Chapter 24 Multistate Corporate Taxation Solutions to Problem by ldv16877

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                                                                    CHAPTER 15

                                                  MULTISTATE CORPORATE TAXATION

                                                 SOLUTIONS TO PROBLEM MATERIALS




                                                                                   Status:    Q/P in
                  Question/                                                        Present     Prior
                  Problem                                         Topic            Edition    Edition

                       1               State tax policy                           Unchanged      1
                       2               Multistate tax incentives                  New
                       3               UDITPA                                     New
                       4               Multistate Tax Commission                  New
                       5               States’ jurisdiction to tax; nexus         Unchanged      5
                       6               Immune sales under P.L. 86-272             Unchanged      6
                       7               P.L. 86-272 solicitation standards         Unchanged      7
                       8               Apportionment and allocation of income     Unchanged      8
                       9               Appointment formula weights                Unchanged      9
                      10               Sales factor                               Unchanged     10
                      11               Throwback rule for sales factor            Unchanged     11
                      12               Unitary theory                             Unchanged     12
                      13               State taxation of S corporations           Unchanged     13
                      14               State S corporation compliance             Unchanged     14
                      15               Out-of-state S shareholders                Unchanged     15
                      16               Composite S corporation filing             Unchanged     16
                      17               Partnerships and LLCs                      Unchanged     17
                      18               Sales and use tax payments                 Unchanged     18
                      19               Sales/use tax incidence                    Unchanged     19
                      20               Sales/use tax exemptions                   Unchanged     20
                      21               Occasional sale exemption                  Unchanged     21
                      22               Streamlined Sales Tax Project              Modified      22
                      23               Planning with nexus rules                  Unchanged     23
                      24               Passive investment subsidiary              Unchanged     24
                      25               Multistate tax planning                    New
                      26               Capital stock tax planning                 New
                      27               State/Federal tax law overlap              New
                     *28               State income tax formula                   Unchanged     28
                      29               State income tax formula                   Unchanged     29
                     *30               Addition and subtraction modifications     Unchanged     30
                     *31               Addition and subtraction modifications     Modified      31
                     *32               Addition and subtraction modifications     Modified      32

                                                                          15-1
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                 15-2                          2007 Corporations Volume/Solutions Manual


                                                                                                Status:      Q/P in
                  Question/                                                                     Present       Prior
                  Problem                                         Topic                         Edition      Edition

                      33               Apportionment formulas                                 Unchanged        33
                      34               Apportionment and allocation                           Unchanged        34
                     *35               Apportionment formulas                                 Unchanged        35
                     *36               Apportionment formulas                                 Unchanged        36
                      37               Apportionment formulas                                 Unchanged        37
                      38               Apportionment formulas                                 Modified         38
                     *39               Sales factor                                           Modified         39
                      40               Throwback rule                                         Modified         40
                      41               Payroll factor                                         Unchanged        41
                      42               Payroll factor                                         Unchanged        42
                      43               Payroll factor                                         Unchanged        43
                      44               Property factor                                        Unchanged        44
                      45               Property factor                                        Unchanged        45
                      46               Property factor                                        Unchanged        46
                      47               Unitary business, apportionment factors                Unchanged        47
                     *48               Water’s edge election                                  Unchanged        48
                      49               Multistate S corporations, apportionment               Unchanged        49
                                         formula
                      50               Sales tax base                                         Unchanged        50
                     *51               Sales and use taxes                                    Unchanged        51
                      52               Sales tax exemptions                                   Unchanged        52
                     *53               Franchise tax                                          Unchanged        53
                      54               Apportionment planning                                 Unchanged        54
                      55               Apportionment planning                                 Unchanged        55

                  Research
                  Problem

                        1             Internet activity                                       Unchanged        1
                        2             Internet activity                                       Modified         2
                        3             Internet activity                                       Unchanged        3
                        4             Internet activity                                       Unchanged        4
                        5             Internet activity                                       Unchanged        5

                                      *The solution to this problem is available on a transparency master.
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                                                        Multistate Corporate Taxation                             15-3


                                                                  CHECK FIGURES

                 28.         Apportionable income $32,000; tax           39.      B $553,000.
                             after credits $436.                         40.      E 79.38%.
                 29.a.       $1,500,000.                                 41.      G 21.05%; H 57.14%; I 36.84%.
                 30.a.       A; $10,000.                                 42.      $190,000 to U.
                 30.d.       S; $3,000.                                  43.      G 68.49%; H 30.10%.
                 30.e.       N.                                          44.      A 63.01%; B 36.99%.
                 30.f.       S; $5,000.                                  45.      B 34.70%.
                 30.i.       N.                                          46.      Annual method, 38.6% property
                 30.j.       Varies.                                              factor.
                 31.         $332,000.                                   47.a.    $49,648.
                 32.a.       $170,000.                                   47.b.    $110,000.
                 32.b.       $450,000.                                   48.      B 40.00%; Q 77.78%.
                 32.c.       $515,000.                                   49.      $0 Y; $173,167 Z.
                 33.         D $739,800; E $1,592,000.                   51.a.    $3,600.
                 34.         E $1,760,200.                               51.b.    $294,000.
                 35.         72.39%; 20.00%.                             52.a.    S.
                 36.         A 80.0%; B 20.5%.                           52.d.    N.
                 37.         A 79.63%; B 23.50%.                         53.      $7,313.
                 38.a.       $321,280.                                   54.      Factor drops to 69.7%.
                 38.c.       $240,000.
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                 15-4                          2007 Corporations Volume/Solutions Manual


                 DISCUSSION QUESTIONS

                  1.      Nontax factors dominate most business relocation decisions. However, a combination of
                          some of the following incentives might also force the consideration of a tax-motivated
                          expansion or relocation.

                          l     Economic development incentives.

                          l     Sales and use tax exemptions reducing a customer’s acquisition price.

                          l     Use of technology to transfer sales and purchase orders, pricing information, and
                                other data.

                          l     Ease in complying with multiple jurisdictions’ tax rules.

