Chapter 16 Solu Older Version

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CHAPTER 15

MULTISTATE CORPORATE TAXATION

SOLUTIONS TO PROBLEM MATERIALS

Question/Problem Topic

Status:PresentEdition

Q/P inPriorEdition

1 State tax policy Unchanged 12 Multistate tax incentives New3 UDITPA New4 Multistate Tax Commission New5 States’ jurisdiction to tax; nexus Unchanged 56 Immune sales under P.L. 86-272 Unchanged 67 P.L. 86-272 solicitation standards Unchanged 78 Apportionment and allocation of income Unchanged 89 Appointment formula weights Unchanged 9

10 Sales factor Unchanged 1011 Throwback rule for sales factor Unchanged 1112 Unitary theory Unchanged 1213 State taxation of S corporations Unchanged 1314 State S corporation compliance Unchanged 1415 Out-of-state S shareholders Unchanged 1516 Composite S corporation filing Unchanged 1617 Partnerships and LLCs Unchanged 1718 Sales and use tax payments Unchanged 1819 Sales/use tax incidence Unchanged 1920 Sales/use tax exemptions Unchanged 2021 Occasional sale exemption Unchanged 2122 Streamlined Sales Tax Project Modified 2223 Planning with nexus rules Unchanged 2324 Passive investment subsidiary Unchanged 2425 Multistate tax planning New26 Capital stock tax planning New27 State/Federal tax law overlap New*28 State income tax formula Unchanged 2829 State income tax formula Unchanged 29*30 Addition and subtraction modifications Unchanged 30*31 Addition and subtraction modifications Modified 31*32 Addition and subtraction modifications Modified 32

15-1


Question/Problem Topic

Status:PresentEdition

Q/P inPriorEdition

33 Apportionment formulas Unchanged 3334 Apportionment and allocation Unchanged 34*35 Apportionment formulas Unchanged 35*36 Apportionment formulas Unchanged 3637 Apportionment formulas Unchanged 3738 Apportionment formulas Modified 38*39 Sales factor Modified 3940 Throwback rule Modified 4041 Payroll factor Unchanged 4142 Payroll factor Unchanged 4243 Payroll factor Unchanged 4344 Property factor Unchanged 4445 Property factor Unchanged 4546 Property factor Unchanged 4647 Unitary business, apportionment factors Unchanged 47*48 Water’s edge election Unchanged 4849 Multistate S corporations, apportionment

formulaUnchanged 49

50 Sales tax base Unchanged 50*51 Sales and use taxes Unchanged 5152 Sales tax exemptions Unchanged 52*53 Franchise tax Unchanged 5354 Apportionment planning Unchanged 5455 Apportionment planning Unchanged 55

ResearchProblem

1 Internet activity Unchanged 12 Internet activity Modified 23 Internet activity Unchanged 34 Internet activity Unchanged 45 Internet activity Unchanged 5

*The solution to this problem is available on a transparencymaster.

15-2 2007 Corporations Volume/Solutions Manual


CHECK FIGURES

28. Apportionable income $32,000; taxafter credits $436.

29.a. $1,500,000.30.a. A; $10,000.30.d. S; $3,000.30.e. N.30.f. S; $5,000.30.i. N.30.j. Varies.31. $332,000.32.a. $170,000.32.b. $450,000.32.c. $515,000.33. D $739,800; E $1,592,000.34. E $1,760,200.35. 72.39%; 20.00%.36. A 80.0%; B 20.5%.37. A 79.63%; B 23.50%.38.a. $321,280.38.c. $240,000.

39. B $553,000.40. E 79.38%.41. G 21.05%; H 57.14%; I 36.84%.42. $190,000 to U.43. G 68.49%; H 30.10%.44. A 63.01%; B 36.99%.45. B 34.70%.46. Annual method, 38.6% property

factor.47.a. $49,648.47.b. $110,000.48. B 40.00%; Q 77.78%.49. $0 Y; $173,167 Z.51.a. $3,600.51.b. $294,000.52.a. S.52.d. N.53. $7,313.54. Factor drops to 69.7%.

Multistate Corporate Taxation 15-3


DISCUSSION QUESTIONS

1. Nontax factors dominate most business relocation decisions. However, a combination ofsome of the following incentives might also force the consideration of a tax-motivatedexpansion or relocation.

l Economic development incentives.

l Sales and use tax exemptions reducing a customer’s acquisition price.

l Use of technology to transfer sales and purchase orders, pricing information, andother data.

l Ease in complying with multiple jurisdictions’ tax rules.

l ‘‘Exporting’’ of local taxes to visitors and outsiders.

l Sophistication and effort of jurisdictional enforcement measures.

pp. 15-2 and 15-3

2. The vast majority of states start with Federal taxable income in deriving their own tax base.p. 15-4

3. The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating tothe assignment of income among the states for corporations that maintain operations inmore than one state. Many states have adopted the provisions of UDITPA, either by joiningthe Multistate Tax Commission or by modelling their laws after UDITPA provisions. p. 15-8

4. The Multistate Tax Commission (MTC) writes regulations and other rules to interpretUDITPA. When a new MTC rule or regulation is created, member states propose itsadoption to their respective legislatures. The majority of member states adopt theregulations with no exceptions or only minor changes.

