Business taxes don’t often make headlines, but they did in 2014 when an unexpected shortfall in franchise and excise taxes prompted the state to call for deeper budget cuts.
By the end of the state’s fiscal year last summer, franchise and excise taxes were $280 million below budgeted estimates.
So if you operate a business in Tennessee, should you be concerned? Will tax revenue become a serious conversation among state leaders in the next legislative session? What could that mean to your business? And what should you watch for?
First, we should recognize that no one has identified with certainty what caused such a large unanticipated shortfall. Several explanations have been considered. Some say it was cyclical, or related to a blip in the economy, or maybe due to businesses taking advantage of tax planning strategies.
Perhaps the problem is in how the state counts its estimated payments. Or another idea that received a lot of attention is the move of a pharmaceutical distribution center from Memphis to Mississippi. No one knows how much this contributed to the budget shortfall, but some estimates put the number at $100 million.
Or is it a structural problem? Businesses have changed, but our tax laws have not changed with them.
We do a lot of work with multi-state businesses, so we see what has happened in other states that have changed their business tax laws to get more revenue. Many have begun to aggressively change their taxing structure to go after out-of-state businesses for more tax revenue.
For example, California adopted “economic nexus” in 2011, which requires businesses with $500,000 in sales in its state to file an income return regardless of whether the business has a physical presence in California. Other states with the same requirement are Washington, Colorado, Connecticut, Michigan and Ohio — and next year, New York. Tennessee, on the other hand, has been committed to requiring a physical presence in the state before requiring a tax return.
Twenty-nine states require affiliated businesses to file a combined report, including Texas, California and New York beginning in 2015. The purpose is to reduce the ability of companies to lower their tax bill by moving their income among their affiliates in various states.
Eighteen states have changed to a “single sales factor,” which apportions your total income based on the sales percentage in their state. The “single sales” factor excludes property and payroll in figuring the apportionment ratio, thereby raising tax liabilities of out-of-state businesses.
Eighteen states have adopted “market-based sourcing” of service revenue. If you are a service-based business, taxing occurs based on where your customer is located. Alabama, Georgia and California have recently adopted market-based sourcing. New York starts this in 2015.
The trends to raise more revenue have followed multiple paths and some have been challenged in court. But the efforts to put more burden on out-of-state business appears to be more palatable for politicians because it reduces pressure to raise taxes on local businesses.
Brian McCuller is a partner at LBMC Audit, Tax, & Advisory, the largest regional accounting and financial services family of companies based in Tennessee. Contact him at 615-690-1971 or firstname.lastname@example.org.