State & Local Taxes
Several important developments have occurred in the area of state taxation so far in 2014. Those developments include amendments to the Multistate Tax Commission's Multistate Tax Compact; significant corporate tax reforms enacted in New York; and a key ruling by California's Franchise Tax Board (FTB) that affects members of multiple-member limited liability companies (LLCs) doing business in the state.
The Multistate Tax Commission (MTC) has been discussing changes to Article IV of the Multistate Tax Compact incorporating the Uniform Division of Income for Tax Purposes Act (UDITPA) and proposed five significant changes to UDITPA.
On July 30, the full MTC voted to approve and adopt the following Compact amendments:
- Business income: The definition of "business income" is replaced with "apportionable income," which includes "all income that is apportionable under the Constitution of the United States and is not allocated under the laws of [the enacting] state."
- Factor weighting: The adopting state's apportionment formula replaces the MTC's current equally weighted, three-factor apportionment formula.
- Sales: The definition of "sales" is replaced by "receipts" that are received from transactions in the regular course of business, except from hedging transactions and disposition of cash or securities.
- Sales-factor sourcing for services and intangibles: The current cost-of-performance sourcing rule for receipts from sales of intangible property and services is replaced with market-based sourcing rules.
- Distortion relief: The state's tax administrator may establish regulations that provide for alternative allocation and apportionment methods for taxpayers in a particular industry or activity, but the regulations adopted must be applied uniformly, except that with respect to any taxpayer to whom such a regulation applies, the taxpayer may petition for, or the tax administrator may require, adjustment.
N.Y. Corporate Tax Reform
The 2014—15 New York state budget contains significant corporate tax reforms that are generally effective for tax years beginning on or after Jan. 1, 2015.
The plan merged the bank tax and corporate franchise tax and reduced the tax rate to the lowest level since the late 1960s. Qualified manufacturers' business income base rate is reduced to 0%.
One of the new rules recognizes the shift to a service- and knowledge-based economy by adopting market-based sourcing of sales and apportioning business income on a single receipts factor. This encourages investments in the state and promotes use of a highly educated workforce without increasing the tax burden.
The New York Department of Taxation and Finance set up a "Corporate Tax Reform" webpage to explain the reforms. For more discussion, see Novitsky, "New York Tax Reforms Include Significant Changes for Nexus, Calculation of NOLs," 45 The Tax Adviser 628 (September 2014).
California Members of Multiple-Member LLCs
On July 22, 2014, the California FTB issued Legal Ruling 2014-01 discussing when a business entity with a membership interest in a multiple-member LLC that is classified as a partnership for tax purposes would be required to file a return and pay applicable taxes and fees.
LLCs are business entities that have some of the characteristics and benefits of both partnerships and corporations. Although every LLC is organized under a state statute and exists under civil law, LLCs are not recognized as an entity choice for tax law purposes and must be treated according to the entity choice the LLC makes for tax law purposes under the federal entity classification election system. California conforms to the federal check-the-box tax classification, which defaults an entity with two or more members to partnership status unless it checks the box to be treated as a corporation.
Under Cal. Rev. & Tax. Code Section 23101(a), a taxpayer is "doing business" when it is "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit." For tax years beginning on or after Jan. 1, 2011, a taxpayer is also doing business in California if it is organized or commercially domiciled in California, or its California presence factors exceed the threshold of Cal. Rev. & Tax. Code Section 23101(b). (The current threshold amounts are $50,950 of property; $50,950 of compensation paid; $509,500 of sales; or 25% of total property, total compensation paid, or total sales. Sales, property, and payroll of the taxpayer include the taxpayer's pro rata or distributive share of passthrough entities.)
California conforms to federal subchapter K provisions, and, for this reason, where the partnership is "doing business," the partners are also "doing business." Members of both "manager-managed" LLCs and "member-managed" LLCs that are "doing business" in California as a partnership for tax purposes are "doing business."
LLCs' acts of registering to do business in California and organizing in California are not attributed to the members. Thus, if LLCs are merely registered to do business or are organized in California, have no activities or factor presence in California sufficient to constitute "doing business," and have no California-source income, the corporate members of these LLCs are not required to file California returns and are not subject to the franchise tax. If the activities of the LLCs constitute "doing business," the corporate members are required to file and pay California franchise tax. Additionally, if a member's distributive share of California sales exceeds the factor presence threshold, the member is considered to be "doing business" in California.
Tax practitioners should be diligent and revisit the client's organization structure, interview personnel to understand the relationship and activities, and review appropriate data carefully to identify all required returns.
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-422-7244 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.