In addition, many of the states that are not MTC members model their laws after UDITPAand MTC regulations. Thus, MTC pronouncements carry great weight in the multistate taxsystem.

p. 15-8

5. a. The state in which a business is incorporated has the jurisdiction to tax the incomeof the corporation, regardless of the volume of its business activities within thestate.

b. If a corporation is to be subject to tax in a state other than that of its incorporation,the former jurisdiction must show that sufficient contact with that state (nexus) hasbeen established. Typically, sufficient nexus exists when a corporation derivesincome from sources within the state, owns or leases property in the state, employspersonnel in the state, or has physical or financial capital there.

c. A state cannot tax the out-of-state activities of an out-of-state corporation.

p. 15-8



6. No Colorado tax applies. Public Law 86-272 limits the states’ right to impose an income taxon interstate activities. This Federal law prohibits a state from taxing a business whose onlyconnection with the state is to solicit orders for sales of tangible personal property, when theorders then are approved or rejected, filled, and shipped from outside the state.

Only the sale of tangible personal property is immune from taxation under P.L. 86-272,however. Leases, rentals, and other dispositions of tangible personal property are notimmune activities. Moreover, dispositions of real estate and intangible assets, as well assales of services, are not protected activities.

p. 15-9

7. No Colorado tax applies. Public Law 86-272 does not define the term solicitation, but theSupreme Court in Wrigley held that order solicitation includes any explicit verbal requestfor orders and any speech or conduct that implicitly invites an order. A de minimis rule alsomay allow a transaction to stay immune under the statute.

Carrying out any of the following (common but substantively) minimal acts within a state,though, in addition to the traditional sales-solicitation tasks of a sales force, could establishnexus through non-immune sales.

l Collecting delinquent accounts; investigating creditworthiness.

l Repairing or maintaining company products (even if performed at no charge to thecustomer).

l Approving or accepting orders.

Exhibit 15-2

8. A business that carries out transactions in more than one state must divide such resultingincome among the states for tax purposes. Generally, this includes both an apportionmentand an allocation of such income.

Apportionment is a means by which business income is assigned to specific states by a for-mula method. The formula usually takes into account the gross receipts, property, andcompensation levels generated within each state, although the states vary in the weightingof the factors for this purpose. Allocation is a procedure by which nonbusiness income isassigned directly to the state(s) in which it is generated. For instance, a manufacturing firmwith some rental income would allocate the net rental profit or loss to the state in which therental property is located.

Several states fail to distinguish between business and nonbusiness income, apportioningall of the taxpayer’s income among the states.

p. 15-9 and Figure 15-1

9. A single-factor apportionment formula consisting solely of a sales factor tends to creategreater levels of apportionable income for the state from nonresident (meaning alsononvoting) entities than an apportionment formula that double weights the sales factor. Moststates now over-weight the sales factor for this reason. p. 15-14 and Example 11

10. In determining the numerator of the sales factor, most states follow UDITPA’s ‘‘ultimatedestination concept,’’ whereunder sales of tangible personal property are assumed to take



place at the point of delivery, as opposed to the location at which the shipment originates.Example 12

11. The solution depends upon whether Arizona applies a throwback rule in its sales factor.

The throwback rule is an exception to the destination concept. It provides that, when acorporation is not subject to tax in the destination state or the purchaser is the U.S. govern-ment, the sales are treated as in-state sales of the origination state, and the actual destina-tion of the product is disregarded.

Consequently, when the seller is immune from tax in the destination state, the sales areconsidered to be in-state sales of the origination state if that state has a throwback provi-sion. The throwback rule was established as an attempt to ensure that none of a corpora-tion’s sales escaped taxation. (Arizona has adopted such a throwback rule.)

Example 13

12. The unitary approach to state taxation attempts to neutralize taxpayer attempts to placeprofitable operations in low- or no-tax jurisdictions. Whether the unitary rules apply often turnson subjective assessments as to the structure and operations of the business. This is unlikethe application of the controlled and affiliated group rules, discussed in text Chapters 2 and 8.

