State & Local Tax

What the Texas Legislature Hath Wrought

2008-05-27T16:18:00.001-05:00

What the Texas Legislature Hath Wrought

We have been saying all along that we thought that Texas legislators didn't really understand what they were voting for when they enacted this new "margin tax" in Texas. Texas has alway been "business friendly". It's a major factor businesses consider when deciding to relocate to this fair state. But the special committee headed by John Sharp that conceived of this tax apparently suffered from California envy. Now Texas has the most onerous corporate income tax in the Union. The legislators who voted for this thing are already hearing it from the Taxpaxers and you can bet the noise will get louder and louder. The Comptroller's Office is charged with implementing this stinker and they seem to making a huge effort to educate the public. The office of Texas Comptroller is an elected position. How would you like to be the Comptroller responsible for implementing the worst tax ever passed by the State of Texas? Susan Combs is just the messenger, but she's getting an earful. She could turn into a hero, if she becomes the public champion of the "Let's Repeal this Tax" committee. Then the legislature would be under a huge amount of pressure. We'll see how this all develops.

Taxation is not usually headline news, but this tax is drawing a lot of press. Here's some news from around the state.

First out of the gate is an article by Kate Alexander of the AUSTIN AMERICAN-STATESMAN on Friday, May 16, 2008. Demands for changes to Texas' new business tax grew louder Thursday from small-business owners who say they will be unfairly burdened. (See this link.)

Speaking at an event to launch the Texas Business Tax Coalition, electrical contractor Keith Bell said the tax bill for his Dallas-area firm will skyrocket from about $3,900 to $50,000 under the so-called margin tax, which is due for the first time in June.

"I cannot believe that if the legislators knew that the inequities and the unintended consequences were going to occur ... that they would have voted for it," said Bell, who leads the government affairs committee for the Independent Electrical Contractors of Texas, a trade association.

But now that "the devil has been exposed in the details," Bell said, the Legislature needs to act.

For most qualifying businesses, the tax is 1 percent of their total revenue minus one of three options: the cost of goods sold, employee compensation or 30 percent of total revenue. Adopted in 2006, the tax applies to about 200,000 more businesses than the franchise tax it replaced.

State Reps are Hearing It

State Rep. Jim Keffer, chairman of the House Ways and Means Committee, said legislators are sensitive to the concerns about the tax and are open to addressing any problems once more is known about the tax impact.

"Our goal is always to keep Texas business-friendly," said Keffer, an Eastland Republican. "We will work hard to make sure that no industry is overtaxed and overburdened."

"It is a mess," said Sen. Dan Patrick, R-Houston, who was not in the state Senate in 2006 when the margin tax was adopted.

The tax is convoluted and confusing, and it punishes many small businesses, Patrick said.

State Rep. Debbie Riddle, R-Tomball, opposed the tax in 2006 and said it continues to be a mistake.

"We need to nuke the tax, we need to repeal the tax, we need to drive a stake through the heart of the margin tax," said Riddle, who attended the coalition event Thursday.

The Governor is Hearing It

Gov. Rick Perry has said the Legislature should revisit the business tax if it brings in more revenue than anticipated or if there are unintended consequences, spokeswoman Allison Castle said.

Check out this Article in the Dallas Business Journal by Dave Moore.

"It's the only tax of its kind in the United States, and perhaps the world... "

This isn't the type of headline the Comptroller is hoping for.

According to Dave Moore: Beyond the tax measure's complexity, business owners are hoping to squelch what they claim is the law's punitive nature.

"It's not a fairly levied tax," said Pete Snider, president of Mesquite-based Alco Glass Inc., which does high-rise commercial and residential glass replacement." It penalizes a businesses when they're not in a profitable mode. It disregards your net revenue."

Snider, for example, reported a loss of $18,000 in 2007, but he calculates he'll owe Texas $6,000 in margin taxes, because the margin tax applies to his cost of material, not his relatively thin profit. Snider said he'll have to take a loan out to cover the tax bill.

So Who Came Up With this Tax?

Dave Moore names names: Efforts to contact the leading author of the tax, John Sharp, were unsuccessful. Sharp was chairman of the Texas Tax Reform Commission that formulated the margin tax; he was Texas' comptroller in the 1990s.

Rich Parsons, press secretary of Lt. Gov. David Dewhurst, said it's likely Dewhurst will wait until after the tax is collected before he decides if it should undergo further reform. As lieutenant governor, Dewhurst sets the legislative agenda for the Texas Senate.

The El Paso Times Weighs In

The El Paso Times had this article in the May 12 edition. It was a report about a recent visit by Texas Comptroller Susan Combs to El Paso at the invitation of the Greater El Paso Chamber of Commerce, who apparently gave her an earful. She noted that the first year of the tax "is really tough" and that she would furnish the Legislature with as much information as possible about the tax's effects. That includes some business being hurt.

