If a business has a physical nexus (sufficient physical presence – which can be people and/or property) within a state, that state then has the right to tax the business. Public Law 86-272 prevents states from taxing businesses simply because customers buy a business’ products within their borders. However, this law only applies to tangible personal property and not to sales of services or intangible property (i.e. trademarks). Thus, in some states, a business that receives income for intangible assets will be considered to have established an economic nexus within the state.
Taxable income is usually determined by the federal taxable income before special deductions (depending on the state’s definition), which includes net operating loss deductions and the dividends-received deduction. This amount is then adjusted by multiple factors:
– Interest from Federal Bonds: subtracting interest received from federal bonds, since this is not subject to state taxes
– Municipal Bonds: adding the interest from municipal bonds that are not subjected to federal taxation but are subject to state taxation.
– State Income Taxes: adding the federal deduction for state income taxes, as this is not allowed to be deducted from state taxes
– Differences in Depreciation Methods: accounting for differences in depreciation methods between state and federal government requirements
Types of Companies and How They Are Treated
– Partnerships – the partners end up paying the tax, hence a partnership is handled the same as individuals would be.
– Limited Liability Company – It is the company’s choice to decide whether it would like to be treated as a corporation or a partnership in the eyes of the federal government. However, while there are some states that follow the federal election that the company chooses, other states disregard the decision and tax LLC’s as a partnership.
– S Corporation – Shareholders must file a tax return in every state where their company has a nexus. On top of that, some states go the extra mile and charge a state corporate income tax.
Methods Used to Report
A company that has all of their locations in one state has fairly straight forward tax procedures for its income taxes. However, what happens in the situation where a company has locations outside state lines? In comes the rivalry between reporting and separate accounting.
Combined reporting requires a company with locations in multiple states to sum up the profits of all its subsidiaries no matter the location, and put the amount into one report. This approach is much less friendly to those seeking to optimize tax strategies.
This type of accounting allows a company to report the profits of each of its subsidiaries into multiple reports, making it a viable option for companies that report from different states. As a result, within this method it is much easier to limit tax expenditures, such as the use of a passive investment company.
Corporate Income Tax Apportionment
Within each state, there are rules for dividing a corporation’s profits when said corporation has nexus within that state. These rules determine the amount of profits that are considered in-state and out-of-state. After this is done, the state can tax the in-state portion.
2015 Maryland Supreme Court Ruling
The Supreme Court ruled in May of 2015 that Maryland may no longer tax residents on their entire income without a credit for out-of-state taxes paid. Along with this provision, the Supreme Court also ruled that Maryland may no longer tax out-of-state citizens on their income earned in Maryland.
As explained above, taxes may have many twists and turns, therefore it is imperative to have someone trustworthy and knowledgeable handling your reporting. Call Lescault and Walderman today for your tax needs at 866-496-2042.