When the business is found to be unitary, apportionment factors are computed on the basisof the entire unitary entity, not just the subsidiary that is based in the taxing state. This com-putational convention can work to the taxpayer’s benefit when high-taxed income now issubjected to apportionment in a low-tax state.

pp. 15-22 to 15-24

13. Michigan, Tennessee, and the District of Columbia fail to recognize the Federal S electionsthat are in effect for business taxpayers. p. 15-25

14. A few states require state-oriented S election and consent forms. In some states, a FederalS corporation can elect to be taxed as a C corporation. p. 15-27

15. Some states apply a corporate-level tax on the income items attributable to out-of-stateshareholders. Others require that the S corporation withhold state income tax on taxableincome attributable to out-of-state shareholders. p. 15-27

16. Many states accept block filing or composite returns from multiple-shareholder Scorporations. Such a return essentially is a spreadsheet that discloses and computes theallocation of ordinary income and separately stated items, on a per-state and per-shareholder basis. p. 15-27

17. Most states use the Federal pass-through system of taxing partners and partnerships. Theentity does not pay income tax, but it files an information return (like Form 1065), allocatingincome, deduction, and credit items to the partners. Other state taxes (such as payroll andunemployment taxes) are payable by these entities. p. 15-27

18. Generally, the seller collects a sales tax from the buyer and remits the tax to the state. Ause tax typically is paid directly by the purchaser to the home state. p. 15-28

19. This statement is correct, as far as it goes. A retail sales tax falls on the customer, but thestate requires the seller to collect it. Sales tax returns are filed by the seller when the fundsare remitted, and no return is required of the customer. p. 15-28



20. Outline Points

Sales/use tax exemptions by:

l Nature of the taxed productl Servicesl Occasional salel Sale for resalel Groceries, medicines

l Nature of the purchaserl Exempt organizationl Government or agency

l Nature of the salel Casual/occasional salel Amnesty or holiday

l Nature of the political processl Manufacturer, farmerl Manufacturing process, packaging, shipping

l Ingredient part, consumed in processl Not fuel or electricity

p. 15-28

21. Sale of a used auto, sale of an entire business, rummage sale, or concert ticket. p. 15-28

22. The Streamlined Sales Tax Project (SSTP) is an effort by state/local tax administrators tounify the definition of items that are subject to the sales/use tax. The Multistate TaxCommission helped to develop a common set of definitions for state legislatures to adopt,so that enforcement of the sales/use taxes would be improved, especially with respect tocross-border sales.

The SSTP does not force the states to adopt common tax rates or enforcement proce-dures, but it includes checklists as to which types of food, clothing, and computing itemsmight be identified as taxable.

Tax in the News on p. 15-31

23. TAX FILE MEMORANDUM

November 3, 2006

From: Daniel S. Lange

Subject: Multistate tax planning

Re: Client Ecru’s relocation decision

Because the states employ different definitions of the amount and type of activity neces-sary to place a tax situs within the state, a company is allowed, to an extent, to select thestates with which it desires to establish nexus. When a corporation has only a limited



connection with an undesired (high-tax) state, it may abandon that activity by electing an al-ternative means of accomplishing the same result. For example, when providing a salesrepresentative with a company-owned fax machine in a home office constitutes nexus in ahigh-tax state, the company could eliminate its connection with that state by reimbursingsales personnel for communication expenses, instead of providing company-owned equip-ment. These distinctions are more important afterWrigley, in which the Supreme Court out-lined the terms of nexus under P.L. 86-272.

Similarly, when nexus is caused by conducting customer training sessions or seminars inthe state, the corporation could bypass this connection by sending the customers’ person-nel to a nearby state in which nexus clearly has been established, or in which the activitywould not constitute nexus.

In addition, when sufficient activity originates from the repair and maintenance of the cor-poration’s products or the activities performed by the sales representatives within the state,the organization could incorporate the service or sales divisions. This would invalidate thestate’s right to tax the parent corporation’s income; only the income of the service or salesdivisions would be subject to tax. However, this technique is successful only if the incorpo-rated division is a bona fide business operation and the state in which it operates is not aunitary state. Therefore, the pricing of any sales or services between the new subsidiaryand the parent corporation must be at arm’s length, and the operations of the new corpora-tion preferably should result in a profit.

