Income Tax Nexus

NEXUS AFTER WAYFAIR: MULTI-STATE TAXATION OF BUSINESSES (MSTB)

Ed Zollars, CPA (Arizona) www.currentfederaltaxdevelopments.com Download update and slides at www.currentfederaltaxdevelopments.com/way19

• States are moving to deal with Wayfair (vast majority have established standards tied to the Wayfair opinion) • US Supreme Court takes on state tax reach again—this time in Trusts – Kaestner Trust decision due from SCOTUS (perhaps today) – May tell us if SCOTUS looks to use Wayfair to settle state tax issues in general or if we are going to see tax type specific changes • States are pushing income tax reach as well (Capital One case in Oregon last year)

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• Importance of Multistate Taxation • Personal Income Tax Considerations • Sales Tax/Use Tax Nexus Developments • Sales Tax Issues and Other Controversies • Income Tax Nexus • Determining State Taxable Income • Apportionment and Allocation of Income • Taxing Pass-Through Entities • Considering Tax Planning Opportunities www.currentfederaltaxdevelopments.com/way19

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© Kaplan, Inc. 4 2018 STATE BUSINESS TAX CLIMATE INDEX—TAX FOUNDATION (CONT.) • No major tax as common factor among many top 10 states • Property taxes and unemployment insurance taxes levied in every state • Several states do without one or more of the following major taxes: – Corporate income tax – Individual income tax – Sales tax

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© Kaplan, Inc. 5 2018 STATE BUSINESS TAX CLIMATE INDEX—TAX FOUNDATION (CONT.) • Wyoming, Nevada, South Dakota—no corporate or individual income tax • Nevada—imposes gross receipts taxes • Alaska—no individual income or state-level sales tax • Florida—no individual income tax • New Hampshire, Montana, Oregon—no sales tax • Indiana, Utah—all major tax types, but with low rates on broad bases

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© Kaplan, Inc. 6 2018 STATE BUSINESS TAX CLIMATE INDEX—TAX FOUNDATION (CONT.) • The bottom 10 states tend to have numerous shortcomings in common: – Complex, non-neutral taxes with comparatively high rates • New Jersey is a good example of why it is last: – Some of the highest property tax burdens in the country – One of just two states to levy both an inheritance tax and an estate tax (for now) – Some of the worst-structured individual income taxes in the country

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• Notable Changes • Kansas—Addressed structural deficits with • Arizona—Improved six places on the Index’s a new income tax bracket and a 5.2% top corporate component as a multiyear rate, slipping three places on the Index phasedown concluded with a 4.9% corporate • New Mexico—Continued phase-in of income tax rate corporate income tax reductions improved • California—Extended income but not sales tax the state one place on the Index’s hikes, though local sales tax increases dropped corporate tax component California in the Index’s sales tax component • North Carolina—Reduced the corporate • District of Columbia—Continued tax reform rate to 3% and the individual rate to efforts (including a corporate rate cut) improved 5.499%, improving the state’s individual D.C. two places on the Index’s corporate component income component ranking • Illinois—Hiked both individual (3.75% to 4.95%) • Rhode Island—Unemployment insurance and corporate (7.75% to 9.50%) income tax tax reform drove its Index UI component rates, dropping the state from 28th to 29th on rank from 50th to 23rd and improved the the Index state to 41st overall www.currentfederaltaxdevelopments.com/way19

• For the complete report, visit: – https://taxfoundation.org/publications/state-business-tax-climate-index/ or – https://files.taxfoundation.org/20171016171625/SBTCI_2018.pdf • Or, visit http://taxfoundation.org/ – Click “State Taxes” – Then, scroll down to “Major Publications” and click link to “State Business Tax Climate Index”

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• http://taxfoundation.org

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• Federal partnership audit reform effective 2018 – Tax assessed at partnership level – Limited opt-out allowed • Tax discrimination decisions based on different business models instead of actual goods or services provided – Examples: ➢ Cable vs. satellite ➢ Taxi vs. rideshare ➢ Hotels vs. online lodging

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• Indiana University sales tax expert John Mikesell addressed the Nebraska Tax Reform Commission: – ‘‘Your objective of tax policy is to get your revenue system to behave like a pickpocket—and not like a mugger.’’

