Indecent Exposure - tax laws in different U.S states - Brief Article

California CPA, Nov, 2000 by Robert A. Petersen

When we tell clients that we serve as their tax advisers, we usually don't include a limiting declaration on the service: Tax includes federal and state income, property, sales and any other tax that might apply to their business. Likewise, our clients expect us to be all-knowing about when another state has the right to levy a tax on their business' income or sales. As more clients expand into the multi-state arena, as their tax adviser, you must know when they are subject to tax by more than one state.

IGNORANCE IS NO EXCUSE

If a business pays income tax to the wrong state, it will not necessarily be refunded. For instance, a business is created in California and pays California franchise tax on 100 percent of its income to California. But say that same company has inventory in Alaska. Based on the inventory, the company is required to file a state income tax return in Alaska and pay tax on its apportioned income there. Does this mean the California tax it already paid will be refunded? Maybe not. The claim for refund of the California tax must generally be made within four years from the return's due date, or one year from the date of overpayment (Cal. Rev. & T.C. Secs. 19507, 19508, and 19087).

However, if no Alaska return was filed for the year, Alaska can require tax payment at any time [Alaska Stat. Sec. 43.20.200(b)]. The Alaska statute of limitations on an assessment does not begin to run until a return is filed. Using the 1996 calendar year return as an example, the California statute of limitations on a refund expires March 15, 2001 assuming the return was timely filed. If then in June 2001 Alaska discovers that it is owed taxes and makes an assessment, the Alaska tax will have to be paid and there can be no recovery from the state of California. This not only makes clients mad, it also, if material, creates problems for the CPA-auditor who failed to reflect the liability on the company's 1996 financial statements.

Be aware that the rules of the ballgame are not the same for income tax and sales and use tax.

FEDERAL LAW CONTROLS STATE

For income tax purposes, including franchise taxes based on income, federal law (P.L. 86-272) controls when a state can impose a tax on net income. The state can always impose tax on the net income from the sale of real property within its borders. It always can impose an income tax on fees collected for services rendered within its borders, and it always can collect income from individuals rendering services within its borders. In fact, a business is protected from another state's income tax only if it is selling tangible personal property in the state and its activities in the state are limited to:

* Employees soliciting orders without the authority to accept them;

* Employees displaying goods or engaged in other promotional activity, but not soliciting or taking orders;

* Solicitation activity by nonemployee representatives; and

* Delivery of goods in the state in company-operated vehicles, regardless of frequency.

In short, maintaining any business location in the state, including any kind of office, creates exposure. Likewise, ownership of real property in a state, inventory in a public warehouse or in the hands of a distributor or other nonemployee representative, if used to fill orders, creates exposure. In addition, usual or frequent activity in the state by employees soliciting orders with authority to accept them (that bind the employer to a contract), or an employee performing services such as installation or assembly of product, repairs, debt-collection, or any other service not specifically protected, gives the state the right to tax the business' net income.

These rules apply even to businesses with Internet presence. The U.S. Supreme Court has looked to physical presence in a state, not the presence created because someone in another state is able to access their Web site. While this may change, Internet presence alone does not give a state the right to tax income of a business with no other presence in the state.

Two states cannot each tax the totality of a businesses income. Rather the net taxable income of the business must be apportioned among the states. However, the states are not required to apportion income using the same formula, so it is very common that states using differing formulas will cause a multi-state taxpayer to pay state taxes on more than, or less than, 100 percent of its income. The answer to this is simply, "That's the law."

Robert A. Petersen, CPA is sole owner of Menlo Park-based Petersen & Associates. Petersen is frequent Education Foundation instructor, teaching state taxation of the mobile taxpayer.