Closing State Corporate Tax Loopholes

1. Closing State Corporate Tax Loopholes Michael Mazerov (mazerov@cbpp.org) Center on Budget & Policy Priorities AFL-CIO Workers’ Voice Conference San Francisco, California July 20, 2003

2. Why address state corporate tax loopholes (and giveaways)?

3. Why address state corporate tax loopholes (and giveaways)?

4. Why address state corporate tax loopholes (and giveaways)?

5. Why address state corporate tax loopholes (and giveaways)?

6. First, DO NO HARM;Stop New Revenue Losses From: • State corporate income tax coupling to federal deduction for “bonus depreciation” in 2002 and 2003 federal tax cut bills • States can “decouple” their laws; 31 have already

7. States that Need to “Decouple” from Federal “Bonus Depreciation”

8. First, DO NO HARMStop New Revenue Losses From: • New economic development giveaways. • Still proliferating (e.g., “single sales factor” corporate tax formula enacted this year in Wisconsin)

9. First, DO NO HARMStop New Revenue Losses From: • Proposed federal legislation restricting state corporate tax powers • Known as “business activity tax” (BAT) “nexus” bill • Would require a corp. to have a “substantial physical presence” in a state before that state could tax its profits • Higher nexus threshold than required at present, so states would lose $ rapidly • Opens up all kinds of new tax shelters

10. First, DO NO HARM; Block Proposed BAT Nexus Bill to Avoid Revenue Losses • NCSL considering resolution to endorse proposed BAT nexus bill • Corporate America demanding this bill as quid pro quo for empowering states to tax Internet sales • NCSL (rightfully) wants this; but too high a price to pay • Need to block any NCSL resolution on BAT nexus at this time

11. Closing Corporate Tax Loopholes: Delaware Holding Companies • Public Enemy #1 • A-k-a Passive Invest. Co. (PIC) or Intangibles Holding Co. (IHC) • Most often set up in DE, NV, MI • Most famous DHC is “Geoffrey [Giraffe]” DE subsidiary of Toys R Us • Are essentially shell corporations set up by banks and accounting firms; “HQs” of 500 DHCs are in a single DE building

12. How the DHC game works • Step 1: Parent corporation sets up DHC in state without corporate income tax (NV) or that doesn’t tax corps whose only income is from intangible assets (DE, MI) • Step 2: Parent transfers to DHC its patents, trademarks, “know-how,” etc. • Step 3: DHC licenses back to parent the right to use patents, trademarks, etc. in exchange for tax-deductible royalties • Result: payment of royalties reduces (perhaps eliminates) taxable profit of parent, while DHC is not subject to tax on its profit

13. Documented DE Holding Companies(see: Glenn Simpson, “A Tax Maneuver in Delaware Puts Squeeze on Other States,” Wall Street Journal, 8/9/02, page 1)

14. States Still Losing Revenue to the “DE Holding Company” Tax Shelter

15. Shutting Down DHC-sStrategy #1: Quick Fix • Amend state law to deny deductions for royalty/interest payments to DHC subsidiaries in tax haven states • Already enacted in AL, CT, MA, MS, NC, NJ, OH • Proposed and still alive in DC, PA • Business killed in MD, MO, TX • MA and NJ laws best model; business community has pushed through ineffective/weak versions in AR & NY

16. Shutting Down DHC-sLong-term Solution • Switch state corporate income tax to “combined reporting” by amending law • Treats parent and subsidiaries as one corp. for tax purposes; therefore, no benefit to shifting income to DHC • Also nullifies other strategies for shifting income to out-of-state subsidiaries • 16 states already use • Govs, legislators, or activists pushed this session in IA, MD, MA, NY, WI (no success)

17. States that Need to Adopt “Combined Reporting”

18. Closing Corporate Loopholes:“Nowhere Income” • Problem: Corporations can make sales in states in which they don’t cross taxability threshold — “have nexus” • Solution: enact “throwback” or “throwout” rule • Ensures that corps. are taxed on profits they earn in states where they aren’t taxable — home state taxes profit instead • NJ enacted 2002; MD 2003 (Gov vetoed)

19. States that Need to Adopt “Throwback Rule”

20. Eliminate Unwarranted Corporate Tax Giveaways • Repeal “single sales factor formula” • Giveaway to corps. that sell most of what they produce out of state — especially manufacturers • Big business still actively seeking in AZ, CA, NJ, NY, PA, RI (be on guard) • Repeal being pushed in IL, MA, MO

21. States that Need to Repeal “Single Sales Factor Formula” (and Similar Giveaway)

22. Eliminate Unwarranted Corporate Tax Giveaways • Repeal ability of corporations to “carry back” current losses to years in which they were profitable and obtain refunds of taxes paid in those years • Only minority of states still allow

23. States that Need to Repeal NOL “Carrybacks”

24. Other Current Corporate Tax Reform Efforts • Legislation was introduced in TX to close “Delaware Sub” loophole (use of limited partnerships to avoid franchise tax). Gov. supported; business killed. • NV Gov. Quinn proposed business gross receipts tax — OK, but CIT better. Business killed.

25. Other Corporate Tax Reform Options: Enact Corporate Minimum Taxes • Enact a second corporate tax not based on profits; corp. pays higher of profits tax or tax on other base • NJ enacted alternative minimum tax last year based on gross receipts • Another good model is NH’s alternative tax based on value added

26. Other Corporate Tax Reform Options: Stop Tax Avoidance from “Limited Liability Companies” • LLCs are businesses whose profits are taxed on the owners’ tax returns — whether owners are individuals or other businesses • Growing evidence that corps are using LLCs to avoid state profits taxes • Need to pass laws requiring LLC to withhold and pay tax due from out-of-state owners unless owners agree in writing to pay tax due on their pro-rata share of LLC income

27. Chipping Away at the Internet/ Catalog Sales Tax Loophole • Need federal law to ensure sales taxation of all Internet/catalog sales • But states can require their vendors to collect sales taxes (e.g. Dell Computer). AR, NC, SD do. • States can amend and then enforce laws to compel “dot-com” subsidiaries of retail store chains to charge sales tax (e.g. Barnes & Noble.com)

28. A recent column headline (and accompanying cartoon): “It’s Time to Curb Corporate Tax Shenanigans” From The Nation? Mother Jones?

29. No! The Wall Street Journal (9/19/02)

30. Closing Corporate Tax Loopholes & Repealing Unwarranted Giveaways • Time is ripe; take advantage of current anger about phony financial reporting and aggressive tax sheltering to push reform • Can raise meaningful amounts of revenue now and help preserve state programs from budget cuts • Lays the groundwork for revitalization of corp. income tax as state revenue source; without it, CIT will steadily decline