Federal legislation to simplify a hodge-podge of state tax laws would give businesses a multi-billion dollar tax break and further strain state and local government budgets, according to state government officials.
The bill, backed by business trade groups, would prevent states from levying corporate income and other business activity taxes on an out-of-state company unless the business had a physical presence that met a specific standard in the taxing state. It was approved by the House Judiciary Committee on July 8 and awaits action on the House floor, where it might pass.
“You’re taking existing revenue away from states at a time when they’re trying to recover,” David Quam, director of federal relations for the National Governors Association, told Bloomberg Government. He said the group also opposes the legislation because it violates the principle that “state tax decisions should be made in state capitals, not in Washington.”
If enacted, the proposal would cost states at least $3 billion annually and possibly much more in forgone tax revenue, Quam said, citing a 2006 Congressional Budget Office report on a narrower bill. At the time, the governors’ group pegged the cost of the legislation at more than $6 billion a year.
Banks, software and information services companies are among businesses that could pay less in state taxes if the measure was enacted.
The bill is sponsored by Representative Bob Goodlatte, a Virginia Republican, and is the seventh iteration of corporate tax pre-emption legislation introduced since 2000. The proposal was approved in committee only once before, in 2006.
Clarify and Simplify
Backers of the bill say it would make more clear and simple a confusing state taxation process that often involves expensive litigation.
“We think it makes more sense to give businesses a bright-line test for knowing what contacts are sufficient to trigger tax,” Goodlatte said.
“Certainty is something that’s very important to the business community on tax issues,” said Doug Lindholm, executive director of the Council on State Taxation, a Washington-based trade association of multistate corporations.
Business taxes are triggered when an out-of-state company has “nexus” in a state, generally defined as a combination of property, payroll or intentionally accessing a state’s marketplace.
Vernon T. Turner, vice president of corporate tax at Smithfield Foods Inc., a Smithfield, Virginia-based company that is the world’s largest pork processor, said a number of gray areas pop up in figuring out-of-state taxation when considering work done by sales people, the taxability of trade names and patents and definition of sales income.
‘Very Arbitrary Manner’
“They’ll say you have taxable nexus with us in this state and we don’t think we do,” said Turner, who submitted testimony in favor of the bill in April “It’s done in a very arbitrary manner and the rules aren’t crystal clear about when a corporation owes taxes.”
State tax collectors become more aggressive during economic declines, he said.
Goodlatte, the bill’s sponsor, said any initial loss of state revenue will be more than offset “tremendously, absolutely” by economic growth because of clearer regulation and less litigation.
Forty-seven states, the District of Columbia and a handful of cities, including New York City, levy taxes that would be affected by the legislation, according to Lindholm. Top marginal rates range up to 12 percent.
Physical Presence Standard
States already collect sales tax based on whether an out-of-state business has a physical presence in a state and Lindholm said the bill would extend that threshold to corporate income taxes.
While business supporters of the bill embrace that standard, some in Congress say the physical presence test is outmoded even for collecting sales tax.
Senator Richard Durbin, an Illinois Democrat, has said he plans to introduce legislation soon that would allow states to collect sales tax on transactions by online retailers, such as Amazon.com Inc. and Overstock.com Inc.
Such businesses aren’t required to collect sales tax when they don’t have stores, warehouses or other brick-and-mortar presence in a state.
“A physical presence standard is a 19th-century rule. It has almost nothing to do with how business is done in the 21st century,” said Joe Huddleston, executive director of the Washington-based Multistate Tax Commission, an organization of state governments that works to administer tax laws applying to multistate businesses.
More worrisome to state government officials is a provision in Goodlatte’s bill that “would open up enormous opportunities for companies to restructure their operations to avoid taxation in states where they’re clearly taxable now,” said Michael Mazerov, a senior fellow at the Washington-based Center on Budget and Policy Priorities, a research group that advocates for the needs of low-income people.
For example, according to Mazerov, a bank wouldn’t be taxed on providing home loans in a state as long as it hired independent contractors to process mortgage applications.
Restaurant franchisors such as Pizza Hut or Dunkin’ Donuts Inc. wouldn’t be liable for state taxes because of language in the bill that exempts an intangible asset, such as a trademark, from triggering a state’s taxing authority, Mazerov said.
Multistate companies’ tax lawyers “would be derelict if they didn’t restructure to take advantage of this legislation,” said R. Bruce Johnson, a member of the Utah State Tax Commission, who testified against the bill on behalf of the Federation of Tax Administrators, a Washington-based research group serving state tax officials.
Three other House bills have been introduced that seek to limit states’ ability to tax rental cars, mobile phone service and video programming.
While businesses “are always lobbying to reduce their taxes,” this flurry of legislative activity is an effort to capitalize on favorable political conditions, said Richard Pomp, a law professor at the University of Connecticut and an expert on state taxation.
“In this anti-tax climate, I think the business community smells blood and sees a chance to mobilize,” Pomp said. “It’s coming at the worst possible time for the states.”
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