Insights

While forming a new entity is generally quite easy, corporate structure and tax considerations play a fundamental role in a startup’s ability to raise capital. Prospective investors have expectations for how a “venture backable” business (i.e., a business with the potential to generate significant returns with a potentially high valuation) is to be organized under state law and classified for income tax purposes. However, the fundamental question for founders is: what actually makes the most sense for the business? Here we briefly discuss four structures for forming a new business and their tax classifications: (1) a state law corporation classified as a C corporation; (2) a state law corporation classified as an S corporation; (3) a limited liability company (“LLC”) classified as either a C corporation or an S corporation; and (4) an LLC classified as a sole proprietorship or partnership.

Maryland became the first U.S. state to create a digital advertising tax on February 12, 2021. The Digital Advertising Gross Revenue Tax (DAGRT) was originally passed in March of 2020, but subsequently vetoed by Maryland Governor, Larry Hogan. Maryland’s legislature voted to override the Governor’s veto, however. The contentious journey for DAGRT passage is likely to be overshadowed by a litigious future.

In Int'l Bus. Machs. Corp. v. Mich., Dep't of Treasury, No. 146440 (Mich. July, 14, 2014) (IBM), the Michigan Supreme Court held that the taxpayer was entitled to elect the Multistate Tax Compact's three-factor apportionment formula to apportion its income for purposes of the Michigan Business Tax (MBT) and was not required to use the "mandatory" single sales factor formula provided in a separate statutory provision. In overruling the Court of Appeals' 2012 decision that the Michigan legislature had repealed the Compact election provision by implication -- a decision that was widely criticized by many state tax experts including the authors of this Alert (see here) -- the Supreme Court found no clear indication that the Legislature intended to repeal the Compact election provision for the years at issue. Accordingly, reading the Compact election provision and the MBT's statutory apportionment provision in pari materia, the Court held that two statutes were compatible and could be read harmoniously. That is, if a taxpayer makes the Compact election, the three-factor formula is mandatory; if a taxpayer does not make the Compact election, the statutory single sales factor formula is mandatory. The Court also held that the MBT's gross receipts tax meets the definition of an income tax, and that the taxpayer could use the Compact's three-factor formula for both the Gross Receipts Tax and the Business Income Tax parts of the MBT.

Two recent lawsuits in federal court suggest companies are fighting back against the estimation techniques used by third-party contract auditors in unclaimed property audits. In Temple-Inland Inc. v. Cook, No. 1:14-CV-00654-SLR (D. Del. filed May 21, 2014), filed in federal district court last month, the holder of unclaimed property is challenging a contract auditor's (Kelmar Associates) $1.3 million estimated assessment based on federal common law and several constitutional provisions including the Due Process Clause, the Commerce Clause, the Full Faith and Credit Clause, and the Takings Clause. The district court could strike a major blow to Delaware if it holds that estimation methods are unconstitutional. Delaware relies on unclaimed property revenue for almost one third of its budget. Even if the court holds that estimation methods may only be used for periods after 2010 (the year Delaware enacted a statute authorizing auditors to use estimation techniques when adequate business records do not exist), or that Kelmar has a higher burden for applying estimation methods when holders offer up business records, refunds could be required and the entire complexion of unclaimed property audits in Delaware could change for the better going forward.

Crowell & Moring's state tax team traveled from coast to coast in 2013 to introduce the corporate world to 10 of the country's top state tax decision makers. In Crowell's Conversations – a monthly column appearing in Bloomberg BNA's Weekly State Tax Report – we bring you timely and candid observations from different states' commissioners and their counsel. The revenue executives discussed everything from litigation and policy-making to resources and technology to their personal careers. While the questions and responses differed in each column, a common theme last year was the core belief that the states have a higher ethical obligation to get to the "right" answer rather than to collect the most revenue. We hope you have enjoyed getting to know our friends in the state revenue departments, and we look forward to bringing you more great interviews in 2014. Below are links to the first nine interviews. 

Taxpayers should consider whether participation in Connecticut's Tax Amnesty Program may be prudent. The program offers taxpayers a two-month window of opportunity to concede and pay back taxes on all issues they suspect Connecticut may challenge, in order to avoid penalties and reduce interest. 

