conduct state tax "year-end" planning early, often & always

This is a Public Service announcement. Revealing a secret from the state and local tax underground. A secret that makes it difficult for companies to do business. To stay in compliance. To avoid compounding tax liabilities and interest and penalties.

What is this secret?

Wait for it . . . . . . . .

State taxes are a "moving target."

A "moving target" is defined as:

• something that moves while someone is trying to hit it

• something that is always changing

Some state tax rules don't change. Some state tax rules change at a certain time or in a certain tax year based on federal or state legislation. Some state tax rules change every year. Some state tax rules change suddenly based on a court case or ruling. Some state tax rules change without you knowing it based on a state's internal policy decision or change in interpretation of a statute or regulation.

• So how does a company plan?

• Conduct year-end planning?

• Conduct beginning of the year planning?

• Plan for acquisitions, mergers, divestitures?

Companies must stay on top of income tax laws on a tax year by tax year basis. Meaning, income tax laws are generally static for a specific tax year, but can change from year to year. Thus, tax pros should not follow "SALY" (same as last year) when preparing returns. This can lead to "IAP" (interest and penalties). With that said, there are situations when court case decisions or rulings happen that may have retroactive impact and create amended return / refund opportunities or may simply alter prospective returns.

In regards to sales tax, there are static rules but the interpretation of some of those static rules can change and are definitely not the same in every state. Sales tax rules and tax rates can change at different times of the year due to court cases, rulings and state legislation. Unlike income tax, sales tax periods are generally monthly, quarterly or annual

It's the lack of uniformity among state tax laws that creates risks and opportunities.

Some state income tax laws that may differ from state to state are:

• Economic Nexus (creating a taxable presence)

• Sales sourcing of sales of tangible property and services

• Requiring throwback of sales

• Allowing or requiring combined reporting

• Allowing a pass-through entity (PTE) to make a PTE tax election (i.e., $10,000 SALT-CAP work around)

• If PL 86-272 protection applies

• Conformity to federal international tax considerations (i.e., GILTI, FDII, deemed dividends, ECI, etc.)

• Treatment of bonus depreciation

• Treatment of disregarded entities (i.e., single-member LLCs or Q-Subs)

Some sales tax laws that may differ from state to state are related to the following:

• Sourcing of sales of services (including multiple points of use)

• Sourcing of sales to/from non-US countries

• Sales of software, SaaS, and other computer services

• Sales of information services or data processing

• Sales of services

• Sales by construction contractors

• Treatment of sellers in drop shipment transactions

• Allowable or acceptable forms of exemption certificates

• Treatment of leases (lessors and lessees)

• Width and breadth of manufacturing exemption

• Occasional sale or casual sale exemption when selling assets or business

• Treatment of repairs and maintenance (labor and parts)

• Treatment of research and development activities

• Sales to governmental and non-profit entities

I could keep going, but I think you get the point.

So what is a company supposed to do?

Depending on what stage your business is (i.e., start-up, emerging, growth, mature), I recommend you inquire of your tax professional about the state tax impacts of your business. You may only have one or a few states to deal with right now. Some of you may have 20 or more states to consider. The key is to get on top of it now. To know what you don't know so you can make informed decisions. To stop problems from growing out of control and implement proper procedures and tax decisions. Be proactive. Don't let blind spots create a compound effect of problems.

Conduct year-end state tax planning, early, often and always.

QUOTES

• "In all affairs, it's a healthy thing now and then to hang a question mark on the things you have long taken for granted." - Bertrand Russell

• "Bureacracy is the art of making the possible impossible." - Javier Pascual Salcedo

• "Knowledge is the beginning of practice; doing is the completion of knowing." - Wang Yangming

"darkness is death"

Time change. Daylight savings time. Fall back. Spring ahead. However you describe it, most (if not all of us) changed our clocks recently. We either gained an hour or lost an hour (depending on how you look at it), but one thing I do know - I've lost daylight. So I'm not sure how this is "daylight savings" time. I don't like to complain, but I just do. So I'll just say that I really like sunlight and dislike darkness. As they said in a cartoon movie I can't remember the title of right now - "Darkness is Death."

Regardless of how you feel about changing your clocks or sunlight or darkness, one thing is certain, times continue to change. The way business is conducted continues to change. New technologies are created (whether that's good or bad; or will be used for good or bad is yet to be seen). And last but not least, state tax legislation continues to change; and court cases and rulings continue to be made which ultimately create certainty and uncertainty. Wait, what? What did you just say?

Yes, new legislation, court cases and rulings create just as much uncertainty as they do certainty.

Well, that's great.

Just as each company's facts and circumstances differ, state tax laws seem to have a life of their own when the answer isn't "black and white" (which is most of the time); or when each state's laws are different. This creates a world of grey (or some may say, "darkness"). This "darkness" is why I say every state tax question is a research question. (A research question that needs to be solved by a human (not A.I., AI or artificial intelligence, just saying)).

Darkness is debilitating. It's hard to drive in the dark without headlights. It's hard to walk in the dark without a flashlight. Darkness creates fear and uncertainty. Darkness creates unknown risks. Thus, light is needed to move forward with some level of assurance and confidence.

Darkness can also create unknown opportunities. You can't see them. This requires faith. A compass. A navigator. A roadmap.

"Darkness" in the state tax world surrounds several areas and questions companies continually ask:

• what states do I need to file tax returns in?

• is what I'm selling subject to sales tax?

• which entity in my affiliated group of companies is required to file the tax return?

• if I sell my interest in this partnership, to what states do I source the gain and have to pay tax?

• I'm selling services all across the United States. How do I source those sales to each state in the apportionment factor of my income tax returns?

• do I really have to get exemption certificates from my customers?

• do I have to register with a state for sales tax purposes to provide a vendor with that state's resale exemption certificate or can I use a multijurisdictional certificate?

• am I required to file combined income tax returns or does every entity file separately?

• should I make this election or that election?

• do I qualify for these tax credits?

• do I have to collect sales tax on my total gross receipts or can I deduct costs reimbursements or costs that I flow-through and pay to someone else?

• how do I know if we really meet the requirements to be protected from a state's income tax by P.L. 86-272?

• I didn't even know that state had a gross receipts tax.

• what is a franchise tax and why is the tax base so high?

• am I really selling SaaS and does the state tax it?

• should I make a state's pass-through entity tax election? How do i quantify or model the impact? Will it be beneficial for all partners and shareholders?

• should I file a Voluntary Disclosure Agreement (VDA) or simply start filing returns?

• should I request a Private Letter Ruling (PLR)?

• should I challenge (protest) this audit assessment or simply pay it and move on?

• when can I stop filing returns in a state?

• how do I dissolve or withdraw from a state?

• is registering with a state's Secretary of State's Office the same thing as registering with a state's Department of Revenue (taxation)?

• what sales tax compliance software should I use? Should I outsource the return prep to a third-party?

I could keep going, but I think you get the point. The darkness is everywhere.

Finding the light in the state tax world is not easy.

Unlike darkness in life where you can just flip the light switch and see, darkness in the state tax world takes research and analysis and judgment based on experience. And even then, the answer may not be clear (still dark or grey).

Consequently, I think the "light" is finding the right-fit state tax consultant that you trust and like working with. Someone with not only the technical knowledge and experience, but the ability to look at an issue from 2 feet and 50,000 feet. To be technical and practical. To look at the risk and provide judgment. To reduce risk. To recommend positions with the proper level of assurance. Knowledge. Judgment. Advocacy. That is the light in the proverbial darkness. The compass. The roadmap. The flashlight. The headlight.

I hope you find the light you need to move your company and clients forward.

If you are a state tax consultant, I hope you "shine brightly."

QUOTES

"The art and science of asking questions is the source of all knowledge." - Thomas Berger

"The prize goes to the person who sees the future the quickest." - William Stiritz

"We are drowning in information and starved for knowledge." - John Naisbitt

17 State Tax and Business Developments You May Want to Know - Sept 5, 2017

The following are state tax and business developments I have curated since August 26th, and posted in the LEVERAGE SALT LinkedIn group:

1. NC market discount income from US govt bonds is not interest

2. CORPORATE CLOSE-UP: THE FTB’S SMALL CAP SOLUTION TO ALLEGED FINANCIAL AND NON-FINANCIAL COMBINED REPORTING APPORTIONMENT DISTORTION

3. COST, EY & State Tax Research Institute Study: Total State and Local Business Taxes (fy16)

4. Oregon revenue online educational services sourced faculty costs

5. State Rundown 8/31: Modernizing Taxes is Sometimes a Sprint, Sometimes a Marathon

6. Oral Arguments Heard in South Dakota’s Challenge to Quill

7. Net Operating Loss Carryforward & Carryback Provisions by State

8. Indiana Files Lawsuit to Defend Out-Of-State Sales Tax Law

9. Amended Colorado Regulations Address Combined and Consolidated Filing and Apportionment

10. Massachusetts DOR Issues Technical Information Release on Policy Change Regarding Treaty-Exempt Income

11. Oregon Tax Court Explains that Only Direct Costs are Relevant in Determining Where Greater Proportion of Costs of Performance Was Incurred

12. Indiana Attorney General Responds to Suit Filed by Trade Groups Regarding Enforcement of New Remote Seller Economic Nexus Law

13. Limited-Time Voluntary Disclosure Program for Out-of-State Sellers Having Click-Through Nexus Runs through November 21 in New Jersey

14. Rhode Island Division of Taxation Explains New Information Reporting and Notice Requirements on Some Remote Sellers - Including Marketplace Facilitators

15. Seattle high-income resident income tax enacted

16. Texas appellate court upholds subcontractor exclusion while reversing and remanding on COGS methodology

17. VA Supreme Ct rules subject to tax exception post apportionment

The above represents 'general curating' of state tax developments into one spot. If you still feel overwhelmed by the volume of state tax developments, please consider my 'custom curating' service. Meaning, clients hire LS to daily curate state tax developments relating to a specific industry, state(s), tax type and issue. You can make it as granular as you prefer. This allows you to reduce information overload, and only get the information you need to help your clients or company. This service is provided on a fixed-fee or subscription basis. Contact me at strahle@leveragesalt.com.

29 State Tax & Business Developments You May Want to Know - August 21, 2017

The following are state tax and business developments I have curated since August 14th, and posted in the LEVERAGE SALT LinkedIn group:

1. Resistance is not Always Futile: New Decision in Ongoing Delaware Unclaimed Property Audit Litigation

2. MTC Voluntary Disclosure Initiative for Online Marketplace Sellers (i.e., Amazon FBA program)

3. A State Tax Administrator's Perspective on Partnership Taxation

4. Illinois Court Upholds Cook County’s Beverage Tax Finding It Passes Constitutional Muster and Related Developments

5. Webinar: August 24th - Best Practices in Achieving Obsolescence Adjustments for Complex and Commercial Properties

6. State Corporate Income Tax Rules for Sourcing of Revenue for Law Firms

7. Nationwide Sales/Use Tax Update - September 12, 2017

8. Credits Can No Longer Be Applied Against Oregon’s Minimum Tax

9. Total Solar Eclipse Won’t Black Out State Taxes

10. South Carolina going after Amazon (the marketplace facilitator) for not collecting sales tax on behalf of the businesses that use the marketplace to sell products to SC residents

11. Summary of New York Corporation Tax Legislation Enacted after the 2016-2017 Budget

12. New York Amendments Regarding Sales Tax Rules for Transactions between Certain Related Entities and for Purchases Made by Nonresident Businesses

13. Technology Company State Tax Guide from Moss Adams (Very Nicely Done)

14. Illinois Amends Rule Regarding Alternative Apportionment

15. Amazon’s Marketplace Business Isn’t a Tax Avoidance Scheme

16. A comparison of enterprise zone programs in Illinois, Indiana, and Wisconsin

17. MTC National Nexus Program Adds 2 More Participating States to Online Marketplace Seller Voluntary Disclosure Initiative

18. Rhode Island DOT Announces that it Will Accept Applications for Recently Enacted Amnesty Program Beginning December 1

19. California FTB Issues Draft Proposed New Pass-Through Entity Withholding Regulation

20. Minnesota Tax Court Holds that Taxpayer May Apply NOL Carryovers from an Acquired Entity to Full Extent Permitted under IRC § 382

21. New North Carolina Law Includes Changes to Intercompany Expense Addback Statute, Added Franchise Tax Base Deduction, and Definition of Business Income

22. Texas Court of Appeals Upholds Subcontractor Exclusion While Reversing and Remanding on Taxpayer COGS Methodology

23. Memo Explains Recent New York Law Changes on Transactions Involving TPP Resold Between Certain Related Entities

24. California Supreme Court Denies Rehearing in Recent Case Involving Taxation of a Transfer of Legal Entity Interests

25. Washington DOR Reissues Emergency Amended B&O Tax Rule on Financial Institution Apportionment to Conform with MTC Changes

26. Three Big Problems with Sales Taxes Today — and How to Fix Them

27. Should Online Platforms Collect Sales Tax For Third-Party Sellers?

28. The United States Of Unicorns: Every US Company Worth $1B+ In One Map

29. Are Remote Retailers and Marketplace Providers in the 'Path of Totality'?

The above represents 'general curating' of state tax developments into one spot. If you still feel overwhelmed by the volume of state tax developments, please consider my 'custom curating' service. Meaning, clients hire LS to daily curate state tax developments relating to a specific industry, state(s), tax type and issue. You can make it as granular as you prefer. This allows you to reduce information overload, and only get the information you need to help your clients or company. This service is provided on a fixed-fee or subscription basis. Contact me at strahle@leveragesalt.com.

Not All Intercompany Transactions Are Created Equal

For any group of affiliated entities, intercompany transactions, such as intercompany purchases, loans, licensing, services, and management, are a way of life. Even though those transactions are a part of normal business operations, they have created problems and opportunities in states that have not adopted combined reporting. States have sought to disallow the deduction of related-party expenses under the presumption that the transactions were not entered into with business purpose or economic substance, or that they distorted the true reflection of income earned in the state.

It could be argued that taxpayers abused the positive effect of ‘‘true’’ intercompany transactions by using special purpose entities such as sales companies, finance companies, and the infamous intangible holding company to shift income from one entity to another or from one state to another. The use of those types of entities and transactions exploded in the 1990s. Since then, states have worked to end that perceived abuse by enacting related-party expense addback legislation or adopting combined reporting. As a result, the ability to use intercompany transactions to shift income has become very difficult.

Taxpayers argue that economic substance and business purpose other than tax savings have always been integral parts of any state tax planning (even in the 1990s). However, taxpayers today approach state tax planning in terms of focusing on the business objective first, and then seeking to implement that objective in a tax-efficient manner. Some practitioners refer to that as business alignment planning. I like to describe it as not putting the cart before the horse.

To read more, check out my article from Tax Analysts State Tax Notes on October 28, 2013. 

Don't forget to sign up to attend the free Bloomberg BNA webinar tomorrow that I am co-presenting: "State Tax Planning for Related-Party Transactions." 

I hope you can join me to discuss:

• Triggers which create problems and opportunities (in regards to related-party transactions)
• Common inter-company transactions
• 6 ways states may respond to related-party transactions (including recent developments and how to analyze, defend and plan)

The Tightrope of Acceptable Intercompany Transactions

The following are excerpts from my January 6, 2014 article in Tax Analysts State Tax Notes. 

The Tightrope
An Indiana taxpayer paid factoring fees to a related entity that was not included in its Indiana income tax return. The taxpayer subcontracted the collection of its accounts receivable to the related entity by factoring the accounts to the entity. According to the taxpayer, the entity charged an arm’s-length rate based on a transfer pricing study prepared in accordance with IRC section 482 and related regulations. An independent third party prepared the study, and the factoring fees reported on the federal returns fell within the range of acceptable prices listed in the study. A portion of the receivable factoring expense that the taxpayer paid came back to it as dividends and loans from the related entity.

