Current Corporate Income Tax Developments, Part I

By Karen J. Boucher, CPA, and Shona Ponda, J.D.


  • States continued the trend toward asserting “economic” nexus (i.e., nexus without physical presence in a state) for purposes of state income taxes. A number of states passed laws asserting that a taxpayer has nexus with the state if the taxpayer has a certain amount of sales, property, or payroll within the state.
  • As a result of recent economic conditions, a number of states passed laws temporarily disallowing net operating loss (NOL) deductions or otherwise modifying their rules regarding NOL deductions.
  • Many states passed legislation decoupling their tax law from certain federal tax provisions. Provisions that were frequently the subject of decoupling include the Sec. 172(b)(1)(H) elective federal five-year carryback provisions for NOL deductions and the Sec. 108(i) deferral of income arising from certain discharged business indebtedness.

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were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn.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



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


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.


The DOR has adopted the Multistate 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


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.


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


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


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.


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.


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


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 in-state 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.


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.


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 activities were not considered activities conducted by the two subsidiaries, and thus those subsidiaries were not taxable. 20

In another nexus development, the New York Tax Appeals Tribunal affirmed that two out-of-state corporate member holding companies that owned an LLC treated as a partnership that in turn held a general partner ownership interest in another New York partnership had nexus with New York based on their ownership interests in the LLC, even though these companies were allegedly not unitary with the partnerships. 21


The Ohio Department of Taxation rejected a taxpayer’s constitutional challenge to the economic presence nexus standard imposed by Ohio’s commercial activity tax, holding that the retailer had substantial nexus despite its lack of physical presence because it had more than $500,000 in annual Ohio taxable gross receipts. 22 In holding that Quill’s 23 physical presence nexus standard applies only to sales taxes and not income or gross-receipts-based taxes, the ruling refers to economic nexus case law from other jurisdictions.


SJR 61, Laws 2010, imposes and sunsets a new business activity tax (BAT) in lieu of ad valorem taxes on the intangible personal property of persons doing business in Oklahoma for tax years 2010–2012. “Doing business” in Oklahoma is defined as “each and every act, power or privilege exercised or enjoyed in the state, as an incident to, or by virtue of the powers and privileges acquired by individual persons or entities.” More details on the BAT will be included in Part II of this article.


A Texas Court of Appeal affirmed that a company had nexus via the activities performed by its Texas-based regional director, who extolled the virtues of the company’s products to distributors and attempted to resolve customer complaints. 24

In another development, the comptroller held that because a company had three employees who were Texas residents and the company and the corporate group of which it was a member performed business contracts in Texas, the company had nexus. 25


The Utah State Tax Commission (STC) explains that an insurer providing Medicare Part D prescription drug plans (which under federal law are exempt from state premiums taxes) qualified for the corporate income/franchise tax exemption because the exemption does not require insurers to actually pay Utah’s premiums tax. 26

In another ruling, the STC explained that a company would not be required to file an income tax return based on its proposed attendance at a four-day trade show and four follow-up visits to shop for suppliers. 27 Under Utah policy, a filing requirement for state corporate income tax is not created where the sole in-state activity is shopping for a supplier; however, if a seller of services is targeting the Utah market and making sales of services into Utah beyond a de minimis level, economic presence is created and Utah is entitled to impose its franchise/income tax.


Responding to an inquiry from a company providing on-demand repair and maintenance services for customers via third-party contractors, the Virginia Department of Taxation explains that whether the company has income tax nexus is largely dependent upon whether any of the third-party providers located in Virginia are independent contractors. 28 A third-party service provider that is not independent is considered to be providing services on behalf of the company to the company’s in-state customers, thereby imparting the out-of-state company with Virginia nexus.


Effective June 1, 2010, SB 6143, Laws 2010, adopts economic nexus for Washington business and occupation tax purposes for taxpayers engaged in certain service activities, including the receipt of royalty income, and that have property or payroll exceeding $50,000 or sales exceeding $250,000 in Washington. Subsequently, the Washington DOR (1) issued Emergency Rule WAC 458-20-19401 and several industry-specific notices describing the new minimum nexus thresholds; (2) issued a September 10, 2010, special notice 29 explaining that a person that stops the business activity that created nexus in Washington continues to have nexus for the remainder of that calendar year, plus one additional calendar year; and (3) launched an online video tutorial to help explain the new law.