Companies incorporated in Delaware have until June 30 to enter into Delaware's recent Voluntary Disclosure Agreement (VDA) program and become compliant with their unclaimed property reporting obligations. Under Delaware law, holders of unclaimed property are subject to audit for all open periods: over 30 years! However, holders that enroll in the Secretary of State's VDA program by June 30 will be subject to a "limited" lookback period that goes back to 1996 and will be relieved of interest and penalties. By contrast, companies that are audited by the Department of Finance are subject to liability, including interest and penalties, for years dating back as far as 1981. Companies incorporated in Delaware ought to consider the VDA program regardless of where they do business. Moreover, Delaware escheat law is so broad that it potentially covers companies that are incorporated anywhere in the U.S. if the owners of the unclaimed property have certain connections with Delaware.

Legislation passed by the U.S. Senate on May 6, 2013 would impose sales tax collection obligations on retailers with no physical presence in a state but would not provide a needed income tax safe harbor. 

The Supreme Court of Pennsylvania held last week in Glatfelter that a taxpayer's gain from the sale of a tract of Delaware timberland constitutes business income subject to apportionment and tax in Pennsylvania. This marks the first time the Court has considered the business income issue since the Pennsylvania General Assembly amended the statutory definition of business income in 2001. The opinion is significant because the Court departed from its earlier precedent for treating as non-business income the gain from dispositions that are not integral to the taxpayer's regular trade or business. The Court based its reasoning on the amendments to the statutory definition of "business income," which the Court said altered the analysis despite the General Assembly's comment that the amendments were merely intended to clarify existing law. When preparing Pennsylvania Corporate Net Income Tax reports and financial statements, taxpayers must be aware of the expanded definition that Pennsylvania can be expected to apply going forward in an attempt to garner as much revenue as possible from multistate taxpayers. However, under the right set of facts, the broadened definition could work to a taxpayer's advantage and present a potential refund opportunity. For example, a taxpayer that has treated gain on the sale of Pennsylvania real property as non-business income or a Pennsylvania domiciled taxpayer that has treated a major gain as non-business income should consider filing a refund claim.

UPDATE: On January 16, 2013, the Supreme Court of California granted the Franchise Tax Board's Petition for Review in Gillette. Stay tuned!

Although the Presidential election is over, our nation remains deeply divided – with respect to whether the Multistate Tax Compact is a binding contract, that is! A California court said in Gillette that it is; now a Michigan court says in IBM that it isn't. Which view is correct? Ultimate resolution of this issue could be worth millions of dollars in potential tax refunds for taxpayers who apportioned income to Compact states using a statutory formula that departs from the Compact's elective three-factor formula. Litigation on this issue does not appear to be slowing down and we can't help but wonder if the U.S. Supreme Court ultimately may get involved.    

Tax authorities in several states – in particular Indiana and North Carolina – are increasingly applying their discretionary authority with respect to alternative apportionment to force taxpayers to file combined corporate income tax returns with their out-of-state affiliates by targeting cash management. Such aggressive administrative action raises both statutory and constitutional questions along with practical concerns for multistate taxpayers. Recent activity in Indiana and North Carolina illustrates the growing willingness of state tax authorities to impose upon taxpayers forced combination in order to raise additional revenues. 

UPDATE: In anticipation of the flurry of refund claims likely to be filed by taxpayers following the Court of Appeal's decision in Gillette, the Franchise Tax Board on October 5, 2012, issued FTB Notice 2012-01 clarifying the FTB's position on the Compact Election Issue and addressing the procedures for filing a protective refund claim. According to the notice, the FTB will continue to fight Gillette's right to a refund, despite the holding in Gillette, based on the FTB's position that an election to use the MTC apportionment formula must be made on a taxpayer's original return and cannot be made on an amended return. This comes as no surprise given the dollar amounts at issue. While final resolution of the issue may not come anytime soon, taxpayers should consider filing a protective refund claim before the period of limitations expires for open years. To discuss the options available to your company for filing protective refund claims based on Gillette, contact one of the authors of this Alert.

On August 31, 2012, the Office of Tax and Revenue (OTR) published a long anticipated second version of proposed Combined Reporting Regulations. These regulations are scheduled to be finalized this Friday (September 14) for tax year 2011.