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Foreign welcome to the ninth episode of How Tax Works. I'm Matt Foreman. In this episode, I'll discuss a smattering of common state and local income tax issues. The premise of this is things I run into in various due diligence and M and A type transactions, but they rear their angry little head all the time. So, you know, just ones I thought would be interesting. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising and is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business choices that we all make before we get started. A few things episodes every two weeks. If my math is correct, I think the next episode will actually come out on a Tuesday to avoid a holiday. That one, which will be episode 10, is going to discuss revenue rulings 99.5 and 99.6, which if you don't work in tax, you really don't know what they are. I just think they're kind of misunderstood and I think people don't totally know how to deal with them. I'm going to talk about like kind of what they do, how they operate, and how people use them to help attacks. You know, structure into them is the phrase that people really use. But I think that that's, you know, really important. They deal with disregarded entities and partnerships and going between the two and different fact patterns that deal with it. And there are often parts of an f Re. Org people say, oh, that's an f Re. Org and not totally f Reorg is kind of a separate thing because 99. 5 and 96 are both taxable transactions, even if no tax maybe imposed sometimes. And I think it's something important to do. If you have any questions, comments or constructive criticism, email me at my FRB email address, which you can find via your favorite search engine. I mentioned this in the last episode. I'm going to mention this again October 29th. I have a free webinar. Free, free, free. One o' clock Eastern Time. I live in New York, so everything's going to be on Eastern time. So if you live somewhere else, I hope you know, I trust that you can figure that out. It's going to be on S Corporations and it has free CLE for those in New York, CPE for CPAs and free for EAs. It's gonna be on S Corps. I don't love them, but you know, I'm gonna talk about them and I promise I will say at least one positive thing about them and give one economic reason to be an S corporation. I think they are robustly overused, to put it politely. I just, I think they are and I'll go through why November 14th also one o'. Clock. That October 29th is an hour. The one on November 14th is 80, 84 minutes. It is with Strafford. And again link will be on the How Tax Works website and the post for this this episode but it's tax strategies for Limited Partner investing in Private Investment funds. I promise you I will talk about general structuring into partnerships and different issues that come up with it. It is not as narrow as it sounds. I promise. I promise it will be super, super fun and interesting and if it's not, you know, you'll get no money back whatsoever. So appreciate that. So this episode again, you know, we're going to talk about some common state and local tax issues with a somewhat focus. It's a little broad and it's not totally focused, but I want to talk about issues that I see during, you know, sales, businesses, purchase of businesses, capital raises. And this episode is really not intended to be all encompassing, I promise you. I'm just, I'm poking a little bit in the issues. I'm really not trying to, trying to stem any problems or get everything or be all encompassing at all. And I'm not close and I think it's just some of them and I think that that's important to note that you're like, oh, Matt didn't say this was an issue. Doesn't mean it's not an issue. It means that I just wasn't one of the ones I decided to discuss in my in this episode. So the biggest one I see is what I call sourcing and registration. So registration. You know people talk about nexus, right? And what it is is nexus is basically where you have to register your business to do business and you register both secretary of state website for non tax purposes and you register it for tax purposes. You can do one without the other. Generally it depends. It wouldn't be a podcast by a lawyer if I didn't say it depends. But I think it's really important. Generally speaking you have to register in the state of formation. Delaware and a few other states can be exceptions to that under certain circumstances. But most businesses are registered where they're formed anyway. Very, very small percentage of businesses are in one of those states or meet one of the exceptions or exclusions anyway. The second, you know reason people have to register in a state is physical nexus. Right. So you have an employee, you have an office, you have inventory. And people say, oh, well, you know, I don't really have that. Or whatever, you know, remote employees. Right. You think the last four, four and a half. Gosh. Can't believe some four and a half years you think about what, you know, has transpired. If you have an employee, let's say you're a business, you're in Iowa and you have an employee, and the employee lives and works in Missouri. Well, there's a very real chance that you now have a filing requirement in Missouri. Right. I don't mean to pick on Missouri, but any state would largely meet that fact pattern. Really. Every state would meet that fact pattern unless there are no income taxes. Right. Then there's no filing requirement for it. So I think it's really important to do that. And that's where physical access comes in. You know, it can be somewhat transitory. But, you know, inventory in a