STATE AND LOCAL TAX
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
Distribution
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
Distribution
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
Investments
Deductions for certain activities the state wants to encourage
Corporate Taxes
4% of state & local taxes
Objective
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%
Licenses
Fines
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
Hypo
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
Disallowed
Domestic production activities
Disallowed
Measurement of Property
Base amount that must get apportioned to the state
Valuation
Based on GAAP book values
Deviation in real estate and publicly traded securities