                          l     ‘‘Exporting’’ of local taxes to visitors and outsiders.

                          l     Sophistication and effort of jurisdictional enforcement measures.

                          pp. 15-2 and 15-3

                  2.      The vast majority of states start with Federal taxable income in deriving their own tax base.
                          p. 15-4

                  3.      The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to
                          the assignment of income among the states for corporations that maintain operations in
                          more than one state. Many states have adopted the provisions of UDITPA, either by joining
                          the Multistate Tax Commission or by modelling their laws after UDITPA provisions. p. 15-8

                  4.      The Multistate Tax Commission (MTC) writes regulations and other rules to interpret
                          UDITPA. When a new MTC rule or regulation is created, member states propose its
                          adoption to their respective legislatures. The majority of member states adopt the
                          regulations with no exceptions or only minor changes.

                          In addition, many of the states that are not MTC members model their laws after UDITPA
                          and MTC regulations. Thus, MTC pronouncements carry great weight in the multistate tax
                          system.

                          p. 15-8

                  5.      a.        The state in which a business is incorporated has the jurisdiction to tax the income
                                    of the corporation, regardless of the volume of its business activities within the
                                    state.

                          b.        If a corporation is to be subject to tax in a state other than that of its incorporation,
                                    the former jurisdiction must show that sufficient contact with that state (nexus) has
                                    been established. Typically, sufficient nexus exists when a corporation derives
                                    income from sources within the state, owns or leases property in the state, employs
                                    personnel in the state, or has physical or financial capital there.

                          c.        A state cannot tax the out-of-state activities of an out-of-state corporation.

                          p. 15-8
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                                                        Multistate Corporate Taxation                                 15-5


                  6.      No Colorado tax applies. Public Law 86-272 limits the states’ right to impose an income tax
                          on interstate activities. This Federal law prohibits a state from taxing a business whose only
                          connection with the state is to solicit orders for sales of tangible personal property, when the
                          orders then are approved or rejected, filled, and shipped from outside the state.

                          Only the sale of tangible personal property is immune from taxation under P.L. 86-272,
                          however. Leases, rentals, and other dispositions of tangible personal property are not
                          immune activities. Moreover, dispositions of real estate and intangible assets, as well as
                          sales of services, are not protected activities.

                          p. 15-9

                  7.      No Colorado tax applies. Public Law 86-272 does not define the term solicitation, but the
                          Supreme Court in Wrigley held that order solicitation includes any explicit verbal request
                          for orders and any speech or conduct that implicitly invites an order. A de minimis rule also
                          may allow a transaction to stay immune under the statute.

                          Carrying out any of the following (common but substantively) minimal acts within a state,
                          though, in addition to the traditional sales-solicitation tasks of a sales force, could establish
                          nexus through non-immune sales.

                          l     Collecting delinquent accounts; investigating creditworthiness.

                          l     Repairing or maintaining company products (even if performed at no charge to the
                                customer).

                          l     Approving or accepting orders.

                          Exhibit 15-2

                  8.      A business that carries out transactions in more than one state must divide such resulting
                          income among the states for tax purposes. Generally, this includes both an apportionment
                          and an allocation of such income.

                          Apportionment is a means by which business income is assigned to specific states by a for-
                          mula method. The formula usually takes into account the gross receipts, property, and
                          compensation levels generated within each state, although the states vary in the weighting
                          of the factors for this purpose. Allocation is a procedure by which nonbusiness income is
                          assigned directly to the state(s) in which it is generated. For instance, a manufacturing firm
                          with some rental income would allocate the net rental profit or loss to the state in which the
                          rental property is located.

                          Several states fail to distinguish between business and nonbusiness income, apportioning
                          all of the taxpayer’s income among the states.

                          p. 15-9 and Figure 15-1

                  9.      A single-factor apportionment formula consisting solely of a sales factor tends to create
                          greater levels of apportionable income for the state from nonresident (meaning also
                          nonvoting) entities than an apportionment formula that double weights the sales factor. Most
                          states now over-weight the sales factor for this reason. p. 15-14 and Example 11

                 10.      In determining the numerator of the sales factor, most states follow UDITPA’s ‘‘ultimate
                          destination concept,’’ whereunder sales of tangible personal property are assumed to take
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                 15-6                          2007 Corporations Volume/Solutions Manual


                          place at the point of delivery, as opposed to the location at which the shipment originates.
                          Example 12

                 11.      The solution depends upon whether Arizona applies a throwback rule in its sales factor.

                          The throwback rule is an exception to the destination concept. It provides that, when a
                          corporation is not subject to tax in the destination state or the purchaser is the U.S. govern-
                          ment, the sales are treated as in-state sales of the origination state, and the actual destina-
                          tion of the product is disregarded.

                          Consequently, when the seller is immune from tax in the destination state, the sales are
                          considered to be in-state sales of the origination state if that state has a throwback provi-
                          sion. The throwback rule was established as an attempt to ensure that none of a corpora-
                          tion’s sales escaped taxation. (Arizona has adopted such a throwback rule.)

                          Example 13

                 12.      The unitary approach to state taxation attempts to neutralize taxpayer attempts to place
                          profitable operations in low- or no-tax jurisdictions. Whether the unitary rules apply often turns
                          on subjective assessments as to the structure and operations of the business. This is unlike
                          the application of the controlled and affiliated group rules, discussed in text Chapters 2 and 8.

                          When the business is found to be unitary, apportionment factors are computed on the basis
                          of the entire unitary entity, not just the subsidiary that is based in the taxing state. This com-
                          putational convention can work to the taxpayer’s benefit when high-taxed income now is
                          subjected to apportionment in a low-tax state.