warehouse, if you know where you're in the warehouse, it's. So we use the warehouse for a day and then it goes somewhere else. And maybe. Right. We should talk about that. There's. There's Public Law 86272. It is not from 1986, from 1959. What it basically says is if the only thing you do in a state is what's called, the phrase they use is solicitation only. So if only thing you do is solicitation in the state, so you're trying to sell, that is not subject, cannot create nexus, but you'd be surprised how little extra you have to do to get there. Right. Just driving through doesn't. Solicitation only doesn't things like that. And also PL 86272 only applies to tangible personal property, does not apply to real property. So if you're, if you own real property or you lease real property in a state, you should probably be filing there. And not to intangibles. Some states ignore that. But for the most, you know, they don't tax intangibles anyway. But for the most part, you know, if you're selling ebooks, right. So the very tangible product, but you're selling an intangible version of it. Congratulations. Even if your only activity toward that state is solicitation, you may have to deal with income tax filings, you may own income tax, et cetera. So we should talk about that. If you do, you know, it's an important one and it's commonly missed, you know, People say, oh, it's just a little bit. And I'm like, yeah, that's fine. You know, a little bit's enough. So I think that's really important. The next thing you know, there's a number of states that have moved into pure economic nexus. Right. There's no law that says they can, but economic nexus, right. As long as you have some real relationship, you're not tripping up. PL86,272. Even if everything you do toward the state, you don't actually physically enter the state, you can do it. Pennsylvania's gone full economic nexus. A number of other jurisdictions have, especially in specific contexts. And I think it's really important for people to think through. You know, are we doing. Are we doing business in that state? What does each state do? And people will say, well, you know, this. I looked into it in the state where I am, and this is what the law says. So therefore I'm not in another state. And I always say, well, every state can have its own rules for it, right. They're hemmed in by the Constitution, by. By P.L. 86, 272 federal law under the dormant commerce clause and the Supremacy Clause. But it's really important to think through. You know, are we doing it right? Right. You know, is that. Is that correct? And I would say, like, look, are you filing incorrect states? Are you sourcing the income properly? Each state has different sourcing rules. So, you know, some states have different ones. I'll go through this a little more in a second. But, you know, you think through, right? Like, how do you know how much income goes to each state? Each state has its own rules for that, which. Which is bonkers and a headache. And every time I talk to people who are new to the US Bringing against the US and you explain to them that, you know, there could be 51 laws, 52 laws could include DC on a specific issue. I really wonder how we have such a successful economy really, despite ourselves in some ways. But I think that's really important to know where you should be filing. One other point I want to point in here. It's not totally a business income tax thing, but what's called the convenience of the employer test. I talked about it, I think, in another episode, but the basic premise is that a lot of people. Again, it goes back to the remote employee issue. And what happens is there are people who. They want to be a remote employee. A lot of businesses are like, you know, fine. Doesn't really matter where you are. You know, service business. What have you and what they do is they go elsewhere and like, oh, I don't have to pay New York taxes anymore. I live in, you know, I live in a lower tax jurisdiction. And so I'm not going to pay those taxes. And a lot of states don't really allow that. New York's notorious for being aggressive, but a lot of states do the same thing. And the premise is, look, your business is still in New York and you don't have an office in the other state. You're not filing in the other state. Why shouldn't that person pay income tax in that state? You know, in the initial state. Right. In the state of the business. And so that's an important way to trip up. And it's an issue, and it's just a general compliance issue because you really have to be aware that it could be an issue for you to catch it. And so I see it a lot in transactions where, you know, six years ago everyone was in, you know, they're in Kansas City or Kansas or Missouri. They're, they're around, you know, right around Kansas City or either one of them or Overland park or whatever. And then the pandemic happened. Everyone kind of spreads out, right? And you have to think like, where are they? Right? And not only are people. You worry about income tax and income tax filings, but you also have to worry about individual tax filings. Right? And is that done? Right. Do we have to file? It does. And everything has to match. So I think that that's really an important distinction and something to really think about. Take a moment break and be back in a sec. The second big one I'm going to talk about is what's called the pass through entity tax. It's a generic term, but a lot of states just call it the pass through entity tax, ptat, whatever you want to call it. New Jersey calls it the bait B A I T. So just a generic term, but basically, and this is sort of an aside, but these are technically optional