SMChap023

Chapter 23 - State and Local Taxes

Chapter 23 State and Local Taxes SOLUTIONS MANUAL Discussion Questions 1. [LO 1] Why do states and local jurisdictions assess taxes? The primary purpose of state and local taxes is to raise revenue to finance state governments. These taxes can be income, sales, property, and excise taxes. 2. [LO 1] Compare and contrast the relative importance of judicial law to state and local and federal tax law. Federal law is governed primarily by Code (statutory law) and Treasury Regulations (administrative law) and judicial law is usually of lesser importance. Judicial law is of critical importance in state law. There are numerous cases that must be understood to have a working knowledge of state and local taxes. 3. [LO 1] Describe briefly the nexus concept and explain its importance to state and local taxation. Nexus is the sufficient connection between a taxpayer and a state that allows the imposition of a tax. The level of connection varies based on the type of tax. For example, any physical presence in a state will create nexus for sales tax while the nexus standard for income taxes is generally higher. 4. [LO 1] What is the difference, if any, between the state of a business’s commercial domicile and its state of incorporation? Commercial domicile is the state where a business is headquartered and directs operations from. The state of incorporation is the location where the corporate charter was filed. Most of the time, a business’s state of commercial domicile and incorporation are the same. However, they sometimes differ. This is particularly true of publicly traded corporations that are usually incorporated in Delaware, but are often domiciled in New York or California.

23-1 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


5. [LO 1] What types of property sales are subject to a sales tax and why might a state choose to exclude the sales of certain types of property? Most states only subject tangible personal property to sales tax. Most states exclude real property and services from the sales tax base. Many states exclude unprepared food (groceries) from the sales tax base because taxing these goods is regressive (disproportionately taxes the poor). Many states also place a surtax on prepared (restaurant) foods. 6. [LO 1] In what circumstances would a business be subject to income taxes in more than one state? Anytime a business conducts its trade or business in a manner exceeding the nexus standard in more than one state (which chooses to assert its sovereign right to tax) the business will be subject to business taxes in multiple states. However, businesses subject to tax in more than one state have the ability to apportion or divide their income between or among the states in which they have income tax nexus to mitigate the consequences of taxing the same income more than once. 7. [LO 1] Describe how the failure to collect sales tax can result in a larger tax liability for a business than failing to pay income taxes. Sales tax is typically collected by the seller from the buyer and is remitted on gross sales. Income tax is determined from the net income base (gross income less deductions) and apportioned when appropriate. For example, imagine that a company operates in a single state having a sales tax rate of 5 percent and an income tax rate of 4 percent. If the company has $1,000,000 in sales, cost of goods sold of $600,000 and other expenses of $300,000 the sales and income tax payable are computed as follows: $50,000 of sales tax payable ($1,000,000 x 5 percent); $4,000 of income tax payable ({[$1,000,000 $600,000]-$300,000}x 4 percent). In addition, if the business would have properly collected the sales tax from its customers, it would simply remit the amount and have no liability. 8. [LO 2] Discuss reasons why restaurant meals, rental cars, and hotel receipts are often taxed at a higher rate than the average sales tax rate. States often impose higher sales tax rates on meals, rental cars, and hotel receipts because these items are typically imposed disproportionately upon non-residents of a state. Non-residents visiting for work or pleasure use these services and capture additional revenue for a state which allows for lower tax revenues to be raised on state residents. 9. [LO 2] Compare and contrast the difference between general sales tax nexus and the new “Amazon” rule creating nexus in New York.



The general sales tax nexus rule established in the Quill decision is that an out of state retailer must have physical presence in the state to create sales tax nexus. For example, salesmen entering the state would create a need for a state to collect and remit sales tax. New York implemented a new law in 2008 which requires internet-based retailers, without physical presence, to collect and remit sales tax. Amazon has already filed suit against the state of New York. 10. [LO 2] What is the difference between a sales tax and a use tax? A sales tax liability accrues on the sale of property within the state. A use tax liability accrues in the state purchased property will be used when the seller in one state ships goods to a customer in a different state and the seller is not required to collect the sales tax (the seller does not have sales tax nexus in the state to which the goods are shipped). 11. [LO 2] Renée operates Scandinavian Imports a furniture shop in Olney, Maryland. Scandinavian Imports ships goods to customers in all 50 states. Scandinavian Imports also appraises antique furniture. Recently in-home appraisals have been done in the District of Columbia, Maryland, Pennsylvania, and Virginia. Online appraisals have been done for customers in California, Minnesota, New Mexico, and Texas. Determine where Scandinavian Imports has sales and use tax nexus. Scandinavian Imports has nexus in Maryland--its state of commercial domicile. It also has nexus in the District of Columbia, Pennsylvania, and Virginia because it has physical presence that is created through personnel performing appraisals. The online appraisals do not create nexus because they lack physical presence that creates sales and use tax nexus. 12. [LO 2] Web Music, located in Gardnerville, Nevada, is a new online music service that allows inexpensive legal music downloads. Web Music prides itself in the fact that it has the fastest download times in the industry. Web Music achieved this speed by leasing server space from 10 regional servers dispersed across the country. Discuss where Web Music has sales tax nexus. Web Music has nexus in Nevada because of its commercial domicile. Because Web sells music in an intangible form, some states may not try to tax the transaction. An important question is whether a leased server is the same as having property within a state. Most states would argue that renting the property creates nexus within the states where the server is located. Web’s business model creates problems in applying the historical sales and use tax nexus rules. 13. [LO 2] Discuss possible reasons for why the Commerce clause was included in the U.S. Constitution.



The Commerce clause was designed to promote interstate commerce by protecting businesses through placing restraints on a state’s ability to burden businesses with the administrative burden of complying and the financial burden of paying the sales tax. 14. [LO 2] Describe the administrative burden that businesses face in collecting sales taxes. Businesses with sales tax nexus must collect and remit sales tax from its customers to the state. The administrative burden is that they must calculate and collect the tax, and then comply by completing the tax returns and remitting the tax. 15. [LO 3] Compare and contrast the rules for where domiciliary and non-domiciliary businesses must file state income tax returns. A domiciliary (an in-state business) must always file a state income tax return—assuming the state taxes income. A non-domiciliary must only file an income tax return if the nexus standard is created. For non-domiciliary businesses, the standard varies based on the type of business. Sellers of tangible personal property are protected by Public Law 86-272; other businesses have a lower threshold—any physical presence creates nexus. 16. [LO 3] Lars operates Keep Flying, Incorporated, a used airplane parts business, in Laramie, Wyoming. Lars employs sales agents that visit mechanics in all 50 states to solicit orders. All orders are sent to Wyoming for approval. All parts are shipped via common carrier. The sales agents are always on the lookout for wrecked, abandoned, or salvaged aircraft with rare parts because they receive substantial bonuses for removing these parts and shipping them to Wyoming. Discuss the states where Keep Flying has income tax nexus. Keep Flying has nexus in all 50 states (assuming they salvage parts in every state). While Keep Flying sells tangible personal property and is protected by Public Law 86-272, its sales personnel violate this by salvaging parts off planes during their travels. 17. [LO 3] Explain changes in the U.S. economy which have caused P.L. 86-272 to become partially obsolete and provide an example of a company that P.L. 86-272 works well for and an example of a company that it does not work well for. P.L. 86-272 was enacted in the 1950s. At that time, the economy was primarily bricks and mortar. The statute was designed for traditional companies that produced tangible goods and sold them through traditional sales personnel. Today’s economy has shifted toward intangibles and services. The rules designed for bricks and mortar type companies do not create a level playing field across businesses—there are winners and losers.