                          pp. 15-22 to 15-24

                 13.      Michigan, Tennessee, and the District of Columbia fail to recognize the Federal S elections
                          that are in effect for business taxpayers. p. 15-25

                 14.      A few states require state-oriented S election and consent forms. In some states, a Federal
                          S corporation can elect to be taxed as a C corporation. p. 15-27

                 15.      Some states apply a corporate-level tax on the income items attributable to out-of-state
                          shareholders. Others require that the S corporation withhold state income tax on taxable
                          income attributable to out-of-state shareholders. p. 15-27

                 16.      Many states accept block filing or composite returns from multiple-shareholder S
                          corporations. Such a return essentially is a spreadsheet that discloses and computes the
                          allocation of ordinary income and separately stated items, on a per-state and per-
                          shareholder basis. p. 15-27

                 17.      Most states use the Federal pass-through system of taxing partners and partnerships. The
                          entity does not pay income tax, but it files an information return (like Form 1065), allocating
                          income, deduction, and credit items to the partners. Other state taxes (such as payroll and
                          unemployment taxes) are payable by these entities. p. 15-27

                 18.      Generally, the seller collects a sales tax from the buyer and remits the tax to the state. A
                          use tax typically is paid directly by the purchaser to the home state. p. 15-28

                 19.      This statement is correct, as far as it goes. A retail sales tax falls on the customer, but the
                          state requires the seller to collect it. Sales tax returns are filed by the seller when the funds
                          are remitted, and no return is required of the customer. p. 15-28
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                                                        Multistate Corporate Taxation                             15-7


                 20.      Outline Points

                          Sales/use tax exemptions by:

                          l     Nature of the taxed product
                                l  Services
                                l  Occasional sale
                                l  Sale for resale
                                l  Groceries, medicines

                          l     Nature of the purchaser
                                l  Exempt organization
                                l  Government or agency

                          l     Nature of the sale
                                l  Casual/occasional sale
                                l  Amnesty or holiday

                          l     Nature of the political process
                                l  Manufacturer, farmer
                                l  Manufacturing process, packaging, shipping
                                   l Ingredient part, consumed in process
                                   l Not fuel or electricity


                          p. 15-28

                 21.      Sale of a used auto, sale of an entire business, rummage sale, or concert ticket. p. 15-28

                 22.      The Streamlined Sales Tax Project (SSTP) is an effort by state/local tax administrators to
                          unify the definition of items that are subject to the sales/use tax. The Multistate Tax
                          Commission helped to develop a common set of definitions for state legislatures to adopt,
                          so that enforcement of the sales/use taxes would be improved, especially with respect to
                          cross-border sales.

                          The SSTP does not force the states to adopt common tax rates or enforcement proce-
                          dures, but it includes checklists as to which types of food, clothing, and computing items
                          might be identified as taxable.

                          Tax in the News on p. 15-31

                 23.      TAX FILE MEMORANDUM

                          November 3, 2006

                          From:        Daniel S. Lange

                          Subject: Multistate tax planning

                          Re:          Client Ecru’s relocation decision

                          Because the states employ different definitions of the amount and type of activity neces-
                          sary to place a tax situs within the state, a company is allowed, to an extent, to select the
                          states with which it desires to establish nexus. When a corporation has only a limited
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                 15-8                          2007 Corporations Volume/Solutions Manual


                          connection with an undesired (high-tax) state, it may abandon that activity by electing an al-
                          ternative means of accomplishing the same result. For example, when providing a sales
                          representative with a company-owned fax machine in a home office constitutes nexus in a
                          high-tax state, the company could eliminate its connection with that state by reimbursing
                          sales personnel for communication expenses, instead of providing company-owned equip-
                          ment. These distinctions are more important after Wrigley, in which the Supreme Court out-
                          lined the terms of nexus under P.L. 86-272.

                          Similarly, when nexus is caused by conducting customer training sessions or seminars in
                          the state, the corporation could bypass this connection by sending the customers’ person-
                          nel to a nearby state in which nexus clearly has been established, or in which the activity
                          would not constitute nexus.

                          In addition, when sufficient activity originates from the repair and maintenance of the cor-
                          poration’s products or the activities performed by the sales representatives within the state,
                          the organization could incorporate the service or sales divisions. This would invalidate the
                          state’s right to tax the parent corporation’s income; only the income of the service or sales
                          divisions would be subject to tax. However, this technique is successful only if the incorpo-
                          rated division is a bona fide business operation and the state in which it operates is not a
                          unitary state. Therefore, the pricing of any sales or services between the new subsidiary
                          and the parent corporation must be at arm’s length, and the operations of the new corpora-
                          tion preferably should result in a profit.

                          Although most planning techniques are employed to disconnect a corporation’s activities
                          from an undesirable state, they also can be utilized to create nexus in a desirable state. For
                          example, when the presence of a company-owned copy machine in a home office creates
                          nexus in a desirable state, the corporation could provide its salespersons in that state with
                          company-owned equipment, rather than reimbursing or providing increased compensation
                          for office expenses. Establishing nexus in the state is advantageous, for instance, when
                          that state has a lower tax rate than the state in which the income presently is taxed.

                          pp. 15-31 to 15-34 and Example 31

                 24.      TAX FILE MEMORANDUM

                          November 3, 2006

                          From:         Mark A. Barnes

                          Subject:      Multistate tax planning

                          Re:           Client Royal’s interest income

                          The creation of a passive investment company is a technique utilized to minimize a corpo-
                          ration’s state tax burden. Nonbusiness or passive income generally is allocated to the state
                          in which the income-producing asset is located, rather than apportioned among the states
                          in which the corporation does business. Therefore, significant tax savings may be realized
                          when nonbusiness assets have a tax situs in a state that either does not levy an income tax
                          or provides favorable tax treatment for passive income. To benefit from the provisions of
                          those states, it is not necessary that the corporation be domiciled in such a state. Instead,
                          the tax savings can be realized by forming a passive investment company to hold the intan-
                          gible assets and to handle the corporation’s investment activities. Although the passive
                          investment company technique usually produces the desired result in any no-tax state,
                          Delaware often is selected for this purpose, because of its additional corporate statutory
                          provisions and favorable political, business, and legal atmosphere.
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                                                        Multistate Corporate Taxation                               15-9