West Virginia

The West Virginia Office of Tax Appeals affirmed that a trademark company that licensed trademarks and trade names to in-state entities (including affiliates and third parties) that manufactured and/or sold the trademarked/trade-named products to in-state customers had sufficient nexus for business income and franchise tax purposes. 30

State Tax Base

The majority of states imposing a corporate income-based tax begin the computation of state taxable income with taxable income as reflected on the federal corporate income tax return (Form 1120, U.S. Corporate Income Tax Return). These states use either taxable income before net operating loss (NOL) and special deductions (line 28) or taxable income (line 30). Certain state-specific addition and subtraction modifications are then applied to arrive at the state tax base. Following is a summary of the more significant developments to the states’ tax bases.

Deductions Related to Dividends


A California superior court held that the taxpayer successfully showed that its loan interest expenses were allocable to its taxed domestic earnings rather than to its nontaxed dividends received from foreign subsidiaries because the dominant purpose of the underlying borrowings was to fund its domestic operations. 31 The California Franchise Tax Board (FTB) unsuccessfully argued that the taxpayer’s primary purpose for borrowing the underlying funds was to avoid having to repatriate the earnings of its “cash-rich” foreign subsidiaries and that the taxpayer could have financed its domestic operations with distributions from the income of its foreign subsidiaries, but instead chose to borrow “as part of a strategy to avoid paying tax on that income.” The court also clarified that the 2004 holding in Fujitsu IT Holdings, Inc., 32 on the distributions ordering issue was expressly limited to current-year earnings and did not govern how to order distributions made by a controlled foreign corporation to its parent when the distributions are made out of earnings from multiple years.

In another development, the California Court of Appeal held in favor of the FTB, concluding that the corporate income/franchise tax dividends-received deduction under California Rev. & Tax. Code Section 24402, which in 2003 was held unconstitutional in Farmer Bros. Co. v. Franchise Tax Board, 33 could not be severed or reformed by eliminating only the unconstitutional restriction and upheld the imposition of the amnesty penalty on the taxpayer’s failure to pay the related deficiency by the March 31, 2005, deadline set forth in California’s amnesty program. 34


For tax years beginning after 2009, captive real estate investment trusts (REITs) may not deduct the federal dividends-paid deduction (DPD), and deductions for dividends received from captive REITs that are not otherwise subject to Connecticut’s corporation business tax are disallowed. 35 In Informational Publication 2010(21) (12/10), the Connecticut Department of Revenue Services explains how the Connecticut corporation business tax applies to REITs and owners of REITs.


The Florida Third District Court of Appeal held that there is no unconstitutional discrimination against foreign commerce with respect to Florida’s tax treatment of dividends paid by foreign corporations. 36 At issue was Florida’s limitation of NOL carryovers to federal NOLs pursuant to Sec. 172; the taxpayer unsuccessfully argued that because losses created by domestic dividend deductions are included in the NOL carryover, while the foreign dividend subtraction is not included in the NOL carryover, the law results in invalid discrimination between domestic and foreign dividends. During 2008, the First District Court of Appeal similarly held that the treatment of foreign dividends was not unconstitutional. 37

In another development, the DOR explains that if the repatriated dividends from a foreign subsidiary constitute foreign-source dividends under Secs. 78, 862, or 951, they will be subtracted in calculating adjusted federal income (and thus excluded from the Florida tax base), regardless of whether such dividends constitute business or nonbusiness income. 38


SB 3901, Laws 2010, provides that effective for tax years ending after June 30, 2010, captive REITs that are not public REITs or owned by a bank or bank holding company are required to add back the federal DPD, and captive REIT affiliated groups are required to file their Tennessee franchise/excise tax returns on a combined basis.



In a case involving a merged corporation, an Arizona superior court held that the Arizona DOR NOL rules apply in lieu of the federal rules set forth in Secs. 381–382. 39


Among other provisions, SB 858, Laws 2010, extends the suspension of NOL deductions for an additional two years to include tax years beginning after 2009 and before 2012, and defers the two-year carryback of NOLs that was to take effect for tax years beginning after 2010 until tax years beginning after 2012, with the phase-in of NOL carryback utilization beginning the same year.


HB 1199, Laws 2010, caps the annual NOL deduction at $250,000 for tax years beginning after 2010 but prior to 2014. Any portion of an NOL carryforward that cannot be used solely due to this limitation can be increased by 3.25%, and NOLs disallowed in a given tax year due to this cap may be carried forward one additional year from the time otherwise prescribed.

