Profits splits, tax incentives, income shifting, nexus, pass-through entity tax elections, and commercial domicile are just some of the state and local tax (SALT) issues that companies should incorporate in planning substantive changes to their supply chain. Tax Beat hosts, Brooks and Sarah, talk with Cherry Bekaert’s State and Local Tax Practice Leader, Cathie Shaw about these issues and more covering income tax, franchise tax, and sales and use tax. As Cathie says, don’t leave SALT as a footnote to your company’s strategic plan.
Chapter Markers:
- 3:53 — Legal Entity, Structuring, and Tax Incentives
- 9:00 — Entering and Exiting Markets
- 10:50 — Splitting Profits and Transfer Pricing
- 15:13 — Nexus and New Guidance for Public Law 86-272
- 19:11 — Sales and Use Tax Considerations
View All Tax Beat Podcasts
HOST: Welcome to the Cherry Bekaert Tax Beat, a conversation about tax that matters.
BROOKS NELSON: Welcome to this edition of the Cherry Bekaert Tax Beat podcast. Today we're looking at the impact of state and local taxes when businesses make changes to their supply chains—income and franchise tax, sales and use tax, and tax credits and incentives. All of this can have implications when you're onshoring related entities that produce parts and supplies.
BROOKS NELSON: New taxes can apply when companies merely shift to new suppliers. Anytime you're moving around states in our country for any aspect of your business, there's always the potential for state and local taxes to play a role. So let's introduce my colleagues who are joining us on the podcast. Kathy.
KATHY STANTON: My name is Kathy Stanton. I'm the national leader of state and local tax for Cherry Bekaert, and I'm sitting in the Washington, D.C., area. We've had some cold weather lately and more snow coming this weekend, but I'm glad to be here.
BROOKS NELSON: Sarah?
SARAH MCGREGOR: This is Sarah McGregor calling in from sunny Greenville, South Carolina, though we're expecting a winter storm this weekend.
BROOKS NELSON: I'm Brooks Nelson. I'm a partner based in Richmond, Virginia, but I'm on the slopes of Snowmass, Colorado, as I speak. Snow is coming, and I gratefully accept it.
KATHY STANTON: So you're telecommuting, eh?
BROOKS NELSON: Yeah.
KATHY STANTON: Are we filing a return in Colorado?
BROOKS NELSON: Of course we are.
BROOKS NELSON: Sarah McGregor, how's life treating you?
SARAH MCGREGOR: Life is good. We're at the beginning of our 2022 tax season for filing 2021 tax returns, and I'm glad we're talking with Kathy because state and local taxes are becoming a much more important and complicated part of tax compliance.
BROOKS NELSON: Let me begin with a little background. From a business perspective, supply chain is at or near the top of concerns for almost everyone. You may have people issues as number one, but the vast majority of businesses have supply chain concerns.
BROOKS NELSON: There are many implications depending on where and how supply chain affects you. The reliance on a single offshore supplier created issues during the pandemic, and companies are rethinking and readjusting operations here in the United States. With that, Kathy, let's talk about companies relocating manufacturing facilities or other parts of their supply chain. What are the key state tax concepts a company should consider?
KATHY STANTON: Whenever you're making changes, moving, or starting something, you have to look at which states are involved. From a high-level perspective, the legal entity structure is very important because states treat C corporations, S corporations, and partnerships differently.
KATHY STANTON: Where you draw legal entity boundaries around operations or functions can change state tax outcomes. You don't want the tax tail wagging the business dog; business decisions should be primary, but some decisions can be changed to achieve substantial state tax consequences.
KATHY STANTON: Legal entity structuring and the location of commercial domicile matter. Nonbusiness income is generally taxed to the commercial domicile state, so that comes into play. Different business functions—manufacturing, distribution, sales—should be structured with tax implications in mind for multistate businesses.
KATHY STANTON: The goal is to be as cost effective as possible and minimize overall state tax costs to avoid surprises.
SARAH MCGREGOR: Economic development processes involve more than incentives when relocating or investing in a facility. You also need strategic planning around how you want to operate.
KATHY STANTON: Exactly. Incentives are often time-limited, and you need to consider what happens when those incentives expire. If you incur costs to move because incentives end, you need to assess the long-term tax situation.
KATHY STANTON: State credits and incentives play a huge role. All states want jobs and good-paying positions, so they're willing to compete. You should not announce expansions until you've evaluated incentives and pitted states against each other to secure the best package. Do this early in planning.
KATHY STANTON: Many people criticize state incentives as poor tax policy and unfair to incumbent businesses, but those are the rules now and companies should take advantage of them.
BROOKS NELSON: There are many unfair elements in tax, so the best you can do is play within the rules that exist.
KATHY STANTON: Right.
BROOKS NELSON: Even within a city divided by state lines, both states may spend heavily to attract a business and end up with the same number of jobs as before.
KATHY STANTON: That splitting of incentives happens frequently in the D.C. area among Maryland, Virginia, and D.C.
BROOKS NELSON: Besides credits and incentives, what other SALT issues arise when entering or exiting a market?
KATHY STANTON: Before entering a market, understand the lay of the land from a tax perspective, including all state and local taxes. Companies get surprised by county-level taxes, like gross receipts taxes, which can be significant.
