state and local tax update for law firms - baker tilly bill apple cpa jdbill apple, cpa, jd baker...
TRANSCRIPT
State and local tax update for law firms
Baker Tilly refers to Baker Tilly Virchow Krause, LLP,an independently owned and managed member of Baker Tilly International. © 2010 Baker Tilly Virchow Krause, LLP
Presenter
Bill Apple CPA JDBill Apple, CPA, JDBaker Tilly Virchow Krause, LLPLaw Firm Services Tax Partner
2
Polling question #1
> In how many different states does your firm file:(choose one)
A. One – three
B. Four – six
C. More than six
3
3
Overview
> State and local governments continue to aggressively look for new revenue sources
> Generating revenue from non-residents (non-voters) is the least t i lcontroversial
> Businesses and individuals are now often faced with tax liability in states and cities where they do not have an office and do not residestates and cities where they do not have an office and do not reside
4
Three step process to determine if income is reportable to a jurisdictionis reportable to a jurisdiction
1. Does the firm have nexus with the jurisdiction?j
2. If nexus exists, how is revenue sourced to that jurisdiction?
3 What is the method of apportioning revenue to that jurisdiction?3. What is the method of apportioning revenue to that jurisdiction?
5
Nexus
> Nexus or Doing Business is defined as the quality or quantity of business connections that must exist between a political jurisdiction and a taxpayer before the jurisdiction can impose a filing requirement for either sales or income tax
> Constitutional basis for nexus Due process clause
Minimal connection – “some definite link, some minimum connection, between the state and the person, property or transaction it seeks to tax.”
• Miller Brothers Co v. Maryland, 347 US 340 (1954)
Requires that “income attributed to the State for tax purposes must be Requires that income attributed to the State for tax purposes must be rationally related to values connected with the taxing state.”
• Moorman Mfg. Co. v. Bair, 437 US 267 (1978)
6>
Nexus
> Commerce Clause – Congress is authorized to “regulate commerce ith f i ti d th l t t ”with foreign nations, and among the several states”
The tax must relate to an activity that has substantial nexus with the taxing state
The tax must be fairly apportioned
The tax must not discriminate against interstate commerce
Th t t b f i l l t d t i id d b th t i t t The tax must be fairly related to services provided by the taxing state
Complete Auto Transit v. Brady, 430 US 274 (1977)
7
Nexus
Landmark case – National Bellas Hess v. Department of Revenue, 386 US 753 (1967)> State could not force taxpayer with no physical presence to
collect taxcollect tax
> Concern expressed over burden that would be imposed on remote sellers
> Seemingly decided based upon both the due process and commerce
8
Nexus
Landmark case – Quill Corp. v. North Dakota, 504 US 298, (1992)
> Established the current physical presence test
> Case was a Use Tax case
> Court said that economic presence was sufficient for the Due Process Clause of minimal connection, but notDue Process Clause of minimal connection, but not sufficient for the Commerce Clause requirement of substantial nexus
> “Substantial nexus” only exists if a corporation has a> Substantial nexus only exists if a corporation has a nontrivial physical presence in the state
9
Nexus
Public Law 86-272Public Law 86 272
> Limited safe harbor from imposition of state taxes based on “net income”
> If corporation’s only instate activity is the solicitation of orders by company representatives for the sale of tangible personal property which orders are sent outside the statepersonal property, which orders are sent outside the state for approval or rejection, and if approved, are filled by shipment or delivery from a point outside the state
10
Nexus
Economic nexus theory
1. Tax Commissioner v. MBNA America Bank (West Virginia Supreme Court) – Pure economic presence case
> Credit card company generated $18 million in gross receipts from WV customers
2 Lanco Inc v Director Division of Taxation (New Jersey2. Lanco, Inc. v. Director, Division of Taxation (New Jersey Supreme Court) – Economic presence through the licensing of intangibles to related corporation
11
Economic nexus
> Generating revenue from clients located within the state
> Defined differently by the various states
> Some states now have a bright-line test while others still have a bj ti t d d f d t i isubjective standard for determining nexus
Factor Presence Test with the Revenue Factor being: California $500,000 (recommended by the MTC) Michigan $350,000 Ohio Commercial Activity Tax $500,000 Washington $250,000
Property or Payroll Factors also create nexus under the factor presence test – Under the MTC guidelines $50,000 of property present in the state or $50,000 of payroll within the state also creates nexus
12
Nexus
Several attempts to pass legislation establishing a national nexus standard have been made in Congress over the last decade, but to date, none have been successful.
ff SLobbying efforts and the States reluctance to give up their right to determine their own rules have helped prevent the passage of this legislation.
