Articles Posted in Corporate Income Tax

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Many individual and corporate taxpayers are becoming annoyed with rising tax rates. For many wealthy Americans, income is taxed federally and by many states at the corporate level and then taxed again when the income is distributed to the shareholders of the corporation. Without even taking into account state and local taxes, most corporations are taxed a 35% rate and, with the recent tax increases, individuals are taxed at a rate over 40%. This has led to some creative tax planning in the recent years.

One recent development, as explained in more detail at CNBC.com, is a move by a number of corporations, namely private prisons, casinos, and billboards, to convert to a Real Estate Investment Trust (“REIT”). The REIT was developed as a vehicle for investors to pool money and share costs when investing in a diversified real estate portfolio. In short, a REIT is an investment pool in which a company (a trust) essentially manages the money of its investors and returns the profits to the investors. For more information about a REIT, please click here to learn about NNN, the REIT that once employed me.

The REIT has been around for decades and was largely used by only for real estate holdings. Recently, companies such as the Correction Corporation of America, a large prison company, has received the IRS’s blessing to be reclassified as a REIT. Other companies, such as Penn National Gaming, M Resort Spa and Casino, and Geo Group have also received the ok to be designated as a REIT.

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It is difficult to change the channel without hearing some development this week in the Boston Marathon explosion. This week in April, 2013 has been mostly a dark one. However, as we tend to in the face of crisis, our nation has shown its resolve and unity. While it can never replace the loss of life and the feeling of fear that stemmed from the incident, there have been some rays of sunshine. Among the acts of good faith to those struck by this horrible event are the IRS and the Massachusetts Department of Revenue. Each has shown some leniency for its respective filing deadlines.

With tax day marked as April 15, 2013, the IRS allowed for an extension as a result of the tragedy. Specifically, the IRS has allowed for a three-month filing and payment extension to Bostonians and others affected by the explosions. Consequently, no filings or payments will be due if completed by July 15, 2013. The three-month leniency applies to all individuals who are residents of Suffolk County, Massachusetts, including the City of Boston. The IRS also allowed an extension for victims and their families, first responders, and those who had preparers that were adversely affected.

Piggybacking on this idea was the Massachusetts Department of Revenue for state and local tax filings. Massachusetts announced that state and local tax payers have another week to file their returns. That means any person or business that has personal, business, or corporate income tax returns has at least until April 23, 2013 to file their returns.

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In 2012, Scioto Insurance Company v. Oklahoma Tax Comm’n, 279 P. 3d 782 (Ok 2012), the Supreme Court of Oklahoma was the most recent high court to tackle the question of foreign intellectual property holding companies. Similar to the line of cases addressed above, Scioto is a Vermont holding company with nothing in Oklahoma. Specifically, Scioto receives fees for the use of its intellectual property used based on a percentage of gross sales made by Wendy’s in Oklahoma.

Digging further into the facts of the case, Scioto was established to insure risks of Wendy’s restaurants. In order to establish Scioto, Wendy’s transferred intellectual property to Scioto. Scioto only insures Wendy’s International and does not insure any restaurants in Oklahoma, rather Wendy’s franchises individual restaurants within Oklahoma’s borders. In exchange for use of the intellectual property, Wendy’s restaurants in Oklahoma pay 4% of their gross sales to Wendy’s International and those amounts are included as income for purposes of its state income tax return. Wendy’s International then pays and deducts 3% of this payment to Scioto for use of the intellectual property.

The court began its analysis by stating that whether or not Wendy’s International received any payments from restaurants in Oklahoma it still had an obligation to pay Scioto for use of the intellectual property. The court went on to distinguish the case from Geoffrey in that Scioto was not a shell corporation and actually had a bonafide business purpose. Perhaps most interesting in the short opinion is the fact that the court seem to decide the case on due process grounds. This highlights the importance to a state and local tax professional to argue due process in addition to commerce clause nexus in state and local tax cases.

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In 2012, West Virginia (home of MBNA) went after ConAgra Foods, Inc. ConAgra is a trademark holding company and wholly owned by a Nebraska subsidiary of CA foods. ConAgra held valuable trademarks and trade names from affiliated and unrelated entities such as Armour, Butterball, Healthy Choice, Kid Cuisine, Morton, and Swift, and licensed them back for a fee. With the recently decided KFC and MBNA on the back burner, West Virginia seemed destined to rule in the state’s favor on a seemingly similar transaction. Surprisingly, the West Virginia Supreme Court went the other direction.

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In 2011 a devastating taxpayer case in the SALT corporate income tax was decided. This slightly different spin on the case was introduced by a famous colonel and his chicken company. The company, known as Kentucky Fried Chicken, was incorporated in Delaware with a headquarters in Kentucky. KFC.jpgKFC licensed its valuable name to franchisors nationwide, including into Iowa. Slightly different than the related trademark license in the Geoffrey cases, KFC licensed its trademark to franchisor’s who independently owned KFC’s. Certainly the use of the KFC trademark in Iowa could not force Kentucky based KFC to pay Iowa income tax could it?