They make a good point about attracting business to Texas: "Also, a destructive franchise-tax structure would be a huge deterrent to businesses thinking about coming to Texas. We need to be thinking about ways to attract business, not drive it away ... So far, Texas is in better economic shape (knock on wood) than most of the rest of the country. We need to keep it that way, and a devastating franchise tax isn't a good way to do that." Ouch.

The Service Industry May Be Hardest Hit

Leslie Wimmer of the Fort Worth Business Press had this quote from Cyndy Kimberling, owner of Kimberling, McFarland and Associates accounting firm. "I know of several of our clients who could be put out of business because the new franchise tax is based on gross receipts rather than bottom line profits," Kimberling said. "It is really going to hurt some of our clients."

The service industry may be hardest hit, she said.

"The ones who are really suffering are going to be your service businesses such as trucking companies," Kimberling said. "They have a lot of expenses such as fuel and truck maintenance. The new franchise tax does not consider these expenses as cost of goods sold so they do not get to deduct them from their gross receipts."

"I think you're going to see some people get voted out of office because of this..." This was a statement of a business owner quoted in an article in the Dallas Morning News by Terrence Stutz.

Among the disenchanted taxpayers is Dallas businessman Andy Ellard, owner of a machine shop with 28 employees. Mr. Ellard said the size of his tax bill doesn't match up with the pledges of state lawmakers. "We were promised a number of things, and none of them happened," said Mr. Ellard. He estimated that he would pay about $8,900 under the new business franchise tax, more than double the $4,200 he paid last year.

"There are going to be some mad business owners [on June 16], and I think you're going to see some people get voted out of office because of this," he said.

"Businesses are just waking up to this," said Will Newton of the National Federation of Independent Business, which has become one of the biggest critics of the new tax. "Texas used to be good for business, but this new tax is making us one of the most anti-business states in the country."

To top it off, Mr. Newton said, "It's the most confusing, complicated system of taxation ever devised. Just the cost of compliance [preparing tax returns] has been devastating for some of our members."

"This tax is going to cost jobs in the long run," he said. "If you want to make sure the Texas economy tanks, just enact a tax that hits small businesses hard."

"The way I see it, it's like kicking a guy when he's down," Mr. Snider said, referring to the slowing economy in Texas.

Major Defeat Dealt to States Seeking to Apportion Income Using the "Operational Function Test"

2008-04-28T17:36:00.001-05:00

The U.S. Supreme Court issued a very interesting ruling affirming its earlier decisions related to the taxation of "unitary businesses". (See MeadWestvaco Corp. v. Illinois Department of Revenue, U.S. Supreme Court, Dkt. 06-1413, vacating the Illinois Appellate Court, April 15, 2008).

In this case, Mead had sold Lexis-Nexis for a $1Billion gain. That gain was allocated to Ohio by Mead. Illinois audited them and took the position that the gain should have been apportioned to IL. IL made the argument at the trial court (which agreed with the State) that although the businesses weren't unitary, the asset (Lexis-Nexis) was used in an "operational function", it should be apportioned. This "operational function" concept has arisen in a couple of recent US Supreme decisions. It has apparently given the states the idea that there is no such thing as allocable income anymore because all they have to do is argue that the asset involved was used in an operation function and they can apportion it. Of course, only the extraterritorial states want to make this argument. But the Supremes in this case, say the IL court erred in their interpretation of this test. See below for their commentary:

"As the foregoing history confirms, our references to "operational function" in Container Corp. and Allied-Signal were not intended to modify the unitary business principle by adding a new ground for apportionment. The concept of operational function simply recognizes that an asset can be a part of a taxpayer's unitary business even if what we may term a "unitary relationship" does not exist between the "payor and payee." See Allied-Signal, supra, at 791-792 (O'Connor, J., dissenting); Hellerstein, State Taxation of Corporate Income from Intangibles: Allied-Signal and Beyond, 48 Tax L. Rev. 739, 790 (1993) (hereinafter Hellerstein). In the example given in Allied-Signal, the taxpayer was not unitary with its banker, but the taxpayer's deposits (which represented working capital and thus operational assets) were clearly unitary with the taxpayer's business. In Corn Products, the taxpayer was not unitary with the counterparty to its hedge, but the taxpayer's futures contracts (which served to hedge against the risk of an increase in the price of a key cost input) were likewise clearly unitary with the taxpayer's business. In each case, the "payor" was not a unitary part of the taxpayer's business, but the relevant asset was. The conclusion that the asset served an operational function was merely instrumental to the constitutionally relevant conclusion that the asset was a unitary part of the business being conducted in the taxing State rather than a discrete asset to which the State had no claim. Our decisions in Container Corp. and Allied-Signal did not announce a new ground for the constitutional apportionment of extrastate values in the absence of a unitary business. Because the Appellate Court of Illinois interpreted those decisions to the contrary, it erred."

