To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 16 MULTISTATE CORPORATE TAXATION SOLUTIONS TO PROBLEM MATERIALS Question/ Problem 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Learning Objective LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO 2, LO LO LO LO Topic State tax policy State/Federal tax law overlap UDITPA and MTC as tax law writers Multistate Tax Commission States’ jurisdiction to tax; nexus Immune sales under P.L 86-272 P.L 86-272 solicitation standards Apportionment and allocation of income Allocation and apportionment Allocation and apportionment Apportionment formula weights Sales factor Throwback rule for sales factor Payroll factor Property factor Unitary theory Unitary taxation Unitary taxation Unitary taxation Out-of-state S shareholders Composite S corporation filing Partnerships and LLCs Sales/use tax incidence Sales/use tax exemptions Streamlined Sales Tax Project Other taxes Planning with nexus rules Passive investment subsidiary Shifting taxable income from intangibles Multistate tax planning Capital stock tax planning Status: Present Edition Q/P in Prior Edition Unchanged Modified New Unchanged Unchanged New New Unchanged Modified Modified Unchanged Modified Modified Modified Unchanged Unchanged Unchanged Unchanged New New Unchanged New New Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged 10 11 12 13 14 15 16 17 18 21 24 25 26 27 28 30 31 Instructor: For difficulty, timing, and assessment information about each item, see p 16-3 16-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-2 2012 Corporations Volume/Solutions Manual Question/ Problem Learning Objective *32 33 *34 *35 *36 37 38 *39 *40 41 42 *43 44 45 46 47 48 49 50 51 *52 53 LO LO LO LO LO LO 4, LO 4, LO LO LO LO LO LO 5, LO 5, LO LO LO LO LO 5, LO 6, LO LO 54 *55 56 *57 58 59 LO LO LO LO LO 5, LO Topic State income tax formula State income tax formula Addition and subtraction modifications Addition and subtraction modifications Addition and subtraction modifications Apportionment formulas Apportionment and allocation Apportionment formulas Apportionment formulas Apportionment formulas Apportionment formulas Sales factor Throwback rule Payroll factor Payroll factor Payroll factor Property factor Property factor Property factor Unitary business, apportionment factors Water’s edge election Multistate S corporations, apportionment formula Sales tax base Sales and use taxes Sales tax exemptions Franchise tax Apportionment planning Apportionment planning Status: Present Edition Q/P in Prior Edition Modified Modified Modified Unchanged Modified Modified Modified Unchanged Unchanged Unchanged Modified Modified Modified Unchanged Modified Modified Unchanged Unchanged Modified Unchanged Unchanged Unchanged 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 Modified Modified Unchanged Modified Unchanged Unchanged 54 55 56 57 58 59 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 16-3 Research Problem Topic Internet activity Internet activity Internet activity Internet activity Internet activity Internet activity Status Present Edition Modified Unchanged Unchanged Unchanged Modified Modified Q/P in Prior Edition © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation Question/ Problem Difficulty Est’d completion time 10 Assessment Information AICPA* AACSB* Core Comp Core Comp Medium Easy Easy 5 Easy 5 Medium Easy Easy Easy Easy 10 11 Easy Easy 10 12 13 Easy Medium 10 14 15 Easy Easy 16 Medium 17 Easy FN-Measurement | FNReporting FN-Reporting 18 19 20 21 22 23 Easy Easy Easy Easy Easy Easy 5 5 5 FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting 24 25 26 27 28 29 30 Medium Easy Easy Medium Medium Easy Medium 10 5 15 20 10 31 Medium 10 32 33 Easy Easy 10 10 10 5 10 16-3 FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting Communication | Analytic | Reflective Thinking Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Analytic Communication | Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty 34 Easy 10 35 36 Easy Medium 10 37 Medium 10 38 Medium 10 39 40 41 42 43 Medium Medium Medium Medium Medium 10 10 10 15 10 44 Medium 10 45 Medium 10 46 Easy 47 Medium 10 48 Easy 10 49 Easy 10 50 Medium 10 51 Medium 20 52 Easy 10 53 Medium 20 54 Easy 55 Medium 10 56 57 58 Easy Medium Medium 10 10 59 Medium 15 5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement FN-Reporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 16-5 CHECK FIGURES 32 Apportionable income $79,000; tax after credits $1,650 33.a $5,400,000 34.a S; $5,000 34.d S; $3,000 34.e N 34.f S; $20,000 35 $387,000 36.a $650,000 36.b $900,000 36.c $920,000 37 D $657,200; E $1,900,640 38 E $2,142,800 39 62.34%; 37.5% 40 A 62.5%; B 30.56% 41 A 67.71%; B 35.42% 42.a $189,990 42.b $187,500 43 B $595,000 44 E 84% Sales factor numerators total to 100% 45 G 16.67%; H 57.14%; I 50.0% 46 $725,000 to U 47 G 73.77%; H 26.24% 48 A 56.79%; B 43.21% 49 B 40.07% 50 Annual method, 40.0% property factor 51.a $60,478 51.b $110,000 52 B 25.0%; Q 80.0% 53 $0 Y; $140,067 Z 55.a $5,400 55.b $990,000 56.a S 56.d N 57 $3,285 58 Factor drops to 76.5% © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-6 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS Nontax factors dominate most business relocation decisions However, a combination of some of the following incentives might also force the consideration of a tax-motivated expansion or relocation • Economic development incentives • Sales and use tax exemptions reducing a customer’s acquisition price • Favorable interest rates on loans to business • Property tax deferrals or forgiveness for a period of time • Offsets against tax liabilities or debt obligations for employee withholding amounts • Income tax credits for new jobs created and retained • Income tax credits for new investment in business equipment or realty • Use of technology to transfer sales and purchase orders, pricing information, and other data • Ease in complying with multiple jurisdictions’ tax rules • ‘‘Exporting’’ of local taxes to visitors and outsiders • Sophistication and effort of jurisdictional enforcement measures pp 16-2 and 16-3 Item True or False a All of the states and the District of Columbia assess an False, a few income tax on entities doing business within the borders states have not adopted an income-like tax b Federal tax accounting methods, such as LIFO inventory and True specific write-off of bad debts, are followed for state income tax purposes c State rules as to which entities can join in a consolidated False, different return match those of Federal law rules are used d Some of the states use Federal taxable income as their True income tax base, while others modify this amount or create their own state taxable income e A typical state income tax credit would equal 10% of the True costs incurred to purchase and install solar energy panels for an existing factory © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation Item 16-7 True or False f The corporate income tax systems of most states can be False, the described as progressive in its rate structure systems are for the most part flat-rate g A state that “piggybacks” onto the Federal income tax likely False, none of allows the U.S Treasury to collect the state corporate the states income tax on the Federal Form 1120 this yet p 16-4 The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to the assignment of income among the states for corporations that maintain operations in more than one state Many states have adopted the provisions of UDITPA, either by joining the Multistate Tax Commission (MTC), or by modeling their laws after UDITPA provisions The MTC issues rulings and regulations, and states can automatically (or as-needed) adopt those regulations into their law The MTC also offers to coordinate audits of business taxpayers, thereby reducing the administrative costs to the state and broadening the reach of the jurisdiction’s enforcement resources pp 16-7 and 16-8 The Multistate Tax Commission (MTC) writes regulations and other rules to interpret UDITPA When a new MTC rule or regulation is created, member states propose its adoption to their respective legislatures The majority of (full or associate) MTC member states adopt the regulations with no exceptions or only minor changes In addition, many of the states that are not MTC members model their laws after UDITPA and MTC regulations Thus, MTC pronouncements carry great weight in the multistate tax system, and many see the functions of the MTC as allowing a state legislature to outsource its tax-writing responsibilities pp 16-7 and 16-8 • The state in which a business is incorporated has the jurisdiction to tax the income of the corporation, regardless of the volume of its business activities within the state • If a corporation is to be subject to tax in a state other than that of its incorporation, the former jurisdiction must show that sufficient contact with that state (nexus) has been established Typically, sufficient nexus exists when a corporation derives income from sources within the state, owns or leases property in the state, employs personnel in the state, or has physical or financial capital there • A state cannot tax the out-of-state activities of an out-of-state corporation p 16-8 No Oklahoma tax applies Public Law 86-272 limits the states’ right to impose an income tax on interstate activities This Federal law prohibits a state from taxing a business whose only connection with the state is to solicit orders for sales of tangible personal property, when the orders then are approved or rejected, filled, and shipped from outside the state © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-8 2012 Corporations Volume/Solutions Manual Only the sale of tangible personal property is immune from taxation under P.L 86-272, however Leases, rentals, and other dispositions of tangible personal property are not immune activities Moreover, dispositions of real estate and intangible assets, as well as sales of services, are not protected activities p 16-8 Oklahoma tax now applies to all of Josie’s sales Public Law 86-272 does not define the term solicitation, but the Supreme Court in Wrigley held that order solicitation includes any explicit verbal request for orders and any speech or conduct that implicitly invites an order A de minimis rule also may allow a transaction to stay immune under the statute Carrying out any of the following (common but substantively) minimal acts within a state, though, in addition to the traditional sales-solicitation tasks of a sales force, could establish nexus through nonimmune sales • Collecting delinquent accounts; investigating creditworthiness • Repairing or maintaining company products (even if performed at no charge to the customer) • Approving or accepting