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Changing tax laws create challenges, planning is essential

Doing business across state lines always presents challenges. Among them is understanding and managing state taxes  sales and use tax, property tax, personal and corporate net income tax, franchise taxes and more. State taxes impact the profitability of businesses and individuals.

States also make compliance difficult by changing laws annually. Some changes are minor, but others can be extensive. Although many states have recently implemented tax law changes, the past couple of years have seen significant changes in tax laws in Ohio, Kentucky, Texas, Florida and Michigan. Add to this the proposed changes in Illinois with a possible gross receipts tax and possible increases in personal income tax rates, and businesses and individuals could see significant changes. Following is a brief summary of some recent state tax changes. While they may not apply directly to you, they illustrate the complexity of managing state taxes for a taxpayer conducting multi-state operations, and the need for professional advice.

Ohio creates Commercial Activity Tax

Apparently Ohio lawmakers feel it is a privilege to do business in their state, and they created the Commercial Activity Tax (CAT) so businesses can pay for the privilege. CAT is being phased in over a five year period that began on July 1, 2005. It replaces the corporation franchise tax and the tangible personal property tax. Basically, the CAT is based on gross receipts for business activities in the State of Ohio, whether the business has a physical presence in the state or not. This new tax creates controversy as to a new test of economic versus physical presence. CAT applies to all business types and forms, and very few exceptions exist.

Kentucky Tax Modernization expands corporate tax base

In Kentucky, the governor signed a sweeping tax bill in March 2005 that will impact taxpayers for years to come. Among the many taxes overhauled, the corporate income tax base was expanded to include all pass-through entities (LLPs, LLCs, including single member LLCs, limited partnerships and S corporations).

Effective for tax periods beginning on Jan. 1, 2005, the top corporate income tax rate was reduced and lower brackets were expanded. Regardless of income, a minimum tax of $175 must be paid by all Kentucky taxpayers subject to the corporation income tax. Corporations subject to the income tax must pay the higher of the income tax, alternative minimum tax, or the minimum tax. The corporate license tax was eliminated for corporations and S corporations effective on or after Dec. 31, 2005.

Texas Franchise Tax gets an overhaul

For years, avoiding the Texas Franchise Tax was as easy as holding Texas assets in a separate limited partnership. Unlike corporations and limited liability companies, limited partnerships were not subject to the tax. That will change with returns due on or after Jan. 1, 2008, when an overhauled franchise tax takes effect. The new law replaces the former franchise tax and applies to a broader class of businesses, including corporations, limited partnerships, business trusts and certain combined groups. Sole proprietorships, most general partnerships and certain other entities will be exempt.

The existing tax based on net income and capital values is replaced with a new tax rate of 1 percent of taxable margin   either 70 percent of total revenue, or total revenue reduced by the cost of goods sold or compensation expenses, the lesser of which is apportioned to Texas based only on sales.

A lower tax rate is applicable to businesses engaged only in retail or wholesale sales. Taxpayers with total revenues from business less than $300,000, or having a tax due of less than $1,000, are exempt from paying the new tax.

Florida repeals Intangible Property Tax

Florida 's Intangible Personal Property Tax expired on Dec. 31, 2006, putting an additional $131 million in the pockets of Floridians. The annual tax was imposed on Jan. 1 of each year. It was based on the current market value of tangible personal property owned, managed or controlled by Florida residents and businesses. The first $250,000 in value was exempt ( $500,000 for married couples). Stocks, mutual fund shares, ownership interest in a limited liability company, interest in limited partnerships, bonds and loans were among the intangible property covered by the law.

Before the repeal, many Floridians avoided the tax by creating an irrevocable trust to hold personal property. With the repeal, these trusts will no longer be needed; however we must ponder how a State with no personal income tax will recoup the tax dollars lost due to the elimination of this tax.

Michigan Single Business Tax ends in 2007

Amid much debate, Michigan decided to accelerate its repeal of the 30-year-old Single Business Tax (SBT) on Dec. 31, 2007. The nation 's only major value-added tax, the SBT is based on the value a firm adds to products  the sale price less the cost of materials. Nearly half of Michigan businesses are subject to the tax, and it accounts for $1.9 billion, or about 20 percent of the state 's annual general fund.

While the governor and legislators agreed that the repeal was a shot in the arm for Michigan businesses, a big concern remains: how the revenue will be replaced.

— Kenton Bowles is a senior manager of state and local tax services at Clifton Gunderson LLP and can be reached at 888-CPA-FIRM or kenton.bowles@cliftoncpa.com.

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