In August, the Colorado DOR updated publication FYI Income 19, 40 which provides guidance on the computation and use of Colorado NOLs. The DOR has also proposed amending Reg. 39-22-504 to reflect this three-year annual NOL limitation.


HB 2594, Laws 2010, decouples from Sec. 382(n) regarding the treatment of a change in ownership of a bank or other corporation. The Hawaii Department of Taxation summarizes the tax provisions contained in HB 2594 in Announcement No. 2010-10 (6/7/10).


Effective January 1, 2010, HB 381, Laws 2010, provides that Idaho NOLs incurred by a corporation will survive a merger, subject to the provisions of Secs. 381 and 382. In addition, changes in the location of a loss corporation’s business or its key employees are not treated as a failure to satisfy the continuity of business requirements. If the premerger corporation conducted operations in Idaho and at least one other state, the Sec. 382 loss limitation is limited further by the premerger loss corporation’s Idaho apportionment factor for the last tax year preceding the merger date. The law also clarifies the definition of an Idaho NOL.

The Idaho STC has proposed amended Rule 200, addressing NOLs in the case of corporate mergers to reflect recently enacted law. The Idaho STC also amended Rule 201, modifying how a taxpayer can make the election to forgo the NOL carryback by removing the option of attaching the federal election and clarifying that if an NOL is required to be carried back and if the statute of limitation has expired on the carryback year, a refund may not be allowed in the closed tax year.


An administrative law judge held that a company was required to check the box on its 2001 and 2002 Illinois corporate income tax returns to forgo its Illinois net loss deduction (NLD) carryback periods. 41 In the absence of a valid election otherwise, the NLDs must be carried back before they can be carried forward.


In Letter of Findings No. 09-0397 (3/24/10), the Indiana DOR held that because an in-state manufacturer failed to demonstrate common parent status as described in Regs. Sec. 1.1502-75(d)(3), it could not carry back NOLs to returns filed for the tax years at issue.

In another development, HB 1086, Laws 2010, decouples from the elective five-year federal NOL carryback provisions.


New Rule LAC 61:I.1125 provides that the IRS’s position set out in Rev. Rul. 81-88 will be followed when determining whether a NOL carryback should be applied against the income claimed on a taxpayer’s return or against the income that should have been reported.


Maine Revenue Services explains that no NOL deductions are allowed for tax years beginning in 2009, 2010, and 2011, and the disallowed deductions generally can be claimed after 2011, as long as they are taken during the federal NOL carryforward period plus the number of years the NOL deduction was disallowed. 42


In Administrative Release No. 18 (September 2010), the Maryland Comptroller’s Revenue Administration Division explains that Maryland recognizes a federal NOL as the NOL for calculating state taxable income, but Maryland’s decoupling modifications could affect the amount of the NOL or the amount used in carryback and carryforward years. For instance, Maryland follows the carryback and carryforward periods under federal law without regard to the five-year carryback election under Sec. 172(b)(1)(H). The release also discusses the relationship between Maryland tax base addition/subtraction modifications (including disallowed intercompany expenses) and the use of NOLs under separate and/or consolidated return filing scenarios.


In Letter Ruling 10-6 (10/5/10), the Massachusetts DOR explains that the limitation on the use of pre-combination NOL carryforwards generally does not apply where the company and its combined group members attributed 100% of the group’s income to Massachusetts in each of the pre-combination tax years in which they either incurred or carried forward the NOLs and in the tax year that the company seeks to use the carryforward.

In another development, for corporations that are allowed NOL deductions, S 2582, Laws 2010, extends the NOL carryforward period from 5 to 20 years and changes the methodology for the calculation of an NOL carryforward from a pre-apportionment to a post-apportionment methodology. In TIR 10-15 (11/12/10), the Massachusetts DOR summarizes this new law.


SB 2113, Laws 2010, clarifies that for tax years beginning after 2007 and ending before 2009, NOL carrybacks are limited to two years. For tax years beginning after 2008, the number of years to which NOLs may be carried back is determined by reference to Sec. 172.


The comptroller explains that if the combined group expands from within, there is no effect on the franchise tax temporary credit for business loss carryforwards of the combined group, but if an existing entity is added to the group, that new member’s temporary credit is lost. 43

In another letter, the comptroller explains that calculating the franchise tax temporary credit for business loss carryforwards is based on business loss carryforwards that were created on the 2003 and subsequent franchise tax reports that were not expired or exhausted on a report due before January 1, 2008. 44 Business loss carryforwards must have been used to offset any positive amount of earned surplus, even in years when no tax was due or the tax due was based on taxable capital.

