Indiana Releases Combined Reporting and Transfer Pricing Studies

Indiana has released two separate studies, one on combined reporting and one on transfer pricing. The studies were a requirement of SB 323 that was amended on January 28, 2016 to study combined reporting instead of adopt combined reporting, as I reported earlier. 

Combined Reporting

The combined reporting study discusses all of the reasons why states adopt combined reporting - to stop base erosion from taxpayers using intellectual property holding companies, captive real estate investment trusts, captive insurance subsidiaries and overseas management affiliates, etc. However, the study also explains that combined reporting creates new problems that separate reporting states do not have to deal with, such as determining the unitary group, and additional administrative burdens during the transition to combined reporting. 

The study also asserts that the impact of combined reporting on state revenues is mixed, according to evidence from other states. Similar to most state tax laws, implementing combined reporting would provide additional revenue from some taxpayers and less revenue from other taxpayers. Consequently, the question remains as to what the overall revenue impact would be. The study suggests combined reporting would increase revenue in the short term, but be neutral in the long term.

Regardless of the revenue impact, the study confirmed that separate reporting does allow taxpayers with more opportunity to create favorable business structures and utilize intercompany transactions to shift income from affiliates based in high-tax states. Despite this fact, the study appears to be leaning towards a recommendation to not enact combined reporting.

Transfer Pricing

The transfer pricing study is a great report to review if you want to learn more about transfer pricing. The conclusion of the report explains the realities of related party transactions that exist due to complex business structures dominated by parent companies with affiliates in multiple states and countries. As a result, scrutinizing intercompany transactions is a necessity.

The study confirms that transfer pricing examinations and analysis are complex and expensive, and asserts that if a transfer pricing study is not conducted in an efficient and effective manner, it could be detrimental to the taxpayer. To reduce the amount of disputed transactions, Indiana requires the addback of deductions taken for royalties, intangible related-party expenses and intercompany interest. However, other states currently have broader addback provisions or have enacted combined reporting.

So What?

Indiana has had many cases and rulings that reflect the complexities and burdens of analyzing and resolving the proper treatment of intercompany transactions and transfer pricing studies. Consequently, Indiana and taxpayers have spent resources (time and money), which both the state and taxpayers do not have, to resolve these matters. Hence, in my opinion, Indiana should adopt combined reporting to reduce the amount of disputes involving intercompany transactions and transfer pricing studies. The whole question of whether an intercompany transaction is at arms-length doesn't matter when intercompany transactions are eliminated in a combined return. Albeit, there may be some entities that are not a part of the group and the issue could still occur. In addition, combined reporting will create new issues to deal with, such as what entities are part of the unitary group. However, I believe it is less of a burden for states and taxpayers to manage the issues related to combined reporting versus the issues related to transfer pricing studies and analyzing related party transactions.

Transfer Pricing, Treasures in the Attic and Using Social Media

Next week I will be attending the Paul J. Hartman State and Local Tax Forum in Nashville. A few of the sessions on Tuesday that I am extremely interested in are:

1. Transfer Pricing - MTC - ALAS program by Carley Roberts and Marshall Stranburg. The MTC program has been struggling to gain traction among the states. With all of the other activity around transfer pricing (i.e., BEPS, IRC Sec. 385 regulations, etc.), I wonder if traction will be found or will states remain in pause mode waiting for the dust to settle from other initiatives? For more info, check out my previous post - State Tax Transfer Pricing - What's Next?
2. Treasures in the Attic - Tried and True Legal Principles in SALT by Janette Lohman and Brian Kirkell. This should be a good session to refresh our knowledge of principles that we can use to help clients avoid and resolve controversy. If this interests you, you may like my previous post - Should the Federal Government Pre-empt A State's Taxing Power?
3. Ethics and Social Media for Tax Professionals by Brett Carter, Mark Holcomb and Glenn McCoy. I have a personal interest in this session as I have used social media for the last 8 years. Personally, social media has been a great tool to meet new people all over the country and help more companies, firms, publishers and policy organizations. If you haven't read it, here is a link to an interview I did for Bloomberg BNA about blogging.  For more history on my blogging adventure, check out this post.

