The Tangled Web of State Taxes

A recent comprehensive state survey by Bloomberg BNA overwhelmingly demonstrates that uniformity and consistency does not exist in state income tax laws, determination of nexus, sales and use tax laws and sourcing of receipts. Perhaps the only consistency is in the complexity, uncertainty and confusion caused by the states’ various interpretations and application of tax law.

Although the surveys were completed by senior tax officials in each state, many answers were qualified as not binding.

Interesting findings that may affect your business:

  • There are over 125 different activities and relationships that could potentially create income tax nexus ranging from sending catalogs to telecommuting employees to visiting states for price negotiations.
  • Twenty states have indicated that a single de minimis sale would create income tax nexus in their respective state, while twenty states indicated that it would not.
  • Thirty-five states base their income tax nexus policy on economic presence rather than physical presence.
  • The majority of states now deem attendance at a one-day seminar as sufficient to create nexus in their state for sales tax purposes.
  • Having even just one telecommuting employee in a state creates income tax nexus in 38 states.

With the extensive differences in state application of tax law and nexus definitions, it is very important to consult with your Somerset Tax Advisor when doing business with clients and customers in other states.

The Sales Tax Battle Continues

A very concerning trend is emerging in state sales tax law as states continue to challenge the “physical presence” requirements under Quill.

Specifically, South Dakota recently passed legislation which require any seller selling tangible personal property, products sold online or services delivered into South Dakota, who does not have physical presence in the state, to remit sales tax as if the seller had a physical presence in the state. South Dakota provides that a retailer is presumed to be liable for the collection of sales and use tax in South Dakota if the seller meets one of two criteria in the previous or current calendar year:

  1. Any person making more than $100,000 of South Dakota sales.
  2. Any person having more than 200 separate South Dakota sales transactions.

This requirement applies to sales made on or after May 1, 2016. This legislation continues the trend of states enacting aggressive nexus statutes aimed at out-of-state retailers.

Two lawsuits have been filed in South Dakota regarding this new legislation. For those who have not yet registered, an injunction is now in place barring enforcement of the provisions until the litigation is resolved. Therefore, out-of-state retailers do not have to comply with this new law until the courts reach a decision. However, it is important to be aware that this trend is expected to continue as states aggressively seek additional sources of revenue. Be sure to keep in contact with your Somerset advisor for up-to-date state and local tax information that may affect your business.

California Updates and Reminders

Refund verification letters: The California Franchise Tax Board (FTB) has 16,000 pending refunds where a refund letter has been sent to the taxpayer. Although the FTB will not immediately deny the refund if the taxpayer does not respond within the time frame prescribed, the taxpayer should expect to receive a follow-up letter within 45 – 90 days from when first letter was sent.

The taxpayer should use the FTB’s website to confirm requested information in order for the refunds to be processed.

Disregarded Entities: There are several types of disregarded entities, some of which do not conform to the Federal treatment for disregarded entities. Below is a summary of California’s treatment of disregarded entities:

  • Single-member LLCs (SMLLC) are regarded as a separate entity from its parent and must file a California income tax return and pay franchise tax and potential LLC fees.
  • Qualified Subchapter S Corporations (QSubs) are regarded as a separate entity and must pay the annual tax of $800. The parent S corp must file a return and include the QSub’s activities and file Schedule QS to notify the FTB that the QSub’s activities are included on the parents’ return and pay the franchise or income tax for the Qsub.
  •  Qualified REIT Subsidiaries (QRS) are not regarded as a separate entity from its parent and therefore all of its activities are to be reported with its parent REIT. A QRS is not subject to the California minimum franchise tax.
  • Grantor Trusts conform to the federal law commonly known as the Grantor Trust Rules (IRS Secs. 671-679) and all of the grantor trust’s activities that are attributable to the portion of the trust will be included in the taxable income of the grantor. Any remaining portion of income and expenses will be taxable to the trust on Form 541.

Illinois Issues New Regulation for Apportioning Business Income of Transportation Companies

The Illinois Department of Revenue has issued a long-awaited regulation to provide guidance on how to apportion the business income of transportation companies, which applies to taxable years ending on or after December 31, 2008.

The new regulation provides that the apportionment for transportation services (other than airline services) is based on a gross receipts calculation instead of revenue miles. The numerator is the receipts from any movement of “people, goods, mail, oil, gas or any other substance (other than by airline)” that both originates and terminates in Illinois (intrastate service), plus a portion of the gross receipts of the shipment of these items outside Illinois that originates in one state and terminates in another state or jurisdiction (interstate service). The portion of receipts that should be included is determined by the ratio of miles traveled in Illinois to total miles everywhere. The denominator is all the revenue derived from the movement of these items.

The regulation provides several comprehensive examples of how to apportion the income of transportation companies.

The regulation also help taxpayers correctly apportion their income depending on the type of transportation they provide by including definitions for “miles transported or traveled,” “revenue mile,” and “freight.”

Taxpayers that overpaid taxes for tax years still open under the statute of limitations may want to consider filing refund claims. Likewise, taxpayers that underpaid taxes may need to consider filing amended tax returns.

If you have questions regarding the above articles, please contact your Somerset advisor, or a member of Somerset’s SALT team.