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During 2010, there were many changes in the state corporate income taxation area. Numerous state statutes were added, deleted, or modified; court cases were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn. This two-part article focuses on some of the more interesting items in the following corporate income tax areas: nexus; tax base; allocable/apportionable income; Sec. 338(h)10) transactions; apportionment formulas; filing methods/unitary groups; and administration. The article also includes several other significant state tax developments. Part I covers the first four areas; the remaining topics will be reviewed in Part II in the
Subject to the limitations provided under P.L. 86-272, for tax years beginning after 2010 a taxpayer is doing business and thus subject to tax if the taxpayer’s
The DOR has adopted the
In Informational Publication 2010(29.1) (12/28/10), the
The Florida DOR ruled that a company has sufficient activities in the state to create nexus through its one in-state employee who performs functions other than the solicitation of sales from the employee’s home office.4
The Indiana DOR held that a company had nexus because it sent visual merchandising coordinators into
Citing economic nexus case law from various jurisdictions, the Iowa DOR explained to a limited liability company (LLC) that it was subject to income tax despite its lack of an in-state physical presence because the LLC was exploiting the
The Louisiana DOR ruled that an insurance company that generated
In another decision, on remand in the same case that previously held that two out-of-state trademark subsidiaries of a parent retailer that did business in
In another decision, the Maryland Tax Court held that two
The DOR issued a notice15 relating to its ongoing enforcement of the filing obligations of corporations that license intangible property for use in the state pursuant to authority under the Massachusetts Supreme Judicial Court 2009 opinions in
In another decision, the
The New Jersey Tax Court held that a taxpayer was subject to the corporation business tax because a
Responding to an inquiry regarding whether various affiliates are subject to franchise tax, the
In another nexus development, the
SJR 61, Laws 2010, imposes and sunsets a new business activity tax (BAT) in lieu of ad valorem taxes on the intangible personal property of persons doing business in
In another development, the comptroller held that because a company had three employees who were
In another ruling, the STC explained that a company would not be required to file an income tax return based on its proposed attendance at a four-day trade show and four follow-up visits to shop for suppliers.27 Under Utah policy, a filing requirement for state corporate income tax is not created where the sole in-state activity is shopping for a supplier; however, if a seller of services is targeting the
Responding to an inquiry from a company providing on-demand repair and maintenance services for customers via third-party contractors, the
State Tax Base
The majority of states imposing a corporate income-based tax begin the computation of state taxable income with taxable income as reflected on the federal corporate income tax return (Form 1120, U.S. Corporate Income Tax Return). These states use either taxable income before net operating loss (NOL) and special deductions (line 28) or taxable income (line 30). Certain state-specific addition and subtraction modifications are then applied to arrive at the state tax base. Following is a summary of the more significant developments to the states’ tax bases.
Deductions Related to Dividends
In another development, the
For tax years beginning after 2009, captive real estate investment trusts (REITs) may not deduct the federal dividends-paid deduction (DPD), and deductions for dividends received from captive REITs that are not otherwise subject to
In another development, the DOR explains that if the repatriated dividends from a foreign subsidiary constitute foreign-source dividends under Sees. 78, 862, or 951, they will be subtracted in calculating adjusted federal income (and thus excluded from the
SB 3901, Laws 2010, provides that effective for tax years ending after
In a case involving a merged corporation, an
Among other provisions, SB 858, Laws 2010, extends the suspension of NOL deductions for an additional two years to include tax years beginning after 2009 and before 2012, and defers the two-year carryback of NOLs that was to take effect for tax years beginning after 2010 until tax years beginning after 2012, with the phase-in of NOL carryback utilization beginning the same year.
HB 1199, Laws 2010, caps the annual NOL deduction at
In August, the Colorado DOR updated publication FYI Income 19,40 which provides guidance on the computation and use of Colorado NOLs. The DOR has also proposed amending Reg. 39-22-504 to reflect this three-year annual NOL limitation.
HB 2594, Laws 2010, decouples from Sec. 382(n) regarding the treatment of a change in ownership of a bank or other corporation.
The Idaho STC has proposed amended Rule 200, addressing NOLs in the case of corporate mergers to reflect recently enacted law. The Idaho STC also amended Rule 201, modifying how a taxpayer can make the election to forgo the NOL carryback by removing the option of attaching the federal election and clarifying that if an NOL is required to be carried back and if the statute of limitation has expired on the carryback year, a refund may not be allowed in the closed tax year.
