Income & Franchise Tax Audit Manual Rev. November 2020 Multistate Tax Commission 444 North Capitol Street, N.W., Suite 425 Washington, D.C. 20001 Telephone: 202-650-0300 Website: www.mtc.gov MTC Income & Franchise Tax Manual Page 1 of 133 [This page intentionally left blank] MTC Income & Franchise Tax Manual Page 2 of 133 Multistate Tax Commission Income & Franchise Tax Audit Manual Contents 1. Introduction ................................................................................................................. 9 01. MTC Joint Audit Program. .................................................................................. 9 02. Income & Franchise Tax Audit Manual. .............................................................. 9 03. Changes in Substantive Law. ............................................................................... 9 04. Nonauthoritative. .................................................................................................. 9 05. Suggestions and Corrections. ............................................................................... 9 2. Definitions ................................................................................................................. 10 01. Introduction. ....................................................................................................... 10 02. Allocation. .......................................................................................................... 10 03. Apportionment. .................................................................................................. 10 04. Apportionment Formula. .................................................................................... 10 05. Business Activity................................................................................................ 10 06. Business Income. ................................................................................................ 10 07. Combined Reporting. ......................................................................................... 10 08. Combined Report or Combined Return. ............................................................ 11 09. Commercial Domicile. ....................................................................................... 11 10. Compensation. .................................................................................................... 11 11. Consolidated Returns. ........................................................................................ 11 12. Fiscalization. ...................................................................................................... 11 13. Foreign Corporation. .......................................................................................... 11 14. Intrastate Apportionment.................................................................................... 11 15. Nexus. ................................................................................................................. 11 16. Nonbusiness (non-apportionable) income. ......................................................... 11 17. PL 86-272. .......................................................................................................... 12 18. Sales (Receipts). ................................................................................................. 12 MTC Income & Franchise Tax Manual Page 3 of 133 19. State. ................................................................................................................... 12 20. Statute of limitations. ......................................................................................... 12 21. Taxable in another state...................................................................................... 12 22. Taxpayer. ............................................................................................................ 12 23. Throwback sales (receipts). ................................................................................ 12 24. UDITPA. ............................................................................................................ 13 25. Unitary Business. ............................................................................................... 13 26. Waiver. ............................................................................................................... 13 3. Pre-Audit Procedures ................................................................................................. 14 01. Introduction. ....................................................................................................... 14 02. Audit assignments. ............................................................................................. 14 03. Request for audit authorizations from the states and determination of audit period. ........................................................................................................................... 14 04. Authorization deadline for the states. ................................................................. 14 05. Gathering information before starting the audit. ................................................ 14 06. Individual state transcripts and tax returns. ........................................................ 15 07. Workload review form and audit activity update. .............................................. 15 08. Audit file organization. ...................................................................................... 15 09. Scope of the audit. .............................................................................................. 15 10. Audit plan. .......................................................................................................... 15 4. Statutes of Limitation & Waivers .............................................................................. 16 01. Timely Completion of Audit; Extension of Statute of Limitations (“SOL”). .... 16 02. SOL Control Procedure. ..................................................................................... 16 03. Taxpayer Refusal to Sign Waivers of Statutes of Limitations. .......................... 17 5. Working with Taxpayers – Conducting the Audit..................................................... 19 01. Introduction. ....................................................................................................... 19 02. Initial Contact with Taxpayer. ............................................................................ 19 03. Procedures for a Non-Responsive Taxpayer. ..................................................... 20 04. Initial Written Correspondence with Taxpayer. ................................................. 20 05. Initial Meeting. ................................................................................................... 21 MTC Income & Franchise Tax Manual Page 4 of 133 06. Conducting the Audit. ........................................................................................ 21 07. Concluding the Audit. ........................................................................................ 25 6. Nexus ......................................................................................................................... 27 01. Introduction. ....................................................................................................... 27 02. Audit Procedures for Nexus Investigations. ....................................................... 27 03. Use of MTC Nexus Questionnaire. .................................................................... 27 04. Public Law 86-272. ............................................................................................ 30 05. Economic Presence Nexus. ................................................................................ 34 06. Nexus through an Agency Relationship ............................................................. 34 7. Unitary Investigation ................................................................................................. 35 01. Applying the Unitary Business Principle through Combination ........................ 35 02. Audit Procedures Applicable to Unitary Investigations. .................................... 38 03. Suggested Approach to Unitary Determination. ................................................ 39 04. Lines of Business ............................................................................................... 48 05. Other Documents to Examine and Other Unitary Information .......................... 48 8. Computation of Income ............................................................................................. 52 01. Starting Point Used for Computing State Taxable Income ................................ 52 02. Reporting Methods ............................................................................................. 52 03. Separate Company (Single Entity) Returns ....................................................... 53 04. Computation of Domestic Combined Income .................................................... 53 05. Computation of Worldwide Combined Income ................................................. 54 06. Income of Foreign Affiliates .............................................................................. 56 07. SEC Forms 10-K and Annual Reports and Their Uses ..................................... 56 08. Consolidated Working Papers and Their Uses ................................................... 57 09. Source of Foreign Financial Statements............................................................