Uncertain state tax positions are everywhere. Your company or your clients likely have them. Have you identified them? Have you addressed them?
During ‘busy season’ or ‘tax season, state tax questions often arise or lay there quietly in the background while federal tax issues get all of the attention.
State tax issues or the state tax impact of an issue or transaction is generally considered after the federal tax impact is addressed.
Non-state tax experts are sometimes just too busy to give state tax issues adequate time before a deadline. In other situations, non-state tax experts may simply view a state tax issue as less complicated than it really is. Consequently, state tax issues may not get addressed before the original due date of the returns and may only get addressed in late summer or early fall prior to the extended due date. This often creates a time crunch for uncertain state tax positions to get adequately addressed. That's one of the problems.
The other problem is that most state tax issues are more complex than they appear. A high-level overview or two hours of research won't cut it, especially when you are trying to determine the state tax impact of a large transaction or adequately source the gain on a sale of a partnership interest to the right state or states.
What are these 'uncertain state tax positions'?
Where can they appear?
The following is a summary of some of the areas or items that create uncertain state tax positions on state income tax returns:
Structure - intangible holding companies; REIT / RIC; buy / sell companies, management / services companies; state-specific structures; captive insurance companies; finance companies; factoring companies; check-the-box entities; pass-through entities;
Transactions - mergers, acquisitions, divestitures; repatriation dividends; reorganizations; bankruptcy issues;
Nexus - P.L. 86-272; economic nexus; attribution of activities; forced combination; foreign company nexus despite no permanent establishment in U.S.;
Filing Options - separate, nexus combined, hybrid nexus combined, unitary combined (waters-edge, worldwide); consolidated;
Apportionment - ability to apportion income; choice of formula; throwback / throwout; joyce vs. finnegan; sales factor sourcing (destination, market-based sourcing, cost of performance, commercial domicile, location of payor);
Tax Base - business v.s nonbusiness income vs. separate accounting; Internal Revenue Code (IRC) conformity; related party addbacks; depreciation adjustments; dividends received deduction conformity; transfer pricing; foreign source income; state specific additions/subtractions;
Treatment of Partnerships - entity vs. aggregate theory; unitary (tax base / factor flow-up) vs non-unitary (allocation); sale of partnership interest;
Tax Attributes - NOLs (pre-apportioned vs. post-apportioned); IRC Sec. 382 limitations; survivor / non-survivor limitations; credits (claw-backs; compliance with agreements);
How do you ensure these items are addressed adequately?
Get a state tax expert involved early.
How do you know when your client has any of these issues?
Create a checklist that helps you identify clients or when your company may have these issues. That checklist may be based on the amount of sales a company has, the amount of taxable income, the number of states they file returns in (or the number of states they should file in), or if they have a specific structure or entered into a transaction that obviously needs reviewed.
There are multiple checklists you could create, the key is to make one that works for your company or firm that doesn't slow down the compliance process, but does allow you to reduce risk and adequately document a supportable, defendable or winnable position.
I hope you have a great tax season (now and in the fall). I hope all of your uncertain state tax positions achieve as much certainty as they can and are adequately addressed and documented.