18. [LO 3] Climb Higher is a distributor of high end climbing gear and is located in Paradise, Washington. Climb Higher’s sales personnel regularly perform the following activities in an effort to maximize sales:    

Carry swag (free samples) for distribution to climbing shop employees. Perform credit checks on new customers to reduce delivery time the first time merchandise is ordered. Check customer inventory for proper display and proper quantities. Accept returns of merchandise for defective goods.

Discuss Climb Higher’s sales activities that are protected and unprotected under the Wrigley Supreme Court decision. Selling activities or solicitation are not well defined by P.L. 86-272. The Wrigley decision defines what activities are considered solicitation (protected) and which activities exceed solicitation. Distribution of free samples and checking inventory for display and quantity are considered solicitation. Performing credit checks and accepting returns exceed solicitation and create nexus for Climb Higher. 19. [LO 3] Describe a situation where it would be advantageous for a business to establish income tax nexus in a state. While nexus creates a potential income tax liability, it can be advantageous in two ways. First, creating nexus in a state that chooses not to tax a business can create nowhere income (income that will go untaxed). Second, creating nexus in a state with a lower effective tax rate than the business’ current effective tax rate can lower the total state taxes paid. 20. [LO 3] States are arguing for economic nexus; provide at least one reason for and against the validity of economic nexus. States create an economic base from which companies benefit. Companies benefit from that economic base whether or not they have physical presence or the other attributes that create nexus. As a result they should compensate the state for creating the market. Nexus creates a burden (administrative, financial or both). Allowing states to tax businesses with a slight presence discourages interstate business or commerce and potentially violates the US Constitution.



21. [LO 3] Explain the difference between separate return states and unitary return states. Separate return states usually require each business to file a separate tax return in the state. For example, if two businesses file a consolidated federal tax return and each has nexus within Maine, each must file a “separate” Maine tax return. A unitary return requires each member of the unitary group to be included on the tax return, even if only one has nexus in the state. The unitary concept is generally set out in the Mobil decision where the Supreme Court specified three factors which have become the basis for determining whether a group of businesses is unitary: functional integration, centralization of management, and economies of scale. For example, if two businesses file a federal consolidated tax return they will file a unitary return only if they are considered to be unitary. If they are unitary they will file a unitary return, even if only one of the businesses has nexus with a given unitary state. 22. [LO 3] Explain the rationale for the factors (functional integration, centralization of management, and economies of scale) used to determine whether two or more businesses form a unitary group under the Mobil decision. The factors are used to determine if the businesses operate as part of a whole or if they operate as truly separate businesses. For example, if two businesses file a federal consolidated tax return because they have common ownership, but the two businesses have nothing in common other than ownership they will not be unitary. However, if the businesses are simply a single business operated in two separate entities they will likely be unitary. Functional integration looks to see if businesses are vertically or horizontally integrated or share knowledge between them. Centralization of management attempts to determine whether common management, accounting systems, common officers, or interlocking boards of directors exist. Economies of scale look to whether the businesses achieve efficiencies or discounts on raw materials, services, or other needs simply because they purchase these items together.



23. [LO 3] Compare and contrast why book/tax and federal/state adjustments are necessary for interest income. While most interest is income for both book and tax purposes, there are exceptions. Book and tax adjustments usually occur because of federal or state bonds. While state and local bond interest income is income for financial statement purposes it is exempt for federal tax purposes. This results in a book/tax difference. However, many states tax state and local bond interest (although many exempt interest from in-state bonds), which requires a federal/state adjustment to include the income for state income tax purposes. For federal bonds (taxable for federal tax) there is no book/tax adjustment since the interest is income for both; however, federal interest is exempt from state income tax—as a result a federal/state adjustment is necessary to exclude the interest for the state income tax calculation. 24. [LO 3] Compare and contrast the differences between how business and non-business income are divided among states for a multi-state business. Business income (income related to the operation of the business) is apportioned or divided among the states in which the business has nexus. The apportionment process allows each state where nexus exists to tax its pro-rata portion of the business. Alternatively, non-business income is sourced or allocated specifically to the state where it is earned. For example, interest income is typically taxed in the state of commercial domicile. Also, rental income from a building is taxed in the state where the rental property is located. 25. [LO 3] Discuss differences between the treatment of government sales and dock sales for the sales apportionment factor. The general rule for sales is that they are assigned to the state where the goods are shipped to. However, there are exceptions. Government sales are assigned to the state where the goods were shipped from. This rule exists on the theory that the government exists throughout the country and attempts to keep government sales from being concentrated to areas with a large government presence. For example, the District of Columbia, Virginia, and Maryland receive a disproportionate share of government shipments because of the large share of the federal workforce concentrated there. Dock sales rules generally try to assign the sale to where the goods will be utilized rather than where the customer takes possession of the goods. For example, if a Washington customer obtains machinery from an Oregon retailer and then transports the goods across state lines, the sales should be assigned to Washington rather than Oregon.



26. [LO 3] Most states have increased the weighting of the sales factor for the apportionment of business income. Discuss the possible motivations for the growing importance of the sales factor in state apportionment. States may raise a greater portion of their revenue from non-residents through increasing the sales factor in its apportionment formula. This is because non-resident companies typically have larger sales factors than payroll or property factors in states other than their commercial domicile. Similarly, resident companies that do business in multiple jurisdictions typically have smaller sales factors and larger payroll and property factors. As a result, increasing the sales factor or eliminating the payroll and property factors can increase the relative state income tax burden of non-resident businesses while decreasing the relative state income tax burden of resident businesses. 27. [LO 3] Compare and contrast federal/state tax differences and book/federal tax differences. Both of these differences are due to differences in the rules of the starting point for the tax calculation and the tax base. For example, federal tax returns require the reconciliation of book income to federal taxable income. Likewise, most states start the state income tax calculation with federal taxable income and then require the necessary adjustment to reach state taxable income. So the differences are simply adjustments to reconcile the relative income calculations.