Intercompany Expenses/Transactions

District of Columbia

Effective for tax years beginning after 2008, B18-0203 (Act 18-255) expands the related-party addback statute to include interest expense that is not attributable to intangibles. In Notice 2010-04, the Office of Tax and Revenue discusses the new intercompany intangible and interest expense addback provisions.


The Indiana DOR held that a restaurant operator could not claim intercompany royalty and interest expense deductions because the deductions had the effect of distorting its Indiana source income. 45 However, the DOR did agree to waive related negligence penalties.

In a similar ruling, having found that the retailer failed to show that its out-of-state trademark subsidiary had licensed the trademarks to unrelated third parties and that it appeared that the retailer maintained control, directly or indirectly, over the trademark subsidiary, the Indiana DOR disallowed the deductions for royalties because doing so more fairly reflected the retailer’s Indiana income. 46

In a ruling involving the financial institutions tax (FIT), the Indiana DOR reversed an auditor’s attempt to disallow deferred recognition of dividend income received from an affiliate REIT because the DOR’s discretionary authority under statute to more fairly represent income permits only one of three options: (1) a separate accounting; (2) the filing of a separate return for the taxpayer; or (3) the reallocation of tax items between a taxpayer and a member of the taxpayer’s unitary group. 47 Thus, the statute does not allow the option of reallocating a single entity’s income from one year to the other to more fairly represent a taxpayer’s Indiana income for each of the years in question. The DOR also agreed with the bank that the FIT does not provide for the addback of dividends paid by a captive REIT.

In another ruling, the Indiana DOR held that intercompany accounts receivable factoring fees were legitimate and reasonable expenses because the taxpayer successfully showed that this related entity was a valid operating company that actively pursued the collection of the factored accounts receivables for which it had charged an arm’s-length rate, and the related entity neither loaned the factoring fees back to the taxpayer nor returned them to the taxpayer in the form of dividends. 48

Similarly, in another ruling, the Indiana DOR held that a subsidiary could deduct royalties and management fees paid to its parent because the payments occurred pursuant to arm’s-length transactions and agreements for valid business purposes, and there was no circular flow of monies concerning the royalty fee payments made by the subsidiary to the parent. 49


In the Massachusetts Appeals Court’s earlier ruling in TJX Companies, Inc., 50 the court held that two retailers that had transferred trademarks/service marks to several related intangible holding companies could not claim related royalty and interest deductions from net income on their state combined corporate excise tax returns because the transfers and license-back arrangements were “sham transactions” and the associated intercompany loans between the retailers and their subsidiaries were not bona fide debt. A panel of the court more recently affirmed that the department’s reattribution of the subsidiaries’ investment income generated from sources other than the licensing agreements to their respective parent retailers was proper because the parents had essentially retained control over the marks and made self-interested investment decisions pertaining to the marks, and the subsidiaries did not earn any independent income. 51 The court deemed irrelevant the fact that the subsidiaries were separate corporate entities because it concluded that the real issue was “whether any of the three wholly-owned subsidiaries earned any income independently of the sham transactions.”

In another decision, the Massachusetts Supreme Judicial Court affirmed that the DOR appropriately adjusted the income of a parent corporation by reallocating back royalty income that was received by a Delaware holding company subsidiary for its licensing of certain trademarks, because the transfer of the license agreements and purported transfer of the company’s logos to the subsidiary constituted sham transactions that resulted in an improper assignment of income. 52


Reversing the Minnesota Tax Court’s decision, the Minnesota Supreme Court held that the DOR does not have the authority to attribute income and assess taxes to a business that structured itself to comply with relevant tax statutes on the ground that it was motivated to do so solely by tax avoidance. 53 The court found that the DOR does not have the authority to completely disregard the taxpayer’s captive REIT structure organized in compliance with relevant accounting methods and statutes in assessing the business’s income and taxes.

New Jersey

The New Jersey Division of Taxation explains that the director will accept the intercompany addback unreasonable exception in the following three common situations: (1) to avoid double taxation by New Jersey that would result from taxing the related party’s interest income and also not permitting the payer a deduction; (2) where a taxpayer has both a receivable and payable from the exact same entity, the department will permit the interest income and interest expense to be netted so that only the excess interest expense will be subject to the addback rule; and (3) where a taxpayer is involved in a cash sweep cash management system and both parties to the arrangement conduct business at arm’s length. 54

In another development, the New Jersey Tax Court held that a subsidiary had satisfied the unreasonable exception because the intercompany financing arrangements had economic substance. 55 The court found the taxpayer’s reason for the intercompany arrangement credible (i.e., the parent received more favorable interest rates than its subsidiaries could), and the parent paid taxes in 17 jurisdictions (most being unitary states) on the interest income it earned from the subsidiary.