Other sites I have used as a resource during my blogging years are:

Real Lawyers Have Blogs

Lawyerist

The Greatest American Lawyer

Amazing Firms, Amazing Practices

In Search of Perfect Client Service

Cordell Parvin Blog

Seth Godin Blog    

Adrian Dayton

*Please note that I am not an attorney, just so happens that most of the resources or people blogging when I started in 2009 were lawyers, not accountants.

Nonresident Withholding 'Nightmare'

In a prior life, I worked in a tax department where we managed the filing of multistate income tax returns and the flood of notices received for over 500 pass-through entities. The group of entities included multi-tiered partnerships, limited liability companies with single-member limited liability companies and S corporations with Q-subs. Consequently, nonresident withholding was a major issue for us and the state tax departments with which returns were filed.

If you or your client operates within a pass-through entity such as a S corporation, partnership or limited liability company, then you know what nonresident withholding is.

In basic terms, nonresident withholding is when a state requires a pass-through entity to withhold state income tax (or make a state tax payment) on a nonresident shareholder's pro rata share of the pass-through entity's income sourced to the specific state. In other words, it is a mechanism for states to better ensure that state tax will be paid by nonresident shareholders.

Now, if you or your client operates within a multi-tiered structure of pass-through entities, then nonresident withholding can become a compliance nightmare for both you and state taxing authorities. Most states have difficulty tracking nonresident withholding when it passes through multiple layers before it gets to the ultimate taxpayer. Therefore, state tax notices upon state tax notices can become an unwelcome, but familiar friend.

With that said, here are a few tips or questions to ask when dealing with nonresident withholding in multi-tiered structures:

1. Does the state require quarterly nonresident withholding on actual payments/distributions or on allocated income? To put it simply, some states only require quarterly nonresident withholding if a cash payment is actually made to a shareholder. If states don't require quarterly nonresident withholding, most, if not all states require annual nonresident withholding on "allocated income" whether a distribution is actually paid or not.
2. Is nonresident withholding required to be done for all nonresident shareholders regardless of the type of shareholder? Meaning, is withholding required for C corp, S corp, partnership, LLCs, individual and/or trust shareholders?
3. Does the state allow or have a mechanism for nonresident shareholders to obtain a waiver or exemption from nonresident withholding? Meaning, can a nonresident shareholder provide the pass-through entity or the state with a document to keep the pass-through entity from withholding on its share of the state's source income?
4. Is the nonresident withholding required to be done on a quarterly basis? Or can it be paid one time a year?
5. In a multi-tiered pass-through entity structure, at what level is nonresident withholding required to be done? Meaning, is the lowest entity required to do the withholding or does the state only require the entity before the ultimate taxpayer to do the withholding? This is a key question, because if it is done at the wrong level, it can cause great confusion and an explosion of notices between the state and the taxpayer.

Some of the top problem states when dealing with nonresident withholding are: California, Colorado, Indiana, and Iowa. Kansas used to be a pain, but withholding is no longer required after July 1, 2014.  These are just a few. As I stated earlier, in a multi-tiered structure, nonresident withholding is a tracking 'nightmare' for both the taxpayer and the state. Obviously, it requires meticulous record keeping to get it right.

The 'Most Significant State Tax Policy Issues'

David Brunori will be in Las Vegas this week speaking at the Council On State Taxation annual meeting (Friday morning) with Doug Lindholm, Helen Hecht, and Richard Pomp. They are leading a debate/discussion on the most significant issues in state tax policy. I can't be there, but thought I would give my two cents. 

I think some of the most significant state tax policy issues are:

• the imposition of sales tax collection obligations on remote retailers;
• expanding the sales tax base to services;
• whether states should ramp-up transfer pricing training/positions or join the MTC ALAS program;
• whether states should adopt tax haven legislation which allows them to cherry-pick the taxation of foreign income or simply adopt mandatory worldwide combined reporting;
• whether states should continue to enact unconstitutional legislation forcing taxpayers to go to court;
• whether states should continue to enact retroactive legislation;
• whether states should continue to enact legislation that benefits in-state taxpayers vs. out-of-state taxpayers (i.e., market-based sourcing, single-sales factor apportionment, credits and incentives).