orders • Picking up or replacing damaged or returned property • For other than sales personnel, conducting training or personnel-related activities Exhibit 16.2 A business that carries out transactions in more than one state must divide such resulting income among the states for tax purposes Generally, this includes both an apportionment and an allocation of such income Apportionment is a means by which business income is assigned to specific states by a formula method The formula usually takes into account the gross receipts, property, and compensation levels generated within each state, although the states vary in the weighting of the factors for this purpose Allocation is a procedure by which nonbusiness income is assigned directly to the state(s) in which it is generated For instance, a manufacturing firm with some rental income would allocate the net rental profit or loss to the state in which the rental property is located A few states, including Connecticut and Rhode Island, fail to distinguish between business and nonbusiness income, apportioning all of the taxpayer’s income among the states p 16-10 and Figure 16.1 a Profits from sales activities Apportion; business income b Gain on the sale of a plot of land held by a real estate developer Apportion; business income c Gain on the sale of a plot of land held by a manufacturer Allocate; nonbusiness income © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation d Rent income received by a manufacturer from the leasing of space to a supplier Apportion; business income e Profits from consulting and other service activities Apportion; business income a The sales factor is positively correlated with the payroll, but not the property, factor Probably out-of-state b The sales factor is much higher than the property and payroll factors Probably out-of-state c The property and payroll factors are much higher than those for other nexus states Probably in-state d The sales and payroll factors are low, but the property factor is very high Probably in-state 16-9 p 16-11 10 p 16-13 11 A single-factor apportionment formula consisting solely of a sales factor tends to create greater levels of apportionable income for the state from nonresident (meaning also nonvoting) entities than an apportionment formula that double weights the sales factor Most states now over-weight the sales factor for this reason It is becoming popular to use a sales-factor-only apportionment formula p 16-14 and Example 11 12 In determining the numerator of the sales factor, most states follow UDITPA’s “ultimate destination concept,’’ whereunder sales of tangible personal property are assumed to take place at the point of delivery, as opposed to the location at which the shipment originates This sale should be sourced to Kentucky Example 12 13 The solution depends upon whether Iowa applies a throwback rule in its sales factor The throwback rule is an exception to the ultimate destination concept It provides that, when a corporation is not subject to tax in the destination state or the purchaser is the U.S government, the sales are treated as in-state sales of the origination state, and the actual destination of the product is disregarded Consequently, when the seller is immune from tax in the destination state, the sales are considered to be in-state sales of the origination state if that state has a throwback provision The throwback rule was established as an attempt to ensure that none of a corporation’s sales escaped taxation (Iowa has not adopted such a throwback rule.) Example 13 14 a Items included in the payroll factor are not split among the states in which an employee works, unless the employee is permanently relocated during the year Rather, compensation is assigned in full under the UDITPA to the state in which the services primarily are performed Megan’s compensation should be assigned only to Tennessee © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-10 2012 Corporations Volume/Solutions Manual b The payroll factor includes only the compensation paid to employees The compensation that is paid to an independent contractor is not part of the numerator or denominator of the payroll factor of any state Thus, Megan’s compensation is excluded from the Tennessee (and Georgia) payroll factor pp 16-17 and 16-18 15 An analysis of this situation should include the following tax-related inquiries • Is the property tangible or intangible? • Where is the property located? • For what portion of the tax year was the property used in this state? • Was the property used in the taxpayer’s productive or other active business? • What is the tax basis of the property? • What was the original purchase price of the property? • What is the balance of accumulated depreciation for the property as of the end of the tax year? • Was the property in-transit on the last day of the tax year? • Was the property idle or obsolete on the last day of the tax year? • What averaging conventions does the state allow in computing the property factor? pp 16-19 to 16-21 16 The unitary theory can increase the taxpayer’s income taxes as the apportionment formula includes operations in locations where payrolls, property values, and selling prices are higher than normally experienced (e.g., California and the U.K.) a The unitary approach to state taxation attempts to neutralize taxpayer attempts to place profitable operations in