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General Sales Individual Corporation Severance Documentary Total 2014 and Gross Income Taxes Net Income Taxes and Stock State Tax Receipts Taxes Transfer Taxes Collections Taxes 271,956,649 310,956,374 46,275,970 17,778,758 6,823,581 653,791,332

41.6% 47.6% 7.1% 2.7% 1.0% 100%

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• Taxing Marijuana: The Washington and Colorado Experience – Tax Foundation Fiscal Fact – No. 437, August 2014

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• Because marijuana can be purchased as a cigarette, an edible, a liquid, or vapor—all with a wide variety of concentrations—a specific excise tax is untenable. • Colorado collects tax revenue from marijuana sales through a 15% excise- based tax on the average wholesale market rate; a 10% state tax on retail marijuana sales; a state sales tax of 2.9%; varied local sales taxes; and local marijuana taxes, such as a 3.5% tax in Denver.

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• Washington State collects tax revenue from marijuana sales through a 25% tax on producer sales to processors; a 25% tax on processor sales to retailers; a 25% tax on retailer sales to customers; a state business and occupation (B&O) gross receipts tax; a state sales tax of 6.5%; and varied local sales taxes. – The total effective tax rate is about 44%. • Tax collections in Colorado have fallen short of projected revenue estimates, whereas collections in Washington have fallen within the wide range of project revenue estimates.

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• Colorado’s marijuana revenue shortfall is due to incorrect projections about the switch from lower-taxed medical marijuana to higher-taxed retail marijuana by consumers. • States with possible upcoming ballot initiatives should take note of effective and ineffective methods of taxing marijuana, as the issue is likely to expand.

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“Sales taxes are some of the most easily understood taxes because every time a consumer makes a purchase, they can see the rate on the receipt.”

—Tax Foundation economist Scott Drenkard

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• There are 45 states that collect statewide sales taxes. • There are 38 states that collect local sales taxes. • The 5 states with the highest average combined state-local sales tax rates are as follows: – Louisiana (10.02%) – Tennessee (9.45%) – Arkansas (9.34%) – Washington (9.20%) – Alabama (9.03%)

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• There are 5 states that do not have statewide sales taxes: – Alaska – Delaware – Montana – New Hampshire – Oregon • Alaska and Montana allow localities to charge sales taxes. • There are 5 states with the lowest average combined rates: – Alaska (1.76%) – Hawaii (4.35%) – Wyoming (5.26%) – Wisconsin (5.42%) – Maine (5.5%) www.currentfederaltaxdevelopments.com/way19

• Sales tax rates differ by states, but sales tax bases also impact how much revenue is collected from a tax and how the tax affects the economy. • Differences in sales tax rates cause consumers to shop across borders or buy products online.

(a) City, county, and municipal rates vary. These rates are weighted by population to compute an average local tax rate. (b) Three states levy mandatory, statewide, and local add-on sales taxes at the state level: California (1.25%), Utah (1.25%), Virginia (1%) we include in their state sales tax. (c) The sales taxes in Hawaii, New Mexico, North Dakota, and South Dakota have broad bases that include many services. (d) Special taxes in local resort areas are not counted here. (e) Salem County is not subject to the statewide sales tax rate and collects a local rate of 3.3125%. New Jersey’s average local score is represented as a negative.

Sources: Sales Tax Clearinghouse, Tax Foundation calculations, State Revenue Department websites.

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1. The Census Bureau of the Department of Commerce’s estimate of U.S. retail ecommerce sales for the first quarter of 2015—adjusted for seasonal variation, but not for price changes—was $80.3 billion, now 7% of total retail sales. 2. Researchers estimated in April 2009 that total state and local revenue loss from new ecommerce in 2012 will be approximately $11.4 billion. 3. California alone was projected to lose $1.9 billion; Texas, $870.4 million; and New York, $865.5 million.

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4. State governments rely on sales and use taxes for nearly one-third (32%) of their total tax revenue. 5. Local governments derive 11.2% of their tax revenue from sales and use taxes. 6. In 1932, Mississippi was the first state to impose a general state sales tax. By 1940, 23 other states implemented a general sales tax. 7. By the late 1960s, 45 states and the District of Columbia enacted a general sales tax. The last state to enact one was Vermont in 1969.

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8. In 34 states and the District of Columbia, groceries are exempt from state and local sales taxes or taxed at a lower rate. 9. The Internet Tax Moratorium prohibits new taxes on internet access services and multiple or discriminatory taxes on internet commerce. Congress has (four times) extended this law, most recently until December 11, 2014. This moratorium has nothing to do with the use tax collection issue. The Permanent Internet Tax Freedom Act, H.R. 235, was passed by the House in June and is currently in the Senate Finance Committee.