How did the IL courts err? Well, this is where it gets interesting. If it were just an asset, they would have been fine, I guess. But this was not just an asset, but another business. Therefore, this "operation function test" doesn't apply. You must apply the unitary test. I'm not sure I understand the distinction. But here it is in their words:

"Where, as here, the asset in question is another business, we have described the "hallmarks" of a unitary relationship as functional integration, centralized management, and economies of scale. See Mobil Oil Corp., 445 U. S., at 438 (citing Butler Brothers v. McColgan, 315 U. S. 501, 506-508 (1942)); see also Allied-Signal, supra, at 783 (same); Container Corp., supra, at 179 (same); F. W. Woolworth Co. v. Taxation and Revenue Dept. of N. M., 458 U. S. 354, 364 (1982) (same).

So on that basis they vacated the appellate court's decision. They did point out that although the trial court had concluded that Mead and Lexis-Nexis were not unitary, that issue wasn't considered in the appeal. The appellate court was invited to consider that question on remand.

Since the trial court already determined that they weren't unitary, it seems logical that IL will lose this case. We will be interested to see how it turns out.

Texas Offers 30 Day Extension on Margin Tax Filing

2008-04-25T14:53:00.001-05:00

Texas --Corporate Income Tax: Comptroller Extends Filing Date by 30 Days

In a Press Release, issued by Texas Comptroller Susan Combs, dated, April 22, 2008 it was announced that businesses unable to meet the May 15 due date for the revised franchise tax, also referred to as the business margin tax, are being granted a 30-day extension to submit their returns or file an extension without penalty. Reports filed on or before June 16, 2008, for annual reports and June 2, 2008, for initial reports will be considered timely. Prior to the extension, a 5% penalty would have been imposed on those not filing by May 15. The comptroller's office is allowing the additional 30 days due to the complexity of the revised franchise tax and the newness of the enhanced electronic reporting methods.

Millionaires in MD Beware

2008-04-11T11:35:00.001-05:00

I don't know how many of our Blog readers in MD are Millionaires -- probably a lot I would guess. Here's a recent development targeting you or your client:

Senate Bill 46, effective July 1, 2008, temporarily (yeah, right) increases the personal income tax rate for those with Maryland taxable income in excess of $1,000,000. For taxable years beginning after December 31, 2007, but before January 1, 2011, the Maryland personal income tax for an individual, including spouses filing a joint return or a surviving spouse or head of household, is 6.25%. Currently, the highest income tax rate is 5.5% and applies to individuals, spouses filing a joint return or a surviving spouse or head of household with Maryland taxable income in excess of $500,000. Those with a Maryland taxable income of $500,001 through $1,000,000 are taxed at the rate of 5.5% for taxable years beginning after December 31, 2007, and ending before January 1, 2011.

I guess MD, doesn't like high earning individuals living in their state.

AL Loses in Bid to Classify Sale of Land/Plant as Nonbusiness Income

2008-03-31T12:19:00.001-05:00

In a recent case decided by the AL Supreme Court, Kimberly Clark won its appeal. Kimberly Clark had classified the income from the sale of timberland and a paper processing plant as business income. AL is a UDITPA state and as such follows the transactional test when it comes to classifying income. If the transaction can be said to occur in the normal course of business of the taxpayer, then it is business income. States are notorious for taking positions that are in their favor of course. Taxpayers are also wise to take positions in their own favor. In this case, the property sold was located in AL. Therefore, its no surprise that AL is going to take the position that the income from the sale is nonbusiness. Nonbusiness income is allocable as opposed to apportionable. Inasmuch as the property is located in AL, the income would be all allocable to AL, if AL could win their argument. AL argued that Kimberly Clark was not in the business of selling timberland and processing plants. In fact, Kimberly Clark had classified the sale as "extraordinary" in its own financial statements.

However, KC was able to show that in fact, it had conducted numerous of these transactions during the audit period. The Supreme Court found KC's argument compelling and ruled in their favor. We can get you a copy of the entire hearing. Of course, AL still got some of the benefit of this transaction, but they wanted the whole thing. KC had argued in the alternative, that if the transaction was nonbusiness in nature, then the income should be allocable to TX. My guess is that KC had a limited partnership structure in place in TX
that could have generated a nice refund for KC in that case. The Supremes didn't comment on the alternative argument since they ruled that it was business income.
--

MA Says 80 New Auditors Will Bring In $60Million

2008-02-22T11:56:00.001-06:00

I saw this headline and it piqued my interest. I wondered how this would be. That would mean each auditor would find over $700,000 in assessments each year. That seems a little overstated. Further reading of the article in the Worcester Telegram and Gazette revealed that the estimates are pretty loose indeed. First of all, MA, is going to focus on the cigarrette tax and try to force the wholesalers to collect the tax instead of the retailers as is currently done. Of course, the primary interest there is to only have to audit wholesalers and not the individual retailers. The next thing they'll do is make the wholesalers collect tax on a marked up amount. Whatever is easiest for the State, right? They didn't make much mention of how these 80 new auditors are going to bring in all this money.