The Wisconsin Tax Appeals Commission held that a taxpayer was not entitled to claim royalty expense deductions for amounts paid to its subsidiary because the relationship between the parent and intellectual property subsidiary resulted in a circular flow of funds that lacked economic substance or a valid business purpose other than tax avoidance. 56 Citing Massachusetts and federal case law, the commission explained that the subsidiary did not appear to manage the intellectual property transferred to it from its parent any differently than the parent previously had, and the parent largely retained control over all decisions related to that property while the intellectual property subsidiary held it.

In another development, the Wisconsin DOR issued tax regulation 3.01, 57 to provide interpretation and explanation of Wisconsin’s statutory provisions for disclosing related entity expenses and the related addition and subtraction modifications. In general, the addback statutes require a taxpayer to add back interest, rental, and intangible expenses and management fees paid to a related entity, and then if certain tests are satisfied, the taxpayer may subsequently deduct the expenses. The addback statutes also impose a disclosure requirement for related entity expenses. Notwithstanding a taxpayer’s satisfying the tests allowing the deductions of related entity expenses, the rule explains that the DOR has express authority to reallocate a taxpayer’s income, deductions, credits, or allowances to prevent tax evasion or to clearly reflect income, or to disregard transactions that lack economic substance.

Conformity to Federal Legislation

While many states generally conform to the federal income tax laws, a number of states have increasingly enacted specific decoupling provisions such as those involving federal bonus depreciation and Sec. 179 expensing, NOL carryover periods, and/or Sec. 163(e)(5)(F) regarding the suspension of applicable high-yield discount obligation rules. During 2010, a number of states enacted legislation that decoupled from the new provisions allowing deferral of income arising from certain discharged business indebtedness under Sec. 108(i). 58 Identifying all of the states’ decoupling developments during 2010 is beyond the scope of this article; readers are encouraged to review state tax law changes as summarized in the states’ tax return instructions and on the states’ websites.


HB 2156, Laws 2010, decouples from Sec. 108(i) and from the five-year NOL carryback provisions under both the American Recovery and Reinvestment Act of 2009, P.L. 111-5, and the Worker, Homeownership, and Business Assistance Act of 2009, P.L. 111-92. In an August 16, 2010, Notice Regarding Non-conformity, the Arizona DOR explains the new law.


Proposition 26, which passed in the general election held on November 2, 2010, amends the California constitution to extend the two-thirds vote requirement for taxes by defining “tax” for state and local purposes to include any levy, charge, or exaction of any kind by the state legislature or a local government; it thus applies to state laws that result in any taxpayer paying higher tax. The proposition also repeals, one year after the proposition was approved, any state law adopted between January 1 and November 2, 2010, that conflicts with Proposition 26 unless passed again by a two-thirds vote. Because California’s federal conformity legislation (SB 401, Laws 2010) raised taxes but was passed by only a majority vote, Proposition 26 repeals SB 401 in one year unless the state legislature reenacts this legislation by a two-thirds vote. If SB 401 is not reenacted, the federal conformity date will revert back to January 1, 2005, the conformity date prior to the 2010 enactment of SB 401.


For tax years beginning after 2009, HB 2, Laws 2010, requires an income tax addition adjustment for a portion of the federal qualified domestic production activities deduction under Sec. 199.


LD 1539, Laws 2010, corrects a technical error in Maine’s subtraction modification for depreciation deductions for tax years beginning after 2008.


The Maryland Revenue Administration Division explains that state law decouples from federal bonus depreciation allowances and Sec. 179 expensing; the elective five-year NOL carryback under Sec. 172(b)(1)(H); Sec. 108(i); and the automatic decoupling from any federal tax law change that affects Maryland’s tax revenues by at least $5 million for any tax year that begins in the calendar year in which the change is enacted. 59


HB 29, Laws 2010, decouples from the federal domestic production activities deduction under Secs. 199 and 108(i). For tax years beginning after 2009, Virginia allows a deduction equal to two-thirds of the federal Sec. 199 deduction. The Virginia Department of Taxation explains the new law in Tax Bulletin 10-08 (6/10/10).

