Today, many banks file tax returns in more than one state. This is often because, with geographic expansion, banks have physical locations in different states. Also, the economic nexus rules of many states now require a tax return to be filed and tax paid, even if the taxpayer does not have a physical presence in the state.
This article will summarize some of the current trends in state taxation for banks—economic nexus, tax apportionment, and combined reporting.
Traditionally, banks have filed tax returns in states where they have physical locations, or in states where employees do their work (i.e., a loan originator working for the bank out of a home office in another state).
However, states are increasing their use of economic nexus standards to raise revenue from out-of-state businesses deriving income from their states. Under the economic nexus rules, a state will require a tax return to be filed if the business has sufficient economic presence in the state, even if the business does not have a physical presence or employees in the state.
For 2016, of the 50 states plus the District of Columbia, 41 have an economic nexus requirement, six do not, and the other four do not have a corporate income tax.
Several states have adopted nexus thresholds, meaning that there is no nexus in that state unless certain levels of property, payroll, and/or gross receipts are reached.
In some states, if a business registers or otherwise obtains authority to do business in the state, nexus is created, even if no business is actually conducted in the state.
Each economic nexus state has different nexus rules, although economic nexus is becoming more prevalent. This means a bank is increasingly likely to have nexus in a state other than its home state. If your bank is deriving income from a state, or is registered to do business in a state, it is important to understand the nexus rules and how they apply to your bank. If a tax return is not filed in a state for a particular year, there is no statute of limitations, so the state can look back as many years as it wants to and impose tax liabilities and penalties if warranted.
After taxable income is computed for a particular state, an apportionment factor is applied to that taxable income to determine the apportioned taxable income, then the tax rate is applied to that amount to compute the tax. In addition to differences between states in the calculation of taxable income, there are also differences in the calculations of the apportionment factors.
There are three factors that states use to apportion income:
Gross Receipts – gross receipts in the state divided by gross receipts everywhere
Payroll – payroll in the state divided by payroll everywhere
Property – average balance of property in the state divided by average balance of property everywhere
Traditionally, most states have used all three factors to calculate apportionment. Some states have equal weighting to each factor (add the factors together and divide by three), while some states double-weight the Gross Receipts factor (double the Gross Receipts factor, add the other two factors, and divide by four).
However, with economic nexus becoming more prevalent, more states are moving toward a single-factor gross receipts apportionment. If a company does not have any payroll or property in a state, but only derives income from that state, the apportionment factor, and therefore the tax, will be higher under the single-factor formula.
It is important to note that states vary in how each factor is computed, so you need to know the apportionment rules in each state in which your bank has nexus. For example, some states source income and/or loans for the Property factor based upon location of the collateral (or borrower address, if an unsecured loan); while others source based upon where the solicitation, investigation, negotiation, approval and administration occurs (SINAA). That is most often the state in which the main office resides. Some states, such as Massachusetts, source income based on collateral location (market based sourcing), but source loans based on SINAA.
If your bank is part of a consolidated group, with a holding company and/or subsidiaries, a consolidated tax return is filed for federal tax purposes. Another trend in state taxation is to require some type of combined reporting for unitary businesses – assessing a tax on the total group, even if only one entity has nexus in that state.
A unitary business is a group of related business organizations doing business that share a unity of ownership, operation, and use, and whose functions are interdependent. Generally, in the community bank arena, corporations filing a federal consolidated return likely comprise a unitary business.
In 2003, 16 states required combined reporting (only New Hampshire and Maine in the Northeast), while the others only assessed tax on the entity with nexus. In 2016, 26 states require combined reporting, including all New England states (other than Vermont) and New York.
This means that, in several states, a greater portion of the combined group’s income will be subject to tax; however, likely with a lower apportionment to that state.
State taxation has become increasingly complex, and will continue that trend in the future. It is important to understand the state tax rules in the states from which your bank derives income so that you can file appropriate and accurate tax returns. It is also critical to understand your bank’s state tax positions in order to record the correct financial statement state tax expense.