Income taxes in a multistate environment.

• Author: Leibtag, Bernard

Cutbacks in Federal aid and escalating government costs have caused many states to begin looking everywhere possible for additional revenue; one major source is the increased enforcement of tax collections. States have become more aggressive in taxing nonfilers, particularly companies doing business in one state while headquartered in another.

A state can tax companies headquartered elsewhere but doing business within its borders with no political fallout, since these companies have no legal clout in the taxing state. In most instances, the company's officers and directors cannot vote in the foreign taxing state; they are residents of the state in which the company is headquartered. In fact, the inability of foreign corporations to wield any significant political influence has encouraged states to change their income tax laws so that companies from foreign states bear a heavier tax burden.

In light of states' aggressive tax collections and the increasing importance of state income taxes, it is important to be aware of the income tax pitfalls and planning opportunities.

Nexus

A state's taxing authority only exists if the entity being taxed has "nexus" with the taxing state. Nexus is defined as a connection between the taxing authority and the taxpayer, of sufficient extent such that the state can impose its tax rules on the business. In general, maintaining an office, having a manufacturing plant or holding inventory in a state will constitute doing business in the state.

Note: PL 86-272 limits a state's ability to tax a seller to tangible personal property if the seller's activity in that state is limited to the solicitation of sales approved out of state and shipped from out of state. However, the applicability of PL 86-272 to various fact patterns, especially in light of recent court decisions, is beyond this discussion, which assumes a taxpayer is already subject to income tax in more than one state and emphasizes planning in such a situation.

Apportionment

From an income tax point of view, if a taxpayer is subject to tax in a state in which it is doing business, it must file income tax returns in that state. In imposing taxes on companies that do business in more than one state, states usually employ an apportionment formula that allows them to equitably allocate the income among the various states. The result of using apportionment formulas should be that the taxpayer's total income is taxed only once in all of the states combined.

The...