By Dennis Spinelli, CPA
Among the most challenging areas of taxation confronting banks today are the state tax ramifications resulting from the institution's business activities. With the prevalence of Internet-based activities, expansion of services offered by banks and extended geographic reach, the evaluation of state tax implications is much more complicated and requires greater analysis.
A key factor is the aggressiveness by many states to target out-of-state businesses for additional tax dollars. In addition to a significant amount of recent judicial activity, many states have enacted legislative changes that facilitate their efforts to obtain increased tax revenues. Stagnant economic conditions and state budgetary concerns will likely lead to a continuation of this trend. Moreover, for service-related businesses, and financial institutions in particular, the landscape has been rapidly evolving, and banks are grappling with a plethora of intricate state tax regulations that contain insufficient guidance and many inconsistencies.
Determining State "Nexus" for Taxation
There is a two-step process for evaluating the multistate tax ramifications that result from the activities of a financial institution. The first step is to identify if there is an obligation to file tax returns in a particular state. The rules governing this first step pertain to the concept of "nexus" which is defined as the level of business connection with a state that is sufficient enough for the state to subject the business to taxation.
While the guidelines regarding nexus differ somewhat from state to state, nexus exists if the bank has a meaningful "presence" in that state. Over the past two decades, there has been a prominent shift from the application of "physical nexus" as the general standard to "economic nexus" as the current prevailing standard. Physical nexus generally limited nexus to those businesses that had a physical office or employees located in a particular state. In contrast, economic nexus standards subject a business to taxation even without the existence of physical nexus (e.g., a defined minimum amount of customers located in the state or a minimum amount of revenue derived from customers in the state).
Out of State, but Not Out of Mind
Once nexus determination has been made, the second step is to quantify the appropriate amount of taxable income that the state is entitled to tax. This is done through a calculation referred to as "apportionment" which attempts to consider the magnitude of the business's activities in that particular state in comparison with the entity's activities everywhere. Many states have changed their apportionment formulas to place a greater emphasis on revenue (income) rather than other factors, such as property and payroll. In most cases, these changes result in a state imposing higher tax assessments on an out-of-state entity.
Does Your Bank Have State Tax Obligations Outside Your Home State?
Even without a physical presence, your institution may be subject to taxation in another state if there is a sufficient business connection (economic nexus) to that state. The tax rules governing banks are complex, constantly changing and vary widely from state to state. Therefore, it is increasingly important for you to work with your tax advisor to ensure compliance and minimize potential exposure.
To learn about our Tax Services, email WhatsYourRisk@pandgassociates.com or call 877-651-1700.
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