low- or no-tax jurisdictions States have adopted combined reporting as a means to discourage the use of passive investment companies and to allow the taxation of income from intangible assets (e.g., trademarks and licenses) Whether the unitary rules apply often turns on subjective assessments as to the structure and operations of the business This is unlike the application of the controlled and affiliated group rules, discussed in text Chapters and b When the business is found to be unitary, apportionment factors are computed on the basis of the entire unitary entity, not just the subsidiary that is based in the taxing state This computational convention can work to the taxpayer’s benefit when high-taxed income now is subjected to apportionment in a low-tax state pp 16-21 to 16-24 and 16-34 17 Unitary rules tend to assign larger portions of a corporation’s taxable income to states with higher compensation levels, property values, and consumer pricing For each of the © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-14 2012 Corporations Volume/Solutions Manual investment company to hold the intangible assets and to handle the corporation’s investment activities Although the passive investment company technique usually produces the desired result in any no-tax state, Delaware and Nevada often are selected for this purpose, because of those states’ additional corporate statutory provisions and favorable political, business, and legal atmosphere For instance, Delaware does not impose an income tax upon a corporation whose only activity within the state is the maintenance and management of intangible investments, and the collection and distribution of income from such investments or from tangible property physically located in another state Consequently, patents, trademarks, stock, and other intangible property can be transferred to a Delaware corporation whose activity is limited to collecting passive income Transfers of the assets to the subsidiary can be effected without a resulting Federal income tax, under § 351 However, to receive the desired preferential state tax treatment, the passive investment company’s activities within the no-tax state must be sufficient to establish nexus, and the holding company should avoid performing any activity outside the state that may result in establishing nexus with another state In addition, the formation of the subsidiary must be properly implemented, to assure the legal substance of the operation The passive investment company must have a physical office, and it must function as an independent operation Nevertheless, ensuring nexus and proper formation is not difficult, since numerous consulting organizations have been established to furnish new passive investment companies with all of the elements necessary to fulfill these requirements Because the subsidiary’s activities are confined to Delaware (or some other no- or low-tax state), and its operations generate only passive income, its income is not taxed in any nonunitary state Moreover, most states exclude dividends from taxation or otherwise favorably treat them; therefore, the earnings of a passive investment company can be distributed as a dividend to the parent at a minimal tax cost If the state in which the parent is located does not levy income tax on dividends received, the entire measure of passive income may escape taxation Formation of a passive investment company also may favorably affect the parent corporation’s apportionment formula in nonunitary states, because the passive income earned by the subsidiary is excluded from the numerator of its sales factor These desired results, however, are not fully available in states that view the entire corporate operation as being unitary Since those states require combined or consolidated reporting, the income earned by the passive investment company is included in the corporation’s apportionable or allocable income HIGH-TAX STATE LOW-TAX STATE Investment Assets SUBCO ROYAL CORPORATION Earnings: dividends paid, qualify for the dividends received deduction Nexus only here p 16-35 and Example 35 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 29 16-15 The Geoffrey rule has been adopted by a number of states, following the South Carolina court case of that name As the U.S economy has shifted to one of returns on service activities and intangible assets, the tax base of some states has been eroded Specifically, taxable income that would be assigned to State A might be shifted to State B through a passive investment subsidiary, or by other means of assigning such portable income across the border Geoffrey legislation allows State A to capture that income, using a rationale that the state has provided economic and legal benefits for the taxpayer Accordingly, the business is subject to income taxation in that state The rules in effect nullify income shifting techniques, especially when the income relates to the use of a trademark or license (the fact pattern involved in the South Carolina case and in Sherri’s situation) Other means by which states attempt to capture shifted taxable income from intangible assets is the use of combined reporting under the unitary theory, and the adoption of a gross receipts tax Tax in the News item on p 16-37 30 • Create nexus in a low- or no-tax state, so that, through the apportionment process, a lower effective tax rate can be used • Physically move operations to a low- or no-tax state, perhaps on a divisional or other functional basis • Move the investment assets into a passive investment subsidiary • Reduce the payroll expense through the use of independent contractors • Acquire a subsidiary that offers a presence in a no- or low-tax state, or a research division whose losses will offset taxable income Then optimize tax liabilities through transfer pricing and management fee structures • If the home state has not adopted a throwback rule, make new sales in low- or no-tax states, or into states with which there is no nexus pp 16-32 to 16-39 31 A corporation might be able to reduce its capital stock liability by: • Funding expansion with debt, rather than retained earnings • Funding subsidiary operations with debt, rather than with direct capital contributions • Regularly paying dividends to parent corporations located in states that offer friendly tax treatment of investment income (e.g., Delaware or Nevada) p 16-39 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-16 2012 Corporations Volume/Solutions Manual PROBLEMS 32 State F taxable income is computed as follows Federal taxable income Addition modifications Subtraction modifications State tax base Allocated income—total Apportionable income Apportionment percentage Apportioned income Allocated income—State F State taxable income Tax rate Gross income tax Credits Tax liability $90,000 +19,000 –15,000 $94,000 –15,000 $79,000 × 40% $31,600 + 3,000 $34,600 × 5% $ 1,730 – 80 $ 1,650 Figure 16.1 33 a $5,400,000 ($9 million × 60%) b $600,000 ($3 million × 20%) c Business income is apportioned to the state, using a state’s apportionment formula Nonbusiness income is allocated to the state using a dollar-for-dollar assignment In most states, business and nonbusiness income are not combined in applying the state income tax formula Figure 16.1 34 a S $5,000 b A $5,000 c In most states, N d S $3,000 e N f S $20,000 g A $3,000 h S $3,000 i In most states, N Exhibit 16.1 35 Perk’s state taxable income is determined as follows Federal taxable income A income tax expense A income tax refund $200,000 +10,000 – 3,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 16-17 Depreciation modification ($300,000 – $120,000) A taxable income +180,000 $387,000 Exhibit 16.1 and Example 36 a Sales Cost of sales Cost recovery (Federal) Interest income (Federal) X income tax expense Federal taxable income $4,000,000 –2,800,000 –400,000 +50,000 –200,000 $ 650,000 b If interest generated from X obligations is exempt from state tax, state taxable income is computed as follows Federal taxable income State income tax expense Depreciation modification ($400,000 – $300,000) Interest on Federal obligations X taxable income c $650,000 +200,000 +100,000 – 50,000 $900,000 If interest generated from X obligations is subject to state income tax, state taxable income is computed as follows Federal taxable income State income tax expense Depreciation modification ($400,000 – $300,000) Interest on Federal obligations Interest on X obligations Expenses related to X obligations X taxable income $650,000 +200,000 +100,000 –50,000 +30,000 –10,000 $920,000 Exhibit 16.1 and Examples and 37 STATE D TAXABLE INCOME Income subject to apportionment (business income) $2,000,000 Apportionment formula Sales $3,000,000/$10,000,000 Property $600,000/$2,100,000 Payroll $1,200,000/$3,000,000 Total State D apportionment factor (98.57%/3) Taxable income apportioned to D Plus: Income allocated to D D taxable income = = = 30.00% 28.57% 40.00% 98.57% × 32.86% $ 657,200 –0–* $ 657,200 *Since the property for which the $800,000 gain was derived was located in E, such income is not allocated to D STATE E TAXABLE INCOME Income subject to apportionment (business and nonbusiness income) $2,800,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-18 2012 Corporations Volume/Solutions Manual Apportionment formula Sales $7,800,000*/$10,800,000* = 72.22% Property $1,500,000/$2,100,000 = 71.43% Payroll $1,800,000/$3,000,000 = 60.00% Total 203.65% State E Apportionment Factor (203.65%/3) E taxable income × 67.88% $1,900,640 *Includes $800,000 gain on sale of nonbusiness property Examples 5, 6, and to 10 38 Jest’s income is subject to tax in States D and E, respectively, is computed as follows D taxable income, as in problem 37 $ 657,200 STATE E TAXABLE INCOME Income subject to apportionment (business income only) $2,000,000 Apportionment formula Sales $7,000,000/$10,000,000 = 70.00% Property $1,500,000/$2,100,000 = 71.43% Payroll $1,800,000/$3,000,000 = 60.00% Total 201.43% State E Apportionment Factor (201.43%/3) Taxable income apportioned to E Plus: Income allocated to E E taxable income × 67.14% $1,342,800 800,000 $2,148,800 Examples 5, 6, 8, and 10 39 Because of the components of the apportionment factors in the two states, less than 100% of taxable income is subject to state income taxation State A Income Apportionment Sales $1,000,000/$1,600,000 = Property $280,000/$680,000 = Payroll $2,500,000/$3,000,000 = Total A Apportionment Factor (187.01%/3) 62.50% 41.18%* 83.33% 187.01% 62.34% *Owned property is included in the factor at net depreciated basis, and rent payments are included in the factor at times the annual rental expense Therefore, the numerator of the factor is computed as $280,000 [$500,000 (average cost) less $300,000 (average accumulated