After an audit investigation, the Indiana Department of Revenue disallowed more than $57 million of the factoring fees the taxpayer paid to the related entity, which represented the portion of the fees paid to the entity that exceeded its expenses for providing the factoring services. The DOR argued that the taxpayer group, as an economic entity, did not achieve any business or operational advantage that it did not have before the taxpayer started factoring its receivables. The in-house factoring did not result in lower financing costs, the most common reason for factoring. The same departments, such as accounting, credit and collection, and customer service, that existed before the receivable factoring was put in place still existed.However, the functions became part of the operations of the related entity, which didn’t file in Indiana. Thus, the major benefit of the factoring operations was the minimization of state income tax. According to the DOR, that distorted the reported Indiana adjusted gross income without benefiting the whole organization. The factoring entity reported more income than all other entities in the consolidated group, including the taxpayer, which is supposed to be the most dominant entity.

In Indiana Letter of Findings 02-20120612, the DOR said corporate form will normally be respected unless the form is a sham or unreal. The DOR relied on the fact that courts have been consistent in holding that tax avoidance in and of itself is not a valid business purpose. It also relied on IC section 6-3-2-2(m) to distribute, apportion, or allocate income derived from sources in Indiana among organizations, trades, or businesses to fairly reflect income. According to the DOR, the regulations allow it to use any method to equitably allocate and apportion a taxpayer’s income.

Working Without a Net
The taxpayer argued that the independently prepared transfer pricing study provided enough support for the state to accept the intercompany transactions. However, the DOR stated in its letter of findings that the arm’s-length status of a transaction, considered in isolation, is not relevant to whether the substance of a taxpayer’s overall company structure, intercompany transactions, and consolidated group’s deductions fairly reflect a taxpayer’s consolidated group’s taxable Indiana income. According to the DOR, the problem was that the transfer pricing study was performed to analyze the arm’s-length status of the transactions for federal, not state, tax purposes. In fact, the transfer pricing study itself asserted it was not performed for state tax purposes and should not be used by the taxpayer as advice for state tax purposes.

Perhaps the most troublesome issue for the taxpayer was that a portion of the receivable factoring expense it paid came back to it as dividends and loans. The Indiana DOR has routinely provided guidance in letters of findings regarding the circular flow of funds between related parties, such as (i) when a taxpayer makes Intercompany payments and takes expenses for those payments but cannot explain the nature and substance of the underlying agreement and transactions; (ii) when the deduction of royalty and interest expenses are part of a continual circular flow of money between related entities—with the result of shifting taxable income to out-of-state entities that then return nontaxable income to the Indiana entities, calling into question the need for the transactions and resulting in an unfair reflection of the income earned from Indiana sources; and (iii) when the payment of royalties results in an intercompany circular flow of money that serves no commercial business purpose.

The taxpayer argued that its position should be sustained because the business purpose and substance of the related factoring entity were substantially similar to that of the factoring company described in Letter of Findings 02-20090805. However, the DOR argued that the taxpayers’ situations were not factually similar because there was no evidence that the other taxpayer had a circular flow of funds in the form of either loans or dividends. Letter of Findings 02-20090805 simply stated that the facts presented little to indicate that the factoring fees constituted an abusive tax avoidance scheme even though the claimed expenses significantly reduced the income subject to Indiana tax. In fact, the DOR held in Letter of Findings 02-20090805 that the related entity incurred legitimate and reasonable expenses associated with the collection of the factored Receivables. In this case, the DOR did request additional documentation regarding the circular flow of funds, but the taxpayer did not provide it. Thus, the DOR held it had legitimate concerns that the taxpayer exploited the company’s structure and the intercompany transactions to shift a substantial portion of its Indiana income outside the state.

Balancing Act
A related factoring entity can withstand audit scrutiny, but taxpayers should take proper steps to support the path to acceptance. Although each state differs, the lessons from the Indiana letters of findings can be used to substantiate the validity of the transactions. First, taxpayers should have a business or operational purpose for the creation of related entities when large intercompany transactions will occur. Second, taxpayers should realize some type of business benefit, such as liquidity or lower interest rates, for the whole organization as a result of the new entity or structure. Third, taxpayers should not rely on federal transfer pricing studies to substantiate state tax consequences of intercompany transactions. Lastly, taxpayers should avoid the circular flow of funds between related parties. Tax planning is each taxpayer’s right and obligation, but finding the balance between what is and isn’t acceptable is like walking a tightrope. As the Indiana letters of finding show, finding the balance is difficult, but not impossible.

Sidenote: Happy Valentine's Day!