KATHY STANTON: When exiting a market, check for clawback provisions tied to incentives that require maintaining jobs within a jurisdiction. If you move jobs out, you may have to repay incentives. With telecommuting, incentive agreements tied to physical jobs can be problematic.
SARAH MCGREGOR: When breaking up a company by function, what happens to profit splits and intercompany activity? We consider this for international operations, but do the same issues apply at the state level?
KATHY STANTON: Yes. You can structure separate legal entities for specific functions, but in unitary states that view the company as one enterprise, those legal separations may not yield tax benefits. In unitary states, the state may look to combine operations for apportionment.
KATHY STANTON: In separate return filing states, where separate legal entity filings are required, you can isolate operations and then determine the fair profit that entity should report. That raises transfer pricing issues: management fees, intercompany charges for intellectual property, and state add-back provisions if income shifting is suspected.
KATHY STANTON: States should tax the value related to that entity in that state, so if operations in a state are low margin, the tax should reflect that. You must evaluate the entire organizational structure and how states will view intercompany transactions.
SARAH MCGREGOR: Filing separately can be positive or negative. If one company has profits and another has losses, separate filings prevent offsetting, while unitary filings combine results and can allocate high-profit income across the group.
KATHY STANTON: Add pass-through entities to the mix and it gets more complex. Some states now have pass-through entity elections to tax at the entity level, which is another layer of complexity.
KATHY STANTON: States may take the position that if they benefit, they won't view you as unitary, and vice versa. It's a give and take.
SARAH MCGREGOR: We can't have this discussion without talking about nexus and apportionment.
KATHY STANTON: Regarding nexus, one important protection is Public Law 86-272, which protects sellers of tangible personal property from state income tax if their only activities in a state are soliciting sales and shipping property into the state.
KATHY STANTON: The Multistate Tax Commission has issued an information statement interpreting this federal law, and in August they revised their interpretation. Their revised view is concerning because they suggest that post-sale internet activities—such as technical support chats or emails—could be considered business activity in the customer’s state and thus eliminate Public Law 86-272 protection.
KATHY STANTON: This interpretation is extreme and will likely lead to litigation, because similar activities over the phone since the 1950s were not considered doing business in the state.
KATHY STANTON: Companies relying on Public Law 86-272 for protection should reevaluate their positions given these developments.
BROOKS NELSON: If I open a new manufacturing facility in a state, it seems clear I need to file an income tax return there. What about sales and use tax in that scenario and sales and use tax nexus issues related to supply chain changes?
KATHY STANTON: Sales and use tax and other indirect taxes are sometimes the last to be considered, and those costs are often buried in vendor purchases. Indirect tax costs need to be considered because they may not show as a separate line item.
KATHY STANTON: Many states have manufacturing exemptions from sales and use tax for items like equipment, utilities, and repairs. If you're in a jurisdiction with such exemptions, you can save 7 to 11 percent on capital acquisitions, which is significant.
KATHY STANTON: States differ on what qualifies as manufacturing for sales and use tax. Some tax equipment for moving raw materials while exempting packaging-related items, and others apply an integrated plant theory where most items within the facility are exempt.
KATHY STANTON: On the sales tax side, selling to end users triggers sales tax, and Wayfair ended the protection for sales tax nexus that Public Law 86-272 provides for income tax. States have low thresholds—commonly $100,000 or 200 transactions—for requiring sellers to collect and remit sales tax.
KATHY STANTON: Manufacturers often don't sell to end users, so they might not worry about sales tax. However, states now require documentation for tax-exempt sales. Manufacturers must maintain exemption certificates from customers, and states are aggressive about enforcing this.
KATHY STANTON: If you're shipping product into a state and claiming an exemption, you should have exemption certificates on file. States have different rules on renewal frequency and valid documentation, so implement a robust process for managing certificates.
SARAH MCGREGOR: That also applies when engaging new vendors to bolster supply. Send your exemption certificates to suppliers so they don't start charging sales tax unnecessarily. Proper documentation is a cash management control.
KATHY STANTON: We have a practice area within our state and local tax practice that audits manufacturers' purchases to recover overpaid sales tax when exemption certificates were not provided or maintained.
BROOKS NELSON: Do we have any final comments, Kathy?
KATHY STANTON: State tax is often left as a footnote in the process, but you should put state tax at the forefront because significant tax dollars can be saved. Simple changes that don't impact business operations can have substantial tax effects, so involve the right players early to design the most tax-efficient supply chain.
SARAH MCGREGOR: Adding income taxes, local property taxes, payroll taxes, and indirect taxes like sales and use can create significant tax burdens at a location, so you must add those together when evaluating a site.
BROOKS NELSON: I will reiterate the need for upfront planning. State and local taxes are complex, and the larger the operations, the bigger the tax stakes.
BROOKS NELSON: Thank you for listening to our discussion of state and local taxes and their impact on supply chain issues. A quick disclaimer: we are not providing tax advice on this podcast. Please consult with your tax advisor, hopefully at Cherry Bekaert, for specific tax issues or to discuss information from today's podcast.
BROOKS NELSON: Check the firm's website at cbh.com for the latest guidance and materials on this and other tax and business topics. This concludes today's podcast. Thank you, Kathy. Thank you, Sarah. Thank you to our listeners.