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• Issue: – Whether a company's selling method or business operations within a state are sufficient to require it to collect sales/use taxes • Risk: – Failure to collect the tax can result in significant tax liability for the company, with little or no hope of obtaining reimbursement from the seller's in-state customers

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• National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967) – Mail-order business

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• National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967) – Mail-order business – “. . . The resulting impediments upon the free conduct of its interstate business would be neither imaginary nor remote.” • U.S. Constitution, Article I, Section 8, Clause 3 – “The Congress shall have power . . . to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.”

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• Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1974) – “. . . For the privilege of engaging or continuing in business or doing business.” – The tax must satisfy a four-pronged test: ➢ Activity with a substantial nexus to taxing state ➢ Be fairly apportioned ➢ Not discriminate against interstate commerce ➢ Fairly related to the services provided by the state

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• Oklahoma Tax Commission v. Jefferson Lines, Inc., 514 U.S. 175 (1995) – Is apportionment needed? – “The taxable event comprises agreement, payment, and delivery of some of the services in the taxing State. No other State can claim to be the site of the same combination.” • Congress reacted passing Section 14505, Interstate Commerce Commission Termination Act [P.L. 104-88, 12/29/1995] to override Jefferson Lines

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• Goldberg v. Sweet, 488 U.S. 252 (1989) – 2nd prong—apportionment; internally consistent ➢ This is to “ensure that each State taxes only its fair share of an interstate transaction.” – 3rd prong—nondiscriminatory; externally consistent ➢ “It is not a purpose of the Commerce Clause to protect state residents from their own state taxes.” – 4th prong—fairly related ➢ This “focuses on the wide range of benefits provided to the taxpayer, not just the precise activity connected to the interstate activity at issue.” www.currentfederaltaxdevelopments.com/way19

• Quill Corporation v. North Dakota, 504 U.S. 298 (1992), May 26, 1992 – North Dakota Supreme Court: ➢ Quill in effect asks us to accept the notion that the United States Supreme Court will abandon its common sense and experience at the courthouse door and ignore the tremendous social, economic, commercial, and legal innovations since 1967, and blindly apply an obsolescent precedent. ➢ The economic, social, and commercial landscape upon which Bellas Hess was premised no longer exists, save perhaps in the fertile imaginations of attorneys representing mail-order interests.

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• Due process – Minimum contact; fairness – Subject itself to the state's jurisdiction ➢ In “modern commercial life,” it matters little that such solicitation is accomplished by a deluge of catalogs rather than a phalanx of drummers: “The requirements of due process are met irrespective of a corporation's lack of physical presence in the taxing State.” • Commerce clause – Need substantial nexus – A means for limiting state burdens on interstate commerce www.currentfederaltaxdevelopments.com/way19

• Two “substantial nexus” theories – Any physical presence – Regular, continuous, meaningful • Agency nexus • Affiliate or “alter-ego” nexus • Responses to states’ actions – Separating parts of the business – Licensing agreements – Independent sales force www.currentfederaltaxdevelopments.com/way19

• Aggressive state compliance enforcement • What is substantial? • Trade show attendance – Conditional presence – De minimis exception – Temporary nexus – Substantial nexus

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• “Congress is now free to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes.” Quill, May 26, 1992 • Motivations – Competitive disadvantage – Loss of revenues for essential services • Set de minimis thresholds • Look at internet influence • Marketplace Fairness Act of 2015—S.698, H.R. 2775 (Remote Transactions Parity Act of 2015) • Digital Goods and Services Tax Fairness Act of 2015 (H.R. 1643, S.851) www.currentfederaltaxdevelopments.com/way19