Problems 28. [LO 2] Crazy Eddie, Incorporated manufactures baseball caps and distributes them across the northeastern United States. Crazy Eddie is incorporated and headquartered in New York. It has product sales to customers in Connecticut, Delaware, Massachusetts, New Jersey, New York, Ohio, and Pennsylvania. It has sales personnel only where discussed in the scenarios below. Determine the states in which Crazy Eddie has sales and use tax nexus given the following information: a) Crazy Eddie is incorporated and headquartered in New York. It also has property, employees, sales personnel, and intangibles in New York. b) Crazy Eddie has a warehouse in Connecticut. c) Crazy Eddie has two customers in Delaware. Crazy Eddie receives orders over the phone and ships goods to its customers using FedEx. d) Crazy Eddie has independent sales representatives in Massachusetts. The representatives distribute baseball related items for over a dozen companies. e) Crazy Eddie has sales personnel that visit New Jersey. These sales employees follow procedures that comply with Public Law 86-272. The orders are received and sent to New York for acceptance. The goods are shipped by FedEx into New Jersey.



f) Crazy Eddie provides graphic design services to another manufacturer located in Ohio. While the services are performed in New York, Crazy Eddie’s designers visit Ohio at least quarterly to deliver the new designs and receive feedback. g) Crazy Eddie receives online orders from its Pennsylvania client. Because the orders are so large, the goods are delivered weekly on Crazy Eddie’s trucks. a) Crazy Eddie would have sales and use tax nexus only in New York; it lacks physical presence required in the other states where it has sales. b) Crazy Eddie would have sales and use tax nexus in New York and Connecticut; it lacks physical presence required in the other states where it has sales. c) Crazy Eddie would have sales and use tax nexus only in New York; it lacks physical presence required in Delaware because it ships the goods using a common carrier. d) Crazy Eddie would have sales and use tax nexus only in New York; it may also have nexus in Massachusetts if the independent representative only represents Crazy Eddie (considered to be an agent). However, typically independent representatives sell merchandise from various vendors and are not considered to be the agent of the vendor. e) Crazy Eddie would have sales and use tax nexus in New York; nexus would not be created in New Jersey because it has no physical contact in that state. f) Crazy Eddie would have sales and use tax nexus in New York and Ohio; the presence of Crazy Eddie’s personnel in Ohio will create nexus there as well. g) Crazy Eddie would have sales and use tax nexus in New York and Pennsylvania; the use of Crazy Eddie’s trucks in Pennsylvania creates physical presence required for sales and use tax. 29. [LO 2] Brad Carlton operates Carlton Collectibles, a rare coin shop in Washington, D.C., Carlton ships coins to collectors in all 50 states. Carlton also provides appraisal service upon request. During the last several years the appraisal work has been done in either the DC shop or at the homes of private collectors located in Maryland and Virginia. Determine the jurisdictions in which Carlton Collectibles has sales and use tax nexus. Carlton Collectibles would have sales tax nexus in the District of Columbia, Maryland, and Virginia because Brad’s appraisal work creates nexus in Maryland and Virginia. Carlton would have a sales and use tax collection requirement in the District of Columbia because it has commercial domicile there.



30. [LO 2] Melanie operates Mel’s Bakery in Foxboro, Massachusetts. Mel’s retail stores are located in Connecticut, Maine, Massachusetts, New Hampshire, and Rhode Island. Mel’s also ships specialty breads nationwide upon request. Determine Mel’s sales tax collection responsibility and calculate the sales tax liability for Massachusetts, Connecticut, Maine, New Hampshire, Rhode Island, and Texas using the information about each state provided below: a) The Massachusetts stores earn $500,000 in sales. Massachusetts’ sales tax rate is 5 percent; assume it exempts food items. b) The Connecticut retail stores have $400,000 in sales ($300,000 from in-store sales and $100,000 for catering) and $10,000 in delivery charges for catering activities. Connecticut sales tax is 6 percent and excludes food products, but taxes prepared meals (catering). Connecticut also imposes sales tax on delivery charges on taxable sales. c) Mel’s Maine retail store has $250,000 of sales ($200,000 for take-out and $50,000 of in-store sales). Maine has a 5 percent sales tax rate and a 7 percent sales tax on prepared food; it exempts other food purchases. d) The New Hampshire retail stores have $250,000 in sales. New Hampshire is one of five states with no sales tax. However, it has a room and meals tax rate of 8 percent. New Hampshire considers any food or beverage that is served by a restaurant for consumption on or off the restaurant premises to be considered a meal. e) Mel’s Rhode Island retail stores have $300,000 in sales. The Rhode Island sales tax rate is 7 percent and its restaurant surtax is 1 percent. Rhode Island considers Mel’s a restaurant because its retail store has seating. f) One of Mel’s best customers relocated to Texas, which imposes an 8.25 percent state and local sales tax rate but exempts bakery products. This customer entertains regularly and ordered $5,000 of food items this year. a) Mel’s would have no liability in Massachusetts. This is because Massachusetts exempts food products from sales tax. However, if the definition of food products didn’t include prepared bakery goods or specialty breads, Mel would pay $25,000 ($500,000 x 5 percent) in Massachusetts’ sales tax. b) Mel’s would have a $6,600 (110,000 x 6 percent) sales tax liability in Connecticut. This is because the state taxes catering receipts and delivery charges on catering at six percent. c) Mel’s would have a $3,500 ($50,000 x 7 percent) sales tax liability in Maine. This is because the state taxes prepared food (in-store sales at 7 percent rather than the 5 percent regular rate). Because Maine exempts other food purchases, there is no sales tax on take out purchases. d) Mel’s would have a $20,000 ($250,000 x 8 percent) sales tax liability in New Hampshire. This is because the state taxes prepared food. However, if there were an exception for bakery goods, then Mel’s would be exempt.



e) Mel’s would have a $24,000 ($300,000 x 8 percent) sales tax liability in Rhode Island. This is because the state taxes Mel’s as a restaurant and places a one percent surtax on top of the regular rate. f) Mel’s would have no sales tax liability in Texas because it lacks physical presence there. Additionally, Mel’s customer would not have a use tax liability in Texas since bakery goods are exempt. 31 [LO 2] {Research} Cuyahoga County, Ohio has a sales tax rate of 7.75 percent. Determine what the state, local, and transit (a local transportation district) portions of the rate are. You may find resources on the State of Ohio website including the following link: http://www.tax.ohio.gov/Portals/0/tax_analysis/tax_data_series/sales_and_use /salestaxmapcolor.pdf