The other big item, they want to go after, and maybe this is where these auditors are going to be spending their time, is investigating companies' classification of workers as contractors vs. employees. Again, this is mostly a matter of changing who they will go after. Theoretically, there should be no difference in state income tax if a company calls an employee a contractor. However, that contractor/employee may not be paying the taxes due. It's hard to go after individuals -- much easier to go after corporations.

Newspaper Calls Wal-Mart State Tax Planning "Corporate Tax Shenanigans"

2008-02-22T11:37:00.001-06:00

I find it interesting how the newpapers and other media report about corporate tax matters. Sometimes it's quite the eye-opener. Take this editorial article in the Carrboro (NC) Citizen which is written by Elaine Mejia who is referred to as the director of the N.C. Budget and Tax Center. In this article she describes a tax planning technique (which I'm sure was done for other than tax-reduction purposes) that was used by Wal-Mart that had the effect of dramatically reducing state income taxes in NC. NC is a separate return state. Following is her description of what Wal-Mart did and take note of the inflammatory adjectives she throws in there. She makes a call for combined reporting -- the bain of state income tax consultants.

"At issue is a clever tax scheme that the company used to avoid paying an estimated $230 million in states' taxes across the country, according to the Wall Street Journal. North Carolina's share of that was $33.5 million between 1998 and 2002. So what did Wal-Mart due to earn the state's scrutiny? Essentially, the company put ownership of its properties into a "real estate investment trust." That trust was owned by Wal-Mart Property Co., a separate holding company. Conveniently, Wal-Mart owned 99 percent of this holding company. It used this complicated set-up to avoid state taxes by making rent payments on its stores to the holding company and then deducting that amount from its tax bills.

"Unfortunately for Wal-Mart, the Department of Revenue didn't buy it and neither did the judge. In fact, the judge found that the scheme served no legitimate business purpose and was used solely to lower the company's tax bills.

"What's lost in most of the media coverage about this case is why it really matters and what can be done to prevent these kinds of corporate tax shenanigans in the future.

"So, why should North Carolinians care about this case? If nothing else, we should care because $33.5 million dollars is at stake. But there are much bigger reasons to care. In North Carolina today, much of our quality of life depends upon healthy public structures — things like an educated workforce, the court system and good roads. It's these investments that enable companies like Wal-Mart to profit from doing business in our state. When companies like Wal-Mart don't pay their fair share, two things happen — we forego investments that would improve our quality of life and make our economy stronger and the rest of us pay more. I'd call that a "lose-lose" scenario.

"There is a change we can make to our state tax laws that would prevent corporations from trying many of these types of tax schemes in the future. It's called "combined reporting."

"Under this system, multi-state corporations would have to file a report with the state that discloses their entire business structure, including related entities. This would include relationships with holding companies like the one Wal-Mart owned 99 percent of and paid its rent to. Over time, using this strategy to close corporate loopholes would raise hundreds of millions of dollars that could be used for investments in things like education and roads or put back into the hands of working families by expanding the state earned income tax credit.

"Twenty-two states already have combined reporting and five states have adopted this reform in just the last three years. In North Carolina, not one but two bipartisan study committees recently recommended that our state adopt this strategy as well. In the end, this really isn't about one company. It's a wake-up call that should prompt us to put into place public policies that are fair to everyone and that will improve our lives and strengthen our economy in the decades ahead."

ALABAMA Income Tax Law Survives Challenge

2008-02-11T09:16:00.001-06:00

The Alabama Court of Civil Appeals on Friday overturned a lower court decision in a corporate tax case that might have resulted in a a multimillion-dollar revenue loss to the state. The vote wasn't close. The 5-0 order by the appeals court reversed Circuit Judge Tracy McCooey of Montgomery, who had ruled that VFJ Ventures' (Vanity Fair) deductions were not unreasonable as that term was defined in the law. What was the definition of "unreasonable" in the law. That was the key to the lower court's ruling -- it was not defined.

State officials had said the ruling last year could have cost the state $30 million to $50 million in annual corporate income tax collections and forced the state to pay as much as $100 million in refunds.

You may remember back in 2001 that Alabama passed a law that required companies to add back as taxable income deductions they took on interest and royalty payments made to sister companies. It was to attack a holding company strategy where you value your intangibles and place them in a separate legal entity and that company charges your other entities royalties and interest for using those patents or trademarks.