Although most planning techniques are employed to disconnect a corporation’s activitiesfrom an undesirable state, they also can be utilized to create nexus in a desirable state. Forexample, when the presence of a company-owned copy machine in a home office createsnexus in a desirable state, the corporation could provide its salespersons in that state withcompany-owned equipment, rather than reimbursing or providing increased compensationfor office expenses. Establishing nexus in the state is advantageous, for instance, whenthat state has a lower tax rate than the state in which the income presently is taxed.

pp. 15-31 to 15-34 and Example 31

24. TAX FILE MEMORANDUM

November 3, 2006

From: Mark A. Barnes

Subject: Multistate tax planning

Re: Client Royal’s interest income

The creation of a passive investment company is a technique utilized to minimize a corpo-ration’s state tax burden. Nonbusiness or passive income generally is allocated to the statein which the income-producing asset is located, rather than apportioned among the statesin which the corporation does business. Therefore, significant tax savings may be realizedwhen nonbusiness assets have a tax situs in a state that either does not levy an income taxor provides favorable tax treatment for passive income. To benefit from the provisions ofthose states, it is not necessary that the corporation be domiciled in such a state. Instead,the tax savings can be realized by forming a passive investment company to hold the intan-gible assets and to handle the corporation’s investment activities. Although the passiveinvestment company technique usually produces the desired result in any no-tax state,Delaware often is selected for this purpose, because of its additional corporate statutoryprovisions and favorable political, business, and legal atmosphere.



Delaware does not impose an income tax upon a corporation whose only activity within thestate is the maintenance and management of intangible investments, and the collectionand distribution of income from such investments or from tangible property physicallylocated in another state. Consequently, patents, trademarks, stock, and other intangibleproperty can be transferred to a Delaware corporation whose activity is limited to collectingpassive income. Transfers of the assets to the subsidiary can be effected without a result-ing Federal income tax, under § 351. Chapter 4

However, to receive the desired preferential state tax treatment, the passive investmentcompany’s activities within the no-tax state must be sufficient to establish nexus, and theholding company should avoid performing any activity outside the state that may result inestablishing nexus with another state. In addition, the formation of the subsidiary must beproperly implemented, to assure the legal substance of the operation. The passive invest-ment company must have a physical office, and it must function as an independent opera-tion. Nevertheless, ensuring nexus and proper formation is not difficult, since numerousconsulting organizations have been established to furnish new passive investment compa-nies with all of the elements necessary to fulfill these requirements.

Because the subsidiary’s activities are confined to Delaware (or some other no- or low-taxstate), and its operations generate only passive income, its income is not taxed in anynonunitary state. Moreover, most states exclude dividends from taxation or otherwisefavorably treat them; therefore, the earnings of a passive investment company can bedistributed as a dividend to the parent at a minimal tax cost. If the state in which the parentis located does not levy income tax on dividends received, the entire measure of passiveincome may escape taxation. Formation of a passive investment company also may favor-ably affect the parent corporation’s apportionment formula in nonunitary states, becausethe passive income earned by the subsidiary is excluded from the numerator of its salesfactor.

These desired results, however, are not fully available in states that view the entire corpo-rate operation as being unitary. Since those states require combined or consolidatedreporting, the income earned by the passive investment company is included in the corpo-ration’s apportionable or allocable income.

HIGH-TAX STATE LOW-TAX STATE

Investment Assets

ROYAL CORPORATION SUBCO

Earnings: dividends paid,qualify for dividends receiveddeduction

Nexus only here


25. l Create nexus in a low- or no-tax state, so that, through the apportionment process, alower effective tax rate can be used.

l Physically move operations to a low- or no-tax state, perhaps on a divisional or otherfunctional basis.



l Move the investment assets into a passive investment subsidiary. This techniquealone could reduce the tax liability by $1.6 million (.08 tax rate � $20 million portfolioincome) per year.

l Reduce the payroll expense through the use of independent contractors.

l Acquire a subsidiary that offers a presence in a no- or low-tax state, or a research divi-sion whose losses will offset Mollusk’s income. Then optimize tax liabilities throughtransfer pricing and management fee structures.

l If State F has not adopted a throwback rule, make new sales in low- or no-tax states,or into states with which there is no nexus.

pp. 15-31 to 15-38

26. Alpha might be able to reduce its capital stock liability by:

l Funding expansion with debt, rather than retained earnings.

l Funding subsidiary operations with debt, rather than with direct capital contributions.

l Regularly paying dividends to parent corporations located in states that offer friendlytax treatment of investment income (e.g., Delaware).

p. 15-38

PROBLEMS

27. Item True or False

a. Federal taxable income is modified to produce state taxable income. Trueb. Federal tax accounting methods, such as LIFO inventory and

specific write-off of bad debts, are followed for state income taxpurposes.

True

c. State income tax payments are piggybacked to Federalestimates (e.g., the state used the IRS as a collection agent).

False

d. State income tax audits are piggybacked to the Federalprocess (i.e., taxpayers must notify the state’s revenuedepartment when a Federal audit is completed).

