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State and Local Taxation
Villanova University School of Law
Hargrove, Joseph


Professor Hargrove

Villanova University Law School

Spring 2017

Significance of State and Local Taxes

US spending $2.6 trillion

Revenue $1.6 trillion

State and local spending was $2.5 trillion

Revenue $1.3 trillion

Types of State and Local Taxes

Property Tax

Generate about 17% of state and local revenue

What is being taxed?

Real property measured by value

The owner of the real property is being taxed

Across a class of property, the tax is proportional
Regressive tax that discriminates against types of property

As income and assets go up, ability to invest in things that are not property goes up

Who’s bearing the economic burden of the tax?

Renters through rental

Doesn’t generate cross-border incentives

Sales and Use Tax

Generate about 12% of state and local revenue

Imposed on transfer

Measure of the tax

Percentage of a price


Regressive tax

Poorer people spend larger % of income on sales tax than wealthy

Economic impact

Cross-border incentive
If there’s inelastic demand, negative effect on consumer
If there’s elastic demand, negative effect on manufacturer

Cause capital to shift from taxed industry to non-taxed industry

Risk of distortion with manufacturers of varying integration

Income Tax

Generate about 12% of state and local revenue
Purpose is to tax income
Measured by amount of income
Progressive tax (MA is proportional)
Economic incentives

Cross-border incentives
Earning incentives

To earn or no to earn

Deductions for certain activities the state wants to encourage

Corporate Taxes

4% of state & local taxes

Privilege for doing business (or incorporating) in the state

Allowed to do business in corporate form
Measured on net income and/or net assets

Economic impact

Companies try to pass income taxes on to customers

Based on elasticity of product

Economic incentives

Decreases returns on equity

Increases incentive to raise capital through debt instead of equity

Debt is deductible, dividends aren’t

Rest of State and Local Revenue

Federal Aid – 20%
Estate Tax – 2%
Excise Tax
User Fees – 25%

Professional fees
State college tuition

Lottery and Casino – 10%

Federal Law Governing State and Local Taxation

Public Law 86-272

Prohibits states from imposing a net income tax derived within the state from interstate commerce if the only business activities carried on within the state are the solicitation of orders for sales of tangible personal property where the orders are sent outside the state for approval or rejection and are filled by shipment or delivery from a point outside the state

Exception: solicitation of orders is an immune activity

A company’s sales office in the state makes the company fall outside the scope of the statute

Companies with sales offices in the state can be taxed on income by the state

Due Process

Substantial Nexus

Is there enough of a connection between the taxing jurisdiction and the taxpayer or the taxable transaction that the taxpayer would be expected to be taxed

Rational Relationship

Between some value connected to the state and the tax the state is trying to impose

Basically, “what’s fair?”

Equity focus


CA company that sells goods
Sales offices in MA and NY
MA wants taxes from MA office to MA customers

No problem under Due Process

MA wants taxes on sales from NY sales to NY customers

Problem under Due Process

Sum of greater of income or property plus property of subsidiaries
Entire net income is basically the federal net tax income

Mass Corporate Structure

Sum of % of net income and % of property
Entire net income is gross income less deductions but not credits at federal level

Income tax based on reliance of federal income tax computations
Typical deviations from federal income deductions

Dividends received

Have to deviate because under federal, the deduction is from “domestic” corporations

States can’t favor investments over domestic companies over foreign companies

Most states either allow 100% deduction or allow no deduction
There may be aspects of the federal tax structure that don’t get perfectly duplicated because of simplifications of the states

Intercompany Royalties

Deny deductions for certain intercompany transfers

Net Operating Losses

Shorter NOL recovery periods
Federal system allows carry backs, state system doesn’t allow carry backs

Interest on municipal bonds

States do not allow deduction for municipal bonds

State taxes

Not deductible on state tax returns
Can’t deduct other state’s taxes paid
No deduction or foreign taxes

Investments in emerging technologies
Bonus depreciation


Domestic production activities


Measurement of Property

Base amount that must get apportioned to the state

Based on GAAP book values

Deviation in real estate and publicly traded securities