taxes and they should not be allowed to be deducted on the federal return. But IRS, known as 202075 says otherwise. And so, so it goes, you know, theoretically treasury could overrule them, Congress could overrule them, but it's one of those ones where I think people are afraid to do it. You know, it's whenever people say, oh, they're going to, you know, tax rates are going to be 9,000% and I'm like, well, they let the ptet happen and that's an easier one to cut off because there's no, you know, it should not be allowed. Anyone who looks at the law and says, well, this is what should happen. It really shouldn't. So, you know, it's important to note that PTED is because the IRS allows it. Just kind of. Kind of crazy to think about. People always think the IRS is trying to fight you. And this way the IRS went entirely the other. Anyway, so with the pizza, the important thing is you must make an election and you must do it right. There's a lot of businesses. You'll see ones in states that have very low tax rates. It's not worth it. It's not worth the extra filing. It's not worth the headache, you know, et cetera. And you must make the election. I always, look, I live in New York, so obviously I think about New York more than other states. But what I think is really important to note here with regards to the PTET is in New York, you have to make the election by March 15. If you create an entity on March 16, you cannot make a PTAT election for that year. So it's important to think through where are your entities, how are you structuring things, et cetera. I've seen deals that were probably going to close by the end of the year that got moved, you know, a month to take advantage of ptet. Whether you can actually take the PTET on a sale is another issue. It's a discussion point. You know, I think the answer is not no, but, you know, states definitely know it's an issue. I suspect they know people are doing it. I'm sure they see it. So I think that that's really important to think through. Another one is issues with multiple entities. And what does that mean? Right. So you see businesses, and it happens from time to time, where they'll have three or four business, three or four entities that are owned by other ones, owned by each other, or they're sibling entities and they're formed for different reasons. You see it pretty commonly in anything that has a franchise or anything that just has different ownership for different entities. Sometimes there's a historic. I'm just going to pick on plumbers, but there's a historic plumber business. And then they opened a second one, you know, and one of the sibling one at one of the kids joined and they opened the third one. And, you know, there's four entities now, and they kind of form one overarching form in plumbing, which. Which is funny to say because I'm fairly certain I've never had. I don't have Any plumbers in the family, but that you run into these issues. And the first big issue you run into is what's called apportionment, right? How you apportion the income between the different entities. And people say, what does it matter? You know, it washes. In the end, they're all partnerships or they're owned by each other, etc. And that's true, but especially on the state level, can be really, really important. Because sometimes what people have, especially with licensed entities like a plumber, right, they might have a New Jersey entity and New York entity and a Connecticut entity and a Pennsylvania entity, etc. Etc. And in doing that, you know, they'll have all the back office by New York. So what happens is they just have income wherever and they don't properly allocate and apportion, you know, different income and different, especially expenses between the different entities and properly reimburse themselves. And by doing that, it can shift income between different, different states pretty easily. And it's a huge, huge problem. You know, I dealt with it a lot when I worked at large places because we dealt with it with public companies, right? Their concern is that they want to decrease their tax rate and they can do it a little on the federal level, but if they could move, you know, this income from New York to New Hampshire, right. I. That's gonna. That. That's a huge drop off. 88, 8.85% is the new York state corporate tax rate. You know, New Hampshire is much lower. And so I think that that's really important. I think New Hampshire is lower, maybe higher. But you get the idea. Shifting it that way can be really important. And this is often somewhat an accidental issue. You know, they just don't think about it. They're like, well, yeah, of course it does it, but you know, I own all the entities, so what does it matter? It matters. You know, it can be really important and the numbers can be important and it can be a tough issue on audit because what happens is two, three, four years later, you're trying to recreate all your sales and understand what your expenses were. And this goes into sort of the other issues that I run into with multiple entities. And it's transfer pricing, right? Transfer pricing, not truly a tax idea. It's really an economic concept. And the premise behind it is just, you know, when you have related persons is the word. So it's not necessarily related businesses, but it can be, you know, if two related. Two businesses that are owned by the same people, same individuals, if they're doing Business between each other. You have to have an arm's length price for the services, goods being provided, you know, from one to the other. And it's really important to think about and where I run into it a lot. Again, we going back to, you know, form and