Problem Materials

Discussion Questions

1.What states do not impose a sales tax?

2.What is a use tax? Who is responsible for collecting and remitting use taxes to the applicable tax authority?

3.Tiger Corporation, a manufacturer based in State P, purchases office furniture from a retailer located in P. Tiger uses the furniture in its administrative offices located in P.

a.What are the sales and use tax consequences of this purchase?

b.Now assume that instead of buying the office furniture from a local retailer, Tiger purchases the furniture from a mail-order vendor located in another state. How does this change the sales and use tax consequences of the purchase?

4.All states impose property taxes. What types of business assets are typically subject to property tax?

5.What methods does a property tax assessor typically use to estimate the market value of taxable property?

6.Which states do not levy a corporate income tax? Which states do not levy an individual income tax?

7.An important state tax concept is “nexus.” What does “nexus” mean?

8.The physical presence test for nexus is based on what legal authority?

9.A company must meet four requirements to qualify for protection under Public Law 86-272. List these requirements.

  1. Larger business enterprises often have legal structures that include a parent corporation with one or more chains of subsidiary corporations. Explain the corporate group filing options for financial reporting, federal income tax and state income tax purposes. Assume the states in which the company has nexus require combined unitary reporting.

11.How would your answer to Question 10 change if the states in which the company has nexus require separate company reporting?

12.Virtually all of the states that tax corporate income piggyback on the federal system by adopting federal taxable income as the starting place for computing state taxable income. Some states conform to a static federal tax base, while other states conform to a moving federal tax base. Explain this distinction.

13.Despite the broad conformity to the federal tax base, each state requires taxpayers to make a number of addition and subtraction modifications to arrive at state taxable income. Identify the common adjustments to the federal tax base in the computation of state taxable income.

14.Most states use apportionment formulae that place more weight on the sales factor than on the property or payroll factors. Why are state lawmakers attracted to apportionment formulae that emphasize the sales factor?

15.Explain the rules for assigning sales of inventory as well as business receipts other than inventory sales to the numerator of each nexus state’s sales factor.

16.How is payroll defined for purposes of computing a state’s payroll factor?

17.Corporations apportion business income among the various states in which the corporation has nexus. In contrast, the entire amount of a corporation’s nonbusiness income is specifically allocated to a single state. How does UDITPA define business versus nonbusiness income?

18.Explain the difference between how states tax the income of resident individuals as compared to nonresident individuals.

19.Explain the difference between how states tax the income of resident versus nonresident partners of a multistate partnership, as well as resident versus nonresident shareholders of a multistate S corporation.

Issue identification questions

20.Hefti Corporation is a retailer of heavy metal music. Hefti sells exclusively over the Internet. Customers go to Hefti’s web site and choose the songs they wish to purchase. Depending on the customer’s preferences, the customer can either download the songs, or Hefti can create a custom-made CD and mail it to the customer. Hefti’s main offices and production facilities are located in State X. Hefti makes sales in all 50 states. The activities of Hefti’s employees are generally limited to X. However, Hefti representatives do travel to States Y and Z on a regular basis to meet with heavy metal bands and close deals to sell their songs at Hefti’s web site. What state income tax issues should the controller of Hefti consider with respect to states other than X?

21.Walnut Corporation is a large corporation headquartered in State N, which does not have a corporate income tax. Walnut also has income tax nexus in about 20 other states. During the current year, Walnut sells its interests in a number of subsidiaries resulting in a total of $100 million in capital gains from the sale of stock. What state income tax issues should the tax director of Walnut consider with respect to these capital gains?