13
Sourcing of revenues
Cost of performance – the traditional approach
> All or nothing approach Is this at the client level, matter level or by attorney? Currently 22 states still follow this method
> Pro rata approachC tl t t f ll thi h Currently seven states follow this approach
14
Sourcing of revenues
Market Based Sourcing – Where the benefit of the service is received by the client
> Currently 15 states use some form of market based sourcing> More states are moving to this method> More states are moving to this method> Definitional and tracking problems with where the benefit is
receivedC lif i d fi iti “B fit f i i i d” th California definition: “Benefit of a service is received” means the location where the taxpayer’s customer has either directly or indirectly received value from delivery of that service. [Cal. Code Regs. 18 §25136-2(b)(1)]g § ( )( )]
15
Polling question #2
> Has your firm received a questionnaire or other inquiry from a y q q ystate where you did not file in the last two years?:(choose one)
A Y A. Yes
B. No
16
Market based sourcing
California Regulations are 15 pages long and contain examples
> Presumed in the state if the client’s billing address is in the state – method accepted by the Franchise Tax Boardp y
> Presumption may be overcome by the taxpayer showing contract or other books and records of the taxpayer that provide evidence of the extent to which the benefit of theprovide evidence of the extent to which the benefit of the service was received at a location or locations in the state
> If the presumption is overcome by the taxpayer, and an alternative method cannot be determined by reference to aalternative method cannot be determined by reference to a contract or the taxpayer’s books and records, then the location where the benefit is received shall be reasonably approximatedpp
17
Apportionment
Apportionment is how the amount of income to be reported to a jurisdiction is calculated
> Three factor apportionment is the traditional methodPropert pa roll and sales factors are sed Property, payroll and sales factors are used
Equal weighting of the three factors is the traditional method Many states have begun weighting the sales factor more heavily –
d bl i hti hi hdouble weighting or even higher States may define factors differently
18
Apportionment
Payroll, property and sales factorsPayroll, property and sales factors> California includes a percentage of partner distributions in the
payroll factor
> States define sales factor differently based on their definition of business and non-business income Generally business income is apportionedy pp Generally non-business income is specially allocated to the state
in which it is earned
Trend is to move to a Single Sales Factor
19
Apportionment
Actual books and records
> Most states require special permission to use this method
> New York State allows this without advance permission> New York State allows this without advance permission however New York City requires a traditional apportionment with a single sales factor being phased in
20
Entity level taxes
Many states, counties and cities now have a tax that is assessed against the pass through entity> States – Ohio CAT, Texas Margin Tax, Washington B&O,
various franchise taxesvarious franchise taxes
> Counties – Virginia counties have the BPOL (Business Professional and Occupational License tax)
> Cities – Income and/or gross receipts taxes to NYC, Philadelphia, Wilmington, DE, DC Ballpark among others
> Other Taxes NY MCTMT San Francisco Payroll Tax> Other Taxes – NY MCTMT, San Francisco Payroll Tax
21
Entity level tax- recent developments
NY MCTMT – Lower court ruled tax unconstitutional in C o e cou t u ed ta u co st tut o a2012, Appellate Court overturned the decision and found it to be constitutional in a July 2013 ruling.
San Francisco – Voters passed legislation in 2012 to repeal the payroll tax beginning in 2014 over the next five years and replace it with a gross receipts tax phased in overand replace it with a gross receipts tax phased in over the same time period.
22
Entity level tax- recent developments
Texas margin tax> Winstead Case (3/18/2013) –Texas District Court ruled that for
franchise tax purposes, a law firm can deduct as compensation the cost of any benefits that it provides to its officers directorsthe cost of any benefits that it provides to its officers, directors, owners or partners, and employees that are deductible for federal income tax purposes.
23
Non-resident withholding
States require firms to withhold tax on non-resident partners> Most require quarterly payments, while some (Virginia) only
require one annual payment
Th ithh ldi t d t l f ll th t ti l> The withholding amount does not always fully cover the potential individual tax liability CA requires withholding on “distributions” at a 7% rate
> Some states allow a request for exemption from withholding and then individuals pay their own estimates
> Participation in a composite or group return generally eliminates> Participation in a composite or group return generally eliminates the withholding requirement, but may create a composite estimated tax payment requirement
24
Composite or group returns
> Does state require advance approval?
