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)?

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 HARM Stop 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 HARM Stop 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) Aaron RentsHome DepotSnap on Tools ADP, Inc.HoneywellStaples American GreetingsJP StevensStanley Works BeatriceKmartSunglass Hut Budget Rent-A-CarKimberly ClarkSyms Burger KingKohl’sSherwin-Williams CompUSALong John Silver’sCasual Male ConAgraMay Department StoresLimited/V’s Secret Dress BarnMarsh SupermarketsTyson Food GapPayless ShoesourceToys R Us Gore[tex] IndustriesRadio ShackUrban Outfitters

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

15. Shutting Down DHC-s Strategy #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-s Long-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