Comply with State Laws Using State-By-State Apportionment Schedules
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WHITE PAPER Comply with State Laws Using State-by-State Apportionment Schedules A version of this white paper was previously published in the June 2018 edition of the Journal of Multistate Taxation and Incentives. 02 APPORTIONMENT SCHEDULES BY STATE Determining the appropriate sales factor numerator and denominator 02 PASS-THROUGH ENTITY APPORTIONMENT CONSIDERATIONS: requires navigating multiple, often contradictory state tax rules—especially CURRENT OPERATIONS for a taxpayer with several sources of revenue, complex operations, and a AND TRANSACTIONS potentially global reach. The increasingly common practice of conducting business through pass-through entities (PTEs), such as limited liability 04 INCLUDING TRANSACTIONS companies (LLCs), adds another dimension to the analysis. WHEN CALCULATING THE When a taxpayer disposes of its investment in a business contained SALES FACTOR: BASE RULES in a PTE, either through selling the assets or selling the interest in the 05 INCLUDING TRANSACTIONS WHEN PTE, various state rules—either statutory or developed through case CALCULATING THE SALES FACTOR: law—may apply. The taxpayer may need to analyze whether, and how, the EXCLUSION FOR SUBSTANTIAL transaction should be reflected in the sales factor and documented in the RECEIPTS FROM OCCASIONAL SALES apportionment schedules. 06 ANALYSIS OF THE EXCLUSION Taxpayers should also consider new, potentially significant changes OF SUBSTANTIAL RECEIPTS resulting from tax reform, commonly known as the Tax Cuts and Jobs Act FROM OCCASIONAL SALES: (TCJA). One such addition is the new class of Subpart F Income, which is TREATMENT OF GOODWILL AND effective for tax years ending on December 31, 2017. OTHER INTANGIBLE ASSETS 07 STATE SOURCING OF RECEIPTS 09 MARKET SOURCING AND THE REVISED MTC REGULATION 10 DIVIDENDS 13 CONCLUSION The material appearing in this communication is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although this information may have been prepared by professionals, they should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC. STATE APPORTIONMENT / WHITE PAPER MOSS ADAMS 02 APPORTIONMENT SCHEDULES BY STATE Each state can have its own set of rules for schedules during the audit. However, displaying the apportionment—such as income from a PTE, income numerators and denominators on a single spreadsheet from dividends, and income realized on the disposition according to each state’s rules is a multidimensional of a PTE. The rules affect not just the computation of a problem that’s extremely cumbersome—if not given state’s numerator, but also whether the income impossible—to solve. should be reflected in the sales factor at all. The following analysis will review the process of In order to document and support its apportionment preparing sales factor apportionment schedules for positions, a taxpayer may have to build separate sales operations transacted through PTEs, and transactions factor apportionment schedules for each state in which involving PTEs, through the rules of five specific it does business—each schedule plotting a different states: California, Colorado, Idaho, New Mexico, and path for the particular state laws. Oregon. The analysis will illustrate the need for several As a strategy, state auditors often demand that sales factor calculations that present the multistate businesses supply their multistate apportionment numerators and denominators according to a specific set of rules. PASS-THROUGH ENTITY APPORTIONMENT CONSIDERATIONS: CURRENT OPERATIONS AND TRANSACTIONS When the Internal Revenue Service (IRS) ruled that Does the state provide for inclusion of a PTE’s income a Wyoming LLC could be taxed as a partnership or loss at the partner level or partnership level? rather than a corporate entity,1 it opened the door A taxpayer that’s computing apportionment factor to additional states authorizing LLC formation. Since numerators and denominators must determine whether that time, the share of taxable income earned by a state treats the PTE as a division of the taxpayer. If PTEs has markedly increased. A linear regression in it does, the taxpayer’s distributive shares of the PTE’s one analytical model shows that corporations’ share apportionment factors—including property, payroll, of taxable income decreased from 50% to 30% from and sales—will be included with the member entity’s 1993 to 2013.2 This means taxpayers have managed standalone factors. If it doesn’t, the member may be compliance with state apportionment rules and their required to include the results of the PTE’s operations application to PTEs for some time. as an allocated item. CURRENT OPERATIONS Oregon & New Mexico Taxpayers Many tax departments have experience with preparing For example, Oregon requires a taxpayer to include their sales factor numerators and denominators from its distributive shares of the PTE’s Oregon sales and ongoing operations conducted through a PTE. To do so, total sales in its own factor.4 This is often referred to as tax departments must answer the following questions. determining the factor at the partner level. Does the state adopt federal entity classifications? Although this process is straightforward in theory, it’s Is a separate election required and, if so, has it easy to forget the importance of having a corporate been met? LLC member obtain apportionment information during Tennessee, for example, will follow the classification for compliance. This information is often omitted from the a single-member LLC owned by a corporation. However, state K-1 and may not be readily available if the member a multimember LLC that’s filing for federal purposes isn’t the tax matters partner. as a partnership will file as a separate entity and pay On the other hand, New Mexico requires that the Tennessee tax on its apportioned business income member’s income include its distributive share of 3 separately from its members. income from the PTE, apportioned to New Mexico STATE APPORTIONMENT / WHITE PAPER MOSS ADAMS 03 using the factors of the PTE. This is often referred to consequences are less clear—taxpayers should analyze as determining the factors at the partnership level. them to avoid unanticipated consequences. To provide additional motivation, New Mexico’s laws For instance, a business that owns a single-member state that if the entity fails to provide the business LLC may bring in additional partners in several different with adequate information, the member must treat ways. Revenue Ruling 99-5 describes two situations, its entire distributive share as apportioned to New discussed below. Mexico.5 SITUATION ONE A taxpayer that owns a PTE operating in New Mexico and Oregon must include apportioned New Mexico An unrelated entity (Purchaser) buys 50% of the income from the entity when preparing its New Mexico owner’s (Seller) interest. Seller doesn’t contribute returns. It must also include its distributive share of any portion of the purchase price to the LLC, which pre-apportioned income and apportionment factors continues to operate as a partnership with two when preparing the Oregon return. In responding to members. In this situation, Purchaser is treated as audit requests, this taxpayer may find it simplest to purchasing a 50% interest in each of the LLC’s assets, prepare two multistate apportionment schedules: one and Seller “recognizes gain or loss from the deemed reflecting the numerators and denominators computed sale of the 50% interest in each asset of the LLC” to using New Mexico rules and one reflecting Oregon rules. Purchaser.10 Unitary Considerations SITUATION TWO Taxpayers should also address unitary considerations. While the term unitary is often used to analyze the An unrelated entity (Purchaser) contributes funds operations of an enterprise with several legal entities, to the LLC in exchange for an ownership interest it’s useful to consider that the unitary principle in the LLC, owned by Seller. The LLC uses all of the was originally developed in connection with valuing contributed cash in its business and continues to the property as a unit of a single legal entity and operate as a partnership with two members. In this assigning a portion of the value to each state.6 Applying situation, Purchaser’s “contribution is treated as a an apportionment factor to a business operation contribution to the partnership in exchange for an presumes that the operation comprises one unitary ownership interest in the partnership.” The Seller “is trade or business.7 treated as contributing all of the assets of the LLC to Several states make this distinction explicit. California, the partnership in exchange for a partnership interest.” for example, instructs a taxpayer to first determine TAKEAWAY whether the partnership’s activities and the taxpayer’s activities “constitute a unitary business” before The distinction between these situations has important 8 combining the factors. Oregon regulations refer ramifications for state tax apportionment purposes.