However, there was one exception in the law says a company doesn't have to add back the deductions if it proves such adjustments were "unreasonable". VFJ argued that it wasn't unreasonable for a corporation to deduct these payments. The lower court agreed. The appeals court vacated that lower decision. It looks like the AL law will live to fight another day.

Forbes magazine has a good layman's discussion of the case.

Tax Court Coming to Georgia?

2008-01-29T14:58:00.001-06:00

The Daily Report Online had an interesting article about a possible development in GA that most tax advisors would welcome -- a dedicated Tax Court. This court would handle mostly income tax cases, but it would also take some complex sales tax cases. It goes (almost) without saying, that a dedicated court makes good sense to specialized state tax attorneys also. Here's a quote from the article:

"Some attorneys and the state's top tax official want the state to establish a new court for hearing complex tax disputes. The attorneys, working through the State Bar's Taxation Law Section, hope to have a pilot program approved in 2009.

"Currently, businesses and individuals who want to dispute their taxes can either bring a suit against the state Department of Revenue or county government in Superior Court or in the Georgia Office of State Administrative Hearings. Both avenues have limitations, according to tax attorney Peter G. Stathopoulos.

"Judicial rulings published in Superior Court aren't published in a recorder, making it difficult for tax attorneys to track developments in case law, Stathopoulos said.

"Right now you only can read about tax cases when they go up to the state Court of Appeals," said Stathopoulos, an accountant with the Atlanta firm Bennett Thrasher and a former tax attorney at Morris, Manning & Martin and McGuireWoods.

"This tax court would actually publish its decisions, and it would create a lot more uniformity," he said. "

Win this $100 Raffle and You Could Owe $150K in Income Taxes

2008-01-29T14:31:00.001-06:00

The Herald-Mail newspaper had a story about a house being raffled off for charity purposes. The house was appraised for $390,000. The newspaper asked a CPA to figure out what taxes the winner would owe. In this case, a $100 purchase would net you a tax bill of $150K. But, it would still be worth it, of course. Here's why:

"Nonetheless, paying $100 for a ticket in the ongoing San Mar Children's Home raffle for a $390,000 house still could be a pretty good investment, according to an official with Smith Elliott Kearns & Co. LLC.

"You've basically gotten $240,000 worth of house for nothing" if you deal with the tax load by getting a home-equity loan on it for $150,000, said Kristi Glass, a certified public accountant and tax manager for the accounting firm.

"I mean, most people don't have that low a mortgage on their house. ... So as long as you can afford the payments on the home-equity loan," you're still a winner, Glass said.

Bruce Anderson, executive director of San Mar, has an alternative solution: You can sell the house.

"I'm saying even if the winner was to turn around and put it on the market for $300,000, they would have no problem at all selling it," Anderson said. "With all this publicity, there's any number of people interested." risis.

Even General Partnerships Subject to Franchise Tax in Texas

2008-01-25T01:30:00.001-06:00

Wait a minute! I thought general partnerships were not subject to the new franchise tax?

I guess in Texas, you're presumed taxable until proven nontaxable. Even though general partnerships made up of only natural persons as general partners are not subject to the revised Texas franchise tax, to preserve that non-taxable status, the comptroller requires the partnership to report certain information. Last June the comptroller published a form for such partnerships to file to preserve their non-taxable status, stating: "If the form is not returned, the partnership will be presumed to be subject to the revised franchise tax and will have an annual report due on May 15, 2008."

Again I ask this question: Why are Texas legislators trying to turn Texas into California?

Another State with a Surplus -- Credit the Income Tax

2008-01-25T01:24:00.001-06:00

Here's the headline and story from the Missouri newspaper the Columbia Tribune:

State tax income higher than expected

Published Thursday, December 6, 2007

JEFFERSON CITY (AP) - Missouri's tax revenue is coming in ahead of what was budgeted.

The state Office of Administration says November's net general revenue was up more than 6 percent compared to November 2006. Missouri's annual budget takes effect in July. Through the first five months of its fiscal year, net general revenue was up about 4.5 percent compared to last year. The state budget was built on an assumption that revenue would grow by 3.8 percent this year.

The larger-than-projected increase is largely because of income taxes. Individual income tax revenue was up more than 7.5 percent during the first five months of the budget year. Sales tax collections were up barely 1 percent over last year.

Does Derek Jeter Live in NYC or Florida?

2007-12-17T10:02:00.001-06:00

According to this article in the New York Times, he says he lives in FL, but the evidence may indicate he lives in NY.

"New York State tax officials say that the Yankee star Derek Jeter claimed he lived in Florida to avoid paying city and state income taxes for several years, when he was actually living in New York, according to documents filed last week with an administrative law judge.

"Mr. Jeter, one of the highest-paid players in baseball, filed nonresident income tax returns to New York State between 2001 and 2003, claiming that he lived primarily at his off-season home in Florida, which, unlike New York, has no state income tax.

