January 4, 2018 — Federal tax reform is all over the news these days, but state tax saving opportunities are often left out of the headlines. A window has opened for many companies to consider changing their entity structure, but they will need to analyze how revenue is being sourced to the various states to help ensure they are paying no more than necessary in state income tax.
Owners of pass-through entities (S corporations, LLC/partnerships) may benefit from analyzing how revenue is being sourced if the owners are residents of states with no income tax (e.g., Florida) or a state with a low income tax rate (e.g. North Dakota).
With federal income tax rates on C corporations decreasing from 35% to 21%, many taxpayers may benefit from being taxed as a C corporation for both federal and state income tax. C corporations only pay income taxes in the states they file in, based on the income apportioned to those states. Income apportioned to states where the company does not have a filing requirement (nexus) is often not subject to tax.
The owners of pass-through entities (S corporations, LLC/partnerships) pay taxes on their share of total company income in their state of residence and may receive a credit for taxes paid to other states. For owners that are residents in Minnesota, the tax rate can be as high as 9.85%. However, owners that are residents of Florida pay no Florida income tax and only pay taxes in the states they file in.
Therefore, C corporations and owners of pass-through entities that are residents of a state that has little or no income tax have significant opportunities for state tax savings. One potential strategy for creating state income tax savings is by reducing the revenue sourced to a particular state. However, the methods used to source revenue vary by state.
The amount of income that is taxable in a state is generally determined based on an apportionment formula that may include: property, payroll, and sales/revenue. The weighting of the property, payroll, and sales factors vary by state, with many states moving to a sales factor only apportionment.
Sales of tangible personal property (goods) is generally included in the numerator of the apportionment formula based on the where the property is delivered or received. The sale of services or intangible assets are included in the numerator of the sale factor based on 1) where the greatest cost of performance took place, 2) market-based sourcing, or 3) a variation of one of these.
The sales factor needs to be analyzed to ensure the income apportioned to a state is correct. Several key questions include:
These are a few of the questions that need to be addressed.
Analyzing the state-specific laws can provide huge tax saving opportunities by decreasing the income apportioned to a state and thus the taxes you or your company pays.
If you have further questions or concerns about federal tax reform, revenue sourcing, or state and local tax you can contact Jared Weiskopf, State and Local Tax Service Area Leader today.