Other Modifications


The Minnesota DOR explains that the following portion of the Michigan Business Tax (MBT) must be added back in determining the state tax base: the business income tax, plus a portion of the surcharge attributable to the business income tax, less credits that reduce the business income tax. The remainder of the MBT is not a tax based on net income. 60

New Hampshire

For tax periods beginning after 2003, SB 483, Laws 2010, provides that in the case of a qualified like-kind exchange under Sec. 1031, in which a business organization uses a single-member LLC, revocable trust, or other entity disregarded for federal income tax purposes as the recipient of replacement property, the recipient entity must take the basis of the relinquished property as held by the parent business organization, prior to the exchange, as computed for federal income tax purposes. In Technical Information Release 2010-009 (8/3/10), the New Hampshire Department of Revenue Administration explains the new law and notes that any taxpayer entitled to a refund as a result of this new law may request a refund within the later of three years from the due date of the tax or two years from the date the tax was paid.

New York

For tax years beginning after 2009, A 9710-D, Laws 2010, conforms the state and city bad debt deduction for banks under Article 32 to that allowed for federal income tax purposes.


Amended Rule 150-317.013 clarifies that capital losses must be carried back before they can be carried forward and that capital losses cannot be deducted against capital gains reported under Oregon’s 2009 amnesty program.

Allocable/Apportionable Income


The Alabama Supreme Court reversed the Alabama Court of Civil Appeals’ ruling, which had held that Kimberly Clark must classify income from the sale of its Alabama manufacturing facility and adjacent timberlands as apportionable business income under the transactional test. 61 The court explained that such income cannot be classified as business income because the sale was an extraordinary transaction that represented the company’s divestiture of a part of its business.


The State Board of Equalization (SBE) affirmed that a manufacturer’s gain from the sale of stock in an affiliated distribution company was properly classified as business income because the gain met the functional test whereby the acquisition, management, and disposition of the stock constituted integral parts of the manufacturer’s regular trade or business operations. 62


The Oregon Tax Court held that a California-domiciled corporation was entitled to classify certain gains from the sale of stock and other corporate assets as nonbusiness income allocable outside Oregon, even though it had characterized this income as business income for California tax purposes, because doing so did not violate any supposed duty of consistent or uniform reporting of income under the Uniform Division of Income for Tax Purposes Act (UDITPA) and/or state law. 63 The court noted that it did appear that the corporation initially failed to comply with an Oregon administrative rule requiring disclosure of disparate tax treatment among jurisdictions because it did not disclose the difference in treatment of the disputed income on its Oregon return; however, the court stated that there are no legal sanctions for untimely disclosure.

In another income classification decision, the Oregon Tax Court ruled that a closely held cell phone service company’s gain from the sale of its Federal Communications Commission license was subject to apportionment as business income under the functional test, even though the sale essentially constituted a liquidation of the company’s business. 64

Sec. 338(h)(10) Transactions


The SBE held that a company must treat Sec. 338(h)(10) gain involving goodwill as business income under the functional test and that the gross proceeds from the liquidating sale were properly excluded from the sales factor pursuant to an administrative regulation, because the receipts were substantial and arose from an incidental or occasional sale of property held or used in the regular course of the company’s trade or business. 65


For stock purchases and sales occurring after June 2, 2010, HB 1138, Laws 2010, requires that all Sec. 338 elections apply for purposes of calculating a corporation’s Georgia taxable net income.


In Letter of Findings No. 09-0397 (3/24/10), the Indiana DOR held that while the Sec. 338(h)(10) gain was business income, a consolidated filing group successfully showed that inclusion of the proceeds in the sales factor did not fairly reflect the location where the group earned its income and unreasonably and arbitrarily attributed a percentage of income to Indiana that was out of proportion to the business transacted in Indiana. Accordingly, the appropriate alternative apportionment method was to exclude the proceeds from the deemed sale from both the numerator and the denominator of the consolidated group’s sales factor.


A Louisiana Court of Appeal affirmed that in a Sec. 338(h)(10) transaction, the selling parent succeeds to the subsidiaries’ NOLs pursuant to federal income tax conformity provisions in state law. 66


The Oregon Tax Court held that a consolidated unitary group of corporations must apportion its Sec. 338(h)(10) gain from the sale of out-of-state subsidiary stock as business income under the functional test. 67 The court explained that a liquidation exception to the functional test was not recognized in the Crystal Communications case; 68 however, even if it were to be recognized, “case law from other jurisdictions recognizing such an exception indicates that the exception does not apply where the seller continues in business and uses the proceeds of a liquidating sale in business.”

This article is written in general terms and is not intended to be a substitute for specific advice regarding tax, legal, accounting, investment planning, or other matters. While all reasonable care has been taken in the preparation of this article, Deloitte Tax LLP accepts no responsibility for any errors it may contain, whether caused by negligence or otherwise, or for any losses, however caused, sustained by any person or entity that relies on it.


1 AZ DOR Private Taxpayer Ruling LR10-010 (7/8/10).

2 CA SBX3 15, Laws 2009.

3 CO Code Regs. §39-22-301.1.

4 FL DOR Technical Assistance Advisement 10C1-009 (9/1/10).

5 IN DOR Ltr. of Findings No. 09-0577 (5/26/10).

6 KFC Corp. v. Iowa Dep’t of Rev., No. 09-1032 (Iowa 12/30/10).

7 IA DOR Policy Ltr., Doc. Reference No. 10240041 (12/16/10).

8 Revenue Cabinet v. Asworth Corp., No. 2007-CA-002549-MR (Ky. Ct. App. 2/5/10), cert. denied, S. Ct. Dkt. 10-662 (U.S. 1/24/11).

9 LA DOR Private Letter Ruling No. 10-018 (10/14/10).

10 The Classics Chicago, Inc. v. Comptroller of the Treasury, 985 A.2d 593 (Md. Ct. Spec. App. 2010).

11 Nordstrom, Inc. v. Comptroller of the Treasury, No. 07-IN-00-0317 (Md. Tax Ct. 2/25/10).

12 W.L. Gore & Assocs., Inc. v. Comptroller of the Treasury, No. 07-IN-OO-0084 (Md. Tax Ct. 11/9/10).

13 MA DOR Notice, Ongoing Enforcement of Massachusetts Filing Obligations of Corporations Licensing Intangible Property for Use Instate (6/10/10).

14 Geoffrey, Inc. v. Commissioner of Rev., 899 N.E.2d 87 (Mass. 2009), cert. denied, S. Ct. Dkt. 08-1207 (U.S. 6/22/09).

15 Capital One Bank v. Commissioner of Rev., 899 N.E.2d 76 (Mass. 2009), cert. denied, S. Ct. Dkt. 08-1169 (U.S. 6/22/09).

