Both business owners and professional advisors should be aware of three important trends developing in state tax law and administration:
Trend #1: Income Tax Repeal
In light of the recent proposals by Governor Heineman to eliminate Nebraska’s income tax, we doubt that many people in Nebraska are unfamiliar with this trend. But the move by Governor Heineman comes as several other states – including neighboring states – have proposed income tax repeals of their own.
Our recent review of states uncovered that, in addition to Nebraska, Oklahoma, Kansas, Missouri, North Carolina, and Louisiana have considered or are now considering the repeal of their state income tax. Oklahoma went so far as to have a bill to repeal Oklahoma’s personal income tax pass the Oklahoma House of Representatives in 2012. The bill did not advance in the Oklahoma Senate. In addition, a group of citizens in Missouri petitioned for a measure that would repeal Missouri’s income tax to be added to the 2012 ballot. Ultimately, a Missouri judge removed the measure from the 2012 ballot on a theory that the state-authored summary did not adequately describe the substance of the measure.
Trend #2: Corporate Tax Disclosure
Under recent or pending proposals in California, New Jersey, Illinois, and the City of Chicago, publicly traded corporations would be required to make a public disclosure of certain key facts regarding the taxes they pay in a given state. For example, the New Jersey bill would require public corporations to disclose their taxable income, tax apportionment or allocation factor (the percentage of income apportioned or allocated to New Jersey), net operating loss deduction, tax credits, and income tax paid.
As noted in the New Jersey bill, the motivation for that bill is as follows: “This bill helps to ensure that corporations are transparent and that they pay their fair share in taxes.”
Trend #3: Apportionment Controversies in Multistate Tax Commission States
18 states are currently full or “Compact” members of the Multistate Tax Commission. Compact members are required to adopt a common group of tax rules, known as the Multistate Tax Compact, as law. The goal of the compact is to help unify tax rules in the 50 states to ease administration burdens on multistate taxpayers.
A key determinant of a company’s state tax liability involves the percentage of the company’s total net income which is apportioned to a state. In other words, if a company makes $100 within the whole United States, what percentage of that $100 will be taxed by the state? Under the Multistate Tax Commission rules, tax apportionment is based on the average of 3 factors: relative property in a state; relative payroll in a state; and relative sales to customers in a state.
The problem with the 3 factor formula is that it apportions a higher percentage of income to in-state companies, thus creating a disincentive to locate in a state. An apportionment formula which gives a higher weight to relative sales is better for in-state companies, generally at the expense of out-of-state companies.
In 1974, California joined the Multistate Tax Compact as a Compact Member. In 1993, California changed its statute to double weight the sales factor, which would reduce the relative tax burden of its in-state companies. California did not, however, withdraw from the Multistate Tax Compact.
In 2010, the Gillette Company filed a tax refund claim with the State of California, claiming that it should be allowed to use the 3 factor apportionment formula mandated by the Multistate Tax Compact. In a recent ruling, the California Court of Appeals agreed, finding that the State violated the terms of the Compact by not offering the 3 factor formula to taxpayers. This ruling has been appealed to the California Supreme Court, who will hear the appeal.
In addition to the California decision, similar cases have also been filed in Michigan and Oregon. The Michigan Court of Appeals ruled against an out-of-state taxpayer (contrary to Gillette), but this case has also been appealed to the Michigan Supreme Court. The Oregon case is still pending at the Oregon Tax Court.
Nebraska is not a “Compact” member of the Multistate Tax Commission and is not directly impacted by the decisions in California, Michigan or Oregon. For Nebraska companies, there may be a tax savings opportunity to file tax refund claims which would apply the 3 factor apportionment formula mandated by the Multistate Tax Compact in all “Compact” states where the State has varied from the 3 factor formula. The claims could be treated as protective claims until final decisions have been issued by the California and Michigan Supreme Courts. As these claims would need to be filed within the normal statute of limitations, some companies may need to get their claims on file quickly.
Feel free to contact a member of the McGrath North Tax Group who will discuss any of these trends with you in more detail.