Combined reporting creates compliance challenges.

• Author: Smith, Annette B.

An increasing number of states have enacted or proposed combined reporting requirements for related entities involved in a unitary business. As of Jan. 1, 2012, 24 states and the District of Columbia require combined reporting as part of their corporate income tax regimes. States assert that combined reporting prevents tax avoidance and provides an appropriate source of revenue. The sometimes ambiguous and differing combined reporting provisions have created increased compliance burdens for taxpayers and administrative challenges for state tax agencies.

Different States, Different Rules

Taxpayers subject to combined reporting face a range of compliance challenges, including:

Defining "unity": Whether a unitary business exists is dependent on state law. In states using the "three unities test," the factors considered are unity of ownership, unity of operation (e.g., centralized purchasing), and unity of use (e.g., centralized executive function) (see Butler Bros. v. McColgan, 315 U.S. 501 (1942)). Other states base the determination on the three criteria of functional integration, centralization of management, and economies of scale (see Mobil Oil Corp. v. Commissioner of Taxes of Vt., 445 U.S. 425 (1980)). In addition, some states consider some other evidence of a sharing or exchange of value (see Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983)). A growing number of states provide a specific definition of unitary business in their statutes or regulations.

Who's in and who's out: While states generally set the combined reporting threshold at more-than-50% ownership, states differ on which members to include. For example, under a concept known as "instant unity," some states allow newly acquired members to be included in the combined report. Another concern is the treatment of members subject to special apportionment provisions. While some states may require a combined report to include all members regardless of their apportionment methodology, other states require the exclusion of members subject to a special apportionment factor.

Still other states may require the use of a modified apportionment factor to account for differences between the individual members' apportionment methods. Similarly, while some states exclude from the combined report any member subject to an alternative tax regime, such as an insurance company subject to gross premiums tax, other states include the member's income and apportionment factors in the...