The total rate is 7.75 percent. The county tax rate is 1.25 percent; the transit tax rate is 1.00 percent. Thus the state tax rate is 5.5 percent. 32 [LO 2] Kai operates the Surf Shop in Laie, Hawaii. The Surf Shop designs, manufacturers and customizes surf boards. Hawaii has a 4 percent excise tax that is technically paid by the seller. However, the state also allows "tax on tax" to be charged, which effectively means a customer is billed 4.166% of the sales price. Determine the sales and use tax liability that the Surf Shop must collect and remit, or that the customer must pay for each of the following orders: a) Bronco, a Utah customer, places an internet order for a $1,000 board that will be shipped to Provo, Utah where the local sales tax rate is 6.25 percent. b) Norm, a California resident, comes to the retail shop on vacation and has a $2,000 custom board made. Norm uses the board on vacation and then has the Surf Shop ship the board to Los Angeles, California where the sales tax rate is 8.5 percent. c) Jim, an Ohio resident, places an order for a $2,000 custom board at the end of his vacation. Upon completion the board will be shipped to Columbus, Ohio where the sales tax rate is 7 percent. d) Bo, a Nebraska resident, sends his current surf board to the Surf Shop for a custom paint job. The customization services come to $800. The board is shipped to Lincoln, Nebraska where the sales tax rate is 7 percent.



a) Kai’s would have no sales tax liability. Bronco would have a $63 ($1,000 x 6.25 percent) use tax liability in Utah. b) Kai’s would have a $83 ($2,000 x 4.166 percent) sales tax liability. Norm would have a $87 ([$2,000 x 8.5 percent] - $83 paid to HI) use tax liability in California. c) Kai’s would have no sales tax liability. Jim would have a $140 ($2,000 x 7 percent) use tax liability in Ohio. d) Kai’s would have no sales tax liability because Hawaii doesn’t tax services. Bo would have no Nebraska use tax liability because it doesn’t tax services. 33 [LO 2] Last year Pete, a Los Angeles, California resident, began selling autographed footballs through Trojan Victory (TV), Incorporated, a California corporation. TV has never collected sales tax. Last year TV had sales as follows: California ($100,000), Arizona ($10,000), Oregon ($15,000), New York ($50,000), and Wyoming ($1,000). Most sales are made over the internet and shipped by common carrier. How much sales tax should TV have collected in each of the following situations: a) California treats the autographed football as tangible personal property subject to an 8.25 percent sales tax. Answer for California. b) California treats the autographed football as part tangible personal property ($50,000) and part services ($50,000) and tangible personal property is subject to an 8.25 percent sales tax. Answer for California. c) TV has no property or other physical presence in New York or Wyoming. Answer for New York and Wyoming. d) TV has Pete deliver a few balls to fans in Arizona (5.6 percent) and Oregon (no sales tax) while attending football games there. Answer for Arizona and Oregon. e) Related to part d, can you make any suggestions that would decrease TV’s Arizona sales tax liability? a) TV would have a $8,250 ($100,000 x 8.25 percent) sales tax liability in California. b) TV would have a $4,125 ($50,000 x 8.25 percent) sales tax liability in California. c) TV would have no sales or use tax liability in New York or Wyoming because TV lacks physical presence in those states. d) TV would have a $560 ($10,000 x 5.6 percent) sales tax liability in Arizona but no Oregon liability. e) If TV shipped the footballs through common carrier to its Arizona clients rather than having Pete (TV’s agent) deliver them then no sales or use tax liability would be accrued by TV. TV’s customers would still have an Arizona state use tax liability.



34 [LO 2] Armstrong Incorporated, a Texas corporation, runs bicycle tours in several states. Armstrong also has a Texas retail store and an internet store, which ships to out of state customers. The bicycle tours operate in Colorado, North Carolina, and Texas where Armstrong has employees and owns and uses tangible personal property. Armstrong has real property only in Texas. Armstrong has the following sales: State Arizona California Colorado North Carolina Oregon Texas Totals

Armstrong Sales Goods Services Total $34,194 $0 $34,194 110,612 0 110,612 25,913 356,084 381,997 16,721 225,327 242,048 15,431 0 15,431 241,982 877,441 1,119,423 $1,458,85 $444,853 2 $1,903,705

Assume the following tax rates: Arizona (5.6 percent), California (7.75 percent), Colorado (8 percent), North Carolina (6.75 percent), Oregon (8 percent), and Texas (8.5 percent). How much sales and use tax must Armstrong collect and remit? Armstrong has sales and use tax nexus in Texas (commercial domicile), Colorado, and North Carolina. Sales tax nexus is created in Colorado and North Carolina because of the physical presence of Armstrong’s employees who provide services there. As a result, Armstrong has sales and use tax liability of $20,568 in Texas, $2,073 in Colorado, and $1,129 in North Carolina. It is important to note that while the provision of services triggers the sales tax liability, the calculation is based on the goods sold within each state. The calculations are as follows: State Colorado North Carolina Texas

Goods Rate Liability 25,913 8.00% $2,073 16,721 241,982 $284,61 6

6.75% 8.50%

$1,129 $20,568 $23,770

35 [LO 3] Kashi Corporation is the U.S. distributor of fencing (sword fighting) equipment imported from Europe. Kashi is incorporated in Virginia and headquartered in Arlington, Virginia. Kashi ships goods to all 50 states. Kashi’s employees attend regional and national fencing competitions where they maintain temporary booths to market their goods. Determine whether Kashi has income tax nexus in the following situations: 23-13 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


a) Kashi is incorporated and headquartered in Virginia. It also has property, employees, sales personnel, and intangibles in Virginia. Determine whether Kashi has nexus in Virginia? b) Kashi has employees that live in Washington, DC and Maryland. All of their employment-related activities are performed in Virginia. Determine whether Kashi has nexus in Washington D.C. and Maryland? c) Kashi has two customers in North Dakota. Kashi receives orders over the phone and ships goods to its customers using FedEx. Determine whether Kashi has nexus in North Dakota? d) Kashi has independent sales representatives in Illinois. The representatives distribute fencing and other sports-related items for many companies. Determine whether Kashi has nexus in Illinois? e) Kashi has sales personnel that visit South Carolina for a regional fencing competition for a total of 3 days during the year. All orders received are sent to Virginia for credit approval and acceptance. The goods are shipped by FedEx into South Carolina. Determine whether Kashi has nexus in South Carolina? f) Kashi has sales personnel that visit California for a national fencing competition and several regional competitions for a total of 17 days during the year. All orders received are sent to Virginia for credit approval and acceptance. The goods are shipped by FedEx into California. Determine whether Kashi has nexus in California? g) Kashi receives orders from its Pennsylvania client over its website. Because the orders are so large, the goods are delivered on Kashi’s trucks on a weekly basis. Determine whether Kashi has nexus in Pennsylvania? h) In addition to shipping goods, Kashi provides fencing lessons in Virginia and Maryland locations. Determine whether Kashi has nexus in Virginia and Maryland? i) Given that Kashi ships to all 50 states, are there locations that Kashi currently does not have nexus in that would decrease Kashi’s overall state income tax burden it nexus were created in these locations?