Principle Discussion 1. Tax Relief Using the internet should not create new or discriminatory taxes not faced in the offline world. Nor should any fresh precedent be created for other areas of interstate taxation by states. 2. Tech Neutrality Brick-and-mortar, exclusively online, and ‘‘brick and click’’ businesses should all be on equal footing. The sales tax compliance burden on online internet sellers should not be less, but neither should it be greater than that on similarly situated offline businesses. 3. No Regulation Without Those who would bear state taxation, regulation, and compliance burdens should have Representation direct recourse to protest unfair, unwise, or discriminatory rates and enforcement. 4. Simplicity Governments should not stifle businesses by shifting onerous compliance requirements onto them; laws should be so simple and compliance so inexpensive and reliable as to render a small business exemption unnecessary. 5. Tax Competition Governments should be encouraged to compete with one another to keep tax rates low and American businesses should not be disadvantaged vis-á-vis their foreign competitors. 6. States’ Rights States should be sovereign within their physical boundaries. In addition, the federal government should not mandate that states impose any sales tax compliance burdens. 7. Privacy Sensitive customer data must be protected. www.currentfederaltaxdevelopments.com/way19

For Legislation Against Legislation 1. This enables collection of a tax that has previously been owed but 1. This is a new tax burden on the consumer. uncollected. 2. Free software provided by the states to calculate tax to the state 2. Must become tax experts in thousands of jurisdictions. governments. 3. Offers relief from liability in many cases. Far less likely to be audited 3. Could potentially be subject to the audits of 45 states and the District than a brick-and-mortar company. of Columbia. 4. Protects small businesses from complying with MFA. 4. Small business exception needs to be higher. 5. Levels the playing field; online retailers would now be required to 5. Brick-and-mortar businesses would be at an advantage because they collect tax regardless of nexus. do not have to report tax on its destination, only remit based on origin. 6. Software will generate the sales tax returns to the various states. 6. Potential to complete over 600 sales tax returns per year with no “free” help. 7. Tax collected and remitted to the state by the seller but paid by the 7. Taxation without representation. purchaser. 8. Studies show billions of dollars uncollected on sales tax revenues to 8. Online sales are already dominated by big-box retailers (like Wal-Mart) the states, which are in need of revenue to provide services. that are already required to collect and remit the tax.

9. Quill specifically mentions Congress reversing the Supreme Court’s 9. Quill found businesses with no nexus to the state are not required to decision through legislation. collect and remit sales tax to that state. 10.“Free” software will require businesses to re-categorize all products to comply. 11. Customers outside the United States would be able to purchase from U.S. companies and not have to pay tax. www.currentfederaltaxdevelopments.com/way19

• Economist Arthur Laffer – Argues that taxing online sales—or more accurately, collecting the online tax that is already due—could be a bonanza for the U.S. economy – Promotes the potential economic benefits of the federal Marketplace Fairness Act

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• Tenth Circuit Court of Appeals dismissed lower court’s permanent injunction • “We reverse because the Colorado Law does not discriminate against nor does it unduly burden interstate commerce.” – The court had enjoined Colorado from enforcing its Amazon law. – There are three principal obligations on noncollecting retailers whose gross sales in Colorado exceed $100,000. They must do the following: 1. Provide transactional notices to Colorado purchasers 2. Send annual purchase summaries to Colorado customers 3. Annually report Colorado purchaser information to the Department – Alternatively, retailers may choose to collect and remit sales tax from Colorado purchasers to forgo notice and reporting obligations. www.currentfederaltaxdevelopments.com/way19

• California held that the Tax Injunction Act (TIA) precludes federal jurisdiction over claim that Colorado’s law violates the Commerce Clause of the U.S. Constitution [Direct Marketing Association v. Brohl, No. 12-1175 (Tenth Cir. 8/20/13)]. • Case remanded to district court to: – Dismiss Commerce Clause claims, and – Lift permanent injunction the lower court had imposed. • [Direct Marketing Association v. Huber, No. 1:10-CV-01546-REB-CBS (D. Colo 3/30/12)] • Any further proceedings in the case must begin in Colorado’s courts or administrative agencies. • The Supreme Court reversed and ruled that the federal courts did have jurisdiction. www.currentfederaltaxdevelopments.com/way19

• The Tenth Circuit panel did not find – This case governed by Quill, nor – That the law unconstitutionally discriminates against and burdens interstate commerce. • The Supreme Court has generally not expanded upon Quill beyond forced collection of sales and use taxes for businesses not having a physical presence in the state. • This provision does not give in-state sellers a competitive advantage over out-of- state sellers. • In-state sellers must actually collect and pay over a sales tax. • Direct Marketing Association v. Brohl, 814 F.3d 1129—Court of Appeals, Tenth Cir. 2016 www.currentfederaltaxdevelopments.com/way19