False

pp. 15-4 and 15-5

28. State taxable income is computed as follows.

Federal taxable income $50,000Addition modifications +8,000Subtraction modifications �11,000State tax base $47,000Allocated income— total �15,000Apportionable income $32,000Apportionment percentage � 21%

Apportioned income $ 6,720Allocated income— in-state +3,000



State taxable income $ 9,720Tax rate � 5%

Gross income tax $ 486Credits �50Tax liability $ 436

Figure 15-1

29. a. $1,500,000 (30%).

b. $100,000 (10%).

c. Business income is apportioned to the state, using the apportionment formula.Nonbusiness income is allocated to the state using a dollar-for-dollar assignment.In most states, business and nonbusiness income cannot be combined in applyingthe state income tax formula.

Figure 15-1

30. a. A. $10,000.

b. A. $10,000.

c. S. $30,000, although in most states the answer is N.

d. S. $3,000.

e. N.

f. S. $5,000.

g. A. $5,000.

h. S. $3,000.

i. N.

j. Answer varies substantially among the states; however, in most states the answeris N.

Exhibit 15-1

31. Perk’s state taxable income is determined as follows.

Federal taxable income $200,000A income tax expense +15,000A income tax refund �3,000Depreciation modification ($300,000� $180,000) +120,000

A taxable income $332,000

Exhibit 15-1 and Example 1



32. a. Sales $4,000,000Cost of sales �3,300,000Cost recovery (Federal) �400,000Interest income (Federal) +20,000X income tax expense �150,000Federal taxable income $ 170,000

b. If interest generated from X obligations is exempt from state tax, state taxableincome is $450,000.

Federal taxable income $170,000State income tax expense +150,000Depreciation modification ($400,000� $250,000) +150,000Interest on Federal obligations �20,000X taxable income $450,000

c. If interest generated from X obligations is subject to state income tax, state taxableincome is $515,000.

Federal taxable income $170,000State income tax expense +150,000Depreciation modification ($400,000� $250,000) +150,000Interest on Federal obligations �20,000Interest on X obligations +75,000Expenses related to X obligations �10,000X taxable income $515,000

Exhibit 15-1 and Examples 1 and 2

33. STATE D TAXABLE INCOME

Income subject to apportionment (business income) $2,000,000

Apportionment formula

Sales $4,500,000/$10,300,000 = 43.69%Property $ 600,000/$2,100,000 = 28.57%Payroll $1,200,000/$3,100,000 = 38.71%

Total 110.97%

State D apportionment factor (110.97%/3) � 36.99%

Taxable income apportioned to D $ 739,800Plus: Income allocated to D 0*

D taxable income $ 739,800

*Since the property for which the $500,000 gain was derived was located in E, suchincome is not allocated to D.



STATE E TAXABLE INCOME

Income subject to apportionment (business andnonbusiness income) $2,500,000


Sales $6,300,000*/$10,800,000* = 58.33%Property $1,500,000/$2,100,000 = 71.43%Payroll $1,900,000/$3,100,000 = 61.29%

Total 191.05%

State E Apportionment Factor (191.05%/3) � 63.68%

E taxable income $1,592,000

*Includes $500,000 gain on sale of nonbusiness property.

Examples 5, 6, 8, 9, and 10

34. $739,800 and $1,760,200 of Jest’s income is subject to tax in States D and E, respectively.

D taxable income, as in problem 33 $ 739,800

STATE E TAXABLE INCOME

Income subject to apportionment (business income only) $2,000,000


Sales $5,800,000/$10,300,000 = 56.31%Property $1,500,000/$2,100,000 = 71.43%Payroll $1,900,000/$3,100,000 = 61.29%

Total 189.03%State E Apportionment Factor (189.03%/3) � 63.01%

Taxable income apportioned to E $1,260,200Plus: Income allocated to E 500,000

E taxable income $1,760,200

Examples 5, 6, 8, and 10

35. Because of the components of the apportionment factors in the two states, less than 100%of Millie’s taxable income is subject to state income taxation.

State A Income Apportionment

Sales $1,200,000/$1,500,000 = 80.00%Property $280,000/$680,000 = 41.18%*Payroll $2,400,000/$2,500,000 = 96.00%

Total 217.18%

A Apportionment Factor (217.18%/3) 72.39%



*Owned property is included in the factor at net depreciated basis, and rentpayments are included in the factor at 8 times the annual rental expense.Therefore, the numerator of the factor is computed as $280,000 [$500,000(average cost) less $300,000 (average accumulated depreciation)] plus [8 �$10,000 (annual rental payments)]. The denominator of the factor is computed as$680,000 {[$800,000 (total average cost) less $400,000 (total averageaccumulated depreciation)] plus [8� $35,000 (total annual rental payments)]}.

State B Income Apportionment

Sales $300,000/$1,500,000 = 20.0%

B Apportionment Factor (20%/1) 20.0%

Examples 11, 19, and 20

36. Because of the components of the apportionment factors in the two states, more than100% of Millie’s taxable income is subject to state income taxation.