a) Kashi has nexus in Virginia, its state of commercial domicile. b) Kashi’s employees living in the District of Columbia and Maryland will not create nexus there. However, if the employees were to make deliveries to customers in those jurisdictions on the way home that would create nexus. c) Kashi does not have nexus in North Dakota. d) The presence of independent contractors in California does not create nexus in California. However, if the independent contractor only represented Kashi (no other vendors) they would likely be considered Kashi’s agent and could create nexus. e) Kashi does not have nexus in South Carolina. Kashi is protected by P.L. 86-272 because it merely solicits for sales of tangible personal property. Kashi is also likely protected by the trade show rule. f) Kashi does not have nexus in California. Kashi is protected by P.L. 86-272 because it merely solicits for sales of tangible personal property. Kashi may also be protected by the trade show rule, this would depend on whether separate shows days are treated separately or aggregated for purposes of calculating the 14 day rule. g) The presence of Kashi’s truck in Pennsylvania will create nexus there. h) The provision of fencing lessons (services) in Virginia and Maryland will create income tax nexus there. Services are not a protected activity under P.L. 86-272. i) Yes, Kashi should create nexus with any state that doesn’t have an income tax. This will allow Kashi to apportion part of its business income to states which do not tax the apportioned income—this creates nowhere income. Kashi may also consider creating nexus in low-tax jurisdictions but would have to balance the lower taxes against the higher tax compliance costs. 36 [LO 3] Gary Holt LLP provides tax and legal services regarding tax-exempt bond issues of state and local jurisdictions. Gary typically provides the services from his New York offices. However, for large issuances Gary and his staff travel to the state to complete the work. Determine whether Gary Holt has income tax nexus in the following situations: a) Gary Holt is a New York partnership and headquartered in New York. It also has property and employees in New York. Does it have income tax nexus in New York? b) Gary Holt has employees that live in New Jersey and Connecticut. All of their employment related activities are performed in New York. . Does it have income tax nexus in New Jersey and/or Connecticut? c) Gary Holt has two customers in California. Gary personally travels to California to finalize the Alameda County bond issuance. Does it have income tax nexus in California?



a) Gary Holt has nexus in New York through its commercial domicile, provision of services, property, and payroll. b) Gary Holt does not have nexus in New Jersey and Connecticut. Its employees do not create nexus there. c) Gary Holt has nexus in California through the provision of services in California. Services are not a protected activity under P.L. 86-272. 37 [LO 3] Root Beer, Inc. (RBI) is incorporated and headquartered in Seattle, Washington. RBI runs an internet business www.makerootbeer.com. RBI sells bottling equipment and other supplies to make home-made root beer. RBI has an Oregon warehouse facility that it ships goods from. Determine whether RBI has income tax nexus in the following situations: a) Root Beer is incorporated and headquartered in Washington. It has property and employees in Oregon and Washington. Determine whether RBI has nexus in Oregon and Washington. b) Root Beer has hundreds of customers in California but has no physical presence (no employees or property). Determine whether RBI has nexus in California. c) Root Beer has 500 New York customers but has no physical presence (no employees or property). Remember New York has the new Amazon rule. Determine whether RBI has nexus in New York. a) RBI has income tax nexus in Washington and Oregon. Nexus is created in Washington through commercial domicile, payroll, and property. However, Washington does not have a corporate income tax, but has a Business and Occupation (gross receipts) tax instead. Nexus is created in Oregon through payroll and property. b) RBI has no nexus in California because it lacks physical presence. c) RBI has no income tax nexus in New York, but New York’s Amazon rule will create sales and use tax nexus. 38 [LO 3] Rockville Enterprises manufactures wood working equipment and is incorporated and based in Evansville, Indiana. Rockville’s real property is all in Indiana. Rockville employs a large sales force that travels throughout the U.S. Determine whether each of the following is a protected activity in non-domiciliary states under Public Law 86-272: a) Rockville advertises using television, radio and newspaper in Wisconsin. b) Rockville’s employees in Illinois check the credit of a potential customer. c) Rockville maintains a booth at an industry tradeshow in Arizona for 10 days. d) Sales representatives check the inventory of a customer to make sure they have enough in stock and that it is properly displayed. e) Rockville holds a management seminar for corporate executives over four days in Florida.



f) Sales representatives supervise the repossession of inventory from a customer that is not making payments on time in Maine. g) Rockville provides automobiles to Idaho and Montana sales representatives. h) An Alabama sales representative accepts a customer deposit on a large order. i) Colorado sales representatives carry display racks and promotional material that they place in customers retail stores without charge. a) All forms of advertising are a protected activity. b) Checking the credit of customers is not a protected activity. Employees may take the customer’s information and forward it to the home office for the credit check (this would be a protected activity). c) The trade show rule protects in-state sales for up to 14 days in most states including Arizona. d) Inventory checks (both quantity and proper display) are protected activities. e) A management seminar is not a protected activity and would create nexus. A sales personnel seminar is a protected activity. f) Collection activities are not a protected activity and create nexus. g) Providing automobiles or monetary compensation for the purchase or lease of an automobile used by sales personnel is a protected activity. h) Accepting a customer deposit is the acceptance of an order and is not a protected activity. i) Placing display racks and promotional materials without charge is a solicitation and is a protected activity. 39 [LO 3] Software Incorporated is a sales and use tax software vendor. It provides customers with a license to use its software that is downloaded on customers’ machines. The licensing agreement provides that Software actually retains ownership of the software. Software has customers in New Jersey and West Virginia. Does Software have economic nexus in these states because of the following decisions (Lanco, Inc. v. Director, Division of Taxation, NJ Sup. Ct., Dkt. No.A-89-05(2006); and Tax Commissioner of West Virginia v. MBNA America Bank, N.A., 640 SE 2d 226 (WV 2006))? The court decisions (Lanco and MBNA) hold that physical presence isn’t necessary in order to create income tax nexus. Lanco licensed trademarks, trade names, and service marks within New Jersey. MBNA issued credit cards to West Virginia customers and had no employees, payroll or property in that state. By analogy, Software’s licensing the use of its intangible product in New Jersey and West Virginia should create nexus under those precedents.



