I Have a (Tax) Plan for That: The Imminent Return of Multistate Tax Planning
The days of naked Delaware holding companies and royalties paid for giraffes named Geoffrey may be long gone but, thanks to the Tax Cuts and Jobs Act of 2017, multistate tax planning is back on the minds of corporate CFOs. During the 1990s, variations in the tax laws and policies among states imposing corporate income taxes inspired practitioners to present a smorgasbord of plans to restructure multistate organizations with the intent of exploiting these differences to reduce the overall corporate state tax burden.
While corporate taxpayers were never under any obligation to pay an excess of tax, bad planning led to bad audit results and bad press for public companies. With the arrival of Sarbanes-Oxley and an obligation to shine a bright financial reporting flashlight into the shady recesses of risky tax planning, CFOs eventually lost their appetite for the topic of multistate tax planning. The entire concept, largely promoted by the tax practices of the Big 4 firms themselves, seemed to just fade away.
This was understandable. While a net multimillion-dollar reduction in state tax was welcome, it was mere noise next to tens of millions in federal tax cost. Weighed against exposure risk and the significant operational disruption some tax planning ideas required, any number of areas became worthier of C-level attention.
Enter the Tax Cuts and Jobs Act
Before the Act, state tax may have represented 20% or less of the overall below-the-line tax burden. Now, the reduction of the federal corporate tax rate from 35% to 21%, along with other federal law changes and significant state decoupling from these changes, means that state income taxes will now represent a third (or more!) of the total tax burden.
Does this mean that risky tax planning should again be considered? Of course not. Bad tax planning only worked while state tax authorities remained ignorant of such schemes. These same tax authorities are today far more sophisticated, and anti-abuse legislation proliferated by state legislatures closed many of the vulnerabilities in the tax codes.
Does this mean that multistate tax planning is dead? Again, of course not. Take, for example, state unitary taxation. During the 1990s, roughly half of the states imposing a corporate income tax did so on a separate legal entity basis, while half taxed unitary corporate group affiliates as a single taxpayer. Because intercompany transactions were eliminated in unitary states, shifting income from a legal entity primarily operating in states taxing entities separately to a legal entity operating primarily in unitary states resulted in lower tax for the first entity with little or no tax effect in unitary states.
Today, almost three quarters of the U.S. population resides in states that have adopted unitary taxation. As intended by such laws, it is now difficult to play the rules of one state off against those of another state. Even where possible, it may be inadvisable to do so as sham transaction, business purpose and related financial reporting requirements negate any financial statement benefit.
Not All State Unitary Taxation is Created Equal
Available state-specific elections and requirements as to unitary group make-up, apportionment methodologies, federal conformity and other quirks militate against cookie-cutter treatment of the corporate group in unitary states. Significant differences may exist in the proper determination of the group tax base in one state vis-à-vis another unitary state. The word “proper” is important here. Whereas historical risky planning took advantage of the unintended consequences of disparate state tax laws, many of the variations that exist today intentionally reflect state policies promoting interests such as business development and in-state industry preservation. To ignore this effect may be, at best, costly and, at worst, poor corporate governance.
As with many things related to taxation, in the end it all comes down to the math. Where the relative portion of the multistate tax burden has now increased more than 150%, the calculus suggests it is once again time to consider available (legitimate) state tax planning.
I began my corporate tax career working in the crucible that was the heyday of large-scale corporate restructuring to reduce multistate income taxes. While I believe that the restructuring my group designed and implemented was legitimate and far more nuanced than the blatant corporate tax avoidance schemes that made the news, those days have come and gone.
What remains are complicated and varied state tax laws that require thoughtful and measured application to corporate groups with divergent facts and goals. At GAGNONtax, our people have the experience, technical know-how and creativity necessary to ensure that your organization is operating at peak tax efficiency.
Please contact us for a no-obligation evaluation of your corporate multistate tax footprint and let us apply the art and science required to develop good tax planning to your organization!