• July 2017—Colorado adopts regulations to implement the tattletale rule and enforcement begins – Emergency Rule 39-21-112(3.5) – Total gross sales into Colorado $100,000 or more in a calendar year – Provide notice, purchase summary, and customer information • March 2018—Colorado begins receiving reports from out-of-state sellers – First reports due by March 1, 2018 – Received reports on over 800,000 people or businesses – Amounts purchased totaling over $250 million – Results were deemed “disappointing” www.currentfederaltaxdevelopments.com/way19

© Kaplan, Inc. 61 CITATION: STATE OF SOUTH DAKOTA V. WAYFAIR, SD SC, CASE NO. 28160, 9/14/17 • South Dakota Supreme Court rules on challenge to Quill in favor of Wayfair • Set up U.S. Supreme Court to reconsider Quill

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© Kaplan, Inc. 63 CITATION: STATE OF SOUTH DAKOTA V. WAYFAIR, SD SC, CASE NO. 28160, 9/14/17 (CONT.) • Oral arguments heard April 18, 2018 • Quote of the day from Justice Breyer: – “When I read your briefs, I thought ‘absolutely right.’ And then I read through the other briefs, and I thought, ‘absolutely right.’ And you cannot both be absolutely right.” • Decision rendered June 21, 2018

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• Washington state adopts tattletale bill with very low sales minimums • Triggered whenever remote seller in a year has more than $10,000 in gross sales to Washington state residents • Requires notice on selling platform and notice to each customer • Annual reporting requirement to customer and to state

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• HB 1019 required out-of-state vendors to notify customers of potential Oklahoma use tax liability by February 1 of each year – Passed and signed April 10, 2018 • SB 337 passed by legislature April 23, 2018, required sellers to either collect and remit sales taxes or send notices, expanding HB 1019 – Governor vetoed SB 337 on April 25, 2018

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• Applies if you sell more than $200,000 into the state or have more than 200 transactions with buyers in the state • Penalties more in line with standard information return penalties; one is less of a problem – 200 transaction issue likely to trip up more sellers than $200,000 in sales, unless seller has average online invoices of $1,000+ • Sent to governor April 5, 2018

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© Kaplan, Inc. 68 CITATION: NORMAND V. WAL-MART.COM USA LLC; 24TH JUDICIAL DISTRICT COURT, JEFFERSON PARISH, NO. 769-149 (3/2/18) • Louisiana tax law imposes obligation on dealer to collect and remit sales and use taxes – Walmart.com argued it had no obligation to collect from customer and remit local sales and use taxes on marketplace program transactions except for its own product sales – It was not retail seller or dealer on these transactions • Court held statutory definition of dealer not limited to retail seller – “Clearly applies to its marketplace program”

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• Chief Judge Jonathan Lippman – “The world has changed dramatically in the last two decades, and it may be that the physical presence test is outdated. An entity may now have a profound impact upon a foreign jurisdiction solely through its virtual projection via the internet. That question, however, would be for the United States Supreme Court to consider. We are bound, and adjudicate this controversy, under the binding precedents of that Court, the ultimate arbiter of the meaning of the Commerce Clause.” • Overstock.com Inc. v. Department of Taxation and Finance, 2013 NY Slip Op 02102 [20 NY3d 586] (Ct. App. 3/28/2013); cert denied 12/3/2013

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• Defining • Sourcing • Solving

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• Tangible personal property—anything perceptible to the senses • Tangible personal property equivalents—sale or use in an electronic form rather than physical is still taxed • Streamlined sales tax project definition—specified digital products • Service—accessing digital products is a service

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• Difficulties for traditional definitions – Multiple locations – Multiple users – Multiple devices – Multiple servers

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• SSUTA general sourcing guidance for digital goods – If digital good received by purchaser at location of seller, seller sources sale to that location – If product not received at a location of seller, seller sources sale to location where purchaser receives product, so long as location is known to seller – If neither of above rules applies, seller sources to location for purchaser available from seller's business records or to address for purchaser obtained during consummation of sale – If none of above rules applies, seller sources to location from which product was provided

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• “Receipt" or “receive“—taking possession or making first use of digital goods, whichever comes first • Origin-based sourcing—retailer to source sale of digital goods to where order is received by seller if certain criteria are met

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• Congressional (in)action—Digital Goods and Services Tax Fairness Act of 2015 (H.R. 1643, S. 851) • Different from SSUTA

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NEXUS: SALES AND USE TAX NEXUS AFTER WAYFAIR

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• Physical Presence Test • Impact of the Internet • Unfair Advantage/Tax Evasion • Limiting States • SD Act as Template • Will Congress Act?

