of customized products
◦ Hiring unrelated parties to repossess property
◦ Hiring unrelated parties to install products
◦ Holding inventory at fulfillment company
◦ Hiring unrelated parties to collect accounts
◦ Hiring unrelated parties for warranty repair

25.  In response to the flexibility of P.L. 86-272
with regard to physical presence, most states
have responded by enacting economic nexus
provisions
 Economic nexus is a subjective concept
focused on determining whether the company
is “doing business” in a state
 Enforcement has been unsuccessful to some
degree, so the states have increased
enforcement and some have passed factor-
based nexus laws

26.  The following states have enacted factor-based
nexus standards with the following thresholds:
 California/Colorado/Ohio
◦ Property $50,000
◦ Payroll $50,000
◦ Sales $500,000
 Connecticut
◦ Sales $500,000
 Virginia
◦ Any apportionment factor is positive

27.  States are moving away from traditional
nexus rules in the following ways:
◦ 3 factor apportionment is switching to single factor
sales apportionment or double weighted sales
apportionment to capture lost revenue from
increasing move toward decreased physical
presence
◦ Nexus rules changing from based on physical
presence or economic nexus to factor-based nexus
◦ Enforcement of economic nexus is increasing

28.  Evaluating nexus for a pure ecommerce
company is challenging. The following
factors are used to determine nexus risk for
these types of businesses:
◦ Internet/Telecommunications provider location
◦ Server location (for website and other data)
◦ Location of intangible property
◦ Location and significance of customers
◦ Physical location of affiliate
◦ Location of advertising/telephone listing
◦ Location of product repairs/support assistance

29.  Filing related returns will most likely result in
a state income tax reporting requirement
 Therefore, be aware of where you file the
following to address nexus exposure:
◦ Company registrations
◦ Annual reports
◦ Sales tax returns
◦ Withholding tax returns
◦ Payroll tax returns
◦ Property tax returns

30.  States often send nexus questionnaires to
taxpayers they suspect of having unreported
activity
 It is acceptable to prepare your own
responses to a nexus questionnaire
 However, make sure to seek a review of your
responses by a state tax expert prior to
submitting to state taxing authorities

31.  Voluntary Disclosure programs are available
in virtually all states to report unreported
state tax filings prior to receiving a notice
from a state taxing authority
 Voluntary Disclosure often guarantees a
shorter look back period for unfiled returns
and ability to ask for abatement of penalties
due to reasonable cause

32.  Amnesty programs offer the ability to file
unfiled state tax returns without any penalty
charges
 These programs are often opened and closed
quickly, so it is important to be on the
lookout for specific states where risk exists

33.  Kentucky – Through June 30, 2013
 Ohio – Through May 1, 2013
 Rhode Island – Through November 15, 2012

34.  If none of the previously suggested courses
of action are possible, you may be forced to
file a state tax return by a state taxing
authority
 In this event, attempt to negotiate look back
periods and penalties to the highest extent
possible
 Some states will allow a 3 year look back
period and will abate penalties in certain
circumstances

35. 1. Identify states with potential nexus
2. Discover state nexus rules, apportionment
factors, and tax rates
3. Develop and implement plan for moving
nexus and apportionment factors to states
with lower tax rates

36.  If a large apportionment fraction is desired in
a low tax state, consider forming a separate
company to hold that state’s activity (if
profitable)
 If avoiding overall company exposure to a
state with a gross receipts based tax is
desirable, consider forming a separate
company to be exposed to the gross receipts
tax on its own
 Be aware of consolidated reporting rules

37.  State modified taxable income may not be
flexible so focus planning efforts on changing
apportionment factors
 Make necessary adjustments to source items
to low tax states while keeping
apportionment factors low in high tax states

38.  If state tax exposure is significant, consider
CDH nexus study to identify risk and
recommend strategies for improvement
 Nexus study can be customized in scope of
states and can include both income and sales
tax if necessary

39.  State nexus is a very complicated topic due to
varying state law
 With proper planning, state taxes can be
minimized
 It is important to stay current on state tax
risk and exposure to maximize company
profits

40.  Thank you for your attendance
 Please complete the course evaluation
worksheets