PORTFOLIO

Income Taxes: The Distinction Between Business and Nonbusiness Income (Portfolio 1140)

Be a trusted advisor to your clients with Bloomberg BNA Tax Portfolios. In this Portfolio, our expert authors examine the various ways in which states determine whether income is business or nonbusiness income.

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DESCRIPTION

Currently, a significant amount of disagreement exists between taxpayers and state taxing authorities over what income may be apportioned under the federal Constitution, and what income constitutes business income under the Uniform Division of Income for Tax Purposes Act (UDITPA). The U.S. Supreme Court's decisions in ASARCO, Inc. v. Idaho State Tax Commission, Container Corp. of America v. Franchise Tax Board, and Allied–Signal, Inc. v. Director, Division of Taxation have made the constitutional issues more, rather than less uncertain. In addition, almost all of the states that have a corporate income or franchise tax or both, experience great difficulty in applying the UDITPA's definition of business income or a similar variant thereof.


The Income Taxes: The Distinction Between Business and Nonbusiness Income Portfolio attempts to present the varied approaches used by the states in characterizing income as either business or nonbusiness in an organized fashion.

 

The Portfolio also focuses on the U.S. Supreme Court's decisions which apply to all taxing states, as well as the UDITPA definitions of apportionable (business) and allocable (nonbusiness) income.


Buy Income Taxes: The Distinction Between Business and Nonbusiness Income (Portfolio 1140) now


AUTHORS

ROY E. CRAWFORD, ESQ.

Roy E. Crawford is Employee Counsel for McDermott, Will & Emery LLP in Silicon Valley. He formerly was a partner in the San Francisco, California office of Brobeck, Phleger & Harrison. Mr. Crawford has served as the Chairman of the State and Local Tax Committee of the ABA Taxation Section, and as a special consultant to the City of New York in the area of taxation of banking institutions. Roy is a co–author of 1910 T.M., California Franchise and Corporation Income Taxes, and 1920 T.M., California Sales and Use Taxes, and the author of “Reorganization and Sale of a Business,” which appears in California Taxation (Matthew Bender). He also sits on the editorial advisory boards of the Journal of State Taxation and the Journal of Bank Taxation.

 

Credentials / Roy received his law degree from the University of Pennsylvania and his L.L.B. degree from Stanford University.


RUSSELL D. UZES, ESQ.

Russell D. Uzes, Esq. is the Partner–in–Charge of the State & Local Practice in the Northwest U.S. for PricewaterhouseCoopers LLP. Before joining PricewaterhouseCoopers LLP, Russell was a partner in the San Francisco, California office of Brobeck, Phleger & Harrison. He was the 1995– 1996 Chair of the State and Local Tax Committee for the California State Bar Association. Russell is co–author of 1910 T.M., California Franchise and Corporation Income Taxes, and 1920 T.M., California Sales and Use Taxes.

 

Credentials / Russell received a B.A. in Economics from the University of California, Berkeley and a J.D. from the University of California, Los Angeles.


