State Corporate Income Tax: Rate Isn’t Top Issue of Concern

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By Che Odom

Companies may be more concerned with how states collect corporate income taxes than with the exact rate.

Still, Arizona, Indiana, New Mexico, North Carolina and the District of Columbia will lower rates this year in an attempt to lure businesses and jobs.

“Those states are still starving for money,” Matthew Mock, a partner in the Chicago office of Baker & McKenzie LLP who focuses on state and local tax litigation and planning, told Bloomberg BNA. “We see those very same states being very aggressive with audits” and “absolutely ignoring” their own laws.

The ways that states audit companies, apportion income and retroactively apply tax statutes are among the big concerns of companies in 2017, according to tax attorneys and analysts who represent companies and advise policymakers.

How states will respond to expected federal tax changes also weighs heavily on the minds of businesses, they say.

“The cornerstone of President Trump’s tax plan is lowering rates and broadening the base,” Renn Neilson, state tax section chair of Baker Botts LLP, told Bloomberg BNA. “It is possible that states will have more room to lower rates by piggybacking on the broader base.”

Some states will view the broader base as creating a windfall, and will keep at least some of the extra revenue by not fully adjusting rates, he said.

“States have been expanding nexus concepts and unitary reporting requirements in an effort to generate additional revenue, so it is possible that states will be opportunistic with the broader base,” he said.

Corporate Rates

Five states lowered their corporate income tax rates for 2017, and New Hampshire reduced its business-profits tax rate, while New York lowered its business capital base rate.

In most of these states, lawmakers decided on the reductions as part of a multiyear phase-down a few years ago.

For example, Arizona reduced its corporate income tax rate to 4.9 percent in 2017 from 5.5 percent in 2016, marking the last step of a phase-down that began in 2015 when the tax rate was 6.5 percent.

Slow Growth

Though corporate income taxes account for just 3 percent of state budgets, states will need to be conservative with cuts in the near term, according to John Hicks, executive director of the National Association of State Budget Officers.

State budgets are growing more slowly than a decade ago. Thirty-nine states have lower spending, when adjusted for inflation, than they did 10 years ago, and half of the states have had back-to-back years of budget shortfalls, he said.

“We haven’t seen that since the great recession,” he added.

States will need to be more reserved, particularly because of the uncertainty of what to expect from the federal government, pension burdens growing and the likelihood of Medicaid funding cuts, he said.

Standout State

North Carolina is a particularly interesting state, according to Nicole M. Kaeding, an economist with the conservative Tax Foundation’s Center for State Tax Policy.

Lawmakers there lowered the corporate income tax rate to 3 percent Jan. 1 from 4 percent, part of a multiyear phase-down.

The reduction was part of a “robust tax reform package” enacted in 2013, when the corporate income tax rate was 6.9 percent, Kaeding told Bloomberg BNA.

“In four years, North Carolina has jumped from one of the highest corporate income tax rates in the South to one of the lowest,” she said. “That’s remarkable progress in a short time frame.”

Phases and Triggers

Generally, the use of triggers or phases to accomplish tax cuts by all of the five states to lower the corporate income tax rate is “striking,” she said.

“Tax triggers and phase-ins are becoming quite popular at the state level as states look to balance tax competitiveness and revenue availability,” she added. “Tax triggers and phase-ins are a responsible way to improve a tax climate.”

The left-leaning Center on Budget and Policy Priorities, however, takes issue with phased-in cuts. In a Feb. 6 paper, the center said they can lead to “major structural problems” for budgets and a “chronic inability of revenues to grow in tandem with economic growth and the cost of government.”

This is, in part, because “lawmakers often adopt large, phased-in cuts not knowing whether or not they will be affordable” down the road, the center said.

Some states find that raising taxes may be more responsible. As part of a budget compromise agreement, Illinois could increase its corporate rate from 5.25 percent to 7.00 percent this legislative session.

The state’s 2.5 percent personal property tax rate would still be applied as well, bringing the total corporate income tax rate to 9.5 percent, Kaeding said.

Total Tax Profile

Corporate income taxes are often a factor in a company’s decision of where to locate, but they are not necessarily the most important factor, Neilson said.

Relatively high rates likely matter less to a company with considerable out-of-state sales “if the state the company locates in uses single sales factor apportionment,” he said.

The entire tax picture is important, he said.

“Texas, for example, collects very little franchise tax,” he said. “Its property taxes, however, are sufficiently high that its overall tax burden is about average, or a little above average, when compared to other states.”

Bigger Concerns

Possibly a more significant concern to companies, states aren’t always clear about how much of a company’s income is subject to tax, Neilson said. Revenue officials may attempt to attribute more income than it should in a given year to the state, he said.

“Equitable apportionment is one concern,” he said. “Some state legislatures have tried to lure businesses by instituting single-sales-factor apportionment. There is a trend for revenue departments to ignore these legislative mandates in cases where companies’ in-state capital and/or labor forces disproportionately outweigh their in-state sales.”

Retroactive legislation is another area of concern, Neilson said. States have been retroactively amending laws to protect state revenue, and they are unlikely to stop without judicial intervention, he added.

The U.S. Supreme Court is currently considering whether it will review state court decisions upholding retroactive tax statutes in Michigan and Washington.

“Taxpayers should be able to rely on tax laws when they are planning transactions,” Neilson said. “They should not have to worry about state legislatures retroactively changing those laws in a money grab years later.”

To contact the reporter on this story: Che Odom at COdom@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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