Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: Part 1

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were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn.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 April 2011 issue.

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Nexus

Arizona

The Arizona Department of Revenue (DOR) ruled that an insurance company that provides Medicare Advantage health plans and Medicare Part D drug plans (which under federal law are exempt from state premiums taxes) is not subject to the corporate income tax because the insurance premium tax is a substitute tax and not an exemption from the corporate income tax. (1)

California

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 California sales exceed the lesser of $500,000 or 25% of the taxpayer's total sales, or it has $50,000 of California property or payroll. (2) SB 858, Laws 2010, requires taxpayers with sales other than sales of tangible personal property to use market-based sourcing to determine whether they are doing business in California.

Colorado

The DOR has adopted the Multistats Tax Commission's factor presence nexus standard under which nexus is created if the taxpayer has $500,000 of Colorado sales or $50,000 of Colorado property or payroll. (3)

Connecticut

In Informational Publication 2010(29.1) (12/28/10), the Connecticut Department of Revenue Services answered frequently asked questions regarding the new economic nexus law provisions effective for tax years beginning after 2009 and established a bright-line economic standard under which an entity generally would not be deemed to have economic nexus for a tax year if it had receipts of less than $500,000 from Connecticut sources.

Florida

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)

Indiana

The Indiana DOR held that a company had nexus because it sent visual merchandising coordinators into Indiana who set up the company's signage and point-of-purchase displays for its customers' stores, coordinated the stores' inventory levels, and ran in-store promotions for its customers, and those activities exceeded the protections of P.L. 86-272. (5)

Iowa

The Iowa Supreme Court affirmed that a company that licensed intellectual property to nonaffiliated restaurant franchisees had corporate income tax nexus even though it lacked physical presence because it derived income from sources within Iowa. (6)

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 Iowa market in providing its registered agent services. (7) Iowa follows the same taxation of LLCs that is allowed for federal income tax purposes; thus, if the LLC is taxed as a partnership for federal income tax purposes, it will also be taxed as a partnership for Iowa tax purposes.

Kentucky

The Kentucky Court of Appeals reissued its opinion affirming that a corporation had nexus due to its 99% limited interest in a partnership doing business in Kentucky. (8) The court also reversed the circuit court's ruling and reasoning requiring the use of a standard three-factor apportionment formula and instead held that the corporation was taxable on its share of the partnership's distributable net income based on its business done in Kentucky, where "business done" was determined under applicable state statutes to be the partnership's single receipts factor of gross receipts or services in Kentucky to gross receipts or services everywhere. The U.S. Supreme Court recently denied the taxpayer's request to review this decision.

Louisiana

The Louisiana DOR ruled that an insurance company that generated Medicare Part D premiums (which under federal law are exempt from state premiums tax) was nevertheless subject to the corporation franchise tax, because the company did not pay tax on its gross premiums in Louisiana and therefore was not exempt from the corporation franchise tax. (9)

Maryland

The Maryland Court of Special Appeals affirmed that a company that licensed various trademarks/intangibles to its parent retailer lacked real economic substance as a separate business entity and agreed that the company's activities could be viewed through the substantial in-state activities of its operating parent, imparting the royalty company with substantial nexus in Maryland for state corporate income tax purposes even though the royalty company did not have an instate physical presence. (10)

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 Maryland were liable for income tax because they lacked real economic substance as separate business entities, the Maryland Tax Court held that this parent-subsidiary relationship also imparts constitutionally sufficient nexus to tax a subsidiary's Sec. 311(b) gains that resulted from the dividend of a licensing agreement authorizing the right to license the use of trademarks to its parent retailer. (11) The Sec. 311(b) gain was incurred in 1999 on a separate company basis, but for federal tax purposes the gain was deferred and recognized in later years as amortization was claimed on the stepped-up value of the intangibles by another member of the federal affiliated group. For the years 2002-2004, the subsidiary had reported approximately $185 million annually in deferred Sec. 311(b) gain on its federal consolidated income tax returns, and it is this amortized Sec. 311(b) gain that the court permitted to be taxed.

In another decision, the Maryland Tax Court held that two Delaware holding companies with no physical presence in Maryland were nevertheless required to pay corporate income tax on their royalty and interest income based on their parent company's in-state physical presence and the economic reality that it was the parent's in-state business that produced these two wholly owned subsidiaries' income. (12) The court agreed that neither holding company had an identity as a separate business entity and that the intangible income each received was directly connected to Maryland activity through the unitary business conducted in Maryland.

Massachusetts

The DOR issued a notice (13) 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 Geoffrey, Inc., (14) and Capital One Bank. (15) The DOR has been issuing and will continue to issue Notices of Failure to File Return to taxpayers that did not file returns in accordance with Directive 96-2 and did not participate in either of the voluntary disclosure programs described in Technical Information Release (TIR) 09-7 or 08-4.

Michigan

The Michigan Court of Appeals reversed a trial court's previous summary judgment to hold that facts surrounding a company's possible single business tax (SBT) nexus were conflicting and therefore "brought to light a material question of fact" that could not be resolved in favor of the company as a matter of law. (16) The company claimed that its employees visited Michigan fewer than two times per year before 2000 and that there was no evidence that its employees solicited sales during any of these visits. However, the Department of Treasury presented evidence in the form of nexus questionnaires in which the company had stated that it had solicited sales in Michigan two to nine times per year for the tax years in question. Given that department guidance (17) on sales solicitation activity indicates that two contacts per year may constitute sufficient business activity to impose the SBT, the court remanded the case for further proceedings.

In another decision, the Michigan Court of Appeals reversed a Michigan Court of Claims ruling to hold that an out-of-state securities broker-dealer company did have nexus for SBT purposes via the in-state physical presence of unrelated persons doing business in Michigan on the company's behalf as agents. (18) The court reasoned that the contractual relationships between the company and in-state local independent registered representatives, who created in-state business for the company because they were required to use a securities broker-dealer to process customer orders, resulted in the company's in-state physical presence.

New Jersey

The New Jersey Tax Court held that a taxpayer was subject to the corporation business tax because a New Jersey resident employed by the company telecommuted by receiving and performing her work assignments each business day at her home via telephone and a company-owned laptop computer, even though none of the employee's duties involved soliciting in-state customers or having any sales responsibilities. (19)

New York

Responding to an inquiry regarding whether various affiliates are subject to franchise tax, the New York Department of Taxation and Finance noted that third parties who entered into sales/service agreements with two mobile home/RV manufacturing subsidiaries appeared to operate in New York as independent contractors whose repair and service...