depreciation)] plus [8 × $10,000 (annual rental payments)] The denominator of the factor is computed as $680,000 {[$800,000 (total average cost) less $400,000 (total average accumulated depreciation)] plus [8 × $35,000 (total annual rental payments)]} State B Income Apportionment Sales $600,000/$1,600,000 B Apportionment Factor (37.5%/1) = 37.5% 37.5% © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 16-19 Examples 11, 19, and 20 40 Because of the components of the apportionment factors in the two states, less than 100% of taxable income is subject to state income taxation State A Income Apportionment Sales $1,000,000/$1,600,000 = 62.5% A Apportionment Factor (62.5%/1) 62.5% State B Income Apportionment Sales $600,000/$1,600,000 Property $300,000/$800,000 Payroll $500,000/$3,000,000 Total B Apportionment Factor (91.67%/3) = = = 37.5% 37.5%* 16.67% 91.67% 30.56% *Property is included in the factor at historical, undepreciated cost, and rent payments are not included in the factor p 16-14 and Examples 11 and 19 41 Because of the components of the apportionment factors in the two states, more than 100% of taxable income is subject to state income taxation State A Income Apportionment Sales $1,000,000/$1,600,000 = 62.5% × Property $500,000/$800,000 Payroll $2,500,000/$3,000,000 Total A Apportionment Factor (270.83%/4) = = = 125.0% 62.5%* 83.33% 270.83% 67.71% *Property is included in the factor at historical, undepreciated cost, and rent payments are not included in the factor State B Income Apportionment Sales $600,000/$1,600,000 = 37.5% × Property $200,000/$400,000 Payroll $500,000/$3,000,000 Total B Apportionment Factor (141.67%/4) = = = 75.0% 50.0%* 16.67% 141.67% 35.42% *Property is included in the factor at net depreciated basis, and rent payments are not included in the factor Examples 10, 11, and 19 42 a Sales ($600,000/$1,000,000) Property ($300,000/$600,000) Payroll ($200,000/$250,000) Sum of Apportionment Factors Average State A apportionment factor = = = = 60.00% 50.00% 80.00% 190.00% ÷3 63.33% © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-20 2012 Corporations Volume/Solutions Manual Apportionable income Income apportioned to State A × $300,000 $189,990 b Sales ($600,000/$1,000,000) × Property ($300,000/$600,000) Payroll ($200,000/$250,000) Sum of Apportionment Factors Average State A apportionment factor Apportionable income Income apportioned to State A = = = 120.00% 50.00% 80.00% 250.00% ữ4 62.50% ì $300,000 $187,500 c Sales ($600,000/$1,000,000) State A apportionment factor Apportionable income Income apportioned to State A = 60.00% 60.00% × $300,000 $180,000 Examples 10 and 11 43 Item A Sales B Sales Ordinary sales Checking account interest Rental income, business U.S Treasury bill interest Occasional sales, nonbusiness Royalty income Sales factor numerator $300,000 $500,000 5,000 40,000 –0– –0– $340,000 –0– –0– 90,000 $595,000 pp 16-15, 16-16, and Example 12 44 The E throwback rule places in the E sales factor any sales to customers in G and to the U.S government E sales factor = $210 million*/$250 million F sales factor = $40 million/$250 million Total of sales factors = = 84% 16% 100% *$75 million (E) + $100 million (G) + $35 million (U.S government) This arrangement calls for better tax planning, in that shipping from E keeps the total of the sales factors at 100%, whereas it appears that the throwback sales should be in the sales factor numerator of no state Shipments should be made from a non-throwback state, like F p 16-16 and Example 13 45 G payroll factor $200,000/$1,200,000 H payroll factor $400,000/$700,000 I payroll factor $600,000/$1,200,000 Total of payroll factors = = = 16.67% 57.14% 50.00% 123.81% This arrangement calls for better tax planning, in that placing the officers’ salaries in I increases the total of the payroll factors far above 100% The salaries for the executives should be sourced to H © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 16-21 p 16-17 and Example 14 46 The State U payroll factor includes $725,000 for Judy An employee’s includible compensation generally is assigned to one state, specifically, the state in which she or he performs services for the employer If such services are performed in several states, the compensation is assigned to the state in which she or he has a base of operations pp 16-17 to 16-19 47 Because of the differences in the G and H payroll factors, Justin’s aggregate factors not equal 100% Justine’s State G payroll factor is determined as follows ($500,000 + $200,000 + $200,000) ($700,000 + $270,000 + $250,000) = $900,000 $1,220,000 = 73.77% Justine’s State H payroll factor is determined as follows [$200,000 + 70%($70,000)] $249,000 [$700,000 + 70%($70,000) + $200,000] = $949,000 = 26.24% pp 16-17 to 16-19 and Examples 16 to 18 48 Under the statutes of States A and B, accumulated depreciation and nonbusiness property (i.e., rental property) are not taken into consideration in computing the property factor Average Property in A Inventory Plant and equipment Land Total Beg of yr $ 300,000 2,500,000 600,000 End of yr $ 400,000 2,500,000 600,000 Total $ 700,000 5,000,000 1,200,000 Average $ 350,000 2,500,000 600,000 $3,450,000 Beg of yr $ 200,000 1,500,000 1,000,000 End of yr $ 150,000 1,200,000 1,200,000 Total $ 350,000 2,700,000 2,200,000 Average $ 175,000 1,350,000 1,100,000 $2,625,000 Average Property in B Inventory Plant and