"But officials at the State Division of Taxation and Finance argued that Mr. Jeter’s primary residence during those years was in New York, where he owns an apartment in the Trump World Tower, near the United Nations, and has rented or owned other living space as well.
Mr. Jeter’s salary was $14 million in 2003, along with an unknown fraction of the signing bonus of $16 million he was to be paid between 2001 and 2008. New York State’s top personal income tax rate for residents was 7.7 percent in 2003, and the city’s was 4.45 percent, including a temporary surcharge imposed after the attack of Sept. 11, 2001.

"Among the evidence cited by officials were Mr. Jeter’s business ties outside Florida, the personal items “near and dear” he keeps in his New York apartment, and his “public statements regarding his desire to be in New York,” according to the filings. "

"According to the documents, state tax officials are not disputing that Mr. Jeter’s primary residence was in Florida before 2001 or after 2003. But they claim that Mr. Jeter established his home in New York at the beginning of 2001, the year he bought the apartment in the Trump World Tower for a reported $13 million. According to state officials, he lived there — for tax purposes, at least — for the next two years as well.

"Besides unspecified business ties and public statements made by the baseball star, state officials also cited “holidays spent in jurisdictions other than Florida” and the fact that Mr. Jeter was “immersed in the New York community.” "

We'll keep you posted.

It's Better When the Legislature is Out of Session

2007-12-17T09:52:00.001-06:00

The Maryland Chamber of Commerce had an eye-catching headline on its website:

"Special Session Results in $800 Million in New Business Taxes"

When you hear your governor call for a "Special Session", grab your wallet! Here is the Chamber's summary of what the legisalture did to Maryland businesses and citizens.

"The General Assembly concluded its 3 week special session today by enacting $1.4 billion in new taxes, $400 million in possible future state budget reductions, and authorizing slots at up to 5 locations, if approved at referendum by the voters in November of 2008. The share of new taxes paid by Maryland businesses will exceed $800 million. The final package of 6 bills differs significantly from the Governor’s original proposals, but should resolve the projected state general fund structural deficit and pump over $400 million annually into state transportation projects.

Corporate Taxes

The corporate income tax rate would increase from 7% to 8.25% effective for taxable years beginning after December 31, 2007.

Although combined reporting was defeated, a 17-member Maryland Business Tax Reform Commission will study changes to the state’s business taxes over the next 4 years. The Maryland Chamber of Commerce will have the only business member on the Commission.
New, extensive and onerous reporting requirements will be imposed on corporations as part of their corporate tax return or for publicly traded companies with any minimal business activity in Maryland, effective for taxable years beginning after December 31, 2005 (see pages 40 - 49 of SB 2).

Sales Tax

Sales tax rate increased from 5% to 6% effective January 3, 2008.
Vendor credit limited to $500 per return from January 3, 2008 to June 30, 2011
Vendors would be allowed to assume or absorb the sales tax.
Sales tax imposed on certain “computer services” from July 1, 2008 to June 30, 2013 (see pages 24 - 25 of SB 2).

Individual Income Tax

New brackets of:
5% of income over $150,000 individual/$200,000 joint
5.25% of income over $300,000 individual/ $350,000 joint
5.5% of income over $500,000

Personal exemption is increased from $2,400 to $3,200, but phased-out at incomes above $125,000 individual and $175,000 joint.Transportation Titling tax increased from 5% to 6%, with a full trade-in allowance, for titles issued on or after January 1, 2008.

No gas tax increase.

Transportation to receive roughly 50% of the sales tax rate increase and other revenues for a total state transportation revenue increase of over $400 million annually.

The state share of revenues would be dedicated to funding education aid, school construction and higher education construction.

See the enacted bills at the following links:
HB 1 - Budget Reconciliation Act (pdf)
SB 2 - Tax Reform Act of 2007(pdf)
HB 5 - Transportation and Sales Tax Bill (pdf)

Michigan Backs Down on Service Tax -- Increases Income Tax Instead

2007-12-14T16:54:00.000-06:00

According to CCH, the surcharge is to be based on a percentage of the taxpayer's liability before credits. For all taxpayers, other than financial institutions, the surcharge would be:

-- 32.9% for tax years ending after 2007 and before 2009; and
-- 27.3% for tax years ending after 2008.

For financial institutions taxpayers, subject to the franchise tax, the surcharge would be:
-- 27.7% for tax years ending after 2007 and before 2009; and
-- 23.4% for tax years ending after 2008.The surcharge would be capped at $2 million per year and would not apply to insurance companies subject to the gross direct premiums tax. The bill also would allow financial institutions to claim the compensation and investment tax credits.
Finally, the bill would revise the provisions that authorize a tax refund if the state collects taxes above certain threshold amounts. Half of the excess taxes would no longer be deposited into the countercyclical budget and economic stabilization fund and taxpayers would be eligible for pro rata refunds based on the amount of the surcharge.

