1. You represent City A, Ohio. City A levies a city income tax on residents of City A at the rate of 2%. Under City A’s income tax code, City A residents are taxed at the rate of 2% on all of their income wherever earned (i.e., whether earned in City A or outside of City A). Nonresidents that work in City A are taxed on 2% of their income that is earned within City A. Under City A’s income tax code, residents that earn income outside of City A are permitted an income tax credit for income taxes paid to another city up to 1% of the Taxpayer’s income (i.e., up to 50% of the income taxes owed to City A). City’s A income tax is levied and administered by City A, such tax is collected by City A, and the tax revenues from such tax are used to benefit City A.
A resident of City A, Ohio (“Mr. Taxpayer”) has notified that the Tax Commissioner that he believes that the City’s taxing statute is unconstitutional because it does not permit a full credit for income taxes paid to other cities (i.e., up to the 2% tax rate). Mr. Taxpayer works in City B, Ohio and is subject to city income tax imposed on nonresidents in City B, Ohio at a rate of 2%. Thus, Mr. Taxpayer pays a city income tax in City B, Ohio at a 2% rate and city income tax in City A, Ohio at a rate of 1% (for a total tax rate of 3%). Mr. Taxpayer believes that he should receive a full credit in City A (up to the 2% rate) for income taxes paid to other cities (rather than only up to 1%).
City A, Ohio has asked you whether its tax code is unconstitutional under the U.S. Constitution (ignore any State constitutional arguments) because City’s A code does not offer a full income tax credit for residents that pay income taxes to other cities. Provide your response. If the answer is not clear, be sure to address both sides of the argument.
2. You are the tax advisor for a furniture manufacturing company (the “Company”). The Company is domiciled and headquartered in State A. All of the Company’s manufacturing is conducted in State A. The Company does not have any physical presence (personnel, warehouses, manufacturing operations, or offices) in any state other than State A. Due the size of the furniture and the cost to ship, the Company does not ship any furniture. Rather, furniture retailers from all over the United States send carriers to pick up the furniture at the Company’s warehouse in State A. The Company’s #1 retailer is Frank’s Furniture. 50% of the Company’s annal sales of approximately $100 million are to Frank’s Furniture ($50 million annually). Frank’s Furniture is the #1 retailer of furniture in the United States and has retail stores in all 50 states. Frank’s Furniture has 1 distribution center in the United States, in State B, where all the furniture it purchases from all retailers, including the Company, are delivered before the furniture is shipped off to Frank’s Furniture’s retail stores throughout the United States, including those in State B.
State B has enacted a gross receipts tax. Under State B’s gross receipts tax, if a company has more than $100,000 in sales in State B in a particular year, such company is subject to State B’s gross receipts tax. State B has audited the Company and is asserting that all of the Company’s sales to Frank Furniture ($50 million annually) are subject to State B’s gross receipts tax.
The Company has asked you to provide advice as to whether the Company has nexus in State B and whether it is subject to State B’s gross receipts tax on its $50 million in sales to Frank’s Furniture? What arguments would you make on the Company’s behalf that it does not have nexus with State B, if any? Address any weaknesses in such arguments and any counter-arguments that State B may raise to such arguments and the potential strength of such counter-arguments. Is there anything the Company could do to strengthen its position?
3. You are the tax advisor to a company (the “Company”) that had $1,000 in apportionable business income for tax year 2019. The Company did business in 4 states in 2019 and had nexus in each of the 4 states. The breakdown of its property, payroll and sales factors in each state is set forth below. Each State’s tax rate is set forth in the last column.
Payroll
Property
Sales
2019 Tax Rate
State A
100
100
600
50%
State B
100
100
300
50%
State C
200
200
100
40%
State D
600
600
0
30%
Total
1000
1000
1000
State A uses a single-sales factor formula. State B uses the three-factor formula, but it triple-weights the sales factor. State C uses the three-factor formula, but it double-weights the sales factor. State D uses the traditional three-factor formula (property, payroll and sales) and weights each factor equally. Assume that no factors are thrown-out, even if zero.