22.Blue Corporation operates a retail furniture business located in a state that imposes a sales and use tax. During the current year, Blue made $10 million of sales, which included sales to some local churches as well as sales to the local state-owned community college. Blue’s purchases included $6 million of inventory purchased from furniture manufacturers and $15,000 of office supplies purchased from a mail-order vendor located in another state. What sales and use tax issues should the controller of Blue Corporation consider with respect to these transactions?

problems

23.Physical presence test. Green Corporation is a mail order vendor of consumer goods. Green’s main office and distribution facility are located in State X. Green has no property or employees located in any other state. All orders for Green’s products are filled out of its State X warehouse with deliveries made by common carriers. During the current year, Green’s sales to customers located in the neighboring state of Y totaled $15 million. Does Green have nexus in Y for income tax purposes? Does Green have nexus in Y for use tax purposes? Explain.

24.Public Law 86-272. Sparrow Corporation produces organic food products at its facilities located in State Q for sale nationwide. Sparrow has no property or employees based in any other state. Sparrow markets its products in State R through salespeople who travel to R on a regular basis to call on organic grocery stores in order to solicit sales, distribute free samples and arrange product displays. The salespeople use company-provided cars to travel in R and carry company-owned free samples and display materials in the trunks of their cars. Does Sparrow have income tax nexus in State R? Explain.

25.Public Law 86-272. Red Corporation manufactures industrial equipment. Red’s main office and production facility are located in State L. Red has no property or employees based in any other state. Because Red has numerous customers located in State M, Red employees regularly travel to M to solicit sales, install Red’s products, conduct customer training sessions and provide repair services. Does Red have income tax nexus in State M? Explain.

26.Public Law 86-272. Thrush Corporation is a market research firm with offices located in State G. Thrush has no property or employees based in any other state. However, Thrush employees regularly travel to State H to solicit sales from potential customers. In each case, the final agreement has to be approved by the home office in G. Thrush provided $1 million of services to its State H clients during the current year. Thrush was able to do virtually all of the work from its State G offices using e-mail, fax and telephone. Does Thrush have income tax nexus in State H? Explain.

27.Corporate reporting options. Giant, Inc. is a State X corporation that has nexus only in X. Giant has the following affiliates:

Sub 1:A 100%-owned State X corporation that is not unitary with Giant or any other affiliate. Sub 1 has nexus in States X and Y.

Sub 2:A 60%-owned State Y corporation that is unitary with Giant and Sub 3. Sub 2 has nexus only in State Y.

Sub 3:A 100%-owned Mexican corporation that is unitary with Giant and Sub 2. Sub 3 has nexus only in Mexico.

What are Giant’s filing options for financial reporting, federal income tax and state income tax purposes? State X requires separate company reporting, whereas State Y requires combined unitary reporting on a water’s-edge basis.

28.Corporate reporting options. BikeCo, Inc. is a Wisconsin corporation that manufactures bicycles. BikeCo’s facilities are located in Wisconsin. BikeCo markets its bicycles through independently owned distributors. BikeCo owns 100% of each of the following corporations:

▪FloCo, Inc.  A Florida corporation that manufactures component parts for BikeCo’s bicycles. FloCo’s facilities are located in Florida.

▪IllCo, Inc.  An Illinois corporation that functions as BikeCo’s research and development arm. IllCo’s facilities are located in Illinois.

▪IowaCo, Inc.  An Iowa corporation that manufactures frames for BikeCo’s bicycles. IowaCo’s facilities are located in Iowa.

▪NewCo, Inc.  A New Jersey corporation that operates a casino in Atlantic City, New Jersey. NewCo’s operations are not unitary with the other affiliates.

▪CanCo, Inc.  A Canadian corporation that markets BikeCo bicycles in Canada. CanCo operates out of offices located in Toronto.

Each of the above corporations has nexus only in the state in which it is organized, except for BikeCo (parent corporation), which has nexus in Wisconsin and Florida.