                          Delaware does not impose an income tax upon a corporation whose only activity within the
                          state is the maintenance and management of intangible investments, and the collection
                          and distribution of income from such investments or from tangible property physically
                          located in another state. Consequently, patents, trademarks, stock, and other intangible
                          property can be transferred to a Delaware corporation whose activity is limited to collecting
                          passive income. Transfers of the assets to the subsidiary can be effected without a result-
                          ing Federal income tax, under § 351. Chapter 4

                          However, to receive the desired preferential state tax treatment, the passive investment
                          company’s activities within the no-tax state must be sufficient to establish nexus, and the
                          holding company should avoid performing any activity outside the state that may result in
                          establishing nexus with another state. In addition, the formation of the subsidiary must be
                          properly implemented, to assure the legal substance of the operation. The passive invest-
                          ment company must have a physical office, and it must function as an independent opera-
                          tion. Nevertheless, ensuring nexus and proper formation is not difficult, since numerous
                          consulting organizations have been established to furnish new passive investment compa-
                          nies with all of the elements necessary to fulfill these requirements.

                          Because the subsidiary’s activities are confined to Delaware (or some other no- or low-tax
                          state), and its operations generate only passive income, its income is not taxed in any
                          nonunitary state. Moreover, most states exclude dividends from taxation or otherwise
                          favorably treat them; therefore, the earnings of a passive investment company can be
                          distributed as a dividend to the parent at a minimal tax cost. If the state in which the parent
                          is located does not levy income tax on dividends received, the entire measure of passive
                          income may escape taxation. Formation of a passive investment company also may favor-
                          ably affect the parent corporation’s apportionment formula in nonunitary states, because
                          the passive income earned by the subsidiary is excluded from the numerator of its sales
                          factor.

                          These desired results, however, are not fully available in states that view the entire corpo-
                          rate operation as being unitary. Since those states require combined or consolidated
                          reporting, the income earned by the passive investment company is included in the corpo-
                          ration’s apportionable or allocable income.


                              HIGH-TAX STATE                                                       LOW-TAX STATE

                                                                  Investment Assets


                        ROYAL CORPORATION                                                             SUBCO

                                                                  Earnings: dividends paid,
                                                                  qualify for dividends received    Nexus only here
                                                                  deduction

                          pp. 15-34 to 15-36 and Example 34

                 25.      l     Create nexus in a low- or no-tax state, so that, through the apportionment process, a
                                lower effective tax rate can be used.

                          l     Physically move operations to a low- or no-tax state, perhaps on a divisional or other
                                functional basis.
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                 15-10                         2007 Corporations Volume/Solutions Manual


                          l      Move the investment assets into a passive investment subsidiary. This technique
                                 alone could reduce the tax liability by $1.6 million (.08 tax rate  $20 million portfolio
                                 income) per year.

                          l      Reduce the payroll expense through the use of independent contractors.

                          l      Acquire a subsidiary that offers a presence in a no- or low-tax state, or a research divi-
                                 sion whose losses will offset Mollusk’s income. Then optimize tax liabilities through
                                 transfer pricing and management fee structures.

                          l      If State F has not adopted a throwback rule, make new sales in low- or no-tax states,
                                 or into states with which there is no nexus.
                          pp. 15-31 to 15-38

                 26.      Alpha might be able to reduce its capital stock liability by:

                          l      Funding expansion with debt, rather than retained earnings.

                          l      Funding subsidiary operations with debt, rather than with direct capital contributions.

                          l      Regularly paying dividends to parent corporations located in states that offer friendly
                                 tax treatment of investment income (e.g., Delaware).
                          p. 15-38

                 PROBLEMS

                 27.      Item                                                                              True or False

                          a.      Federal taxable income is modified to produce state taxable income.       True
                          b.      Federal tax accounting methods, such as LIFO inventory and                True
                                    specific write-off of bad debts, are followed for state income tax
                                    purposes.
                          c.      State income tax payments are piggybacked to Federal                      False
                                    estimates (e.g., the state used the IRS as a collection agent).
                          d.      State income tax audits are piggybacked to the Federal                    False
                                    process (i.e., taxpayers must notify the state’s revenue
                                    department when a Federal audit is completed).

                          pp. 15-4 and 15-5

                 28.      State taxable income is computed as follows.

                          Federal taxable income                                  $50,000
                          Addition modifications                                  +8,000
                          Subtraction modifications                               À11,000
                          State tax base                                          $47,000
                          Allocated income — total                                À15,000
                          Apportionable income                                    $32,000
                          Apportionment percentage                                 Â 21%
                          Apportioned income                                      $ 6,720
                          Allocated income — in-state                             +3,000
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                                                        Multistate Corporate Taxation                          15-11


                          State taxable income                                  $ 9,720
                          Tax rate                                                Â 5%
                          Gross income tax                                      $ 486
                          Credits                                                  À50
                          Tax liability                                         $ 436

                          Figure 15-1

                 29.      a.       $1,500,000 (30%).

                          b.       $100,000 (10%).

                          c.       Business income is apportioned to the state, using the apportionment formula.
                                   Nonbusiness income is allocated to the state using a dollar-for-dollar assignment.
                                   In most states, business and nonbusiness income cannot be combined in applying
                                   the state income tax formula.

                          Figure 15-1

                 30.      a.       A. $10,000.

                          b.       A. $10,000.

                          c.       S. $30,000, although in most states the answer is N.

                          d.       S. $3,000.

                          e.       N.

                           f.      S. $5,000.

                          g.       A. $5,000.

                          h.       S. $3,000.

                           i.      N.

                           j.      Answer varies substantially among the states; however, in most states the answer
                                   is N.