What do you think are the most significant issues in state tax policy?

STATE TAX PRACTICES: WHAT PEOPLE THINK BUT DO NOT SAY

(Note: I wrote this blog post originally in 2014, but unfortunately, it still applies today. It has also been one of my most popular posts.)

Did you ever see the movie, "Jerry Maguire"? In the beginning of the movie, Tom Cruise (as Jerry Maguire) has a breakdown or "break-through" as he called it. He had been working for a large sports agent firm and had grown tired of the profession, the way he treated clients, the focus on money, etc. Hence, he woke up in the middle of the night and wrote a several page "mission statement." The mission statement described how the firm should change everything - how it should change its focus from solely making money and treat clients like people, develop true relationships and actually care. 

The mission statement was called, "What People Think, But Do Not Say."

I have worked in the state tax profession for 20+ years and most of that time I have been a state and local tax consultant. I worked in industry at some large Fortune 500 companies and several accounting firms (large and small). Based on my experience and from talking to my SALT colleagues at other firms, some disturbing trends exist in our profession:

1. SALT consultants tend to move from firm to firm at a high rate, with the average length of time at one firm being 2 years.
2. Accounting firms that hire SALT consultants to build SALT practices don't always know what that actually means; they don't know what it actually looks like for their size firm (or office) and target market.  They just know they want to build one.
3. SALT consultants often struggle in getting the tax and audit folks to invite them to client meetings and pull them into projects earlier rather than later.
4. Most tax and audit folks are often used to doing things themselves - hence, their first inclination is to use SALT consultants on an as needed basis or as a "help-desk." I get it. I am a "do it yourself" kind of guy as well. Often times, it is a cost/benefit or materiality issue. I understand.
5. SALT consultants struggle with their billable time getting written off by tax or audit partners because SALT consultants are often not in control of the billing process on engagements which were obtained or started by non-SALT folks.
6. Most firms recognize SALT is a growing area and need/want a SALT resource to grow their firm; however, most firms may not be able to support or sustain a full-time SALT group.

The trends listed above do not apply to every firm. Some SALT consultants have had long careers at one firm. This is especially common in larger firms. The trends described are just a product of reality - or economic pressures on the firm or the partners themselves. Everyone is just trying to meet their goals in the best way they can. With that said, it is also a fact that so many SALT practices suffer from these trends. Hence, the question is - is there a cure? 

You have probably heard the saying - "don't keep doing the same things and expect a different result."  Well, I very much agree with that statement in this area.  I am passionate about changing these trends - in helping SALT consultants get off of the "merry-go-round." 

These trends can be overcome by building strong relationships with partners, positioning the SALT practice effectively within the firm and/or office, marketing the SALT practice effectively in the marketplace and focusing on your highest and best use - the actions that will produce the most effective results. 

Another solution for firms would be to outsource their SALT function - this would allow the firm to have access to SALT resources they need, when they need it, without having to invest a great deal upfront or year after year.

What do you think?  Have you suffered from these trends?  What solutions can you think of?

CONNECT AND BUILD COMMUNITY

Join with me in building a state tax community that builds real relationships and works together to help each other resolve complex state tax problems, influence state tax policy and further our careers and profession. 

Be a Control FREAK! and Are You Attending the Paul J. Hartman SALT Forum THIS MONTH?

I am a control freak. I hate problems, but what I hate even more - are problems that could have been avoided or problems caused by unintended consequences. Life is uncertain. Thus, it is important for us to embrace uncertainty if we are going to be happy on a daily basis. We must learn to let go. However, in regards to state taxes, embracing uncertainty can cause unintended consequences and problems that could have been avoided. Consequently, we need to be a control freak when it comes to state taxes. We must use our power for good.

If you are going to the Paul J. Hartman State and Local Tax Forum in Nashville on October 25-27, 2016, please comment or e-mail me at strahle@leveragesalt.com. I would love to meet you and talk shop.