Most multistate companies currently apportion their taxable business income among the various jurisdictions by utilizing some variation of the 3 factor apportionment method. This division of income based upon a percentage of Sales, Wages and Property using a variety of weighting formulas in individual states is another example of an overly complicated mechanism that can easily be streamlined by utilizing a more simple approach. Additionally, a significant amount of successful state tax planning also currently takes advantage of the disparate treatment that results from having 50 states attempt to apportion income using their own unique formulas and weightings of factors. Naturally this only results in tax savings for business at the detriment to state coffers. Only a very few states currently make use of a single sales factor for apportioning income.
I am recommending the use of a single sales factor to apportion business income. With the exception of businesses in certain industries such as mining, transportation, etc. which will need to make use of extraction or mileage percentages (however, even these can use a single relevant factor as befits the industry), the majority of companies can best and most fairly be taxed by each jurisdiction by the single sales factor. Applying a uniform definition of sales across all states and by use of a throw-back rule for sales made to a non-nexus location, 100% of taxable income will be sourced and taxable somewhere. The simplicity is obvious, but another benefit is that it does not punish a company located within its borders by paying more than its fair share to that particular state. A state that currently uses the wage or property factors is actually providing a non-incentive to business to locate its facilities there.
Here is a prime real world example. A Fortune 500 company based in a high tax Northeast state does business in all 50 states. In its home state it employs approximately 10,000 people, owns a million square foot headquarters building and various warehouse facilities totaling another million square feet within the state. Its resulting in-state apportionment factors are 8% sales; 35% wages; and 20% property. Using the 3-factor method required by the state results in the company's income attributable to the state to be 21% as compared to the 8% that would result from a single sales factor. This is a vast distortion of the company's source of income within the state and actually punishes it for having created a large number of jobs and having invested significant capital within the state. The state already benefits directly from the jobs being located there by taxing the income of the employees working there and the property is also taxed locally and by other means at the state level. The state also benefits from the multiplier effect of having the company's work force generate sales tax and property tax revenue. The state is virtually taxing the company twice on the jobs it has created and the capital it invests within the state by using the wage and property factors to distort the apportionment of income. The state is punishing the key driver of the state's economy, the in-state business. This is a company that could locate in any state since it has no overwhelming business need to be in that particular location.
What is really hurtful is that same state is under-taxing companies doing business there that are located outside of the state. Another company may be making significant sales (profits) from that state but has only minimal physical presence and therefore has little or no wages or property attributable to the state. As a result it pays a relatively small portion of tax compared to the real income derived from within the state. Under this example, from a purely tax oriented viewpoint, why would any business locate its major facilities in that state? The simple answer is, none would and in reality fewer and fewer actually do.
The logic of using anything other than a single sales factor escapes me. A multi-factor apportionment method is overly cumbersome to administer, harmful to in-state businesses, does not contribute to attracting new businesses and creates an environment for businesses to employ strategies to take advantage of variations among the states' different laws to produce income that goes untaxed at the state level. When coupled with a throw back rule for sales made into states where nexus has not been established means that all sources of income (sales) will be accounted for and tax appropriately. The only untaxed income will be that which is joyfully earned in a jurisdiction that just doesn't impose a tax on business income.
Once again, simple is better. Extending this theory to sweep in non-business taxable income will create the "full apportionment" approach and eliminate the complexity of allocation of nonbusiness income. Although there may be legitimate arguments for treating no-business income as allocable versus apportionable, in the big picture scope the end result is a wash. The added level of complexity just doesn't justify the need to continue this separate method for non-business income.
When combined with a simple computation of the taxable base, a simple apportionment method will allow for a streamlined, single form to be utilized for many businesses. This is clearly a win-win result for all parties. The compliance burden for business is reduced while the states benefit from the removal of a hurdle to attracting new business and at the same time reducing its own administrative burdens.
Sunday, April 8, 2012
Monday, March 26, 2012
Basic Outline for Corporate Income Tax
Today, I am going to present the basic outline for a simplified state computation of corporate income taxes. Among the 50 states (with notable exceptions for Nevada and Wyoming which generally do not tax corporate income) there are currently 50 different methods of computing the amount of income that is subject to tax (taxable base). Indeed, a handful of states require multiple methods to be computed and then choose the one with the highest tax result. Derived over many years of legislative tinkering to appease special interest groups, social engineering initiatives and perhaps to even generate revenue, each state's computation methodology in unique to itself and therefore requires any multistate business to perform countless complex computations to come up with its taxable base for each taxing jurisdiction. Each state then must employ its own collection and audit teams to monitor compliance within its borders. The result is a great amount of effort to derive a unique taxable base for each state. The playing field is therefore ripe for creative attempts to reduce or shelter income from taxation by the use of many strategies which take advantage of the variety of rules among the states.