An administrative law judge held that a company was required to check the box on its 2001 and 2002
In Letter of Findings No. 09-0397 (3/24/10), the Indiana DOR held that because an in-state manufacturer failed to demonstrate common parent status as described in Regs. Sec. 1.1502-75(d)(3), it could not carry back NOLs to returns filed for the tax years at issue.
In another development, HB 1086, Laws 2010, decouples from the elective five-year federal NOL carryback provisions.
New Rule LAC 61:1.1125 provides that the
Maine Revenue Services explains that no NOL deductions are allowed for tax years beginning in 2009, 2010, and 2011, and the disallowed deductions generally can be claimed after 201 1, as long as they are taken during the federal NOL carryforward period plus the number of years the NOL deduction was disallowed.42
In Administrative Release No. 18 (
In Letter Ruling 10-6 (10/5/10), the Massachusetts DOR explains that the limitation on the use of pre-combination NOL carryforwards generally does not apply where the company and its combined group members attributed 100% of the group’s income to
In another development, for corporations that are allowed NOL deductions, S 2582, Laws 2010, extends the NOL carryforward period from 5 to 20 years and changes the methodology for the calculation of an NOL carryforward from a preapportionment to a post-apportionment methodology. In TlR 10-15 (11/12/10), the Massachusetts DOR summarizes this new law.
SB 2113, Laws 2010, clarifies that for tax years beginning after 2007 and ending before 2009, NOL carrybacks are limited to two years. For tax years beginning after 2008, the number of years to which NOLs may be carried back is determined by reference to Sec. 172.
The comptroller explains that if the combined group expands from within, there is no effect on the franchise tax temporary credit for business loss carryforwards of the combined group, but if an existing entity is added to the group, that new member’s temporary credit is lost.43
In another letter, the comptroller explains that calculating the franchise tax temporary credit for business loss carryforwards is based on business loss carryforwards that were created on the 2003 and subsequent franchise tax reports that were not expired or exhausted on a report due before
Intercompany Expenses/ Transactions
Effective for tax years beginning after 2008, B18-0203 (Act 18-255) expands the related-party addback statute to include interest expense that is not attributable to intangibles. In Notice 2010-04, the
The Indiana DOR held that a restaurant operator could not claim intercompany royalty and interest expense deductions because the deductions had the effect of distorting its
In a similar ruling, having found that the retailer failed to show that its out-ofstate trademark subsidiary had licensed the trademarks to unrelated third parties and that it appeared that the retailer maintained control, directly or indirectly, over the trademark subsidiary, the Indiana DOR disallowed the deductions for royalties because doing so more fairly reflected the retailer’s
In a ruling involving the financial institutions tax (FIT), the Indiana DOR reversed an auditor’s attempt to disallow deferred recognition of dividend income received from an affiliate REIT because the DOR’s discretionary authority under statute to more fairly represent income permits only one of three options: (1) a separate accounting; (2) the filing of a separate return for the taxpayer; or (3) the reallocation of tax items between a taxpayer and a member of the taxpayer’s unitary group.47 Thus, the statute does not allow the option of reallocating a single entity’s income from one year to the other to more fairly represent a taxpayer’s
In another ruling, the Indiana DOR held that intercompany accounts receivable factoring fees were legitimate and reasonable expenses because the taxpayer successfully showed that this related entity was a valid operating company that actively pursued the collection of the factored accounts receivables for which it had charged an arm’s-length rate, and the related entity neither loaned the factoring fees back to the taxpayer nor returned them to the taxpayer in the form of dividends.48
Similarly, in another ruling, the Indiana DOR held that a subsidiary could deduct royalties and management fees paid to its parent because the payments occurred pursuant to arm’s-length transactions and agreements for valid business purposes, and there was no circular flow of monies concerning the royalty fee payments made by the subsidiary to the parent.49
In the Massachusetts Appeals Court’s earlier ruling in
In another decision, the Massachusetts Supreme Judicial Court affirmed that the DOR appropriately adjusted the income of a parent corporation by reallocating back royalty income that was received by a
Reversing the Minnesota Tax Court’s decision, the
In another development, the New Jersey Tax Court held that a subsidiary had satisfied the unreasonable exception because the intercompany financing arrangements had economic substance.55 The court found the taxpayer’s reason for the intercompany arrangement credible (i.e., the parent received more favorable interest rates than its subsidiaries could), and the parent paid taxes in 17 jurisdictions (most being unitary states) on the interest income it earned from the subsidiary.
