Creating nexus in another state.

Being subject to tax in another state might not be such a bad thing. The examples that follow illustrate a (very common) factual situation in which significant savings can be achieved by establishing nexus in another state.

Example 1: A Corporation is a California taxpayer that manufactures widgets for sale to customers in several states. A employs resident salespersons in three states who are responsible for designated geographic areas. A has been careful in restricting the activities of its salespeople to selling activities considered "immune" under P.L. 86272. A also delivers its products to customers in other states via common carrier; all goods are delivered from inventory located in California. Therefore, A has positioned itself to be subject to corporate income tax only in California. Finally, A's sales to California customers are 25% of its total sales; its taxable income last year was $4,000,000.

Due to A's state tax planning, it files a corporate income/franchise tax return only in California. (A does not carry on activities in states that impose nonincome corporate taxes (e.g., Texas, Michigan, Pennsylvania, etc.).)

As a result, A calculates its California taxable income as if all its sales were made to California customers. Even though it makes only 25% of its sales to California customers, all of its non-California sales are "thrown back" to California for tax purposes. A's California corporate income/ franchise tax liability is, therefore, 8.84% X $4,000,000, or $353,600.

Apportionment of A's Income

Example 2: A changes its multistate activities subtly so as not to interfere with normal operations or require any additional administrative chores. Beginning this year, A's resident salespersons are now permitted to approve orders to customers in the state of the salesperson's residence. This is a minor activity, but one that is clearly listed as a "non-immune activity" in most states' administrative adoption of P.L. 86-272. Other activities that would result in nexus include most post-sale activities (such as installation, consulting, training, etc.).

A's sales to customers in states where its resident salespersons reside comprise 40% of its total sales. Further, 10% of A's total payroll is attributable to salaries paid to the resident salespeople. Finally, the states where A's salespersons reside impose an 8% tax rate and apply a three-factor apportionment factor to determine taxable income for state purposes.

When A prepares its state returns (now including California and three other states), it is permitted to apportion its overall taxable income. This is done by way of a fraction comprised of sales, payroll and property. A's California liability is reduced to $272,272, while its liability in each of the other three states is $17,600, for a total state income tax liability of $325,072. This represents savings of $28,528 per year, simply by filing tax returns in states where A already does business.

Of course, taxpayer-specific facts and circumstances will determine whether overall state income tax savings are available. However, the key issue is not to assume that having nexus in another state always means more overall tax.

FROM THOMAS DELONG, CPA, ZAINER RINEHART CLARKE DFK CPAs, SANTA ROSA, CA

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA