Are You Paying Too Much in State Taxes?
How Manufacturers Can, with Careful Planning, Minimize Their BillsAs all manufacturing business owners know, today’s economic climate is one of the most difficult in U.S. history. Some analysts have likened the current recession to the Great Depression of the 1930s, wreaking havoc with corporate and industrial America in ways that were unimaginable a few short years ago.
State and local governments, reliant on the profitability of corporations and individuals to fund their operations, are struggling to keep their states functioning and provide expensive services to their populace as unemployment statistics rise. Given these challenges, governors nationwide are turning to their legislatures to update tax codes and raise revenue. In some instances, these efforts result in legislative proposals to broaden the tax base through different methodologies, including the imposition of tax on Internet businesses that provide goods and services, the creation of new nexus standards, and the enactment of required combined corporate income-tax reporting.
Since many of these initiatives can impact the manufacturing industry in particular, it is important to consider how you as a manufacturer and taxpayer can combat some of these initiatives and use them as planning opportunities.
Nexus, a Latin word used in state taxation, means ‘connection.’ States are continually seeking to show that out-of-state companies have nexus in (connection with) their state, requiring tax filings. States have become increasingly aggressive as a result of recent government victories in so-called ‘economic nexus’ decisions, and taxpayers are struggling with the validity of each state’s authority to tax out-of-state businesses. Taxpayers should be concerned that any decision they make as to filing gross-receipts tax returns based on economic nexus principles can have historic and long-range effects.
When confronting the issue of nexus, you might consider the following:
• Don’t give up the fight. Despite the lack of success with regard to challenging state gross-receipts taxes, taxpayers should not necessarily concede the economic-nexus issue. If taxpayers do cease such challenges and allow the states to impose these taxes based on economic nexus, the states may become even more aggressive in their pursuit of manufacturers under those regimes. If you are not convinced that you should be filing taxes in specific states, seek out the advice of a qualified tax advisor before you file.
• Also consider the risks. Taxpayers who choose to take an aggressive stance by using a wait-and-see approach in filing their tax returns will face an increased risk of exposure that could affect their financial statements. This risk is due to the potential for retroactive application of economic-nexus standards and a possible reduction in the voluntary disclosure and amnesty program deals offered by the various states. Manufacturers should carefully consider whether the risks outweigh the rewards, and, if so, may want to take advantage of the voluntary disclosure and amnesty programs currently offered.
• Will Congress step in? Finally, although the discussion of state-tax nexus continues at the federal level, manufacturers should not have confidence that these issues will be resolved any time soon. Until Congress steps in and clarifies this area of state-tax law, taxpayers may continue to press for favorable federal legislation through their own in-house government-relations professionals, trade associations, or other industry groups.
Another way that states are trying to increase revenue is through revisiting their approach when it comes to apportionment, the method used to determine what share of a company’s profit they are entitled to. Many states that use a three-factor apportionment (sales, property, and payroll) are modifying their formulas or even eliminating some factors. Because of this and other differences in calculating taxable income from state to state, the potential exists to subject more than 100% of a manufacturer’s revenues to tax.
One strategy used to counter this scenario begins with knowing what states you are doing business in and their ‘throwback rules.’ The throwback rule dictates that, when tangible personal property is delivered or shipped to an out-of-state purchaser, it is considered an in-state sale if the selling taxpayer is not taxable in the state where the property is sold. If you have a facility in a state where there are no throwback rules and can modify your procedures to have sales considered sold by the non-throwback state instead of your home state, you could create a overall percentage of less than 100% for your sales factor, which would provide for a lower tax.
While nexus and apportionment-tax reforms seem to be leading the way this year, some states are continuing to offer generous tax credits and incentives to manufacturers choosing to locate, expend, or retain jobs in their jurisdictions. A number of states continue to show support for companies included in state-designated ‘enterprise zones.’ Generally, these enterprise zone credits incentivize employers to hire, retain employees, or expand in certain designated areas. Some states and localities encourage ‘going green’ by offering incentives. They provide for this through property and/or income-tax credits, exemptions, or abatements tied to green initiatives. However, many states require you to become certified for eligibility before you can claim these credits.
Don’t be caught by surprise and miss potential tax-saving opportunities. Find out about available credits before you make a relocation or expansion of your business. Area economic-development agencies can help you identify potential credits.
As with corporate income taxes, states are reviewing how their sales-and-use tax structures can be amended to bring about increases in revenue. There are two prevalent factors causing this: an economy stalled by lack of consumer spending, and an increase in transactions such as Internet purchases. Some states are trying to overcome their shortfalls by considering increases to their rates (states like Massachusetts, California, and Minnesota have recently increased their rates).
Some states are also considering expanding their sales-and-use tax bases to incorporate service transactions (i.e., accounting, advertising, information services). Finally, states are seeking out businesses they believe have sales-and-use tax nexus and assessing for uncollected sales tax on taxable sales into their states. This poses a significant liability since states typically look back seven years, and a company’s ability to correspondingly bill and collect from their customers is difficult.
Personal Property Taxes
Allocations to local cities and towns have also suffered, and they have become aggressive in the area of assessing personal property taxes. Cities and towns will often request taxpayers’ depreciation reports, which will be a listing of their personal property. They will use original cost on these listings as a starting point in their assessment of personal property subject to tax.
Some cities and towns contend that any asset you own cannot be worth less than 50% of its original cost. One way to help lower these taxes is to review your fixed-asset listings and remove all items that are no longer in service, or that have been discarded.
In Massachusetts, corporations that are ‘classified manufacturers’ benefit from a lower tax rate on their manufacturing machinery as well as their inventory. This benefit does not apply to any corporation that has not filed for classification as a classified manufacturer. Cities and towns are cross-matching their records of businesses in their locality to the annual state listing of classified manufacturers. Businesses that never filed or are organized as an LLC, partnership, business trust, or sole proprietorship do not benefit from the lower tax rates regardless of their line of business.
If your business is a Massachusetts-based manufacturer, consider the tax benefits of qualifying and enrolling as a classified manufacturer. Your tax adviser can help you with this process.
If yours is a manufacturing corporation doing businesses out of state, you need to be aware of the potential nexus and apportionment issues, increased rates, as well as the expanded taxable services. However, there are credits and strategies that can help you minimize your multi-state tax burden. A qualified tax advisor can help you make the most of these opportunities.
Cheryl Fitzgerald is a senior tax manager with the certified public accounting firm Meyers Brothers Kalicka, P.C., based in Holyoke; (413) 536-8510.