Dallas CPA Society7th Annual Education Conference

May 26, 2011

How the States Want to Ruin Your Budget: Multistate Tax Development

I. Context

II. Tax Administration Challenges

III. Managing the States’ Cash Crunch

IV. Expanding Nexus, or Life After a Physical Presence Requirement

V. Compliance Complexity

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I. Context

• Overwhelming Concern: Uncertainty• Rapidly changing environment

o Formerly separate legal entity state tax returns with generally equally weighted factors; cost of performance for services

o More MUCR states, but varying definitions of who is in the group

o Heavier weights of sales factors: in 1998 only 5 states weighted sales greater than double-weighted; in 2101, 16 states weighted the sales factor greater than 50%

o More states are adopting market sourcing

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I. Context (cont’d)

• States’ Budgetary Challengeso More extensive and more aggressive audit activityo Decoupling from favorable federal tax treatment in

areas such as Bonus depreciation

Section 199 Domestic Production Activities Deduction

o Bad Tax Policy / Bad Legislation Suspension of Net Operating Losses

Distortive Apportionment Schemes: Throwback, throwout

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II. Tax Administration Challenges

• Independent Tax Courts in roughly half the stateso Alabama Taxpayer Bill of Rights/Alabama Tax

Appeals Commission (HB 427 / SB 232) filed this session (TEI filed a letter April 12 supporting this legislation.)

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II. Tax Administration Challenges (cont’d)

• Contingent Fee Audits: legislation filed in Minnesota, California. Ongoing “transfer pricing” income tax audits in New Jersey, District of Columbia, Kentucky, and Alabama. Contingent fee audits in areas of unclaimed property area and gross receipts taxes.

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II. Tax Administration Challenges (cont’d)

• Retroactivity issueso How much retroactivity is permissible?

o California’s substantial underpayment penalty – 5 year retroactivity – due process concern (TEI submitted an amicus letter in CalTax case challenging the penalty.)

o Ameritech in Wisconsin: the law at the time of the case was cost of performance, although Wisconsin subsequently changed its law to market sourcing. Ameritech marketed telephone directories in Wisconsin, but none of the cost was incurred in Wisconsin. It almost appeared that the court imposed the new market sourcing retroactively to a period when COP was the law of the land.

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II. Tax Administration Challenges (cont’d)

• Administrative rules and audit practice contrary to unambiguous statuteo North Carolina statute requires a separate legal entity

tax return YETo Forcible combinations on audit in Delhaize and

Walmarto New combined reporting regulation offers little

guidance, but appears to suggest that intercompany pricing creates a presumption of distortion

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III. Managing the States’ Cash Crunch

• If the state has no cash, can you apply state IOU’s to other taxes?

• Can taxpayers use the cash crunch to their advantage?o New Jersey’s Throwout Settlement Initiative (Note:

Pfizer / Whirlpool oral argument set for May 3-4).

o Nortel – failure to pay California’s expert witness

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IV. Expanding Nexus, or Life After a Physical Presence Requirement

• Economic nexus – the “death of 1000 cuts” beginning with Geoffrey, Lanco, The Classics. If the U.S. Supreme Court continues to refuse to hear these cases, does that validate economic nexus?o Initial economic nexus cases required affiliation, but

MNBA, KFC were third partieso There is hope the USSC will take KFC (briefs due in

May)

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IV. Expanding Nexus, or Life After a Physical Presence Requirement (cont’d)

• Factor Presence Nexus: the California standard ($50,000 property or payroll, $500,000 sales); Washington B&O changeso Provisions apply to controlled foreign corporationso Concern with disparate tax treatment of foreign

corporations for U.S. and state income tax purposes

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IV. Expanding Nexus, or Life After a Physical Presence Requirement (cont’d)

• New federal Business Activity Tax Simplification Act of 2011 (“BATSA”) filed April 8: HR 1439 by Bob Goodlatte (R-VA) and Bobby Scott (D-VA) would clarify the nexus standard governing state assessments of corporate income taxes and comparable taxes on business.

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V. Compliance Complexity

• Nortel Networks vs. SBOE

o Strange resulto Disruptiono Unpredictability

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V. Compliance Complexity

• Colorado requirement to alert customers of use tax responsibilities and providing state with information on customers’ purchases

• Massachusetts tax return schedule showing impact of single sales factor versus traditional 3-factor with double-weighted sales

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V. Compliance Complexity (cont’d)

• Maryland information return to assess impact of combined reporting, as well as schedule to assess impact of single sales factor versus 3-factor apportionment

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V. Compliance Complexity (cont’d)

• Mandatory unitary combined reporting (MUCR) is statutorily different state by state – and may be different on audit: New York’s 10-step test of “who’s in and who’s out” of the combined group was supposed to avoid discretion to determine distortion

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