plumbing. And the premise is that, you know, people say, oh, it really doesn't matter. I'm like, well, it can, you know, especially if you have an S corporation versus partnership, if it's in different states, it can really matter. Also what happens is transfer pricing can create certain entities that have losses and certain ones that have gains. And what I, a lot of people, I tell them to do, you know, they're like, well, I'm not gonna, I'm not gonna file in this state. I have a loss there. You know, if they want to make me file, they can make me file and I'll pay 500 bucks. I don't care, you know, what's the penalty anyway? And I'm like, well, you might want the, you know, CT losses, the NOLs to sit there. So in case it ever becomes profitable in Connecticut that you have those losses, you can use them. And I think that that's really important to think about is that tax, you know, is not just a zero sum this year only kind of gain. It's really about thinking through kind of the long term picture of what is the way to get the lowest tax rate long term. And a lot of times that's making sure you transfer pricing, right? Making sure you have it done in case you get audited, you know, and I think that that's really important to take a quick break. Be back in a moment. Welcome back. Another big state and local tax income tax issue is, is conformity with the Internal Revenue Code. And this always kind of fascinates me is when you think about it, you know, people always, first off, a lot of people who are not practitioners don't realize that income tax from the state level is really built on the federal tax code, Right? On tax law, what I refer to as tax law, even though it's the federal Right. But there's a number of areas where states very, very, very often, what's called decouple, which is they just don't follow federal or they follow an old federal rule or they modify a federal rule. The most common one, I think is depreciation amortization. Federal government. Their love for immediate expensing, with the exception of 174, which is stupid, is bonkers. And it's, it's just divorced from economic reality. States Are like, whoa, slow down, slow down, man. You know, let's, let's, let's just, you know, not saying we need to use straight line, but, you know, use something a little slower than immediate. It's a revenue thing. That's why they're not doing it. But it's a big issue. I've seen it where states, you know, people model out the federal and they're like, oh, yeah, well, state will be the same. And what happens is federal, you know, they make $4 and for the state, they make 17 million. Right. Because they don't get all the depreciation right away. And that could be an issue. The other one that I always point out, for IRC conformity, I always talk about 280e, right? Which is cannabis. A lot of states, pretty much every state that's legalized it has decoupled. New York and New York City both have, et cetera. So it's really important to know those things. The other big issue for irc, Internal Revenue Code conformity is to make sure that you've properly made your elections. And at the state and at the federal level, I specifically talk about the S election, even though, again, as mass corporations. But this is one thing that I always found kind of fascinating is that I think we're down to one state. I think New York is the only state left that requires a separate selection. But it does. You know, there are some states, New Jersey, for example, where you can make a different election, but New York requirements requires it still. And it's important to know what states do if you have to make a conforming one, if you want to change it, what it means. Because I've seen it far too many times. I literally saw this once was for federal purposes, they were a S corp. For New Jersey purposes, they were a partnership. And for New York purposes, they were a C corporation. They just filed different elections. Actually, New Jersey, they never filed it, and they were an llc, so they defaulted into partnership. Federal, they filed S. And for New York, for some reason, they filed C. I never quite figured it out, Was able to really figure out what, why, but you can see that, and it's important to understand that. And so when you're doing a transaction, it's important to know, is this a S corporation or whatever for federal and state and local purposes, what is it? And that's an important way where internal revenue conformity can come up in just this kind of clunky ways. The other one is. Another one that I always bring up is other gross receipts, taxes that function as income taxes, but we pretend they're not income taxes. If anyone's ever heard me talk about, you know, Washington state or Texas, you're like, oh, they don't have a corporate income tax. You know, they don't have an income tax. That's great. But they don't have income taxes, you know, for businesses and things like that. I'm like, that's okay. And what it is is they just have these very, very low percentage gross receipts taxes that function like income taxes because they have, they have things you can deduct from them, but they're somehow not income taxes. You know, Texas has a very large exclusion amounts like a million dollars of sales. So most businesses in Texas are not subject to it. There was a time where LPs, limited partnerships were not subject to it at all. So you got some really, really, really weird tax rules there. But they did eventually correct that. And, and you know, their gross receipts taxes, people run into that, oh, there's no income tax. Great. There's, there are taxes and a lot of them have basically no, what I call nexus restrictions. You make