equipment Land Total Property Factor for A $3,450,000 (In-state property) $6,075,000 (Total property $3,450,000 + $2,625,000) = 56.79% Property Factor for B $2,625,000 (In-state property) $6,075,000 (Total property $3,450,000 + $2,625,000) = 43.21% pp 16-19 to 16-21 and Example 19 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-22 49 2012 Corporations Volume/Solutions Manual Under the statutes of A and B, accumulated depreciation is not taken into consideration in computing the property factor Nonbusiness property (i.e., rental property) is excluded from the property factor of A, but is included in determining the property factor for B HISTORICAL COST—EXCLUDING NONBUSINESS PROPERTY Property factor for A, as in problem 48 56.79% HISTORICAL COST—INCLUDING NONBUSINESS PROPERTY Average Property in A Inventory Plant and equipment Land Rental property Total Beg of yr $ 300,000 2,500,000 600,000 900,000 End of yr $ 400,000 2,500,000 600,000 950,000 Total $ 700,000 5,000,000 1,200,000 1,850,000 Average $ 350,000 2,500,000 600,000 925,000 $4,375,000 Beg of yr $ 200,000 1,500,000 1,000,000 300,000 End of yr $ 150,000 1,200,000 1,200,000 300,000 Total $ 350,000 2,700,000 2,200,000 600,000 Average $ 175,000 1,350,000 1,100,000 300,000 $2,925,000 Average Property in B Inventory Plant and equipment Land Rental property Total Property Factor for B $2,925,000 (In-state property) $7,300,000 (Total property $4,375,000 + $2,925,000) = 40.07% Example 19 50 Annual Method Average X property [($1.5 million + $700,000)/2] = $1.1 million Average total property [($3 million + $2.5 million)/2] = $2.75 million = X property factor (1.1/2.75) = 0.40 Monthly Method 11 $1.5 million $3.0 million + 12 $0.7 million $2.5 million = 0.481 property factor The late disposal of the X facility is reflected much more favorably in that state’s property factor when the annual method is used p 16-20 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 51 a 16-23 State A Income Tax Total apportionable income ($1,000,000 – NOL $400,000) $600,000 Apportionment formula Sales $2,500,000/$6,500,000 = Property $1,000,000/$3,500,000 = Payroll $500,000/$2,000,000 = Total State A apportionment factor (92.03%/3) Taxable income apportioned to State A State A tax rate State A tax liability, if unitary 38.46% 28.57% 25.00% 92.03% × 30.68% $184,060 × 8.00% $ 14,725 State B Income Tax Total apportionable income ($1,000,000 – NOL $400,000) $600,000 Apportionment formula Sales $4,000,000/$6,500,000 = Property $2,500,000/$3,500,000 = Payroll $1,500,000/$2,000,000 = Total State B Apportionment Factor (207.97%/3) Taxable income apportioned to State B 61.54% 71.43% 75.00% 207.97% State B tax liability, if unitary × 69.32% $415,940 × 11.00% $ 45,753 State A tax liability State B tax liability Overall state tax liability, if unitary $ 14,725 45,753 $ 60,478 b True Corporation, State A ($0 × 8%) Trumaine Corporation, State B ($1,000,000 × 11%) Aggregate state income tax, if nonunitary $ –0– 110,000 $110,000 c OFFICIAL CORRESPONDENCE November 3, 2011 To: Board of Directors Trumaine Corporation 1234 Mulberry Lane Chartown, AL 35298 From: Alison Brown, CPA, MST Re: Unitary treatment of operations of the True and Trumaine Corporations Some states apply a so-called unitary approach in computing the income tax liabilities of corporations doing business within its borders When the unitary theory is in effect, operating income and losses, and indicators of the level of in-state business activities are computed taking into account all of the other entities related to the corporation © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-24 2012 Corporations Volume/Solutions Manual Unitary computations are favorable to a taxpayer when related corporations generate operating losses or generally are less profitable than the taxpayer When more profitable entities enter the mix, state tax liabilities tend to increase Similarly, if a unitary group can shift taxable income into low- and no-tax states, the overall tax liability of the group declines Related corporations generally are found to constitute a unitary group where their ownership, operations, and corporate decision-making are interrelated I have determined that, if True and Trumaine are found to be a unitary group, the combined A and B income tax liability for the group will be cut almost $50,000 (i.e., from $110,000 to about $60,000) This happens essentially because of our ability to shift more taxable income into A, a lower tax rate state, and to use the True operating loss to shelter the net taxable income of Trumaine I recommend that we undertake to establish and document our position that True and Trumaine constitute a unitary group, and to inform the A and B revenue departments of that fact as soon as possible pp 16-21 to 16-24 and Examples 24 and 25 52 Because of the water’s edge election, the sales to the Despina customers are not included in either state’s sales factor Sales B Q Entity Sales Factor Chang Unitary group $20 million/$80 million = 25.00% $80 million/$100 million = 80.00% pp 16-22, 16-23, Concept Summary 16.1, and Global Tax Issue on p 16-24 53 MEMORANDUM November 3, 2011 To: Shareholders of Hernandez Corporation 5678 Alabaster Circle Koopville, KY 47697 From: Dustin Greene, CPA, MST Re: Tax liability of the corporation this year We elected so-called S corporation status at the Federal level long ago This election