In another development, the Wisconsin DOR issued tax regulation 3.01,57 to provide interpretation and explanation of
Conformity to Federal Legislation
While many states generally conform to the federal income tax laws, a number of states have increasingly enacted specific decoupling provisions such as those involving federal bonus depreciation and Sec. 179 expensing, NOL carryover periods, and/or Sec. 163(e)(5)(F) regarding the suspension of applicable high-yield discount obligation rules. During 2010, a number of states enacted legislation that decoupled from the new provisions allowing deferral of income arising from certain discharged business indebtedness under Sec. 108(i).58 Identifying all of the states’ decoupling developments during 2010 is beyond the scope of this article; readers are encouraged to review state tax law changes as summarized in the states’ tax return instructions and on the states’ websites.
HB 2156, Laws 2010, decouples from Sec. 108(i) and from the five-year NOL carryback provisions under both the American Recovery and Reinvestment Act of 2009, RL. 111-5, and the Worker, Homeownership, and Business Assistance Act of 2009, RL. 111-92. In an
Proposition 26, which passed in the general election held on
For tax years beginning after 2009, HB 2, Laws 2010, requires an income tax addition adjustment for a portion of the federal qualified domestic production activities deduction under Sec. 199.
LD 1539, Laws 2010, corrects a technical error in
The Maryland Revenue Administration Division explains that state law decouples from federal bonus depreciation allowances and Sec. 179 expensing; the elective five-year NOL carryback under Sec. 172(b)(1)(H); Sec. 108(i); and the automatic decoupling from any federal tax law change that affects
HB 29, Laws 2010, decouples from the federal domestic production activities deduction under Sees. 199 and 108(i). For tax years beginning after 2009,
The Minnesota DOR explains that the following portion of the Michigan Business Tax (MBT) must be added back in determining the state tax base: the business income tax, plus a portion of the surcharge attributable to the business income tax, less credits that reduce the business income tax. The remainder of the MBT is not a tax based on net income.60
For tax periods beginning after 2003, SB 483, Laws 2010, provides that in the case of a qualified likekind exchange under Sec. 1031, in which a business organization uses a single-member LLC, revocable trust, or other entity disregarded for federal income tax purposes as the recipient of replacement property, the recipient entity must take the basis of the relinquished property as held by the parent business organization, prior to the exchange, as computed for federal income tax purposes. In Technical Information Release 2010-009 (8/3/10), the New Hampshire Department of Revenue Aa^ninistration explains the new law and notes that any taxpayer entitled to a refund as a result of this new law may request a refund within the later of three years from the due date of the tax or two years from the date the tax was paid.
For tax years beginning after 2009, A 9710-D, Laws 2010, conforms the state and city bad debt deduction for banks under Article 32 to that allowed for federal income tax purposes.
Amended Rule 150-317.013 clarifies that capital losses must be carried back before they can be carried forward and that capital losses cannot be deducted against capital gains reported under
The Oregon Tax Court held that a
In another income classification decision, the Oregon Tax Court ruled that a closely held cell phone service company’s gain from the sale of its
Sec. 338(h) (10) Transactions
The SBE held that a company must treat Sec. 338(h)(10) gain involving goodwill as business income under the functional test and that the gross proceeds from the liquidating sale were properly excluded from the sales factor pursuant to an administrative regulation, because the receipts were substantial and arose from an incidental or occasional sale of property held or used in the regular course of the company’s trade or business.65
For stock purchases and sales occurring after
In Letter of Findings No. 09-0397 (3/24/10), the Indiana DOR held that while the Sec. 338(h)(10) gain was business income, a consolidated filing group successfully showed that inclusion of the proceeds in the sales factor did not fairly reflect the location where the group earned its income and unreasonably and arbitrarily attributed a percentage of income to
The Oregon Tax Court held that a consolidated unitary group of corporations must apportion its Sec. 338(h) (10) gain from the sale of out-of-state subsidiary stock as business income under the functional test.67 The court explained that a liquidation exception to the functional test was not recognized in the
This article is written in general terms and is not intended to be a substitute for specific advice regarding tax, legal, accounting, investment planning, or other matters. While all reasonable care has been taken in the preparation of this article,
* States continued the trend toward asserting “economic” nexus (i.e., nexus without physical presence in a state) for purposes of state income taxes. A number of states passed laws asserting that a taxpayer has nexus with the state if the taxpayer has a certain amount of sales, property, or payroll within the state.
