Tag Archives: income tax

Market-Based Sourcing: One Size Does Not Fit All

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Three more jurisdictions have added their names to the growing list of states that are implementing market-based sourcing into their income tax rules. Effective for tax years beginning on or after January 1, 2016, Connecticut, Louisiana, and Tennessee will change their method of calculating the sales factor for sales of other than tangible personal property to a market-based rule from a cost-of-performance rule. Service providers will likely bear the brunt of this change.

Of course, when it comes to implementing market-based sourcing provisions, one size does not fit all. There are many variations of how states define a service providers market and a number of hierarchical step-down rules that are used when the general rule cannot be applied. For example, a state may define a taxpayer’s market as where the service is delivered, where the benefit of the service is received, or where the customer is located. These may be distinctions without a difference depending on a taxpayer’s particular facts. Tax practitioners could engage in lengthy debates regarding if and when these slight differences in the state market-based sourcing rules result in different outcomes for service providers.

However, it’s the differences clear as day, which should cause the most concern for taxpayers. For instance, many states have enacted market-based sourcing for one business entity type, but not for all. This is reflected in the most recent group of states: Connecticut, Louisiana, and Tennessee, who are moving to market-based sourcing. Louisiana’s legislation (H.B. 20) is specific to the corporate income and franchise tax. Thus, pass-through entities will still apply a rule that requires taxpayers to source revenue from services based on where they’re performed. Tennessee and Connecticut, on the other hand, made the change applicable to both its corporate and individual income and excise tax rules. Nonetheless Connecticut’s shift to market-based sourcing will take effect for tax year 2016 for corporate taxpayers, while the individual income law will not change until 2017.

Thus, taxpayers have to deal with states having different sourcing rules such as cost-of-performance v. market-based, as well as the variations from state-to-state within those different rules. Currently, a handful of states now have different sourcing rules for different types of taxpayers; New York, Pennsylvania, and Rhode Island have contradicting sourcing rules across different entity types. These states are also relative newcomers to market-based sourcing. There may be valid reasons for states limiting the application of market-based sourcing, and those reasons may vary from state-to-state. Regardless, as we move toward market-based sourcing as the majority rule in states with an income tax, taxpayers and practitioners alike should be mindful that the lack of uniformity in revenue sourcing arises on varying fronts.

If you have questions about your company’s revenue sourcing methodology, please contact Michael L. Colavito, Jr., JD, at 301.231.6200.

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Appeals Court Says Neigh; Reigns in Tax Court’s Horse Race Hobby Loss Ruling

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The Seventh Circuit Court of Appeals found a Tax Court ruling on a taxpayer’s horse racing business untenable. The Tax Court had ruled that, in essence, every business start-up is de facto a hobby until it shows profit.

Under IRC §183, an activity conducted by an individual or an S corporation that is not engaged in for-profit cannot deduct expenses in excess of revenues. Such businesses are deemed to be a hobby. The Code presumes that an activity is engaged in for profit when income exceeds expenses for at least 3 out of the past 5 years. In the case of horse racing (as well as breeding, showing, and training businesses), the measurement is 2 years out of the past 7 years. Failing this test presumes that the business is a hobby.

This does not mean that a business failing the above test is a hobby, case closed. Rather, the burden shifts to the taxpayer to prove that the activity is in fact a business and that a profit motive exists.

The case in question, Roberts v. Commissioner, involved a taxpayer who started a horse racing business. The business lost money from 2005 thru 2008, the years in dispute. The Appeals Court stated that though this activity can be presumably considered a hobby, the Court is nonetheless weighing the testimony of the business owner to decide if in fact the business is being operated with a profit motive or not.

In its biting commentary on the Tax Court’s ruling, the Appeals Court notes that just because a business may be fun, that aspect does not categorically turn it into a hobby, and that “suffering has never been made a prerequisite to deductibility.”

If you believe this situation applies to you, or have any questions or concerns, please contact Aronson’s tax controversy lead partner, Laurence C. Rubin, CPA at 301-231-6200.

 

 

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Are Taxes Dischargeable in Bankruptcy?