The solution I propose is a single simple formula to be applied across all jurisdictions. First, since a great deal of effort has already been expended by business to determine their Federal taxable income, let's use that as our starting point. (In reality, most state do use this now but then layer on a variety of addbacks and deductions.) Instead of the numerous adjustments currently employed among the states, only a very few adjustments that have a practicable purpose will be uniformly allowed such as adjusting for tax exempt income to compute a common taxable base used by all states. Next, to compute each state's portion of a multistate business's taxable base, a simple apportionment formula using what is commonly known as the single sales factor (based on destination sales with a throwback rule) would be applied. A more thorough vetting of the rationale of using this approach to apportionment will be addressed in a later blog. This method would divide 100% of each business's tax base among the jurisdictions it has nexus with. No income goes untaxed (except in states blessed with no tax on income) and by applying a unitary group rule for affiliated groups of corporations will also eliminate the gamesmanship that exists in today's environment to shelter income from state taxes.
The only remaining variable will be each state's individual tax rate and any applicable credits it wishes to allow. Here is where each state will now be exposed to an easy comparison amongst its neighbors of who has a business friendly environment and who does not. The transparent contrast of tax rates and tax credits will now allow companies to easily analyze how its operations will be impacted by taxes resulting from the decision to locate in one state versus another. Although many variables determine what the best situs is for a company's operations, the mysterious tax factor will be now be made clear. With a simple, common taxable income base the state needs only to determine how much revenue it needs to meet its own budget requirements and can set its tax rate accordingly. A state which has control of its spending appetite can offer a lower business tax rate which will in turn make itself more attractive and lure new business to locate there and contribute a bit more to the state's coffers. Lather, rinse, repeat.
The beauty of this approach is that a multistate business can compute its tax liability for all locations nationwide on a single form. The taxable base is uniformly computed and apportioned among the applicable jurisdictions of its operations. The army of tax accountants and attorneys hired by businesses are grumbling already, what will they be doing? Meanwhile on the opposing side, the army of state auditors are worried about whether their services are still be needed due to the simplicity of now verifying compliance to a very straight forward method. Since all returns will be centrally processed, the total headcount required can be reduced significantly at great savings to the individual states. The state workers unions may not like this but the states' governors and general population will enjoy the enormous budget savings.
Among the topics I will be discussing in future posts: 1.) Merits of a single sales factor apportionment, 2.) State tax credits and incentives, 3.) Organization and benefits of a centralized processing facility for all states, 4) Expected resistance from various groups to this proposal, 5) Applications of this proposal to individual income taxes, sales tax and other forms of state tax.
The solution I propose is a single simple formula to be applied across all jurisdictions. First, since a great deal of effort has already been expended by business to determine their Federal taxable income, let's use that as our starting point. (In reality, most state do use this now but then layer on a variety of addbacks and deductions.) Instead of the numerous adjustments currently employed among the states, only a very few adjustments that have a practicable purpose will be uniformly allowed such as adjusting for tax exempt income to compute a common taxable base used by all states. Next, to compute each state's portion of a multistate business's taxable base, a simple apportionment formula using what is commonly known as the single sales factor (based on destination sales with a throwback rule) would be applied. A more thorough vetting of the rationale of using this approach to apportionment will be addressed in a later blog. This method would divide 100% of each business's tax base among the jurisdictions it has nexus with. No income goes untaxed (except in states blessed with no tax on income) and by applying a unitary group rule for affiliated groups of corporations will also eliminate the gamesmanship that exists in today's environment to shelter income from state taxes.
The only remaining variable will be each state's individual tax rate and any applicable credits it wishes to allow. Here is where each state will now be exposed to an easy comparison amongst its neighbors of who has a business friendly environment and who does not. The transparent contrast of tax rates and tax credits will now allow companies to easily analyze how its operations will be impacted by taxes resulting from the decision to locate in one state versus another. Although many variables determine what the best situs is for a company's operations, the mysterious tax factor will be now be made clear. With a simple, common taxable income base the state needs only to determine how much revenue it needs to meet its own budget requirements and can set its tax rate accordingly. A state which has control of its spending appetite can offer a lower business tax rate which will in turn make itself more attractive and lure new business to locate there and contribute a bit more to the state's coffers. Lather, rinse, repeat.
The beauty of this approach is that a multistate business can compute its tax liability for all locations nationwide on a single form. The taxable base is uniformly computed and apportioned among the applicable jurisdictions of its operations. The army of tax accountants and attorneys hired by businesses are grumbling already, what will they be doing? Meanwhile on the opposing side, the army of state auditors are worried about whether their services are still be needed due to the simplicity of now verifying compliance to a very straight forward method. Since all returns will be centrally processed, the total headcount required can be reduced significantly at great savings to the individual states. The state workers unions may not like this but the states' governors and general population will enjoy the enormous budget savings.
Among the topics I will be discussing in future posts: 1.) Merits of a single sales factor apportionment, 2.) State tax credits and incentives, 3.) Organization and benefits of a centralized processing facility for all states, 4) Expected resistance from various groups to this proposal, 5) Applications of this proposal to individual income taxes, sales tax and other forms of state tax.