Sales $1,200,000/$1,500,000 = 80.0%

A Apportionment Factor (80%/1) 80.0%


Sales $300,000/$1,500,000 = 20.0%Property $300,000/$800,000 = 37.5%*Payroll $100,000/$2,500,000 = 4.0%

Total 61.5%

B Apportionment Factor (61.5%/3) 20.5%

*Property is included in the factor at historical, undepreciated cost, and rentpayments are not included in the factor.

p. 15-14 and Examples 11 and 19

37. Because of the components of the apportionment factors in the two states, more than100% of Millie’s taxable income is subject to state income taxation.


Sales $1,200,000/$1,500,000= 80.0%� 2 = 160.0%Property $500,000/$800,000 = 62.5%*Payroll $2,400,000/$2,500,000 = 96.0%

Total 318.5%

A Apportionment Factor (318.5%/4) 79.63%

*Property is included in the factor at historical, undepreciated cost, and rentpayments are not included in the factor.




Sales $300,000/$1,500,000= 20.0%� 2 = 40.0%Property $200,000/$400,000 = 50.0%*Payroll $100,000/$2,500,000 = 4.0%

Total 94.0%

B Apportionment Factor (94%/4) 23.50%

*Property is included in the factor at net depreciated basis, and rent payments arenot included in the factor.

Examples 10, 11, and 19

38. a. Sales ($600,000/$1,000,000) = 60.00%Property ($300,000/$350,000) = 85.71%Payroll ($200,000/$210,000) = 95.24%

Sum of Apportionment Factors = 240.95%Average ‚ 3

State A apportionment factor 80.32%Apportionable income � $400,000

Income apportioned to State A $321,280

b. Sales ($600,000/$1,000,000)� 2 = 120.00%Property ($300,000/$350,000) = 85.71%Payroll ($200,000/$210,000) = 95.24%

Sum of Apportionment Factors 300.95%Average ‚ 4

State A apportionment factor 75.24%Apportionable income � $400,000


c. Sales ($600,000/$1,000,000) = 60.00%State A apportionment factor 60.00%Apportionable income $400,000


Examples 10 and 11

39. Item A Sales B Sales

Ordinary sales $200,000 $490,000Checking account interest 3,000Rental income in A 50,000Treasury bill interest –0– –0–Occasional sales –0– –0–Royalty income 60,000

Sales factor numerator $250,000 $553,000

pp. 15-15, 15-16, and Example 12



40. The E throwback rule places in the E sales factor any sales to customers in G and to theU.S. government.

E sales factor = $154 million/$194 million = 79.38%*F sales factor = $40 million/$194 million= 20.62%

Total of sales factors 100.00%

*$64 million (E) + $55 million (G)+ $35 million (all 50 states) = $154 million.

This arrangement calls for better tax planning by Orange, in that shipping from E keeps thetotal of the sales factors at 100%. Shipments should be made from a non-throwback state,like F.

p. 15-16 and Example 13

41. G payroll factor $200,000/$950,000= 21.05%H payroll factor $400,000/$700,000= 57.14%I payroll factor $350,000/$950,000= 36.84%

Total of payroll factors 115.03%

This arrangement calls for better planning by Aqua, in that placing the officers’ salaries inI increases the total of the payroll factors far above 100%. The salaries for the executivesshould be sourced to H.

p. 15-17 and Example 14

42. The State U payroll factor includes $190,000 for Judy. An employee’s includible compensationgenerally is assigned to one state, specifically, the state inwhich she or he performs services forthe employer. If such services are performed in several states, the compensation is assigned tothe state inwhich sheor hehasabaseof operations. pp. 15-17 to 15-19

43. Justine’s State G payroll factor is determined as follows.

ð$475,000þ $95,000þ $180,000Þð$675,000þ $160,000þ $260,000Þ ¼

$750,000

$1,095,000¼ 68:49%

Justine’s State H payroll factor is determined as follows.

½$200,000þ 70%ð$65,000Þ�½$675,000þ 70%ð$65,000Þ þ $95,000� ¼

$245,500

$815,500¼ 30:10%

pp. 15-17 to 15-19 and Examples 16 to 18

44. Under the statutes of States A and B, accumulated depreciation and nonbusiness property(i.e., rental property) are not taken into consideration in computing the property factor.

Average Property in A

Beg. of yr. End of yr. Total Average

Inventory $ 300,000 $ 400,000 $ 700,000 $ 350,000Plant and equipment 2,500,000 2,500,000 5,000,000 2,500,000Land 600,000 600,000 1,200,000 600,000

Total $3,450,000



Average Property in B


Inventory $ 200,000 $ 150,000 $ 350,000 $ 175,000Plant and equipment 1,500,000 1,200,000 2,700,000 1,350,000Land 600,000 400,000 1,000,000 500,000

Total $2,025,000

Property Factor for A

$3,450,000 ðIn-state propertyÞ$5,475,000 ðTotal property $3,450,000þ $2,025,000Þ ¼ 63:01%

Property Factor for B



45. Under the statutes of A and B, accumulated depreciation is not taken into consideration incomputing the property factor. Nonbusiness property (i.e., rental property) is excludedfrom the property factor of A, but is included in determining the property factor for B.