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Bankruptcy is often viewed as the option of last resort to resolve seemingly unsurmountable debts.  In working with clients owing large amounts of tax, we have found that their prevalent thought is that tax liabilities survive bankruptcy.  However, it is possible for taxes and the associated penalties and interest to be discharged, if the following three time periods are met:

  1. The taxes must become due at least three years prior to filing bankruptcy. “Become due” means the date on which the taxes were due on a timely filed return, or would have been due had the return been timely filed.  For individual taxpayers, the “become due” date is April 15 of the year following the tax year, or October 15 if an extension was filed.
  1. The income tax returns must have been filed at least two years prior to filing for bankruptcy. Thus, if a return was never filed, and the IRS computed the tax based on information available, this test is not met. When the IRS does the return, called a “substitute for return” that does not count as a filed return.  The IRS has authority to prepare such a return under IRC 6020(b). It is therefore paramount, regardless of your tax situation, to file all returns in a timely manner.
  1. The income tax must be assessed at least 240 days prior to bankruptcy filing. “Assessed” means the IRS has posted the tax liability due.  Normally the IRS posts the assessments using a date at or close to the date the return is filed.  But this is not always the case.

The first test is obvious on its face whether the tax in question passes it or not. The results of the remaining two tests can be ascertained by requesting a record of account from the IRS, which lists all activity for that particular tax year.  That transcript will show when the IRS says the return was filed and when the tax was assessed.

Bankruptcy is a very specialized area of law.  In conjunction with your tax advisor, a qualified bankruptcy attorney must be consulted.  To discuss your particular situation, or for any other matters, please contact Aronson’s tax controversy lead partner Laurence C. Rubin, CPA at 301-222-8212.

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The Sourcing Tail Wagging the Nexus Dog

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There is a growing list of states that have adopted a more aggressive income tax nexus standard.  On August 11, 2015, Alabama added itself to the group of states that impose their income tax on out-of-state businesses solely based those businesses a certain level of sales to customers in the state.  The trend is a natural response to the impact that technology has had on the ability of businesses to provide their services on a national (or even global) scale without having an expansive physical presence.

The legislation enacted in Alabama (H.B. 49), which will take effect for tax years beginning after December 31, 2014, is commonly known as a “factor presence” or “bright-line” nexus test.  Under Alabama’s the new nexus rule, a business organized outside the state will have an income tax filing obligation if:

  • Its in-state property exceeds $50,000;
  • Its in-state payroll exceeds $50,000; its in-state sales exceeds $500,000; or
  • 25 percent of its total property, payroll, or sales are attributed to Alabama.

In the last year, New York and Tennessee have also adopted similar nexus rules.  Other states that have a factor presence nexus rule for their income tax (or other business activity tax) include California, Colorado, Connecticut, Ohio, and Washington.

For years, state tax practitioners would typically advise their clients that they did not have an income tax filing obligation in a state unless they had a physical presence in the state.  Thus, the fact that a state applied a destination-based sourcing rule for sales of services was irrelevant because the business did not have the requisite nexus with the state to have a filing obligation.  Under a factor presence nexus rule, sourcing is front and center.  An out-of-state business will have a filing obligation in the state by merely making sales to customers in the state.  Service providers should pay close attention to this trend, as states that adopt a factor presence nexus rule typically change their rules to consider a sale of a service to be an in-state sale when the customer is located in the state.  Thus, the location from which the service is performed is largely irrelevant in determining if the business has a filing obligation in the state.  The result is that companies with very small physical footprints could have a much larger tax compliance footprint.

While the list of states imposing a more aggressive factor presence nexus rule is still relatively small, the fact that three states have enacted such a rule in the last year suggest that more will follow suit.  Service providers should know where their large customer bases are located, and monitor legislation in those states to ensure they are in compliance.

If you have concerns about whether your company is filing income tax returns in the appropriate states, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298.

If you are interested in learning more about how states are taxing the new economy, please register for our upcoming webinar on August 25th.

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#AskAronson: “How Much Do You Charge for a Tax Return?”

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AskAronsonThe answer, like many in the field of tax, is “it depends.” When it comes to tax preparation, there is no one price fits all solution. For many business returns, the largest cost drivers include the size of the entity, the number of states the business operates in, the number of partners the business has, and the complexity of the entity as a whole. Costs pertaining to individual or personal tax engagements are largely driven by the number of states in which the individual must file, as well as how many sources of income are reported, such as K-1 statements, capital gains, small business ownership income, sales of stocks and bonds (capital gain income), itemized deductions, etc.

Typically, in order to prepare a fee quote, we will review your prior year return(s) and the supporting documentation.  We may also request details around your current year actuals or projections, depending on how far into the year we are.

For more information about how much your tax returns may cost, please contact your Aronson tax advisor or Melissa Tarkett at 301.231.6200.

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