16 Barr Laboratories, Inc. v. Department of Treasury, No. 291968 (Mich. Ct. App. 10/21/10).

17 MI Revenue Administrative Bulletin 1998-1.

18 Vestax Securities Corp. v. Department of Treasury, No. 292062 (Mich. Ct. App. 10/28/10).

19 Telebright Corp. v. Director, Div. of Tax’n, No. 011066-2008 (N.J. Tax Ct. 3/24/10).

20 NY Dep’t of Tax’n & Fin. TSB-A-10(2)C [Jayco Corp.] (3/9/10).

21 In re Shell Gas Gathering Corp., DTA No. 821569 (N.Y. Tax App. Trib. 9/23/10).

22 OH Tax Comm’r, Final Determination in re L.L. Bean, Inc. (8/10/10).

23 Quill Corp. v. North Dakota Tax Comm’r, 504 U.S. 298 (1992).

24 Galland Henning Nopak Inc. v. Comptroller, 317 S.W.3d 841 (Tex. Ct. App. 2010).

25 TX Policy Letter Ruling No. 201009931H (9/21/10).

26 UT Private Letter Ruling No. 09-004 (4/13/10).

27 UT Private Letter Ruling No. 09-013 (6/25/09) (released 5/3/10).

28 VA Pub. Doc. Rul. No. 10-252 (11/10/10).

29 WA DOR, Special Notice, B&O Tax Reporting Requirement Continues After Business Activity Stops (9/10/10).

30 WV Decisions Nos. S 06-544N and 06-545FN (1/6/10).

31 Apple Inc. v. California Franchise Tax Bd., No. CGC 08-471129 (Cal. Super. Ct., San Francisco County 1/26/10).

32 Fujitsu IT Holdings, Inc. v. California Franchise Tax Bd., 120 Cal. App. 4th 459 (2004).

33 Farmer Bros. Co. v. California Franchise Tax Bd., 108 Cal. App. 4th 976 (2003).

34 River Garden Retirement Home v. California Franchise Tax Bd., 186 Cal. App. 4th 922 (2010).

35 CT HB 5494, Laws 2010.

36 Worldwide Fuel Services Corp. v. Florida Dep’t of Rev., 23 So. 3d 1293 (Fla. Dist. Ct. App. 2010).

37 Colgate-Palmolive Co. v. Florida Dep’t of Rev., 988 So. 2d 1212 (Fla. Dist. Ct. App. 2008).

38 FL DOR Technical Assistance Advisement, No. 10C1-004 (3/17/10).

39 Wells Fargo and Co. v. Arizona Dep’t of Rev., TX 2007-000496 (Ariz. Super. Ct., Maricopa County 5/21/10).

40 CO DOR, FYI Income 19, Net Operating Losses (August 2010).

41 IL DOR Administrative Hearing Decision No. IT 10-05 (9/28/10).

42 ME Rev. Serv., Modifications Related to Net Operating Losses—Examples for C Corporations (April 2010), and ME Rev. Serv., 20 Maine Tax Alert No. 11 (December 2010).

43 TX Policy Letter Ruling No. 201007816L (7/21/10).

44 TX Policy Letter Ruling No. 201007819L (7/21/10).

45 IN DOR Ltr. of Findings No. 09-0446 (1/27/10).

46 IN DOR Ltr. of Findings No. 08-0749 (5/26/10).

47 IN DOR Ltrs. of Findings Nos. 08-0696 and 08-0697 (7/28/10).

48 IN DOR Ltr. of Findings No. 09-0805 (7/28/10).

49 IN DOR Ltr. of Finding No. 09-0857 (9/1/10).

50 TJX Cos. v. Commissioner of Rev., 74 Mass. App. Ct. 1103 (2009), review denied, 908 N.E.2d 388 (Mass. 6/3/09).

51 TJX Cos. v. Commissioner of Rev., 77 Mass. App. Ct. 1112 (2010).

52 IDC Research Inc. v. Commissioner of Rev., No. 09-P-1533 (Mass. 11/30/10).

53 HMN Financial, Inc. v. Commissioner of Rev., No. A09-1164 (Minn. 5/20/10).

54 NJ Div. of Tax’n Notice: Corporation Business Tax Add Back of Interest Expense (6/10/10).

55 Beneficial New Jersey Inc. v. Director, Div. of Tax’n, No. 009886-2007 (N.J. Tax Ct. 8/31/10).

56 Hormel Foods Corp. v. Wisconsin Dep’t of Rev., No. 07-I-17 (Wis. Tax App. Comm’n 3/29/10).

57 WI Admin. Code Tax 3.01.

58 Some examples include AZ HB 2156, Laws 2010; DC B18-0203 (Act 18-255); GA HB 1138, Laws 2010; HI HB 2594, Laws 2010; OK SB 1396, Laws 2010; SC SB 1174, Laws 2010; and VA HB 29, Laws 2010.

59 MD Comptroller, Administrative Release No. 38 (September 2010).

60 MN DOR Revenue Notice No. 10-04, Individual Income and Corporate Franchise Tax—Credits and Additions to Federal Taxable Income—Michigan Business Tax (11/22/10).

61 Kimberly-Clark Corp. v. Alabama Dep’t of Rev., No. 1070925 (Ala. 2/26/10). On September 17, 2010, the Alabama Supreme Court denied the taxpayer’s rehearing petition and affirmed its nonbusiness income holding.

62 Appeal of Rheem Manufacturing Co., No. 485872 (Cal. State Bd. of Eq. 5/26/10).

63 Oracle Corp. v. Department of Rev., No. TC-MD 070762C (Or. Tax Ct. 2/11/10).

64 Crystal Communications, Inc. v. Department of Rev., No. TC 4769 (Or. Tax Ct. 7/19/10).

65 In re Imperial, Inc., No. 472648 (Cal. State Bd. of Eq. 7/13/10).

66 ConAgra Foods, Inc. v. Department of Rev., 2010 CA 0907 (La. Ct. App. 10/29/10).

67 Centurytel, Inc. v. Department of Rev., No. TC 4826 (Or. Tax Ct. 8/9/10).

68 Crystal Communications, Inc. v. Department of Rev., No. TC 4769 (Or. Tax Ct. 7/19/10).


Karen Boucher is a director with Deloitte Tax LLP in Milwaukee, WI. Shona Ponda is a senior manager with Deloitte Tax LLP in New York, NY. For more information about this article, contact Ms. Boucher at

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.