HISTORICAL COST - EXCLUDING NONBUSINESS PROPERTY

Property factor for A, as in problem 44 63.01%

HISTORICAL COST - EXCLUDING NONBUSINESS ASSETS

Average Property in A


Inventory $ 300,000 $ 400,000 $ 700,000 $ 350,000Plant and equipment 2,500,000 2,500,000 5,000,000 2,500,000Land 600,000 600,000 1,200,000 600,000Rental property 900,000 950,000 1,850,000 925,000

Total $4,375,000

Average Property in B


Inventory $ 200,000 $ 150,000 $ 350,000 $ 175,000Plant and equipment 1,500,000 1,200,000 2,700,000 1,350,000Land 600,000 400,000 1,000,000 500,000Rental property 300,000 300,000 600,000 300,000

Total $2,325,000



Property Factor for B


Example 19

46. Annual Method $1:5 million

$3:0 millionþ $0:6 million

$2:2 million

2¼ 0:386 property factor

Monthly Method11

$1:5 million

$3:0 million

� �þ $0:6 million

$2:2 million

12¼ 0:481 property factor

The late disposal of the X facility is reflected more favorably in that state’s property factorwhen the annual method is used.

p. 15-20

47. a. State A Income Tax

Total apportionable income ($1,000,000� $500,000) $500,000


Sales $2,500,000/$6,500,000 = 38.46%Property $1,000,000/$3,500,000 = 28.57%Payroll $800,000/$2,000,000 = 40.00%

Total 107.03%

State A apportionment factor (107.03%/3) � 35.68%

Taxable income apportioned to State A $178,400State A tax rate � 8.00%

State A tax liability, if unitary $ 14,272

State B Income Tax

Total apportionable income ($1,000,000� $500,000) $500,000


Sales $4,000,000/$6,500,000 = 61.54%Property $2,500,000/$3,500,000 = 71.43%Payroll $1,200,000/$2,000,000 = 60.00%

Total 192.97%

State B Apportionment Factor (192.97%/3) � 64.32%

Taxable income apportioned to State B $321,600� 11.00%

State B tax liability $ 35,376



State A tax liability $ 14,272State B tax liability 35,376

Overall state tax liability, if unitary $ 49,648

b. True Corporation, State A ($500,000� 8%) $ 40,000Trumaine Corporation, State B ($1,000,000� 11%) 110,000

Aggregate state income tax, if nonunitary $150,000

c. OFFICIAL CORRESPONDENCE

November 3, 2006

To: Board of DirectorsTrumaine Corporation1234 Mulberry LaneChartown, AL 35298

From: Alison Brown, CPA, MST

Re: Unitary treatment of operations of the True and Trumaine Corporations

Some states apply a so-called unitary approach in computing the income tax liabil-ities of corporations doing business within its borders. When the unitary theory is ineffect, operating income and losses, and indicators of the level of in-state businessactivities are computed taking into account all of the other entities related to the cor-poration.

Unitary computations are favorable to a taxpayer when related corporations gener-ate operating losses or generally are less profitable than the taxpayer. When more-profitable entities enter the mix, state tax liabilities tend to increase. Similarly, if aunitary group can shift taxable income into low- and no-tax states, the overall taxliability of the group will decline.

Similarly, if a unitary group can shift taxable income into low- and no-tax states, theoverall tax liability of the group will decline.

Related corporations generally are found to constitute a unitary group where theirownership, operations, and corporate decision-making are interrelated.

I have determined that, if True and Trumaine are found to be a unitary group, thecombined A and B income tax liability for the group will be cut by more than two-thirds (i.e., from $150,000 to about $50,000). This happens essentially because ofour ability to shift more taxable income into A, a lower tax rate state.

I recommend that we undertake to establish and document our position that Trueand Trumaine constitute a unitary group and to inform the A and B revenue depart-ments of that fact, as soon as possible.

pp. 15-22 to 15-24 and Examples 24 and 25



48. Because of the water’s edge election, the sales to the Despina customers are not includedin either state’s sales factor.