40 [LO 3] {Research}Peter Inc., a Kentucky corporation owns 100 percent of Suvi Inc., a Mississippi corporation. Peter and Suvi file a consolidated federal tax return. Peterhas income tax nexus in Kentucky and South Carolina. Suvi in Mississippi and South Carolina. Kentucky, Mississippi, and South Carolina are separate return states. In which states must Peter and Suvi file tax returns? Can they file a combined/consolidated return in any states? Explain. (Hint: Use South Carolina Form SC 1120 and the related instructions.) Peter must file in Kentucky and South Carolina because it has nexus in those states. Suvi must file in Mississippi and South Carolina because it has nexus in those states. South Carolina permits a consolidated tax return (see Form SC1120, Schedule J). Each corporation electing to file a consolidated return determines its income or loss separately, allocates its allocable income separately, and calculates its apportionable income separately using separate apportionment factors. 41 [LO 3] Use California Publication 1061 (2011) to determine the various tests California uses to determine whether two or more entities are considered to be part of a unitary group. In Publication 1061, California uses tests from the following cases:  Butler Brothers, Butler Brothers v. McColgan, 315 U.S. 501 (1942), (unity of ownership, operations, and a centralized executive force)  Edison California Stores v. McColgan (1947) 30 Cal.2d.472, (if the operations within the state is dependent on or contributes to operations outside the state);  Container Corporation, Container Corporation v. Franchise Tax Board (1983) 463 U.S. 159, (three unities test and dependency and contribution test);  Mobil Oil, Mobil Oil Corp. v. Comm’r of Taxes of Vt. (1980) 445 U.S. 425, (functional integration, centralization of management, and economies of scale). 42 [LO 3] Bulldog, Incorporated is a Georgia corporation. It properly included, deducted, or excluded the following items on its federal tax return in the current year:



Federal Treatment Item

Amount

Georgia Income Taxes Tennessee Income Taxes Washington Gross Receipts Tax Georgia Bond Interest Federal T-Note Interest Domestic Production Act. Ded. (DPAD)

$25,496 $13,653 $3,105 $10,000 $4,500 $15,096

Deducted on federal return Deducted on federal return Deducted on federal return Excluded from federal return Included on federal return Deducted on federal return

Use the Georgia Corporate Income Tax Form 600 and Instructions to determine what federal/state adjustments need to be made for Georgia. Bulldog’s Federal Taxable Income was $194,302. Calculate the Bulldog’s Georgia state tax base. Bulldog’s Georgia state tax base is $218,551, which is calculated as follows: Bulldog Georgia Tax Base (1) Federal Income Additions (2) DPAD (3) Tennessee tax Subtractions (4)Federal T-note interest

$194,30 2 $15,096 Per instructions $13,653 Per instructions $4,500 Per return $218,55 1 (1) + (2) +(3) – (4)

Additionally, Publication 611 (corporate instructions) indicates that non-income based tax (Washington Gross Receipts Tax) is deductible (no adjustment is necessary) and Georgia bond interest is deductible.

43 [LO 3] Herger Corporation does business in California, Nevada, and Oregon and has nexus in these states as well. Herger’s California state tax base was $921,023 after making the required federal/state adjustments. Herger’s state tax base contains the following items:

Georgia Tax Base



Item Federal T-note interest Nevada municipal bond interest California municipal bond interest Interest expense related to T-note interest Royalty income Travel expenses

Amount $5,000 $3,400 $6,000 $1,400 $100,000 $9,025

Determine Herger’s business income. Herger’s California business income would be $817,623 ($921,023 - $100,000 of royalty income - $3,400 of Nevada municipal bond interest). The royalty income would be considered non-business or allocable income. The Federal T-note interest and related expenses are excluded from the California state income tax base as is the California municipal bond interest. The travel expenses are in the state tax base and are a business expense (no adjustment is necessary). 44 [LO 3] Bad Brad sells used semi trucks and tractor trailers in the Texas panhandle. Bad Brad has sales as follows: Bad Brads State Colorado Oklahoma New Mexico Texas Totals

Sales $234,99 2 402,4 50 675,204 1,085,24 9 $2,397,8 95

Bad Brad is a Texas Corporation. Answer the questions in each of the following scenarios. a) Bad Brad has nexus in Colorado, Oklahoma, New Mexico and Texas. What are the Colorado, Oklahoma, New Mexico and Texas sales apportionment factors? b) Bad Brad has nexus in Colorado and Texas. Oklahoma and New Mexico sales are shipped from Texas (a throwback state). What are the Colorado and Texas sales apportionment factors? c) Bad Brad has nexus in Colorado and Texas. Oklahoma and New Mexico sales are shipped from Texas (a throwback state); $200,000 of the Oklahoma sales were to the federal government. What are the Colorado and Texas sales apportionment factors? 23-20 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


d) Bad Brad has nexus in Colorado and Texas. Oklahoma and New Mexico sales are shipped from Texas (assume Texas is a non-throwback state). What are the Colorado and Texas sales apportionment factors?



a) The sales factors are the state sales divided by the total sales. For example Colorado’s sales factor is 9.8 percent ($234,992/$2,397,895). The sales factors are as follows: Colorado sales factor Oklahoma sales factor New Mexico sales factor Texas sales factor

9.80% 16.78% 28.16% 45.26% 100.00%

b) Thrown back sales are added to the Texas numerator. Thus, the Texas sales numerator increases to $2,162,903($402,450 + $675,204 + $1,085,249). The Colorado and Texas factors are as follows: Colorado sales factor Texas sales factor* *($2,162,903/$2,397,895)

9.80% 90.20% 100.00%

c) Federal government sales are added to the numerator of the state where they shipped from (Texas). As a result, all of the Oklahoma sales are added to Texas through either the throwback or government sales rules. The Colorado and Texas factors are as follows: Colorado sales factor Texas sales factor

9.80% 90.20% 100.00%

d) Without the throwback rules, the sales from New Mexico and Oklahoma are excluded from both the numerator and denominator. The Colorado and California sales factors are 17.8 ($234,992/$1,320,241) percent and 82.2 (1,085,249/$1,320,241) percent, respectively. Colorado sales factor Texas sales factor

17.80% 82.20% 100.00%



45 [LO 3] Nicole’s Salon a Louisiana Corporation, operates beauty salons in Arkansas, Louisiana, and Tennessee. These salon sales by state, are as follows: Nicole’s Salon State Sales Arkansa s $130,239 Louisian 309,19 a 2 Tenness ee 723,010 $1,162,4 Total 41 What are the payroll apportionment factors for Arkansas, Louisiana, and Tennessee in each of the following alternative scenarios? a) Nicole’s Salon has nexus in Arkansas, Louisiana, and Tennessee. b) Nicole’s Salon has nexus in Arkansas, Louisiana, and Tennessee, but $50,000 of the Arkansas amount is paid to independent contractors. a) Nicole’s salon’s payroll factors are as follows: Arkansas

11.20%

Louisiana

26.60%

Tennessee

62.20% 100.00%

($130,239/$1,162,441 ) ($309,192/$1,162,441 ) ($723,010/$1,162,441 )

b) The independent contractor amount is subtracted from the Arkansas numerator, which also lowers the denominator. Nicole’s salon’s payroll factors are as follows: Arkansas

7.21%

Louisiana

27.79%

Tennessee

64.99% 100.00%

($80,239/$1,112,441) ($309,192/$1,112,441 ) ($723,010/$1,112,441 )



46 [LO 3] Delicious Dave’s Maple Syrup a Vermont Corporation, has property in the following states: Property State Beginning Ending Maine $923,032 $994,221 Massachusetts 103,311 203,109 New Hampshire 381,983 283,021 Vermont 873,132 891,976 Total $2,281,458 $2,372,327 What are the property apportionment factors for Maine, Massachusetts, New Hampshire, and Vermont in each of the following scenarios? a) Delicious has nexus in each of the states. b) Delicious has nexus in each of the states, but the Maine total includes $400,000 of investment property that Delicious rents out (unrelated to its business). c) Delicious has nexus in each of the states, but also pays $50,000 to rent property in Massachusetts. a) Delicious has the following property factors:

Maine Massachusetts New Hampshire Vermont

Beginning $923,032 $103,311 $381,983 $873,132

Ending Average Factor $994,221 $958,627 41.20% $203,109 $153,210 6.58% $283,021 $332,502 14.29% $891,976 $882,554 37.93% $2,372,32 $2,326,89 $2,281,458 7 3 100.00%

b) Delicious must remove the investment (non-business property) from the property factors. Delicious would have the following property factors:


Beginning $523,032 $103,311 $381,983 $873,132




c) Delicious must add the rental property to Massachusetts. The annual rent ($50,000) is multiplied by eight and thus ($400,000) is included in both the numerator and denominator. Delicious would have the following property factors:


Beginning $923,032 $503,311 $381,983 $873,132


47 [LO 3] Susie’s Sweet Shop has the following sales, payroll and property factors:

Sales Payroll Property

Iowa Missouri 69.20% 32.01% 88.00% 3.50% 72.42% 24.04%

What are Susie’s Sweet Shop’s Iowa and Missouri apportionment factors under each of the following scenarios: a) Iowa and Missouri both use a three-factor apportionment formula. b) Iowa and Missouri both use a four-factor apportionment formula that doubleweights sales. c) Iowa uses a three-factor formula and Missouri uses use single-factor apportionment formula (based solely on sales). a) Using a three-factor formula, the total apportionment would be 96.39 percent. Susie’s Iowa and Missouri apportionment factors would be as follows:

Sales Payroll Property

Apportionment Factor

Iowa Missouri 69.20% 32.01% 88.00% 3.50% 72.42% 24.04% 229.62% 59.55% /3 /3 76.54% 19.85%

96.39%

b) Using a four-factor (double-weighted sales) formula, the total apportionment would be 97.60 percent. Susie’s Iowa and Missouri apportionment factors would be as follows: 23-25 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


Sales Sales Payroll Property


Iowa Missouri 69.20% 32.01% 69.20% 32.01% 88.00% 3.50% 72.42% 24.04% 298.82% 91.56% /4 /4 74.71% 22.89%

97.60%

c) If Iowa uses a three-factor formula, as in part (a), and Missouri uses a single (sales) factor apportionment factor, the total apportionment would be 108.55 percent. Susie’s Iowa and Missouri apportionment factors would be as follows:


Iowa Missouri 76.54% 32.01%

108.55%

48 [LO 3] Brady Corporation is a Nebraska Corporation but owns business and investment property in surrounding states as well. Determine the state where each item of income is allocated. a. b. c. d.

$15,000 of dividend income. $10,000 of interest income. $15,000 of rental income for South Dakota property. $20,000 of royalty income for an intangible used in South Dakota (where nexus exists). e. $24,000 of royalty income from Kansas (where nexus does not exist). f. $15,000 of capital gain from securities held for investment. g. $30,000 of capital gain on real property located in South Dakota.



a. Nebraska; dividend income is generally allocated or sourced to the state of commercial domicile. b. Nebraska; interest income is generally allocated or sourced to the state of commercial domicile. Although, one exception is that interest on working capital is considered business income and is apportioned rather than allocated. c. South Dakota; rental property income is generally allocated or sourced to where the property is located. d. South Dakota; royalty income is generally allocated or sourced to where the property is used. e. Kansas, royalty income is generally allocated or sourced to where the property is used, but if nexus does not exist it is allocated to the location where the intangible is controlled (Nebraska). f. Nebraska; capital gain from property held for investment is generally allocated or sourced to the state of commercial domicile. g. South Dakota; capital gain from real property is generally allocated or sourced to the state where the property is located. 49 [LO 3] Ashton Corporation is headquartered in Pennsylvania. Ashton has a Pennsylvania state income tax base of $500,000. Of this amount, $50,000 was nonbusiness income. Ashton’s Pennsylvania apportionment factor is 42.35 percent. The non-business income allocated to Pennsylvania was $32,000. Assuming a Pennsylvania corporate tax rate of 8.25 percent, what is Ashton’s Pennsylvania state tax liability? Ashton Corporation’s Pennsylvania state tax liability is $18,362. The state tax liability is calculated as follows: Ashton Corporation (1) State tax base (2) Total allocated income (3) Apportionable income (4) PA apportionment factor (5) PA apportioned income (6) PA allocated income (7) PA taxable income (8) PA tax rate (9) PA state tax liability

$500,00 0 $50,000 $450,00 0 42.35% $190,57 5 $32,000 $222,57 5 8.25% $18,362

Given Given (1) - (2) Given (3) x (4) Given (5) + (6) Given (7) x (8)

Comprehensive problems



50. [LO 3] Do you know what Cloud computing is? Cloud computing is the use of hosted computer facilities through the internet. Gmail, RIA Checkpoint, and even using your iPhone are some applications of cloud computing. a. If HP provides a customized bundle of servers, storage, network and security software, business application software to a customer in Washington state how is it taxed? b. Is HP leasing tangible personal property which is taxable or providing a non-taxable service? c. Is the buyer of HP’s products subject to Washington’s sales and use tax? d. Is HP subject to Washington’s B&O tax? Solution: If you’re buying or selling cloud computing services, it is critical to determine what you’re buying or selling. You may be leasing equipment, making service payments, or paying a license for using software — these distinctions are important and can have an impact on your company’s tax filings. Current tax law does not necessarily reflect the realities of cloud computing. Cloud computing transactions aren’t quite leases and aren’t quite services, but tax law requires them to be classified in one of these two categories. Eventually, tax regulations will be updated and clarified. Now, there isn’t enough consensus to know how to treat them for most states. To deal with these issues, Washington State changed its laws in 2009 to deal with the shift, the report said. The state now requires that Washington residents pay state tax regardless of how their goods are delivered. So Washington residents will be subject to the sales and use tax. HP would be subject to the Washington B&O tax because nonincome based taxes are not protected under Public Law 86-272.



51. Sharon, Inc. is headquartered in State X, Sharon owns 100% of Carol, Josey and Janice Corps. Assume sales operations are within the “solicitation” bounds of Public Law 86272. Each of the corporations has operations in the following states: Domicile State Dividend income Business income Sales: State X State Y State Z State A State B Property: State X State Y State Z State A Payroll: State X State Y State Z State A

Sharon, Inc. State X (throwback) 1,000

Carol Corp State Y (throwback) 200

Josey Corp State Z (nonthrowback) 300

Janice Corp State Z (nonthrowback) 500

50,000

30,000

10,000

10,000

70,000

10,000 40,000 20,000

10,000 5,000 20,000

10,000

20,000 10,000 50,000

10,000 10,000 10,000

20,000 80,000

50,000 10,000

25,000

20,000

3,000

10,000 10,000

10,000 40,000

Compute the following for State X assuming a tax rate of 15 percent. a. Calculate the State X apportionment factor for Sharon Inc., Carol Corp., Josey Corp., and Janice Corp. b. Calculate the business income apportioned to State X. c. Calculate the taxable income for State X for each company.



d. Determine the tax liability for State X for the entire group.