Analyze the BikeCo group’s filing options for each of the following purposes:

(i)Wisconsin corporate income tax (Wisconsin requires separate company reporting)

(ii)Florida corporate income tax (an affiliated group filing a federal consolidated return may elect to file a Florida consolidated return, but only if the parent corporation has nexus in Florida)

(iii)Illinois corporate income tax (Illinois is a mandatory combined unitary reporting state, with a water’s-edge combination)

(iv)Iowa corporate income tax (Iowa permits affiliates that are included in a federal consolidated return and have nexus in Iowa to elect to file an Iowa consolidated return)

(v)New Jersey corporate income tax (New Jersey generally requires separate company reporting)

29.Apportionment formula. Acme Corporation, which has nexus in a number of states, derived a total of $100 million of apportionable income during the current year. Acme has 10% of its property, 10% of its payroll and 40% of its sales located in State Z. Z uses a double-weighted sales apportionment formula. How much of Acme’s income is apportioned to Z?

30.Apportionment formula. Hawk Corporation conducts business in States X and Y. During the current year, Hawk derives a total of $10 million of apportionable income, and its property, payroll and sales are distributed as follows:

State XState Y

Property.....100%...... 0%

Payroll...... 100%...... 0%

Sales...... 70%...... 30%

Compute Hawk’s State X and State Y taxable income under each of the following independent assumptions:

  1. Both X and Y employ an equally-weighted three-factor apportionment formulae.
  2. X employs an equally-weighted three-factor formula. Y employs a double-weighted sales formula.
  3. X employs a single-factor sales-only formula. Y employs an equally-weighted three-factor formula.
  4. Both X and Y employ a single-factor sales-only formula.

31.Sales factor. Rose Corporation has nexus in States L and M. All goods are shipped from State L. Current year revenues include $60 million of sales to L customers and $30 million of sales to M customers. Other business receipts include $10 million of fees derived from services performed for customers located in M. The underlying income-producing activity for these services took place in State L. Compute Rose’s sales factor for State L.

32.Sales factor throwback rule. Tulip Corporation has nexus in States B and C. All goods are shipped from State B, which uses a single-factor sales-only formula. Current year revenues include $12 million of sales to customers located in B, $20 million of sales to customers located in C and $18 million of sales to customers in states that Tulip does not have nexus. How much higher will Tulip’s State B apportionment percentage be if B has a throwback rule than if B does not have a throwback rule?

33.Sales factor throwback rule. Acme is a State L corporation that manufactures and sells consumer products. Although Acme makes sales to customers nationwide, it has nexus only in States L and M. All shipments are made from Acme’s factory located in State L. Both L and M employ double-weighted sales apportionment formulae. During the current year, Acme’s property, payroll and sales are distributed as follows (all numbers in millions):

State LState MOther statesTotal

Property...... $90...... $10...... $ 0...... $100

Payroll...... 18...... 2...... 0...... 20

Sales...... 72...... 12...... 36...... 120

Compute Acme’s State L and State M apportionment percentages under each of the following independent assumptions:

a.State L does not have a sales throwback rule.

b.State L has a sales throwback rule.

34.Sales factor. Birch Corporation markets its products nationwide but has nexus only in States Q and R. All goods are shipped from Birch’s production facility located in Q, which has a sales throwback rule. States Q and R include business interest, dividends and royalties in the sales factor, and assign such income to the state of commercial domicile. Birch is commercially domiciled in Q. States Q and R source sales other than sales of inventory using the income producing activity rule. Acme’s current year business receipts are as follows (all numbers in millions):

 Sales shipped to Q customers...... $ 60

 Sales shipped to R customers...... 90

 Sales shipped to customers in other states...... 120

 Interest income on short-term investments of working capital...... 2

 Income from renting excess space in warehouse located in Q...... 8

 Fees for services performed for R clients (work performed in Q)...... 11

 Royalty from industrial patent...... 9

$300

Compute Birch’s sales factors for States Q and R.