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• New Jersey – 1st Wayfair Law • Wisconsin begins on 10/1/18 • Alabama also begins 10/1/18 • Louisiana begins on 1/1/19 • South Carolina will use South Dakota limits • North Dakota – 10/1/18 • Utah – 1/1/19 • Minnesota – 10/1/18 www.currentfederaltaxdevelopments.com/way19

• Majority of states with sales tax now have out of state collection rules – Indiana – Kentucky – Nebraska • North Carolina – 11/1/18

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• Found in additional material – maintained as part of State Tax Today • Most states have adopted Wayfair economic nexus law or rules, as well as marketplace rules • Triggers – $100,000 is the most popular trigger along with 200 transactions (Wayfair) – Seeing a move to remove the transaction trigger (or NY’s requirement to meet both tests) – Also seeing some states move to a higher revenue number • Note effective dates are either in the past or will happen soon • Still some states that may take action in the future www.currentfederaltaxdevelopments.com/way19

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• In-state sales • In-state deliveries • De minimis presence

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• Used by almost every state • Reduced expense and time • Must take state to court to throw out

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• Pursuing sales tax liabilities – Assessment against business that cannot be sustained – Rational basis for issuance against individual • Usually officers and owners

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• Sales tax issues do not equal income tax issues • Sale of business should be exempt from sales tax • Reorganization provisions of IRC defer tax, not avoid it

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• Who should collect sales/use tax? • Manufacturer is not liable—approximately 31 states – Resale exemptions • States that deem manufacturer to be distributor – Manufacturer liable to collect • Goods ordered online

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• Unclaimed, abandoned, escheat property • Which state is entitled to claim it? • Compliance and enforcement traps

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© Kaplan, Inc. 93 HOUSE PASSES THE MOBILE WORKFORCE TAX SIMPLIFICATION BILL (H.R. 1393) • The bill prohibits the wages or other remuneration earned by an employee who performs duties in more than one state from being subject to income tax in any state other than: – (1) the state of the employee’s residence, and – (2) the state within which the employee is present and performing employment duties for more than 30 days during the calendar year. • Exempts employers from withholding of tax and information reporting requirements for employees not subject to income tax under the act • Allows employer, for purposes of determining penalties related to employer withholding or reporting requirements, to rely on employee's annual determination of time such employee will spend working in a state in absence of fraud or collusion by such employee • For purposes of the act, definition of employee excludes professional athletes, professional entertainers, and public figures who are persons of prominence who perform services for wages or other remuneration on per-event basis • Nonheadline performers, including dancers and musicians, would be covered by 30-day national standard www.currentfederaltaxdevelopments.com/way19

A LOOK AT THE CHANGING ENVIRONMENT FOR STATE SALES TAX AND INCOME TAX NEXUS

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• Olivia Newton-John was born (September 26, 1948) in Cambridge, England, to a Welsh father, Brinley ("Bryn") Newton-John, and a German mother, Irene Born (the eldest child of the Nobel prize–winning atomic physicist Max Born).

• Max Born (December 11, 1882–January 5, 1970) was a German-born physicist and mathematician who was instrumental in the development of quantum mechanics. He also made contributions to solid-state physics and optics and supervised the work of numerous notable physicists in the 1920s and 1930s. Born won the 1954 Nobel Prize in Physics (shared with Walther Bothe).

• Newton-John is the youngest of three children, following brother Hugh, a doctor, and sister Rona, an actress once married to Grease co-star Jeff Conaway.

• Newton-John's father was an MI5 officer on the Enigma project at Bletchley Park and was the officer who took Rudolph Hess into custody during World War II. Newton-John's family emigrated to Melbourne, Australia, in 1954 where her father worked as a professor of German and master of Ormond College at the University of Melbourne. www.currentfederaltaxdevelopments.com/way19

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• State of incorporation has jurisdiction to tax • Right to tax business depends on sufficient connections – Nexus describes degree of connection – Sufficient connection determined by amount of activity ➢ Legal existence ➢ Property location ➢ Services performed

• Limit to states’ rights to impose tax on interstate activity • Mere solicitation of orders is not sufficient • Applies to “net income” • Does not extend to the following: – Selling or providing services – Leasing or renting personal property – Real or intangible property

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• “Solicitation" of orders includes: – any explicit verbal request for orders, and – any speech or conduct that implicitly invites order. • Not subject to net income tax when activities within a state are either: – ancillary to requesting orders of tangible property, or – de minimis.