Tuesday, March 20, 2012
A simple approach towards efficient state taxes
Here's the problem: Why do each of the 50 individual states need to have its own unique set of tax laws administered by its own revenue collection agency?
This only results in a massively inefficient bureaucracy of multiple state agencies all doing the same manner of interpretation, administration, auditing and collecting of taxes from a confused and frustrated taxpaying public. All of this seems rather redundant to me. As a tax professional with over 30 years of experience working with individuals, small businesses and large Fortune 500 corporations, I can see no reason for the level of complexity that exists currently in the state tax arena. In the current economic environment where nearly every state is looking for ways to raise revenue, slash budgets and attract new business within their borders, it all appears extremely wasteful to have each state working so hard to administer an individual set of complex rules and regulations with the sole goal of collecting revenue from taxpayers. The whole structure of state tax collection is needlessly redundant. There is an army of state (not to mention local) employees working with generally inefficient systems, inadequate funding and insufficient support trying to collect the tax dollars so desparately needed to fund government budgets.
In addition to the inherent wastefulness of 50 different state agencies to collect taxes, consider the enormous expense and effort imposed upon taxpayers to make an honest attempt at complying with 50 different sets of rules and regulations, court cases and administrative policies. Which, by the way, are constantly being changed and tweeked by the 50 different state legislatures for either revenue raising or social policy purposes. The army of accountants, lawyers and support persons needed to comply with the current tax strucure is staggering. I know, I am a member of that army. This army is highly educated and generally well paid.
So now there two armies of people working to navigate through the maze of complex, often poorly written tax rules to determine how much is owed and by whom. The insanity of all this must be clear to nearly anyone who has ever earned a dollar. The only benefit from this? It is a great jobs creator. Wasteful? You bet! It drains state budgets merely because of its inefficient nature and forces individuals and businesses to hire expensive staff and consultants to comply.
Here's the solution: Quite simple really.
Create a single unified multi-state tax collection agency which will administer a single set of rules and regulations for the collection of state taxes. And yes, while we're at it, the computation will be made so simple that it can be easily administered by both the tax collector and the taxpayer.
So that is the purpose of this blog. To create a forum to flesh out the details and present solutions to this wasteful environment. I propose to start with the Income Tax first since it the area of my own expertise and the one I think is actually the most complex currently and is most in need of repair. The approach I will be proposing can be applied to both the individual income tax and the corporate business income tax. The ultimate goal will be to champion a new simplified approach to state tax administration that will benefit both the collector and the payer. If successful, I may be putting a lot of talented people out of work. However, isn't better to put those great brains to work doing something more beneficial to society than merely calculating tax liability?
This only results in a massively inefficient bureaucracy of multiple state agencies all doing the same manner of interpretation, administration, auditing and collecting of taxes from a confused and frustrated taxpaying public. All of this seems rather redundant to me. As a tax professional with over 30 years of experience working with individuals, small businesses and large Fortune 500 corporations, I can see no reason for the level of complexity that exists currently in the state tax arena. In the current economic environment where nearly every state is looking for ways to raise revenue, slash budgets and attract new business within their borders, it all appears extremely wasteful to have each state working so hard to administer an individual set of complex rules and regulations with the sole goal of collecting revenue from taxpayers. The whole structure of state tax collection is needlessly redundant. There is an army of state (not to mention local) employees working with generally inefficient systems, inadequate funding and insufficient support trying to collect the tax dollars so desparately needed to fund government budgets.
In addition to the inherent wastefulness of 50 different state agencies to collect taxes, consider the enormous expense and effort imposed upon taxpayers to make an honest attempt at complying with 50 different sets of rules and regulations, court cases and administrative policies. Which, by the way, are constantly being changed and tweeked by the 50 different state legislatures for either revenue raising or social policy purposes. The army of accountants, lawyers and support persons needed to comply with the current tax strucure is staggering. I know, I am a member of that army. This army is highly educated and generally well paid.
So now there two armies of people working to navigate through the maze of complex, often poorly written tax rules to determine how much is owed and by whom. The insanity of all this must be clear to nearly anyone who has ever earned a dollar. The only benefit from this? It is a great jobs creator. Wasteful? You bet! It drains state budgets merely because of its inefficient nature and forces individuals and businesses to hire expensive staff and consultants to comply.
Here's the solution: Quite simple really.
Create a single unified multi-state tax collection agency which will administer a single set of rules and regulations for the collection of state taxes. And yes, while we're at it, the computation will be made so simple that it can be easily administered by both the tax collector and the taxpayer.
So that is the purpose of this blog. To create a forum to flesh out the details and present solutions to this wasteful environment. I propose to start with the Income Tax first since it the area of my own expertise and the one I think is actually the most complex currently and is most in need of repair. The approach I will be proposing can be applied to both the individual income tax and the corporate business income tax. The ultimate goal will be to champion a new simplified approach to state tax administration that will benefit both the collector and the payer. If successful, I may be putting a lot of talented people out of work. However, isn't better to put those great brains to work doing something more beneficial to society than merely calculating tax liability?
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