The bill would be effective January 1, 2008, and would apply to all business activity occurring after December 31, 2007. The bill would repeal the new use tax on selected services.

You Own a Farm/Ranch and Want to Deduct the Losses?

2007-12-14T16:35:00.001-06:00

The question of "hobby-losses" come up frequently in income tax. So this issue is always an interesting one to watch. In this case, a couple in Alabama won their case at the administrative level against the AL DoR. Even though both of them had full-time jobs off the farm, they were able to show they were operating it for a profit. Here is the analysis performed by the ALJ considered in ruling for the taxpayer:

"The general test for whether a taxpayer is engaged in a "trade or business," and thus entitled to deduct all ordinary and necessary business expenses, is "whether the taxpayer's primary purpose and intention in engaging in the activity is to make a profit." State of Alabama v. Dawson, 504 So.2d 312, 313 (Ala. Civ. App. 1987), quoting Zell v. Commissioner of Revenue, 763 F.2d 1139, 1142 (10th Cir. 1985). To be deductible, the activity must be engaged in "with a good faith expectation of making a profit." Zell, 763 F.2d at 1142. As stated by the U.S. Supreme Court - "We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify." Commissioner v. Groetzinger, 107 S.Ct. 980, 987 (1987). But a taxpayer's expectation of a profit need not be reasonable. Rather, the taxpayer must only have a good faith expectation of realizing an eventual profit. Allen v. Commissioner, 72 T.C. 28, 33 (1979). Whether the taxpayer had an intent to make a profit must be determined on a case-by-case basis from all the circumstances. Patterson v. U.S., 459 F.2d 487 (1972)."

Treas. Reg. §1.183-2 specifies nine factors that should be considered in determining if an activity was entered into for profit.
Factor (1). The manner in which the taxpayer conducted the activity.
Factor (2). The expertise of the taxpayer in carrying on the activity.
Factor (3). The time and effort exerted by the taxpayer in conducting the activity.
Factor (4). The expectation that the assets used in the activity will appreciate.
Factor (5). The taxpayer's success in similar or related activities.
Factors (6) and (7). The taxpayer's history of profits and losses, and the amounts of any occasional profits.
Factor (8). The taxpayer's financial status.
Factor (9). The activity was for the taxpayer's personal pleasure and recreation.

Corporate Officers NOT Liable for TX Franchise Tax -- Why Not?

2007-11-09T15:45:00.001-06:00

In this case (Paccar Financial Corp. v. Potter, Texas Court of Appeals, Fifth District, No. 05-05-00403-CV, October 31, 2007), the individuals who had been corporate officers when a corporation's Texas franchise tax report was due had actually resigned before the corporate debt was incurred after the report was not filed. As a result they were not personally liable for the corporation's debts.

That is somewhat of a surprising result, but good news for the officers. The states have been generally successful in attaching personal liability to corporate officers, but in this case, they were able to escape the pain. Good for them!

It's not necessarily a good thing to be a corporate officer these days. Lots of potential liabilities. As the old saying goes, "you can't know what you don't know".

Legal Experts Say High Court Will Not Dare Upset the Municipal Bond Market

2007-11-09T15:39:00.000-06:00

In an earlier post, we discussed the pending US Supreme Court case on the issue of whether KY can tax out-of-state municipal bond income while exempting in-state bond income. It seems unconstitutional on its face. But according to this article in the Wall Street Journal, legal experts are pretty much agreeing the Court will let the states continue to tax them that way.

Everything's Bigger in Texas -- But This New Franchise Tax Is No Joke

2007-11-06T14:25:00.000-06:00

Many of you know that Texas has recently enacted sweeping changes to its corporate income tax. Oh I know, Texas has no income tax – that would be unconstitutional. I’ve been asking myself -- How did we get to this?

Not that long ago, Texas had no income tax on individuals or corporations. There used to be a tax on the amount of “capital” a business employed in the state, which was poorly formulated and a few court cases and subsequent policy changes basically gutted it. Next they introduced the income component of the tax back in about 1991 or so. Still it was only applicable to certain business entities, because the Texas Constitution prohibits an individual income tax.

Now they have revised the tax once again. Somewhat curiously, they’re making a big to do about this not being a new tax or even a “margin tax” as some people call it. They say it’s merely a revised “franchise” tax. I guess they’re strategy is to minimize complaints, I’m really not sure. Their chief argument for it being the same old franchise tax, just slightly modified, is that it is still found in Chapter 171 of the Texas Tax Code. This all seems sort of silly – like they want to make the argument out to be what the tax is called. Who care’s what it’s called? The truth is this is a Texas-sized change in corporate taxation. For right now we’re stuck with it and we have to be ready for it since it is effective for reports due on or after January 1, 2008.

