July 13, 2024

You’re the Boss: Battle Over State Tax Rules

The Agenda

How small-business issues are shaping politics and policy.

Are national corporations using state laws to shave millions of dollars off their tax bills — and gain an advantage over smaller rivals? That’s the claim some lawmakers and activists are making in statehouses around the country, and as states grapple with deep cuts in spending and seek new sources of revenue, it is putting big business on the defensive. This year, the fight moved to Rhode Island.

At issue was a measure proposed by Gov. Lincoln D. Chafee, an Independent, that would make it much harder for companies to move profits earned in Rhode Island to states with lower tax rates. Known as combined reporting, it requires companies to file state income taxes in the same manner they file federal taxes, accounting for profits and losses of affiliated companies, even those that may have no connection to Rhode Island, and increasing, proponents say, the amount of income subject to state taxes.

Since the 1990s, leading corporations have redoubled efforts to cut their state tax obligations, and total corporate tax revenue to the states has fallen both as a share of state revenue and of corporate profits.
In Rhode Island and 21 other states — half the states that tax corporate income — big businesses have been helped by rules that require companies doing business in the state to file tax returns that account only for their own operations and not those of sister companies. This system allows a company to pay expenses to a sister company in another state and then deduct those expenses from its revenue, resulting in less taxable income in Rhode Island. Of course, the affiliate reports more income, but if it is based in a state with lower taxes, the corporation saves money.

Several national retailers, for example, charge individual stores a licensing fee for company logos and other trademarks; the fees typically go to an affiliate in a state where income from intellectual property is not taxed at all, such as Delaware. Starting in the mid-1990s, Wal-Mart began paying rent on its stores to a real estate investment trust, a Delaware-based subsidiary, and was able to use a variety of rules to shelter that income from taxes in several states. Naturally, local stores competing with these national brands have no way to obtain similar tax savings.

In recent years several states, including Rhode Island, have closed off these avenues for shifting income to low-tax states, but according to Michael Mazerov, a senior fellow at the Center on Budget and Policy Priorities, a Washington policy research organization that focuses on tax and spending policies that affect low-income people, without combined reporting many more potential tax-sheltering opportunities remain available to national corporations. Under combined reporting, a member of a family of companies (or, legally, a “unitary corporation”) files a tax return that encompasses all of its affiliates, whether or not they have a physical presence in the state. The company then apportions a share of its total combined income to the state based on sales, or on a formula that takes into account sales, property and payroll.

Combined reporting has been standard practice in most western states for decades — California was the first to adopt it, in the 1930s. But in the last five years, as state budgets have been squeezed, the practice has migrated eastward, often propelled by organizations hoping to preserve spending on social services. Since 2006, six states have adopted variations on the rule, including Michigan, Wisconsin and Massachusetts, all of which made the switch in 2009. “Combined reporting is an essential tax policy for any state with a corporate income tax,” Mr. Mazerov told Rhode Island legislators at a hearing in April. “Rhode Island continues to suffer very serious erosion, year in and year out, of its corporate tax base because it’s not a combined reporting state.”

This spring, combined reporting came up for consideration in eight states, said Joseph Crosby, of the Council on State Taxation, which represents large corporations on state tax issues and opposes combined reporting. The Rhode Island version was part of an even more ambitious proposal to revamp business taxes. Under Governor Chafee’s plan, the state would use the additional revenue from combined reporting, which officials projected would be about $9 million in the first year, to reduce the state’s corporate tax rate — one of the highest in the nation — and to reduce the minimum corporate tax for the state’s smallest businesses.

Reliable estimates of how much money combined reporting can bring to state coffers are difficult to come by, since states that adopt it are reluctant to go to the trouble of comparing it to a system they no longer use, and year-to-year tax comparisons are always difficult. A report (pdf) produced for the National Conference for State Legislators used econometric modeling to show that it would be impossible to predict how much money — if any — combined reporting might raise. However, advocates point to a study by the state of Maryland, where lawmakers have flirted with combined reporting for several years. In 2007, the legislature required companies in the state to file both a standard separate-entity return and returns showing how much they would pay under various combined reporting regimes. For 2006 and 2007, combined reporting would have increased state revenues by 13 to 20 percent, depending on the version used. In 2008, when the economy plunged into recession, combined reporting would have brought in slightly less tax money.

In Rhode Island, as elsewhere, opponents seized on this volatility. (Ultimately, the Maryland Business Tax Reform Commission created to study combined reporting recommended the legislature there not adopt the system in 2011.) More to the point, the opponents argued that a new tax regimen would force corporations to look elsewhere when making new investments. At the April hearing, representatives from Amgen, a California-based pharmaceutical giant that has 1,500 employees in Rhode Island, told legislators that “combined reporting would create disincentives for future expansion and investment for Amgen in Rhode Island, dramatically increase our tax liability by unfairly subjecting income that is unrelated to our Rhode Island manufacturing activity to Rhode Island tax, and put our site at a competitive disadvantage with our other manufacturing locations throughout the United States and globally.” (A spokesman for Amgen declined to elaborate on its lobbying against the measure.)

“When the economy improves, and a company needs to put in a third shift at one of its facilities around the country, the question is, where are they going to do it?” said Mr. Crosby, of the Council on State Taxation. “Taxes matter exactly as much as any other expense.”

Moreover, proponents had a difficult time articulating how the current rules that shelter big-business income disadvantage small businesses. At the hearing, a Republican skeptic noted that, apart from one small-business owner, “I have not heard any testimony this afternoon from anybody representing smaller companies that are sharing that complaint or that concern that things are not equal.”

In the end, Democratic lawmakers, who control both chambers of the Rhode Island General Assembly, declined to make any of the changes to the corporate tax code that Governor Chafee proposed. Instead of adopting combined reporting, the legislature decided to follow Maryland’s example and study it. For two years, companies will file both a standard separate tax return and a return showing how much they would owe under combined reporting. Then state officials will spend a year analyzing the data. Last Wednesday, the Rhode Island Senate approved the House budget by a wide margin. Governor Chafee signed the legislation last Thursday.

“There wasn’t enough information, and there was conflicting data, so this will allow us to collect enough data to gauge the effect of implementing combined reporting,” said Larry Berman, spokesman for House Speaker Gordon Fox.

Representative Teresa Tanzi, the most vocal advocate for combined reporting — she proposed her own version in a stand-alone bill — acknowledged that legislators didn’t have much to go on. “Amgen came up to me and said they alone would pay more to the state of Rhode Island than the state’s entire projection of how much combined reporting would bring in,” she said. Ms. Tanzi believed that ultimately the study would help her cause: “They really, truly are doing a full study of this and making an informed decision.”

In the meantime, Ms. Tanzi said, supporters of combined reporting would have to devote more effort to organizing small businesses behind the bill. “The one thing that was lacking in this was the voice of small business,” she said. “And we can say over and over that small business will be affected by this, but until they actually hear from small-business people, they won’t take it seriously. We have to now spend the next three years developing leaders among our small businesses who will come forth and talk about the impact that this has on their businesses.”

Article source: http://feeds.nytimes.com/click.phdo?i=d59933e0c80820226131a533a649dcf6

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