                          Exhibit 15-1

                 31.      Perk’s state taxable income is determined as follows.

                                   Federal taxable income                                                $200,000
                                   A income tax expense                                                   +15,000
                                   A income tax refund                                                     À3,000
                                   Depreciation modification ($300,000 À $180,000)                       +120,000
                                   A taxable income                                                      $332,000

                          Exhibit 15-1 and Example 1
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                 15-12                         2007 Corporations Volume/Solutions Manual


                 32.      a.       Sales                                                                    $4,000,000
                                   Cost of sales                                                            À3,300,000
                                   Cost recovery (Federal)                                                   À400,000
                                   Interest income (Federal)                                                  +20,000
                                   X income tax expense                                                      À150,000
                                   Federal taxable income                                                   $ 170,000

                          b.       If interest generated from X obligations is exempt from state tax, state taxable
                                   income is $450,000.

                                   Federal taxable income                                                    $170,000
                                   State income tax expense                                                  +150,000
                                   Depreciation modification ($400,000 À $250,000)                           +150,000
                                   Interest on Federal obligations                                            À20,000
                                   X taxable income                                                          $450,000

                          c.       If interest generated from X obligations is subject to state income tax, state taxable
                                   income is $515,000.

                                   Federal taxable income                                                    $170,000
                                   State income tax expense                                                  +150,000
                                   Depreciation modification ($400,000 À $250,000)                           +150,000
                                   Interest on Federal obligations                                            À20,000
                                   Interest on X obligations                                                  +75,000
                                   Expenses related to X obligations                                          À10,000
                                   X taxable income                                                          $515,000

                          Exhibit 15-1 and Examples 1 and 2

                 33.      STATE D TAXABLE INCOME

                                   Income subject to apportionment (business income)                       $2,000,000

                                   Apportionment formula

                                   Sales            $4,500,000/$10,300,000 =                43.69%
                                   Property         $ 600,000/$2,100,000 =                  28.57%
                                   Payroll          $1,200,000/$3,100,000 =                 38.71%
                                   Total                                                   110.97%

                                   State D apportionment factor (110.97%/3)                                  Â 36.99%
                                   Taxable income apportioned to D                                          $ 739,800
                                   Plus: Income allocated to D                                                      0*
                                   D taxable income                                                         $ 739,800

                                  *Since the property for which the $500,000 gain was derived was located in E, such
                                   income is not allocated to D.
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                                                        Multistate Corporate Taxation                          15-13


                          STATE E TAXABLE INCOME
                               Income subject to apportionment (business and
                                   nonbusiness income)                                                  $2,500,000

                                   Apportionment formula

                                   Sales         $6,300,000*/$10,800,000*    =           58.33%
                                   Property      $1,500,000/$2,100,000       =           71.43%
                                   Payroll       $1,900,000/$3,100,000       =           61.29%
                                   Total                                                191.05%

                                   State E Apportionment Factor (191.05%/3)                              Â 63.68%
                                   E taxable income                                                     $1,592,000

                                   *Includes $500,000 gain on sale of nonbusiness property.

                           Examples 5, 6, 8, 9, and 10

                 34.      $739,800 and $1,760,200 of Jest’s income is subject to tax in States D and E, respectively.

                                   D taxable income, as in problem 33                                    $ 739,800

                          STATE E TAXABLE INCOME

                                   Income subject to apportionment (business income only)                $2,000,000

                                   Apportionment formula

                                   Sales        $5,800,000/$10,300,000    =              56.31%
                                   Property     $1,500,000/$2,100,000     =              71.43%
                                   Payroll      $1,900,000/$3,100,000     =              61.29%
                                   Total                                                189.03%
                                   State E Apportionment Factor (189.03%/3)                               Â 63.01%
                                   Taxable income apportioned to E                                       $1,260,200
                                   Plus: Income allocated to E                                              500,000
                                   E taxable income                                                      $1,760,200

                          Examples 5, 6, 8, and 10

                 35.      Because of the components of the apportionment factors in the two states, less than 100%
                          of Millie’s taxable income is subject to state income taxation.

                          State A Income Apportionment

                                   Sales           $1,200,000/$1,500,000     =           80.00%
                                   Property        $280,000/$680,000         =           41.18%*
                                   Payroll         $2,400,000/$2,500,000     =           96.00%
                                   Total                                                217.18%

                                   A Apportionment Factor (217.18%/3)                                      72.39%
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                 15-14                         2007 Corporations Volume/Solutions Manual


                                  *Owned property is included in the factor at net depreciated basis, and rent
                                   payments are included in the factor at 8 times the annual rental expense.
                                   Therefore, the numerator of the factor is computed as $280,000 [$500,000
                                   (average cost) less $300,000 (average accumulated depreciation)] plus [8 Â
                                   $10,000 (annual rental payments)]. The denominator of the factor is computed as
                                   $680,000 {[$800,000 (total average cost) less $400,000 (total average
                                   accumulated depreciation)] plus [8 Â $35,000 (total annual rental payments)]}.
                          State B Income Apportionment
                                   Sales       $300,000/$1,500,000                =       20.0%

                                   B Apportionment Factor (20%/1)                                      20.0%

                          Examples 11, 19, and 20

                 36.      Because of the components of the apportionment factors in the two states, more than
                          100% of Millie’s taxable income is subject to state income taxation.

                          State A Income Apportionment

                                   Sales       $1,200,000/$1,500,000              =       80.0%

                                   A Apportionment Factor (80%/1)                                      80.0%

                          State B Income Apportionment

                                   Sales          $300,000/$1,500,000             =       20.0%
                                   Property       $300,000/$800,000               =       37.5%*
                                   Payroll        $100,000/$2,500,000             =        4.0%
                                   Total                                                  61.5%

                                   B Apportionment Factor (61.5%/3)                                    20.5%

                                   *Property is included in the factor at historical, undepreciated cost, and rent
                                    payments are not included in the factor.

                          p. 15-14 and Examples 11 and 19

                 37.      Because of the components of the apportionment factors in the two states, more than
                          100% of Millie’s taxable income is subject to state income taxation.