• Model law—allocation and apportionment of income among states for corporations with multistate operations • Mere registration and qualification “to do business” does not create nexus

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• Public Law 86-272 – Immunity to certain in-state activities conducted by independent contractors – Would not be permitted if performed directly by the business • Third-party repair services creates nexus • Nexus standards for income taxes not the same as—or lower than—sales taxes

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• Physical vs. economic presence • Intangible holding companies • Geoffrey v. South Carolina – Physical presence not required in net income tax cases – “Minimum connection" and "substantial nexus“ satisfies due process clause and commerce clause of U.S. Constitution

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• Use of subsidiary or affiliate with presence of the following: – Intangible asset – Account receivable • Recent cases involving the following: – Trademarks – Credit cards – Software • U.S. Supreme Court continues to avoid

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• Lack of economic substance • Statutory add-back • Unitary reporting • Restricted nexus • Tax other than net income

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• Business income – Transactional: activities – Functional: assets • Nonbusiness income

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• A majority of states now have some form of market based sourcing for some or all service sales – and the number continues to grow • However, a substantial number still use location services performed for some or all service sales • Market sourcing – sale is sourced to where service is consumed – Some states use contract for this purpose – Others use the ultimate consumer – And if services performed in a services performed state a lot of states may claim the same sale

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• UDITPA – Jurisdiction – Subject to tax • Apportionment or allocation • Business vs. nonbusiness income • Apportionment formulas – Sales – Property – Payroll www.currentfederaltaxdevelopments.com/way19

• Consolidated returns • Combined unitary returns • Unitary tests • Benefits and detriments of consolidated or combined reporting • Sale of subsidiary stock • Income in the return – Transactional – Functional

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Outside these, four walls lies, anarchy babe Unnatural acts and sights abound Glass glaring, eyes staring, young pairing, maybe What does the world care if I'm not around

Cos, I think I'd rather stay at home With people I know I could watch the whole thing on TV And the neighbors never know Men At Work, “Stay At Home” www.currentfederaltaxdevelopments.com/way19

• Pass-through business income taxed on businessowners’ tax returns through individual income tax code • Pass-through business income faces marginal tax rates that exceed 50% in some states • Pass-through businesses face only one layer of tax on profits compared to double taxation faced by C corporations

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• The number of pass-through businesses has nearly tripled since 1980, while the number of traditional C corporations has declined. • Pass-through businesses earn more net business income than C corporations. • Pass-through businesses employed more than 50% of the private sector work force and accounted for 37% of total private sector payroll in 2011.

www.currentfederaltaxdevelopments.com/way19

• Although pass-through businesses are smaller than C corporations on average, they are not all small businesses. Many people work for large pass- through companies. • Most pass-through business income is taxed at top individual tax rates. • Tax reform aimed at improving the competitiveness of U.S. businesses needs to address the individual income tax code due to the economic importance of pass-through businesses.

www.currentfederaltaxdevelopments.com/way19

• Recognize entity, but then what? – Disregard status – Impose special tax – Tax both entity and shareholders • Nonresident shareholder reporting • Collection of tax – Agreement – Withholding – Composite www.currentfederaltaxdevelopments.com/way19

• Determining income – Mere shareholder – Trade or business connected with state – Harrison case—narrow view of S corporation subject to taxation and use of losses

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• Corporate partner – General: include share of income and apportionment factors – Limited: some states treat as nonbusiness income • Unitary vs. nonunitary treatment • Composite treatment only for individual partners • Reaching nonresident income

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• Owning an interest in an investment partnership or an LLC that has operations in the state is sufficient to create nexus in nearly every state. • All but five states said nexus could arise from owning a nonmanagement interest in an LLC: – Connecticut – The District of Columbia – Georgia – Tennessee – Vermont • Only the District of Columbia and Vermont said a general partnership interest would not trigger nexus. www.currentfederaltaxdevelopments.com/way19

• Every state has its own statute • Most follow federal treatment – May be partnership – May be corporation – May be taxed at entity • Single-member LLC – Disregarded entity – Similar to consolidated or unitary returns