35.Sales factor. Eagle, Inc., a State L corporation, is a website development firm that provides services to customers located in States L, M, N and O. Eagle’s sales are distributed equally among these four states. Because Eagle employees regularly travel to L, M, N and O to solicit sales for its services, Eagle has nexus in all four states. However, the underlying income-producing activity (i.e., website development services) is performed at Eagle’s home office in State L. Assuming L, M, N and O all use a single-factor sales-only apportionment formula, compute Eagle’s apportionment percentages for States L, M, N and O in each of the following independent scenarios.

a.For purposes of computing the numerator of the sales factor, all four states use an income-producing activity rule for sales of services.

b.L uses an income-producing activity rule, while M, N and O use a location-of-recipient rule.

c.L uses a location-of-recipient rule, while M, N and O use an income-producing activity rule.

36.Sales factor. PureCo, Inc., a State B corporation, is a consulting firm that provides water purity testing services. PureCo’s customers include water purification plants in States B, C, D and E, with sales spread equally among the four states. Because PureCo employees regularly travel to B, C, D and E to meet with customers, PureCo has nexus in all four states. Customers mail water samples to PureCo’s offices in State B, where the analyses are performed. Therefore, the entire underlying income-producing activity is performed at its home office in State B. For purposes of computing the numerator of the sales factor, States B and C use an income-producing activity rule to source sales of services, whereas States D and E use a location-of-recipient rule. All four states use an equally-weighted three-factor apportionment formula.

a.Assuming 100% of PureCo’s property and payroll is located in State B, compute the percentage of PureCo’s income subject to taxation in each of the four states.

b.How would PureCo’s state apportionment percentages change if PureCo were to relocate its offices to State D, in which case PureCo’s underlying income-producing activity as well as 100% of its property and payroll would now be located in State D?

37.Property factor. Pine Corporation has nexus in several states. During the current year, the average balances in Pine’s asset accounts is as follows (all numbers in millions):

 Cash...... $10

 Accounts receivable...... $30

 Inventory...... $40

 Machinery and equipment (original cost)...... $200

 Accumulated depreciation...... $60

 Patents (net of amortization)...... $20

 Construction-in-progress...... $50

Compute the denominator of Pine’s property factor.

38.Property factor. ABC, Inc. is a calendar year corporation that manufactures exercise equipment. ABC’s main office and production facilities are located in State Y. ABC markets it products mainly through independent distributors. However, ABC does have a warehouse in State Z, which it leases at a cost of $5 million per year. ABC has income tax nexus only in States Y and Z. ABC’s balance sheet at the beginning and end of the current year is as follows (all numbers in millions):

January 1 account balances:
State YState ZTotal

  • Cash...... $ 20....$ 10....$ 30
  • Accounts receivable...... 40..... 20.... 60
  • Inventory...... 150..... 80.... 230
  • Property, plant and equipment...... 800..... 180.... 980
  • Accumulated depreciation...... (300).... (20).... (320)
  • Land...... 200..... 0.... 200
  • Rental property (see Note 1)...... 400..... 0.... 400
  • Accumulated depreciation: Rental property..... (80).... 0.... (80)
  • Patents, net of amortization (see Note 2)...... 50..... 0.... 50
  • Construction-in-progress (see Note 3)...... 100..... 0.... 100

December 31 account balances:
State YState ZTotal

  • Cash...... $ 30....$ 20....$ 50
  • Accounts receivable...... 50..... 30.... 80
  • Inventory...... 250..... 80.... 330
  • Property, plant and equipment...... 1,000..... 180....1,180
  • Accumulated depreciation...... (400).... (30)... (430)
  • Land...... 200..... 0.... 200
  • Rental property (see Note 1)...... 0..... 0.... 0
  • Accumulated depreciation: Rental property..... n.a...... 0.... n.a.
  • Patents, net of amortization (see Note 2)...... 40..... 0.... 40
  • Construction-in-progress (see Note 3)...... 250..... 0.... 250

Note 1:Last year, ABC moved into new office facilities. ABC rented its old office building while it was for sale. The building was sold in June of the current year.

Note 2:Several years ago, ABC purchased some patents on exercise equipment.

Note 3:Last year, ABC began construction of an addition to its production facilities. The addition was neither completed nor placed into service during the current year.