                          State A Income Apportionment

                                   Sales             $1,200,000/$1,500,000 = 80.0% Â 2   =            160.0%
                                   Property          $500,000/$800,000                   =             62.5%*
                                   Payroll           $2,400,000/$2,500,000               =             96.0%
                                   Total                                                              318.5%

                                   A Apportionment Factor (318.5%/4)                79.63%
                                   *Property is included in the factor at historical, undepreciated cost, and rent
                                    payments are not included in the factor.
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                                                        Multistate Corporate Taxation                           15-15


                          State B Income Apportionment
                                   Sales               $300,000/$1,500,000 = 20.0% Â 2          =         40.0%
                                   Property            $200,000/$400,000                        =         50.0%*
                                   Payroll             $100,000/$2,500,000                      =          4.0%
                                   Total                                                                  94.0%

                                   B Apportionment Factor (94%/4)                          23.50%

                                   *Property is included in the factor at net depreciated basis, and rent payments are
                                    not included in the factor.
                          Examples 10, 11, and 19

                 38.      a.       Sales ($600,000/$1,000,000)         =                   60.00%
                                   Property ($300,000/$350,000)        =                   85.71%
                                   Payroll ($200,000/$210,000)         =                   95.24%
                                   Sum of Apportionment Factors        =                  240.95%
                                   Average                                                      ‚3
                                   State A apportionment factor                            80.32%
                                   Apportionable income                                 Â $400,000
                                   Income apportioned to State A                          $321,280

                          b.       Sales ($600,000/$1,000,000) Â 2 =                                       120.00%
                                   Property ($300,000/$350,000)    =                                         85.71%
                                   Payroll ($200,000/$210,000)     =                                        95.24%
                                   Sum of Apportionment Factors                                            300.95%
                                   Average                                                                       ‚4
                                   State A apportionment factor                                             75.24%
                                   Apportionable income                                                  Â $400,000
                                   Income apportioned to State A                                           $300,960

                          c.       Sales ($600,000/$1,000,000)         =                  60.00%
                                   State A apportionment factor                           60.00%
                                   Apportionable income                                  $400,000
                                   Income apportioned to State A                         $240,000

                          Examples 10 and 11

                 39.      Item                                               A Sales                     B Sales

                          Ordinary sales                                     $200,000                   $490,000
                          Checking account interest                                                        3,000
                          Rental income in A                                   50,000
                          Treasury bill interest                                  –0–                        –0–
                          Occasional sales                                        –0–                        –0–
                          Royalty income                                                                  60,000
                          Sales factor numerator                             $250,000                   $553,000

                          pp. 15-15, 15-16, and Example 12
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                 15-16                         2007 Corporations Volume/Solutions Manual


                 40.      The E throwback rule places in the E sales factor any sales to customers in G and to the
                          U.S. government.

                                   E sales factor = $154 million/$194 million =        79.38%*
                                   F sales factor = $40 million/$194 million =         20.62%
                                   Total of sales factors                             100.00%

                                   *$64 million (E) + $55 million (G) + $35 million (all 50 states) = $154 million.
                          This arrangement calls for better tax planning by Orange, in that shipping from E keeps the
                          total of the sales factors at 100%. Shipments should be made from a non-throwback state,
                          like F.

                          p. 15-16 and Example 13

                 41.      G payroll factor                  $200,000/$950,000 =                  21.05%
                          H payroll factor                  $400,000/$700,000 =                  57.14%
                          I payroll factor                  $350,000/$950,000 =                  36.84%
                          Total of payroll factors                                              115.03%

                          This arrangement calls for better planning by Aqua, in that placing the officers’ salaries in
                          I increases the total of the payroll factors far above 100%. The salaries for the executives
                          should be sourced to H.

                          p. 15-17 and Example 14

                 42.      The State U payroll factor includes $190,000 for Judy. An employee’s includible compensation
                          generally is assigned to one state, specifically, the state in which she or he performs services for
                          the employer. If such services are performed in several states, the compensation is assigned to
                          the state in which she or he has a base of operations. pp. 15-17 to 15-19

                 43.      Justine’s State G payroll factor is determined as follows.

                                    ð$475,000 þ $95,000 þ $180,000Þ   $750,000
                                                                    ¼          ¼ 68:49%
                                   ð$675,000 þ $160,000 þ $260,000Þ $1,095,000

                          Justine’s State H payroll factor is determined as follows.

                                        ½$200,000 þ 70%ð$65,000ފ       $245,500
                                                                      ¼          ¼ 30:10%
                                   ½$675,000 þ 70%ð$65,000Þ þ $95,000Š $815,500

                          pp. 15-17 to 15-19 and Examples 16 to 18

                 44.      Under the statutes of States A and B, accumulated depreciation and nonbusiness property
                          (i.e., rental property) are not taken into consideration in computing the property factor.

                          Average Property in A
                                                              Beg. of yr.    End of yr.          Total           Average
                           Inventory                         $ 300,000      $ 400,000        $ 700,000          $ 350,000
                           Plant and equipment                2,500,000      2,500,000        5,000,000          2,500,000
                           Land                                 600,000        600,000        1,200,000            600,000
                           Total                                                                                $3,450,000
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                                                        Multistate Corporate Taxation                           15-17


                          Average Property in B
                                                              Beg. of yr.       End of yr.      Total       Average
                           Inventory                          $ 200,000         $ 150,000     $ 350,000    $ 175,000
                           Plant and equipment                 1,500,000         1,200,000     2,700,000    1,350,000
                           Land                                  600,000           400,000     1,000,000      500,000
                           Total                                                                           $2,025,000

                          Property Factor for A

                                              $3,450,000 ðIn-state propertyÞ
                                                                                       ¼ 63:01%
                                   $5,475,000 ðTotal property $3,450,000 þ $2,025,000Þ

                          Property Factor for B

                                              $2,025,000 ðIn-state propertyÞ
                                                                                       ¼ 36:99%
                                   $5,475,000 ðTotal property $3,450,000 þ $2,025,000Þ

                          pp. 15-19 to 15-22 and Example 19

                 45.      Under the statutes of A and B, accumulated depreciation is not taken into consideration in
                          computing the property factor. Nonbusiness property (i.e., rental property) is excluded
                          from the property factor of A, but is included in determining the property factor for B.

