State and Local Allocation Tax Changes Affecting Your Bottom Line
June 07, 2010
The slow economy has inhibited state tax collections to a degree that we haven’t seen in a generation. New York state and City, New Jersey, and Connecticut confront a collective shortfall in revenue in the tens of billions, and policy makers have been implementing a twin approach to make up for it.
They are reaching out to attract and retain business as a method of broadening and stabilizing the tax base as well as implementing new taxes on remote sellers and on non-residents. In preparation for your 2010 taxes, learning early how tax law changes will affect your business will help you take advantage of the opportunities and avoid the new traps.
New York City
The city has addressed some of the long-held tax concerns of the business community. The Unincorporated Business Tax (UBT), as well as the General Corporation Tax (GCT) phased in a “single sales factor” method of computing a business’s income tax beginning in 2009 and will be phased in over a 10-year period.
The single sales factor is already the law in New York State. By aligning city tax laws with the state, businesses will find it less complicated to estimate their combined state and city tax liability. Also, by doing away with the property and payroll components of income tax allocation, locating property, renting space, and incurring payroll costs in the city will not cause an increase in city taxes.
Although the tax rates remain high–4 percent under the UBT, and 8.85 percent on corporations–the benefit of the single sales factor can ameliorate this burden. For example, under the old rules, suppose a corporation is currently located solely in the city, but its sales are nationwide; say 12 percent to New York State. The company would pay Corporation Tax based upon three factors: 100 percent property, 100 percent payroll and 12 percent sales, which average 70.67 percent At a tax rate of 8.85 percent equals an effective tax of 6.25 percent of its income. Under the single sales factor, the effective rate is barely over 1 percent (12 percent of 8.85 percent this is an 83 percent reduction.
Other UBT changes are designed to attract the service industry (consultants, financial advisors, media) to New York City. Sales for services will be sourced to the place where the client or customer resides, which enables a lower UBT for city-headquartered service businesses. Moreover, unincorporated businesses with a gross income of $95,000 or less are not even required to file a UBT return.
New York State
The state has proposed innovative theories to capture the sales tax on sales originating “remotely.” Under a new law, a mere link on a website operated by a New York resident, may trigger a sales tax collection obligation. For example, an Internet retailer of sporting goods enters into an agreement to maintain a link on a New York health club’s website and pays a commission on sales. Non-resident small business owners should evaluate their contacts with New York resident entities for signs of “agency.” Documentation is required to rebut a potential taxable “click-through” in New York. (The state accepts written or email certification that the resident is prohibited from engaging in sales activities on behalf of the remote seller)
Favorable business allocation provisions were enacted in 2009 under the New Jersey Corporation Business Tax (CBT). Beginning in 2011, the “throwout rule” was repealed so that a business can allocate its sales receipts to other states, even if the company has no office or “state income tax nexus” outside New Jersey. Also, the requirement of maintaining an out-of-state office as a prerequisite to apportionment of operating income has been repealed. These changes will be very attractive to small businesses that can operate worldwide from a single headquarters in-state.
In a parallel trend, other states including Connecticut are reaching out to impose taxes on non-residents who “exploit” the in-state market from outside the state’s borders. For example, out-of-state franchisors who licenses franchisees in-state; and, out-of-state banks with credit card customers in-state have become targeted as potential taxpayers.
Effective in 2010, the corporation business tax is imposed on any company that merely derives income in Connecticut. This means companies without a physical presence in Connecticut are subject to this tax. Small business owners should be alerted to a potential Connecticut tax-filing obligation that did not previously exist. For example, a business consultant with clients in Connecticut who had been dealing with instate accounts by phone and via the Internet may be required–even in the absence of changing its operations to suddenly file a Connecticut corporation tax return.
States want to attract and retain business as well as raise revenue; and the business owners in pursuit of the growth of their business can both benefit from some tax legislation; but businesses can also suffer if they don’t plan correctly. State taxes can frequently be the thin margin which represents a competitive advantage. Business owners need to remain current on changing state and local tax laws.