We are tax advisors and that the old saying within the industry is that any change in the tax law is good for business. However, I have a hard time taking off my Joe Citizen and Joe Business Owner hat and speaking strictly as a Tax Advisor when something as bad as this new tax is offered up by our elected officials.

Problem is, in speaking with many other business owners over the last several months, I’ve realized that very few people are even aware of this new tax and what it means to them. So we decided to inform people of this new tax and how it operates. That’s the reason for this newsletter and we will also be offering seminars on the new tax. Stay tuned and we’ll let you know when to tune in.

Here’s the basics:

This new franchise tax is basically a tax on the total revenues of a business with only a few deductions. The total revenues of the business are determined by adding up all the receipts of the “unitary combined group” – which is a totally new concept in Texas taxation. You are allowed the choice of two deductions. You can choose to deduct cost of goods sold or compensation. Then you multiply the net “margin” by the Texas apportionment factor giving you the taxable “margin”. Then finally you apply the applicable tax rate (either 1% or .5%)

Sounds simple and straight forward right? It’s not.

For example, here are just a couple issues that immediately come to mind:

What is a combined/unitary group? First of all, it starts with 50% ownership, and it appears that “unitary” will be very broadly defined. That’s not good.
The election of using cost of goods sold or the compensation deduction applies to all members of the group. What if some members of the group are service entities and others are manufacturers?

This tax will be a menace to businesses in Texas. But for now, this is what we’re stuck with. We will continue to stay on top of changes as they occur in this tax over the next few years and beyond.

She's Married with Children in New York - Or is she?

2007-11-02T11:24:00.000-05:00

One and one is two, unless you're an accountant or an official with any department of revenue. I saw this summary of a recent NY case on CCH (Ilyaich, New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 820875, October 18, 2007).

"A taxpayer was entitled to claim head of household filing status, for New York personal income tax purposes, despite being legally married during the years in question. The taxpayer met the requirements under IRC Sec. 7703(b) to be considered unmarried for the years in question because she: (1) did not live with her husband; (2) solely and individually maintained an apartment that was the principal place of abode for her minor children; and (3) was otherwise entitled to claim a deduction for a personal exemption for her minor children."

Supreme Court Ruling Could Roil Municipal Bond Markets

2007-11-02T09:53:00.000-05:00

The Supreme Court will hear arguments Nov. 5 on whether Kentucky violates the Constitution by taxing income earned on out-of- state bonds while exempting interest on ones issued by its own cities, school districts and other debt-issuing authorities. According this article from Bloomberg.com, "barring such preferential treatment would force 42 states, including New York and California, to either tax their own bonds or give identical breaks to out-of-state bonds. "

Most states tax the income from other states' municipal bonds while exempting the income from their own state's bonds. This would certainly seem to be an infringement on interstate commerce. The power to regulate interstate commerce is reserved for the Congress. States have been routinely prohibited from taxing out-of-state income more than they tax in-state income. So it would seem that the Court will rule against Kentucky in this case also.

If they do go against KY, then states would most likely have to decide whether they will tax all municipal bond income, or exempt it all. Either of those choices would seem to make the bonds from these 42 states immediately less valuable relative to bonds issued in the other states that presumably offered a higher yield relative to these 42 states.

It will be very interesting to see how this goes. There's one more aspect to this case that is very intriguing and that is, what if Justice Roberts continues on with this new argument that if a state has legitimate goals in mind and isn't just trying to favor commercial interests, it may be able to tax out-of-state income more than in-state. See the Bloomberg article for a great discussion on this. But if that reasoning takes hold, brace yourself for a whole new world in state taxation as states figure out ways to tax out-of-staters and exempt in-staters. It's so easy to tax non-voters isn't it?

The Extended Moratorium on Taxation of Internet Access Has Some Income Tax Implications

2007-11-01T18:28:00.000-05:00

You might not immediately think of the recently signed Internet Access taxation ban as having anything other than an effect on state sales taxes, but there was a potential loophole in it that states like Texas smoked out.

As you probably know, Texas has enacted a sweeping new state income tax. They would like to call it simply a "modification to existing franchise taxes", but it's a big new tax -- but I digress. Some might call it a new tax. There was some concern evidently that the grandfathering provisions of the ban, would prevent Texas from imposing their modified franchise tax on Internet Service Providers. But, as we say here in Texas -- Don't Mess With Texas. It's not only Texas that might have been impacted. Michigan might have been affected with its business tax. So might also Ohio, with its commercial activity tax, and Washington's business and occupation tax might have been affected as well.

They made sure to get some language in the bill to clarify that it does not apply to state general business taxes, such as gross receipts taxes, that are structured in such a way as to be a substitute for or supplement the state corporate income tax.

These guys are on top of things.

By the way, you can get an actual copy of the bill from us. Just ask.