                                    HISTORICAL COST - EXCLUDING NONBUSINESS PROPERTY

                                   Property factor for A, as in problem 44                       63.01%

                                      HISTORICAL COST - EXCLUDING NONBUSINESS ASSETS

                           Average Property in A

                                                                  Beg. of yr.    End of yr.      Total      Average
                           Inventory                              $ 300,000     $ 400,000     $ 700,000    $ 350,000
                           Plant and equipment                     2,500,000     2,500,000     5,000,000    2,500,000
                           Land                                      600,000       600,000     1,200,000      600,000
                           Rental property                           900,000       950,000     1,850,000      925,000
                           Total                                                                           $4,375,000

                           Average Property in B

                                                                  Beg. of yr.    End of yr.      Total      Average
                           Inventory                              $ 200,000      $ 150,000    $ 350,000    $ 175,000
                           Plant and equipment                     1,500,000      1,200,000    2,700,000    1,350,000
                           Land                                      600,000        400,000    1,000,000      500,000
                           Rental property                           300,000        300,000      600,000      300,000
                           Total                                                                           $2,325,000
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                 15-18                         2007 Corporations Volume/Solutions Manual


                          Property Factor for B

                                      $2,325,000 ðIn-state propertyÞ
                                                                               ¼ 34:70%
                           $6,700,000 ðTotal property $4,375,000 þ $2,325,000Þ

                          Example 19

                 46.       Annual Method        $1:5 million $0:6 million
                                                            þ
                                                $3:0 million $2:2 million ¼ 0:386 property factor
                                                            2
                                                               
                           Monthly Method           $1:5 million    $0:6 million
                                                11                þ
                                                    $3:0 million    $2:2 million
                                                                                 ¼ 0:481 property factor
                                                               12

                          The late disposal of the X facility is reflected more favorably in that state’s property factor
                          when the annual method is used.

                          p. 15-20

                 47.      a.       State A Income Tax
                                   Total apportionable income ($1,000,000 À $500,000)                         $500,000

                                   Apportionment formula

                                   Sales               $2,500,000/$6,500,000      =      38.46%
                                   Property            $1,000,000/$3,500,000      =      28.57%
                                   Payroll             $800,000/$2,000,000        =      40.00%
                                   Total                                                107.03%
                                   State A apportionment factor (107.03%/3)                                   Â 35.68%
                                   Taxable income apportioned to State A                                      $178,400
                                   State A tax rate                                                            Â 8.00%
                                   State A tax liability, if unitary                                          $ 14,272

                                   State B Income Tax

                                   Total apportionable income ($1,000,000 À $500,000)                         $500,000

                                   Apportionment formula

                                   Sales                $4,000,000/$6,500,000     =      61.54%
                                   Property             $2,500,000/$3,500,000     =      71.43%
                                   Payroll              $1,200,000/$2,000,000     =      60.00%
                                   Total                                                192.97%
                                   State B Apportionment Factor (192.97%/3)                                  Â 64.32%
                                   Taxable income apportioned to State B                                     $321,600
                                                                                                             Â 11.00%
                                   State B tax liability                                                     $ 35,376
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                                                        Multistate Corporate Taxation                                 15-19


                                   State A tax liability                                                         $ 14,272
                                   State B tax liability                                                           35,376
                                   Overall state tax liability, if unitary                                       $ 49,648

                          b.       True Corporation, State A ($500,000 Â 8%)                                     $ 40,000
                                   Trumaine Corporation, State B ($1,000,000 Â 11%)                               110,000
                                   Aggregate state income tax, if nonunitary                                     $150,000

                          c.       OFFICIAL CORRESPONDENCE

                                   November 3, 2006

                                   To:      Board of Directors
                                            Trumaine Corporation
                                            1234 Mulberry Lane
                                            Chartown, AL 35298

                                   From: Alison Brown, CPA, MST

                                   Re:      Unitary treatment of operations of the True and Trumaine Corporations

                                   Some states apply a so-called unitary approach in computing the income tax liabil-
                                   ities of corporations doing business within its borders. When the unitary theory is in
                                   effect, operating income and losses, and indicators of the level of in-state business
                                   activities are computed taking into account all of the other entities related to the cor-
                                   poration.

                                   Unitary computations are favorable to a taxpayer when related corporations gener-
                                   ate operating losses or generally are less profitable than the taxpayer. When more-
                                   profitable entities enter the mix, state tax liabilities tend to increase. Similarly, if a
                                   unitary group can shift taxable income into low- and no-tax states, the overall tax
                                   liability of the group will decline.

                                   Similarly, if a unitary group can shift taxable income into low- and no-tax states, the
                                   overall tax liability of the group will decline.

                                   Related corporations generally are found to constitute a unitary group where their
                                   ownership, operations, and corporate decision-making are interrelated.

                                   I have determined that, if True and Trumaine are found to be a unitary group, the
                                   combined A and B income tax liability for the group will be cut by more than two-
                                   thirds (i.e., from $150,000 to about $50,000). This happens essentially because of
                                   our ability to shift more taxable income into A, a lower tax rate state.

                                   I recommend that we undertake to establish and document our position that True
                                   and Trumaine constitute a unitary group and to inform the A and B revenue depart-
                                   ments of that fact, as soon as possible.

                          pp. 15-22 to 15-24 and Examples 24 and 25
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                 15-20                         2007 Corporations Volume/Solutions Manual


                 48.      Because of the water’s edge election, the sales to the Despina customers are not included
                          in either state’s sales factor.