State Entity Sales Factor

B Gerald $10 million/$25 million = 40.00%Q Unitary group $35 million/$45 million = 77.78%

pp. 15-23, 15-24, Concept Summary 15-1, andGlobal Tax Issue on p. 15-25

49. MEMORANDUM

November 3, 2006

To: Shareholders of Hernandez Corporation5678 Alabaster CircleKoopville, KY 47697

From: Dustin Greene, CPA, MST

Re: Tax liability of the corporation this year

We elected so-called S corporation status at the Federal level long ago. This election elimi-nates the exposure of corporate income to double taxation—the corporate level tax is zero,but all of the taxable income for the year passes through to the shareholders proportion-ately and is taxed to them immediately.

Not all of the states recognize the S election in computing corporate and individual incometaxes. In our case, one of the states in which we do business (Z) taxes Hernandez as a reg-ular or ‘‘C’’ corporation, while our other state (Y) applies the S election for its purposes. Thismakes our tax computation more complicated—corporate taxable income must be com-puted in the aggregate and then apportioned among the states, based on the sales, prop-erty, and payroll activities in each. Here is a summary of my determinations of Hernandez’stax liabilities for this year.

State Y

Since Y recognizes S corporation status, Hernandez is not subject to tax on any of itsincome in that state. The income of the corporation is passed through to the shareholders;such income then is subject to tax at the shareholder level.

State Z

Since Z does not recognize S corporation status, Hernandez is subject to tax in the samemanner as a C corporation. Hernandez’s taxable income before apportionment, deter-mined as though it were a regular corporation, is $518,000. By applying the Z apportion-ment formula to this amount, Hernandez is subject to a corporate level tax on $173,167.

Income determined as though it were a C corporation

Ordinary business income $500,000Taxable interest income 10,000Capital loss (–0–)*Dividend income 40,000



Income before dividends received deduction $550,000Dividends received deduction ($40,000� 80%) (32,000)

Taxable income $518,000

*Corporations can offset capital losses only against capital gains.

Z Taxable Income

Sales $800,000/$1,800,000 = 44.44%Property $200,000/$700,000 = 28.57%Payroll $300,000/$1,100,000 = 27.27%

Total 100.28%

Average (100.28%/3) 33.43%

Taxable income $518,000Z apportionment percentage � 33.43%

Z taxable income $173,167

pp. 15-26, 15-27, and Example 26

50. Businesses are merely the collection agents for the states with regard to the sales tax.Thus, Grande must collect and remit, to the state, tax on the $700,000 general salestransactions. Medical devices and out-of-state sales are exempt from this collectionrequirement, although use tax might be due on the mail-order sales. On the goods Grandepurchased from its supplier, neither party need collect and remit the tax. A resale exemp-tion applies in virtually all states, so that only the ultimate consumers of the goods—here,Grande’s customers—pay tax on the transaction. pp. 15-28 and 15-29

51. a. 6% sales tax rate� $60,000 office supplies= $3,600.

Granite is the final consumer of the office supplies, so it must pay the sales tax onsuch materials to the vendors from whom purchases are made. Other supplies andtools used in the assembly process to create the computer systems are exemptfrom tax, in anticipation of the subsequent resale of the systems. The final consum-ers of those systems are liable for the tax thereon.

b. 6% sales tax rate � ($1,400,000 software sales + $3,500,000 computer sales) =$294,000. No reductions to the tax base are made for cost of sales or packagingmaterials.

pp. 15-28 and 15-29

52. a. S.

b. N. Probably exempt as a targeted item.

c. U.



d. N. Probably exempt because of charitable status.

e. N. Probably exempt under the resale rule.

p. 15-28

53. Net Worth Assets $1,700,000Liabilities (950,000) $750,000

Apportionment Sales Factor 0.40

Property Factor[$300,000/$1,200,000] 0.25

0.65/2= � 0.325

Net Worth Apportioned to A $243,750Tax Rate � 3%

Liability $ 7,313

Since property includes only real and tangible property, the cash of $500,000 is not in thedenominator.


54. The home state payroll factor drops from .750 ($1,500,000/$2,000,000) to .697($1,150,000/$1,650,000). p. 15-38 and Example 36

55. Presentation outline

l Select Optimal States in which to Operatel Put losses into high-tax states

l Research divisionl Inventory

l Put profits into no- and low-tax states

l Nexusl When to avoid itl When to create it

l Investment Subsidiariesl What they accomplishl How to organize theml Not good in unitary statesl Court case challenges

l Apportionment Factor Planningl Sales factor

l Shipping methodl Recordkeepingl Property factor



l Leasesl Idle property

l Payroll factorl Relocating executivesl Using independent contractors

pp. 15-32 to 15-38

The answers to the Research Problems are incorporated into the 2007 Corporations Volume ofthe Instructor ’s Guide with Lecture Notes to Accompany WEST FEDERAL TAXATION: CORPO-RATIONS, PARTNERSHIPS, ESTATES & TRUSTS.



NOTES


Documents

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