eliminates the exposure of corporate income to double taxation—the corporate level tax is zero, but all of the taxable income for the year passes through to the shareholders proportionately and is taxed to them immediately Not all of the states recognize the S election in computing corporate and individual income taxes In our case, one of the states in which we business (Z) taxes Hernandez as a regular or ‘‘C’’ corporation, while our other state (Y) applies the S election for its purposes This makes our tax computation more complicated—corporate taxable income must be computed in the aggregate and then apportioned among the states, based on the sales, property, and payroll activities in each Here is a summary of my determinations of Hernandez’s tax liabilities for this year © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation 16-25 State Y Since Y recognizes S corporation status, Hernandez is not subject to tax on any of its income in that state The income of the corporation is passed through to the shareholders; such income then is subject to tax at the shareholder level State Z Since Z does not recognize S corporation status, Hernandez is subject to tax in the same manner as a C corporation Hernandez’s taxable income before apportionment, determined as though it were a regular corporation, is $518,000 By applying the Z apportionment formula to this amount, Hernandez is subject to a corporate level tax on $140,067 Income determined as though it were a C corporation Ordinary business income Taxable interest income Capital loss Dividend income Income before dividends received deduction Dividends received deduction ($40,000 × 80%) Taxable income $500,000 10,000 (–0–)* 40,000 $550,000 (32,000) $518,000 *C corporations can offset capital losses only against capital gains Z Taxable Income Sales $800,000/$1,800,000 Property $100,000/$600,000 Payroll $200,000/$1,000,000 Total Average (81.11%/3) Taxable income Z apportionment percentage Z taxable income = = = 44.44% 16.67% 20.00% 81.11% 27.04% $518,000 × 27.04% $140,067 pp 16-25, 16-26, and Example 26 54 Businesses are merely the collection agents for the states with regard to the sales tax Thus, Grande must collect and remit, to the state, tax on the $1,100,000 general sales transactions Medical devices and out-of-state sales are exempt from this collection requirement, although use tax might be due on the mail-order sales On the goods Grande purchased from its supplier, neither party need collect and remit the tax A resale exemption applies in virtually all states, so that only the ultimate consumers of the goods—here, Grande’s customers—pay tax on the transaction pp 16-27 and 16-28 55 a 9% sales tax rate × $60,000 office supplies = $5,400 Granite is the final consumer of the office supplies, so it must pay the sales tax on such materials to the vendors from whom purchases are made Other supplies and tools used in the assembly process to create the computer systems are exempt from tax, in anticipation of the subsequent resale of the systems The final consumers of those systems are liable for the tax thereon © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-26 2012 Corporations Volume/Solutions Manual b 9% sales tax rate × ($2,500,000 software sales + $8,500,000 computer sales) = $990,000 No reductions to the tax base are made for cost of sales or packaging materials pp 16-27 and 16-28 56 a S b N Probably exempt as a targeted item c U d N Probably exempt because of charitable status e N Probably exempt under the resale rule p 16-28 57 Net Worth Assets Liabilities Apportionment Sales Factor Property Factor * [$600,000/$1,800,000] Net Worth Apportioned to A Tax Rate Franchise Tax Liability $2,100,000 (1,350,000) $750,000 0.40 0.33 0.73/2 = × 0.365 $273,750 × 1.2% $ 3,285 *Since property includes only real and tangible property, the cash and intangibles are not included in the denominator pp 16-30, 16-31, and Example 29 58 Independent contractor fees are excluded from the payroll factor numerator and denominator The home state payroll factor drops from 80 ($4,000,000/$5,000,000) to 765 ($3,250,000/$4,250,000) p 16-39 and Example 38 59 Presentation outline • Select Optimal States in which to Operate • Put losses into high-tax states • • • • Research division Inventory Put profits into no- and low-tax states Nexus • • When to avoid it When to create it © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Multistate Corporate Taxation • Investment Subsidiaries • • • • • 16-27 What they accomplish How to organize them Not good in unitary states Court case challenges Apportionment Factor Planning • Sales factor • • • Property factor • • • Shipping method Recordkeeping Leases Idle property Payroll factor • • Relocating executives Using independent contractors pp 16-32 to 16-39 The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16-28 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16- 14 2012 Corporations Volume/Solutions Manual investment company to hold the intangible assets and to handle the corporation’s... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16- 16 2012 Corporations Volume/Solutions Manual PROBLEMS 32 State F taxable income is computed as follows Federal taxable... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 16- 8 2012 Corporations Volume/Solutions Manual Only the sale of tangible personal property is immune from taxation under