a dollar you may have to file. And filing is important and you can really step into it in very material ways very quickly. So I think that that's really important. There are weird, quirky local taxes. You know, it's not quite gross receipts taxes, but you know, I always point out that. But you know, Ohio has a thousand kind of clunky gross receipts or income or different kinds of taxes that exist. I know that a lot of practitioners pick on Ohio and I'm okay with that because they definitely do things differently than a lot of other states have tax and jurisdictions and other problems like that. So I'm going to take a quick moment break, be back in just a gym. Okay, we're back for the final one. I kind of led into this, but local income taxes, right. I talked about Ohio asm, you know, the big one that I always talk about. Right. Again, I'm biased. Right. My east coast bias. But New York City, right. New York City is really, really a different income tax world. Because first off, New York City ignores the S election. If you're an S corporation, congratulations, you're a C in New York City. For New York City source income only. Okay. That's the GCT and then also the UBT unincorporated business tax. And that is a up to 4%. Once you're over about $135,000 of income, it's a flat four sort of goes back, it gets, it has a weird crediting Mechanism which your income is below 135, it lowers the rate. But basically 4% tax on unincorporated businesses which is basically anything taxed as a partnership or disregarded entity. So sole, sole proprietorships, etc. Man, are those traps. Are you weary. They really, really are. People who don't live around here have no idea they exist. They're like what do you mean you have a New York City tax? Or I'm an S corporation, why am I paying attacks at the state level. And my answer is well, okay, I don't know what to tell you. Like that's, that's how it is. That's what New York's going to do. And it's aggressive and it's probably anti business but you know, so it goes and I always cite this as a reason not to make the selection is that the, the GCT is 8.85% the UBT is 4 and has an exemption up to a certain point through the crediting mechanism. So for a lot of businesses like it really can make a difference especially if you're in real estate. Right. Another reason not to put real estate s is in New York City is that UBT does not is not imposed on real estate rents from real estate whereas the GCT does impose tax on rents from real estate. So it's just total base differences can happen too. And base differences can happen with different sourcing, things like that. And you know, leading me into my next point that sourcing really matters. Subsourcing, right? Not just what is New York State tax? What is New York City tax? What is Miami Dade county tax? What is Los Angeles county tax? A lot of large counties, large cities have their own special taxes and they do it because they can really important. You know, people laugh when I say that, but it's true, right? They're not doing it because they want to be friendly or business friendly. They do it because you really can't leave the large metropolitan areas because that's the easiest way to get a whole lot of customers. Right. The concentration is important. And then I often, you know, one, one thing I run into, and this is sort of a tangential point, but it's a local one. It's kind of runs into the nexus issues and issues with, you know, just think about where, where you have to register. But I will see people who have business expenses for things they attended or they went to see a client or something like that in jurisdictions but they say well, I have no physical presence and obviously PL86272 provide some protection for if you're selling tangible personal property. But you know, for SaaS businesses, it's literally as if it's not there. Or, you know, someone has rent for an office in New Jersey and they're like, oh, I never go there. And I'm like, well, then why do you have the office? You know, is it actually a business expense at that point? Right. Going back to a prior episode as well. But that's a really important thing to think about is, you know, what are you deducting? Are you allowed to deduct it and is it in a jurisdiction where you actually have it, you know, actually have a business? So if, you know, this goes back to, like, if you have employees in the state, you know, you're probably doing business there. So you need to make sure your returns match what you say you're doing. And then that's a really important kind of conclusion. Concluding point is that it's all kind of comes together. Where are you doing business? Are you doing business? What states you need to pay attention to? And that's why, you know, a lot of people kind of poo poo state and local tax. And I like a lot of it because it's thinking through problems that really can get nuanced and have a quirk to them that I just think the complexity of them can be really interesting to think about and work through the problems. And they're definitely becoming bigger issues as things move on and people go through. I'm seeing more and more attention paid to, say, local taxes. Definitely post Wayfair, sales tax became a big issue. It's calmed down a bit. People have gotten better at it. There's more focus on it. But you know, definitely, definitely sales tax is an issue. And I think income tax can be really one too. Okay, so. So that was the ninth episode of How Tax Works. I hope you enjoyed it. I hope you learned something. We'll be back in two weeks with the 10th episode. I'm going to be discussing revenue rulings 99. 5 and 99. 6. And now for the best song of all time.