* As a result of recent economic conditions, a number of states passed laws temporarily disallowing net operating loss (NOL) deductions or otherwise modifying their rules regarding NOL deductions.
* Many states passed legislation decoupling their tax law from certain federai tax provisions. Provisions that were frequently the subject of decoupling include the Sec. 172(b)(1)(H) elective federal five-year carryback provisions for NOL deductions and the Sec. 108(i) deferral of income arising from certain discharged business indebtedness.
The Florida DOR ruled that a company has sufficient activities in the state to create nexus through its one in-state employee who performs functions other than the solicitation of sales from the employee’s home office.
1 AZ DOR Private Taxpayer Ruling LR10-010 (7/8/10).
2 CA SBX3 15, Laws 2009.
3 CO Code Regs.
4 FL DOR Technical Assurance Advisement 10C1-009 (9/1/10).
5 IN DOR Ltr. of Findings No. 09-0577 (5/26/10).
7 IA DOR Policy Ltr., Doc. Reference No. 10240041 (12/16/10).
8 Revenue Cabinet v. Asworth Carp., No. 2007-CA-002549-MR (Ky. Ct. App. 2/5/10), cert, denied, S. Ct. Dkt. 10-662 (
9 LA DOR Private Letter Ruling No. 10-018 (10/14/10).
12 W.L. Gore & Assocs., Inc. v. Comptroller of the Treasury, No. 07-INOO-0084 (Md. Tax Ct. 11/9/10).
13 MA DOR Notice, Ongoing Enforcement of Massachusetts Filing Obligations of Corporations Licensing Intangible Property for Use Instate (6/10/10).
17 MI Revenue Administrative Bulletin 1998-1.
20 NY Dep’t of Tax’n & Fin. TSB-A-10(2)C [
21 In re
22 OH Tax Comm’r, Final Determination in re
25 TX Policy Letter Ruling No. 201009931H (9/21/10).
26 UT Private Letter Ruling No. 09-004 (4/13/10).
27 UT Private Letter Ruling No. 09-013 (6/25/09) (released 5/3/10).
29 WA DOR, Special Notice, B&O Tax Reporting Requirement Continues After Business Activity Stops (9/10/10).
30 WV Decisions Nos. S 06-544N and 06-54SFN (1/6/10).
34 River Garden Retirement Home v. California Franchise Tax Bd., 186 Cal. App. 4th 922 (2010).
35 CT HB 5494, Laws 2010.
38 FL DOR Technical Assistance Advisement, No. 10C1-004 (3/17/10).
40 CO DOR, FYI Income 19, Nef Operating Losses (
41 EL DOR Administrative Hearing Decision No. GG 10-05 (9/28/10).
42 ME Rev. Serv., Modifications Related to Net Operating Losses – Examples for C Corporations (
43 TX Policy Letter Ruling No. 201007816L (7/21/10).
44 TX Policy Letter Ruling No. 201007819L (7/21/10).
45 IN DOR Ltr. of Findings No. 09-0446 (1/27/10).
46 IN DOR Ltr. of Findings No. 08-0749 (5/26/10).
47 IN DOR Ltrs. of Findings Nos. 08-0696 and 08-0697 (7/28/10).
48 IN DOR Ltr. of Findings No. 09-0805 (7/28/10).
49 IN DOR Ltr. of Finding No. 09-0857 (9/1/10).
54 NJ Div. of Tax’n Notice: Corporation Business Tax Add Back of Interest Expense (6/10/10).
57 WX Admin. Code Tax 3.01.
58 Some examples include AZ HB 2156, Laws 2010; DC Bl 8-0203 (Act 18-255); GA HB 1138, Laws 2010; HI HB 2594, Laws 2010; OK SB 1396, Laws 2010; SC SB 1 174, Laws 2010; and VA HB 29, Laws 2010.
59 MD Comptroller, Administrative Release No. 38 (
60 MN DOR Revenue Notice No. 10-04, Individual Income and Corporate Franchise Tax – Credits and Additions to Federal Taxable Income – Michigan Business Tax (11/22/10).
62 Appeal of
65 In re imperial, Inc., No. 472648 (CaI. State Bd. of Eq. 7/13/10).