TABLE OF CONTENTS

Detailed Analysis

1140.01. INTRODUCTION

1140.02. HISTORY OF THE DISTINCTION BETWEEN BUSINESS AND NONBUSINESS INCOME

Introductory Material

A. Early Apportionment Schemes

B. Federal Action Affecting Apportionment

C. The Uniform Division of Income for Tax Purposes Act (UDITPA)

D. The Multistate Tax Compact and the Multistate Tax Commission

E. U.S. Supreme Court Decisions

1140.03. CONSTITUTIONAL LIMITATIONS ON APPORTIONABLE INCOME

Introductory Material

A. The Mobil Oil and Exxon Cases

B. The ASARCO, Woolworth, and Container Cases

C. The Allied-Signal Decision

D. Apportionment of Income After Mobil Oil, Exxon, ASARCO, Woolworth, Container, and Allied-Signal

1. Apportionment of Income Prior to ASARCO and Woolworth

a. Florida

b. Missouri

2. Apportionment of Income After ASARCO and Woolworth

a. Alaska

b. Arkansas

c. Florida

d. Maryland

e. Missouri

f. Wisconsin

3. Apportionment of Income After Container

a. Definition of "Unitary" Business

b. Classification of Working Capital Investment Income as Business Income

(1) Colorado

(2) Maryland

(3) Ohio

(4) South Carolina

(5) Wisconsin

c. Dividends or Gains from Stock under the Corn Products Doctrine

d. Dividend-Payor Conducting Business in the State

(1) New York

e. Limitation of ASARCO and Woolworth to Their Specific Facts

(1) Alaska

(2) Iowa

(3) Maryland

(4) Montana

(5) New Jersey

f. Limitation of ASARCO and Woolworth to Stock Investments

(1) Virginia

4. Apportionment of Income After Allied-Signal

5. Treatment of Receipts from Intangibles

6. Apportionment Factor Adjustment

a. Apportionment Factor Adjustment in State Cases

(1) Maine

(2) Minnesota

(3) Wisconsin

7. Summary

1140.04. APPORTIONABLE AND ALLOCABLE INCOME

Introductory Material

A. The UDITPA Distinction Between Business and Nonbusiness Income

B. What Is a "Business"?

C. Tests for Business Income

1. The Transactional Test

a. Colorado

b. New Mexico

c. Other States

2. The Functional Test

a. District of Columbia

b. Illinois

c. Indiana

3. The Transactional Test Versus the Functional Test

a. Illinois

4. Other Factors Used to Characterize Individual Transactions

a. Post-Transaction Use of Proceeds of a Sale

b. Built-in Gains and Losses

(1) California

D. Apportionment and Allocation of Income Outside of the UDITPA Statutory Framework

1. Selected States

a. District of Columbia

b. North Carolina

c. Texas

d. Virginia

1140.05. ALLOCATION OF NONBUSINESS INCOME UNDER UDITPA AND NON-UDITPA STATUTES

1140.06. THE CHARACTERIZATION OF SPECIFIC TYPES OF INCOME

Introductory Material

A. Dividend Income

1. MTC Regulations Regarding Dividend Income

2. Dividends from Unitary and Nonunitary Subsidiaries

a. Alabama

b. California

c. Louisiana

d. Non-dividend Distributions

3. Dividends from Investments of Working Capital

4. Dividends Received from Affiliates

a. California

b. Missouri

c. Dividends Received from Less-than-50-Percent-Owned Affiliates

5. Dividends That Are Nonbusiness Income

B. Income from the Sale of Stock

1. MTC Regulations Regarding Income from the Sale of Stock

2. Gains from Sale of Stock of a Subsidiary

a. Minnesota, Maryland, and Illinois

b. Wisconsin

c. California

3. Investment of Working Capital

4. Gains from Sales of Stock of Affiliates

a. California

b. Indiana

c. Pennsylvania

5. Transactional Test Applied to Sales of Stock

a. Income from Trading in the Stock of Subsidiaries

(1) Kansas

(2) Missouri

b. Income from Stock Traded for Investment Purposes

(1) Illinois

(2) Oregon

(3) Pennsylvania

c. Income from Stock Acquired in Business Transactions

(1) Alaska

(2) California

d. Other Scenarios

6. Apportionment Factor Relief

7. Relationship to Internal Revenue Code § 338(h)(10)

8. Nonbusiness Income

C. Interest Income

1. MTC Regulations on the Apportionment of Interest Income

2. Interest Income from Investments of Working Capital

a. California

b. Illinois

c. Missouri

d. Oregon

3. Interest Income from Intercompany Loans

4. Interest Income from Other Investments

a. California

b. Oregon

5. Nonbusiness Interest Income

D. Income from Dispositions of Real or Tangible Personal Property

1. MTC Regulations Regarding Income from Dispositions of Property

2. Application of the Functional Test to Sales of Property

a. District of Columbia

b. Illinois

3. Transactional Test Applied to Sale of Property

a. Minnesota

b. Pennsylvania

4. Liquidation or Partial Liquidation

a. Alabama

b. Illinois

c. Kansas

d. New Mexico

e. North Carolina

f. Pennsylvania

g. Tennessee

h. Conclusion

5. Property Not Yet Integrated Into Business

6. Property Withdrawn from Property Factor

a. California

b. Virginia

c. Conclusion

7. Nonbusiness Income

E. Rental and Royalty Income Derived from Tangible Property

1. MTC Regulations Regarding Rental and Royalty Income

2. Transactional Test Applied

a. Wisconsin

3. Functional Test Applied

a. California

b. Oregon

4. Rental and Royalty Income from Tangible Property in Non-UDITPA States

a. North Carolina

b. South Carolina

c. Virginia

5. Nonbusiness Rental and Royalty Income under UDITPA

F. Income from Patents, Licenses, Copyrights, and Trademarks

1. MTC Regulations Concerning Income from Patents, Licenses, Copyrights, and Trademarks

2. Case Law Dealing With Patents, Licenses, Copyrights, and Trademarks

a. Arizona

b. California

c. Illinois

d. Maryland

3. Nonbusiness Income

G. Income from Partnerships and Joint Ventures

1. Unitary Approach

2. Investment Approach

a. Missouri

b. Tennessee

H. Income from Discharge of Indebtedness

1. Iowa

1140.07. COMMERCIAL DOMICILE

Introductory Material

A. Commercial Domicile under UDITPA

1. Alabama

2. California

3. Kansas

4. Tennessee

B. Commercial Domicile Under Other Statutory Provisions

1. California (Pre-UDITPA)

2. Louisiana

C. Commercial Domiciles of Parent and Subsidiary Corporations

1140.08. COMBINED VERSUS SEPARATE RETURNS


WORKING PAPERS

Working Papers

Item Description Sheet

Worksheet 1 Business/Nonbusiness Income Audit Guidelines

Worksheet 2 Adoption of UDITPA, Apportionable Income, Conformity With MTC Regulations, and MTC Membership

Worksheet 3 UDITPA (Article IV of Multistate Tax Compact) Uniform Division of Income for Tax Purposes Act - Annotated

Worksheet 4 Multistate Tax Commission - Allocation and Apportionment Regulations Pertaining to Business/Nonbusiness Income

Worksheet 5 Multistate Tax Commission - Proposed Regulations on Allocation and Apportionment- Excerpts ("April 1995 Proposal")

Worksheet 6 American Institute of Certified Public Accountants

Worksheet 7 Forty Years of UDITPA: Its Successes and Failures in Limiting Federal Intrusion Into State Taxing Power

Bibliography

Bibliography