Dallas CPA Society 7 th Annual Education Conference

1. Dallas CPA Society7th Annual Education Conference May 26, 2011

2. How the States Want to Ruin Your Budget: Multistate Tax Development • Context • Tax Administration Challenges • Managing the States’ Cash Crunch • Expanding Nexus, or Life After a Physical Presence Requirement • Compliance Complexity DLI-6351186_1

3. I. Context • Overwhelming Concern: Uncertainty • Rapidly changing environment • Formerly separate legal entity state tax returns with generally equally weighted factors; cost of performance for services • More MUCR states, but varying definitions of who is in the group • Heavier weights of sales factors: in 1998 only 5 states weighted sales greater than double-weighted; in 2101, 16 states weighted the sales factor greater than 50% • More states are adopting market sourcing DLI-6351186_1

4. I. Context (cont’d) • States’ Budgetary Challenges • More extensive and more aggressive audit activity • Decoupling from favorable federal tax treatment in areas such as • Bonus depreciation • Section 199 Domestic Production Activities Deduction • Bad Tax Policy / Bad Legislation • Suspension of Net Operating Losses • Distortive Apportionment Schemes: Throwback, throwout DLI-6351186_1

5. II. Tax Administration Challenges • Independent Tax Courts in roughly half the states • Alabama Taxpayer Bill of Rights/Alabama Tax Appeals Commission (HB 427 / SB 232) filed this session (TEI filed a letter April 12 supporting this legislation.) DLI-6351186_1

6. II. Tax Administration Challenges (cont’d) • Contingent Fee Audits: legislation filed in Minnesota, California. Ongoing “transfer pricing” income tax audits in New Jersey, District of Columbia, Kentucky, and Alabama. Contingent fee audits in areas of unclaimed property area and gross receipts taxes. DLI-6351186_1

7. II. Tax Administration Challenges (cont’d) • Retroactivity issues • How much retroactivity is permissible? • California’s substantial underpayment penalty – 5 year retroactivity – due process concern (TEI submitted an amicus letter in CalTax case challenging the penalty.) • Ameritech in Wisconsin: the law at the time of the case was cost of performance, although Wisconsin subsequently changed its law to market sourcing. Ameritech marketed telephone directories in Wisconsin, but none of the cost was incurred in Wisconsin. It almost appeared that the court imposed the new market sourcing retroactively to a period when COP was the law of the land. DLI-6351186_1

8. II. Tax Administration Challenges (cont’d) • Administrative rules and audit practice contrary to unambiguous statute • North Carolina statute requires a separate legal entity tax return YET • Forcible combinations on audit in Delhaize and Walmart • New combined reporting regulation offers little guidance, but appears to suggest that intercompany pricing creates a presumption of distortion DLI-6351186_1

9. III. Managing the States’ Cash Crunch • If the state has no cash, can you apply state IOU’s to other taxes? • Can taxpayers use the cash crunch to their advantage? • New Jersey’s Throwout Settlement Initiative (Note: Pfizer / Whirlpool oral argument set for May 3-4). • Nortel – failure to pay California’s expert witness DLI-6351186_1

10. IV. Expanding Nexus, or Life After a Physical Presence Requirement • Economic nexus – the “death of 1000 cuts” beginning with Geoffrey, Lanco, The Classics. If the U.S. Supreme Court continues to refuse to hear these cases, does that validate economic nexus? • Initial economic nexus cases required affiliation, but MNBA, KFC were third parties • There is hope the USSC will take KFC (briefs due in May) DLI-6351186_1

11. IV. Expanding Nexus, or Life After a Physical Presence Requirement (cont’d) • Factor Presence Nexus: the California standard ($50,000 property or payroll, $500,000 sales); Washington B&O changes • Provisions apply to controlled foreign corporations • Concern with disparate tax treatment of foreign corporations for U.S. and state income tax purposes DLI-6351186_1

12. IV. Expanding Nexus, or Life After a Physical Presence Requirement (cont’d) • New federal Business Activity Tax Simplification Act of 2011 (“BATSA”) filed April 8: HR 1439 by Bob Goodlatte (R-VA) and Bobby Scott (D-VA) would clarify the nexus standard governing state assessments of corporate income taxes and comparable taxes on business. DLI-6351186_1

13. V. Compliance Complexity • Nortel Networks vs. SBOE • Strange result • Disruption • Unpredictability DLI-6351186_1

14. V. Compliance Complexity • Colorado requirement to alert customers of use tax responsibilities and providing state with information on customers’ purchases • Massachusetts tax return schedule showing impact of single sales factor versus traditional 3-factor with double-weighted sales DLI-6351186_1

15. V. Compliance Complexity (cont’d) • Maryland information return to assess impact of combined reporting, as well as schedule to assess impact of single sales factor versus 3-factor apportionment DLI-6351186_1

16. V. Compliance Complexity (cont’d) • Mandatory unitary combined reporting (MUCR) is statutorily different state by state – and may be different on audit: New York’s 10-step test of “who’s in and who’s out” of the combined group was supposed to avoid discretion to determine distortion DLI-6351186_1