> Allowed by virtually all states
> Most require that the partner have no other income from the state to participate
> Many allow spouses to each participate if they each have only one source of income (both are partners in law firms)only one source of income (both are partners in law firms)
> Virginia requires that all eligible must participate
> Usually taxed at the highest marginal rate on all income> Usually taxed at the highest marginal rate on all income
> Limited or no deductions allowed to offset income
25
Individual tax considerations
> Partners get a credit on their home state return for taxes paid to non-resident state
> Credit is limited to amount of tax at home states rates
> Th f i dditi l t if id t t t t i> Therefore, may incur additional tax if non-resident state rate is higher than home state
> A few states are reverse credit states so credit is taken on non-resident state return (example is CA and VA)
> Partners should evaluate their decision to participate in composite returns in certain states due to ratesreturns in certain states due to rates
26
Telecommuters
Most states consider the employment of a person working from their home to create nexus.
> Withholding and payroll taxes due to the state notifies them of the firm’s presencefirm s presence
> Depending on method for sourcing of revenues may have little or even no income to apportion to the state
> A few states have a minimum amount that can be earned by individuals before tax is due
27
More recent developments
> Minnesota – nexus questionnaires Economic nexus and market based sourcing Single sales factor fully phased in in 2014 No dollar threshold- any level of activityo do a t es o d a y e e o act ty Individual rates range from 5.5% to 9.85% Withholding is required at the rate of 7.85% if MN distributive
share of income to partner is over $1,000 and not in compositeshare of income to partner is over $1,000 and not in composite Minimum filing requirement for non-resident individuals for 2012
was $9,750> Washington B&O – sending nexus questionnaires> Washington B&O sending nexus questionnaires
28
More recent developments
New Jersey> Issued proposed regulations in April changing the way receipts from
services are sourced to the State to a market basis
St t t d “ i f d ithi th t t ” d t NJ> Statute reads “services performed within the state” are sourced to NJ
> Effective beginning in 2014
Ohio
> Effective July 1, 2013, tax reforms include a reduction in individual income tax rates and revisions to the CAT tax which reduces theincome tax rates and revisions to the CAT tax which reduces the maximum tax at various revenue levels
29
More recent developments
California> Passed legislation to repeal and revamp their Enterprise Zone
tax credit program
> Repeals the EZ Tax Credit and replaces it with three other incentives Statewide sales tax exemption on mfg equipment Hiring credit for specific categories of hard to hire workers A state fund to offer negotiated tax breaks to companies locating
or expanding in California
30
More recent developments
Pennsylvania> Effective for 2014 PA moves to market based sourcing of
revenues for services
Massachusetts> Adopted market based sourcing for services beginning in p g g g
2014 but still uses physical presence standard for nexus
31
More recent developments
Cook County, (Chicago) IllinoisOn July 24, 2013, the Cook County district Court issued a preliminary injunction enjoining the County from enforcing its Non-Titled Personal Property Use Tax Theenforcing its Non Titled Personal Property Use Tax. The County may not enforce or collect the tax unless the court reconsiders and lifts the injunction after the parties brief the County's motion to reconsider or an appellatebrief the County s motion to reconsider, or an appellate court reverses the decision in the future. Thus, taxpayers should are not obligated to file any further Cook County Non Titled Personal Property Use Tax returns unlessNon-Titled Personal Property Use Tax returns unless and until the injunction is dissolved.
32
Polling question #3
> Does your firm have telecommuters in states where you do not y yhave an office?:(choose one)
A Yes A. Yes
B. No
33
Thank you for attending!
> For more information or questions about today’s presentation, please connect with us at [email protected]
> If you requested CPE for this session certificates will be> If you requested CPE for this session, certificates will be mailed to the address you provided when registering
35
Disclosure
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury nothing containedpromulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one without our express prior written permission may use or refer to any taxone, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan, or arrangement to any other party.
Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International. The information provided here is of a general nature and is not intended to address specific circumstances of any individual or entity. In specific circumstances, the services of a professional shouldindividual or entity. In specific circumstances, the services of a professional should be sought © 2013 Baker Tilly Virchow Krause, LLP.
36