1. Calculate the taxes owed by the Company in each state for the 2019 tax year and the total taxes owed by the Company for the year.
2. Would the total 2019 taxes owed by the Company be higher or lower if each of the States used the traditional three-factor formula (with each factor equally weighted) and why? (You are not required to calculate the exact taxes on this question, but you may).
3. If the Company were able to show using separate accounting that only $300 of its income for the tax year should be apportioned to State A (which would result in $150 taxes owed for 2019), would this prove that State A’s apportionment calculation was unconstitutional when applied to the taxpayer? Is State A’s use of a single-sales factor formula unconstitutional?
4. Ali Jones is a new client at your firm. Ali owns a majority interest in an appliance manufacturing company, “Ali’s Appliances.” Ali owns 51% of Ali’s Appliances. Ali’s Appliances has manufacturing operations in State A and State B and makes substantial sales every year in State A, State B, State C, and State D. Ali owns a house in State A and State B. Ali has approached your firm and says that she is going to be selling the business, Ali’s Appliances, for $50 million. The other owners of Ali’s Appliances (each owning a 1% interest) have agreed to sell the business as well. Ali says she has knows the federal tax stuff, but needs advice on the state tax considerations of the sale of the business.
In order to asses the state tax issues, what questions do you ask Ali? What additional information do you need about Ali and Ali’s Appliances? What would you research about State A, State B, State C, and State D? Ali also asks whether it matters whether she sells her ownership interest in the business or all of the assets of the business from a state tax standpoint. Does it? Initially, what advice would you provide to Ali with respect to the state tax consequences?
5. Ali Jones is a new client at your firm. Ali owns a majority interest in an appliance manufacturing company, “Ali’s Appliances.” Ali owns 51% of Ali’s Appliances. Ali’s Appliances has manufacturing operations in State A and State B and makes substantial sales every year in State A, State B, State C, and State D. Ali owns a house in State A and State B. Ali has approached your firm and says that she is going to be selling the business, Ali’s Appliances, for $50 million. The other owners of Ali’s Appliances (each owning a 1% interest) have agreed to sell the business as well. Ali says she has knows the federal tax stuff, but needs advice on the state tax considerations of the sale of the business.
In order to asses the state tax issues, what questions do you ask Ali? What additional information do you need about Ali and Ali’s Appliances? What would you research about State A, State B, State C, and State D? Ali also asks whether it matters whether she sells her ownership interest in the business or all of the assets of the business from a state tax standpoint. Does it? Initially, what advice would you provide to Ali with respect to the state tax consequences?
6. You are the tax advisor for a company (the “Company”) that sells pre-made pizzas that customers take home to bake. The Company pre-makes the pizzas by making the dough and adding sauce and various toppings to the pizzas. However, customers must bake the pizzas at home before consuming. State A imposes a sales tax on “Prepared food,” but does not impose a sales tax if the food does not satisfy the definition of “Prepared food.” The Company does not provide any utensils with the pizzas. The Streamlined Sales and Use Tax Agreement (which has been adopted in State A) provides the following definition of “Prepared food”:
“‘Prepared food’ means:
A. Food sold in a heated state or heated by the seller;
B. Two or more food ingredients mixed or combined by the seller for sale as a single item; or
C. Food sold with eating utensils provided by the seller, including plates, knives, forks, spoons, glasses, cups, napkins, or straws.
A plate does not include a container or packaging used to transport the food.”
(Streamlined Sales and Use Tax Agreement, Appendix C, Part II).
Please provide an explanation to the Company on how you recommend that the Company proceed on this issue. If you had to amend this provision to clearly exempt the pizzas from the definition of “Prepared food,” how would you amend this provision? Provide the language that you would recommend to amend to the statute.