                                 State       Entity               Sales Factor

                                      B      Gerald               $10 million/$25 million = 40.00%
                                      Q      Unitary group        $35 million/$45 million = 77.78%

                          pp. 15-23, 15-24, Concept Summary 15-1, and Global Tax Issue on p. 15-25

                 49.      MEMORANDUM

                          November 3, 2006

                          To:     Shareholders of Hernandez Corporation
                                  5678 Alabaster Circle
                                  Koopville, KY 47697

                          From: Dustin Greene, CPA, MST

                          Re:     Tax liability of the corporation this year

                          We elected so-called S corporation status at the Federal level long ago. This election elimi-
                          nates the exposure of corporate income to double taxation—the corporate level tax is zero,
                          but all of the taxable income for the year passes through to the shareholders proportion-
                          ately and is taxed to them immediately.

                          Not all of the states recognize the S election in computing corporate and individual income
                          taxes. In our case, one of the states in which we do business (Z) taxes Hernandez as a reg-
                          ular or ‘‘C’’ corporation, while our other state (Y) applies the S election for its purposes. This
                          makes our tax computation more complicated—corporate taxable income must be com-
                          puted in the aggregate and then apportioned among the states, based on the sales, prop-
                          erty, and payroll activities in each. Here is a summary of my determinations of Hernandez’s
                          tax liabilities for this year.

                          State Y

                          Since Y recognizes S corporation status, Hernandez is not subject to tax on any of its
                          income in that state. The income of the corporation is passed through to the shareholders;
                          such income then is subject to tax at the shareholder level.

                          State Z

                          Since Z does not recognize S corporation status, Hernandez is subject to tax in the same
                          manner as a C corporation. Hernandez’s taxable income before apportionment, deter-
                          mined as though it were a regular corporation, is $518,000. By applying the Z apportion-
                          ment formula to this amount, Hernandez is subject to a corporate level tax on $173,167.

                          Income determined as though it were a C corporation

                                    Ordinary business income                                                   $500,000
                                    Taxable interest income                                                      10,000
                                    Capital loss                                                                   (–0–)*
                                    Dividend income                                                              40,000
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                                                        Multistate Corporate Taxation                             15-21


                                   Income before dividends received deduction                              $550,000
                                   Dividends received deduction ($40,000 Â 80%)                             (32,000)
                                   Taxable income                                                          $518,000

                                  *Corporations can offset capital losses only against capital gains.

                          Z Taxable Income

                                   Sales          $800,000/$1,800,000              =          44.44%
                                   Property       $200,000/$700,000                =          28.57%
                                   Payroll        $300,000/$1,100,000              =          27.27%
                                   Total                                                     100.28%

                                   Average (100.28%/3)                              33.43%

                                   Taxable income                                                            $518,000
                                   Z apportionment percentage                                                Â 33.43%
                                   Z taxable income                                                          $173,167

                          pp. 15-26, 15-27, and Example 26

                 50.      Businesses are merely the collection agents for the states with regard to the sales tax.
                          Thus, Grande must collect and remit, to the state, tax on the $700,000 general sales
                          transactions. Medical devices and out-of-state sales are exempt from this collection
                          requirement, although use tax might be due on the mail-order sales. On the goods Grande
                          purchased from its supplier, neither party need collect and remit the tax. A resale exemp-
                          tion applies in virtually all states, so that only the ultimate consumers of the goods—here,
                          Grande’s customers—pay tax on the transaction. pp. 15-28 and 15-29

                 51.      a.       6% sales tax rate  $60,000 office supplies = $3,600.

                                   Granite is the final consumer of the office supplies, so it must pay the sales tax on
                                   such materials to the vendors from whom purchases are made. Other supplies and
                                   tools used in the assembly process to create the computer systems are exempt
                                   from tax, in anticipation of the subsequent resale of the systems. The final consum-
                                   ers of those systems are liable for the tax thereon.

                          b.       6% sales tax rate  ($1,400,000 software sales + $3,500,000 computer sales) =
                                   $294,000. No reductions to the tax base are made for cost of sales or packaging
                                   materials.

                          pp. 15-28 and 15-29

                 52.      a.       S.

                          b.       N. Probably exempt as a targeted item.

                          c.       U.
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                 15-22                         2007 Corporations Volume/Solutions Manual


                          d.        N. Probably exempt because of charitable status.

                          e.        N. Probably exempt under the resale rule.

                          p. 15-28

                 53.       Net Worth                 Assets                     $1,700,000
                                                     Liabilities                  (950,000)         $750,000

                           Apportionment             Sales Factor                0.40

                                                     Property Factor
                                                     [$300,000/$1,200,000]       0.25
                                                                                 0.65/2 =           Â 0.325
                           Net Worth Apportioned to A                                              $243,750
                           Tax Rate                                                                   Â 3%
                           Liability                                                               $ 7,313

                          Since property includes only real and tangible property, the cash of $500,000 is not in the
                          denominator.

                          pp. 15-29 to 15-31 and Example 29

                 54.      The home state payroll factor drops from .750 ($1,500,000/$2,000,000) to .697
                          ($1,150,000/$1,650,000). p. 15-38 and Example 36

                 55.      Presentation outline

                          l     Select Optimal States in which to Operate
                                l  Put losses into high-tax states
                                   l Research division
                                   l Inventory
                                l  Put profits into no- and low-tax states

                          l     Nexus
                                l  When to avoid it
                                l  When to create it

                          l     Investment Subsidiaries
                                l   What they accomplish
                                l   How to organize them
                                l   Not good in unitary states
                                l   Court case challenges

                          l     Apportionment Factor Planning
                                l  Sales factor
                                   l Shipping method
                                   l Recordkeeping
                                   l Property factor
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                                                         Multistate Corporate Taxation               15-23


                                     l   Leases
                                     l   Idle property

                                l    Payroll factor
                                     l Relocating executives
                                     l Using independent contractors


                          pp. 15-32 to 15-38




                 The answers to the Research Problems are incorporated into the 2007 Corporations Volume of
                 the Instructor’s Guide with Lecture Notes to Accompany WEST FEDERAL TAXATION: CORPO-
                 RATIONS, PARTNERSHIPS, ESTATES & TRUSTS.
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                 15-24                         2007 Corporations Volume/Solutions Manual


                                                                  NOTES

								
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