The Supreme Court of Iowa ruled that it could in 2010. Lacking physical presence, the court said KFC was economically present in Iowa because its trademarks were firmly rooted in Iowa. Further, the court opined that such intangibles were functionally equivalent of physical presence. The court concluded “the intangibles in Iowa” provided sufficient nexus. How an intangible trademark could be firmly rooted anywhere or be present in Iowa is beyond me. In its liberal reading of Quill the court stated that physical presence was limited to sales and use tax cases because the burdens of filing income tax are far less than that of a sales and use tax. Following the logic in this case, there is no telling how far states can go to tax foreign trademark holding companies.

About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, and Florida probate. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone listed on this page.

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From the days of Geoffrey through 2011, the states were largely victorious in corporate income tax nexus cases involving “foreign” holding companies. For example, Geoffrey itself lost in Louisiana (2008) (Bridges v. Geoffrey, Inc., 984 So. 2d 115 (La. Ct. App. 2008)), Massachusetts (2009) (Geoffrey, Inc. v. Comm’r of Revenue, 899 N.E. 2d 87 (Mass. 2009)), and Oklahoma (2005) (Geoffrey, Inc. v. Oklahoma Tax Comm’n, 132 P.3d 632 (Okla. Ct. App. 2005)). Other companies such as Lanco Inc in New Jersey (Lanco, Inc. v. Director, 908 A. 2d 176 (N.J. 2006)), Abercrombie & Fitch in North Carolina (A&F Trademarks, Inc. v. Tolson, 605 SE 2d 187 (N.C. App. 2004)), and The Classics Chicago, Inc. in Maryland (The Classics Chicago, Inc. v. Comptroller, 985 A 2d 593 (Md. Ct. Speical App. 2010)) all marked taxpayer losses.
In 2006, the Geoffrey concept was extended by the Supreme Court of West Virginia in Tax Commissioner v. MBNA America Bank, 640 SE 2d 226 (W. Va. 2006).

In MBNA, a credit card company with its headquarters in Delaware had no real or tangible property in West Virginia. For the two years of corporate income tax at issue, MBNA had gross receipts totaling over $18 million. The court concluded that while physical presence was required for sales and use tax purposes, it was not for corporate income tax purposes.
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With sparse logic and a few “authoritative law review” articles, the court opined that Quill was limited by the following language:

Although in our cases subsequent to Bellas Hess and concerning other types of taxes we have not adopted a similar bright-line, physical-presence requirement, our reasoning in those cases does not compel that we now reject the rule that Bellas Hess established in the area of sales and use taxes.

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Trademark licensing companies have always been a difficult inquiry for courts to analyze from a constitutional perspective in the state and local tax arena. At its very basic level, the trademark licensing company cases involve a holding company (almost always a Delaware company) with no physical assets or employees in the taxing state. The holding company holds a valuable intangible asset, a trademark for example, and charges another company a fee to use that intangible asset to sell goods in a taxing state. The question then arises – does the taxing state have the power to tax the out-of-state holding company based on other company’s use of its trademarks within that state?
Trademark.jpgThe only Supreme Court case that attempts to address this issue is Quill Corp. v. North Dakota, in 1992. In Quill, the Court held that in order for a state to have the power to tax a company within that state, the company must have some “physical presence” within that state. To add another wrinkle, Quill dealt with the ability for a state to force a company to collect its use tax. Does this “physical presence” apply to sales tax? What about corporate income tax?
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Traditionally, if a corporation met the eligibility requirements of an S-Corporation, then it is almost always advisable to elect “S” status for small corporations. However, amidst the fiscal cliff tax act of 2012, some of our clients have explored the option of converting to a C-Corporation. While the results of an empirical analysis are important, other often overlooked ramifications should be considered.

By way of background, many businesses incorporate to shield its owners from personal liability as a result of acts of the business. Most small businesses organize as “pass-thru entities,” which are S-Corporations, Limited Liability Companies (LLC’s), or partnerships. Such entities are called “pass-thru entities” because the entity itself does not pay tax; rather the income is taxed when it “passes through” to the owners. In a simple example if ABC, Inc. earns $100 and it has 2 owners taxed at a 35% rate, it will not pay tax on $100. Rather the owners will report income of $50 and pay tax of $17.50.

In contrast, the traditional C-Corporation is not a “pass thru entity,” because a corporation is taxed twice. The C-Corporation is taxed on income it earns and then is taxed again when its earnings are distributed to its shareholders in the form of a dividend. In my simple example, if ABC, Inc. was a C-Corporation, it would be taxed at 35% on its $100 of income, resulting in $35 of tax at the corporate level. Upon distributing its remaining $65 to its lone shareholder, the income would get taxed again. Assuming the old 15% tax rate on dividends, the shareholder would then pay another $9.75 in tax. Therefore, purely because of its structure, $9.75 in additional tax would be due if the company were set up this way. Adding several 0’s to my simple example, one can easily see how this simple example can quickly become an issue.
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