Josey has no nexus in State X because it has no property or payroll there (no physical presence). The State X tax liability is $6,793; calculated as follows: Sharon Sales

X Total

70,000 100,000

10,000 70,000

Josey No NEXUS 10,000 35,000

Property

X Total

50,000 100,000

20,000 100,000

0 25,000

10,000 30,000

Payroll

X Total

10,000 10,000

10,000 50,000

0 3,000

0 20,000

0.70 0.50 1.00 2.20

0.14 0.20 0.20 0.54

0.3333 0.3333 0.00 0.6666

Apportionment Factor Income

0.7333 50,000

0.18 30,000

0.2222 10,000

Apportioned Income Allocated Income

36,667 1,000

5,400 0

2,222 0

State Taxable Income

37,667

5,400

2,222

Sales Property Payroll

Carol

Janice 10,000 30,000

45,289 15% 6,793

Taxable income Tax rate State tax liability

52. Happy Hippos (HH) is a manufacturer and retailer of New England crafts. HH is headquartered in Camden, Maine. HH has sales, employees, property, provides services, and commercial domicile as follows:

State Connecticut Maine Massachusetts New Hampshire Rhode Island Vermont

Sales      

Happy Hippos In-State Activities Commercial Employees Property Services Domicile         





Happy Hippos sales of goods and services by state are as follows: 23-30 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


State Connecticut Maine Massachusetts New Hampshire Rhode Island Vermont Totals

Happy Hippos Sales Goods Services Total $78,231 $52,321 $130,552 292,813 81,313 374,126 90,238 90,238 129,322 98,313 123,914 $812,831

129,322 98,313 147,856 $970,407

23,942 $157,576

HH has federal taxable income of $282,487 for the current year. Included in federal taxable income are the following income and deductions: $12,000 of Vermont rental income; City of Orono, Maine bond interest of $10,000; $10,000 of dividends; $2,498 of state tax refund included in income; $32,084 of state net income tax expense; and $59,234 of federal depreciation. Maine state depreciation for the year was $47,923 and Maine doesn’t allow deductions for state net income taxes. The employees present in Connecticut, Massachusetts, and Rhode Island are sales personnel and perform only activities protected by Public Law 86-272. Each of the states is a separate-return state. HH’s payroll is as follows: Payroll State Connecticut Maine Massachusetts Rhode Island Vermont Total

Wages $94,231 392,195 167,265 92,391 193,923 $940,005



HH’s property is as follows: State Maine Vermont Total

Property Beginning Ending Rented $938,234 $937,652 329,134 428,142 $12,000 $1,267,368 $1,365,794 $12,000

a) Determine the states in which HH has sales tax nexus. b) Calculate the sales tax HH must remit assuming the following sales tax rates: Connecticut (6%), Maine (8%), Massachusetts (7%), New Hampshire (8.5%), Rhode Island (5%), and Vermont (9%). c) Determine the state in which HH has income tax nexus. d) Determine HH’s state tax base for Maine assuming federal taxable income of $282,487. e) Calculate business and non-business income. f) Determine HH’s Maine apportionment factors using the three-factor method (assume that Maine is a throwback state). g) Calculate HH’s business income apportioned to Maine. h) Determine HH’s allocation of non-business income to Maine. i) Determine HH’s Maine taxable income. j) Calculate HH”s Maine net income tax liability assuming a Maine tax rate of 5 percent. a) HH has sales tax nexus in Maine, Connecticut, Massachusetts, Rhode Island and Vermont. HH does not have sales tax nexus in New Hampshire because there is no physical presence. b) HH sales tax remittance will be as follows: Connecticu t Taxable sales Sales tax rate Sales tax liability

Maine

Massachusetts

New Hampshir e

Rhode Island

Vermont

$78,231 6.0%

$292,813 8.0%

$90,238 7.0%

$0 8.5%

$98,313 5.0%

$123,914 9.0%

$4,694

$23,425

$6,317

$0

$4,916

$11,152

c) HH has income tax nexus in Maine (commercial domicile), Connecticut (provides services), and Vermont (provides services). d) HH’s Maine state tax base is $323,384 and is calculated as follows:



Federal taxable income

$282,4 87

Positive adjustments State tax expense Federal depreciation

Negative adjustments State tax refund Maine depreciation

Maine state tax base

$32,08 4 $59,23 4 $91,31 8 $2,498 $47,92 3 $50,42 1 $323,3 84

e) HH’s non-business and business income is as follows: Maine state tax base Allocable income Vermont rental income

$323,3 84

Dividends Non-business income

$12,00 0 $10,00 0 $10,00 0 ($32,0 00)

Business income

$291,3 84

Maine bonds

f) HH’s Maine apportionment factor is 59.81; the average of the sales, payroll and property factors. HH’s sales, payroll, and property factors are 71.31, 41.72, and 66.40 percent, respectively.



HH’s Maine sales apportionment factor is 71.31% ($691,999/$970,407). New Hampshire, Rhode Island, and Massachusetts sales are thrown back to Maine because HH lacks income tax nexus in those states (remember that Public Law 86-272 protects sales activities). Connectic ut 130,552 New Hampshire Rhode Island Massachuset ts Numerator

Vermon t 147,85 374,126 6 129,322 98,313

Maine

0

90,238

130,552

691,999

0 147,85 Denominato 6 r 970,407



HH’s Maine payroll factor is 41.72 ($392,195/$940,005) percent. HH’s Maine property factor is 66.40 ($937,943/$1,412,581) percent. The beginning and ending amounts are averaged. The Vermont beginning and ending amounts include $96,000 ($12,000 x 8), which is eight times the rents paid during the year State Maine Vermont Total

Beginnin g $938,234 $425,134

Ending Average $937,652 $937,943 $524,142 $474,638 $1,412,58 1

g) HH’s business income apportioned to Maine is $174,277. Total business income ME apportionment ME business income

$291,384 59.81% $174,277

h) HH’s non-business income allocable to Maine is $20,000 (City of Orono, Maine bond interest of $10,000 and $10,000 of dividends). Investment income is typically allocated to the state of commercial domicile. i) HH’s Maine taxable income is $194,277. Maine

ME business income ME non-business income ME taxable income

$174,277 $20,000 $194,277

j) HH’s Maine tax liability is $9,714. Maine taxable income Maine tax rate Maine tax liability

$194,277 5% $9,714


SMChap023

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