Apportionment is a key feature of state corporate taxes

Apportionment formulas are important features of state corporate income taxes. They determine how much of a business’s income is taxable and affect the incidence and competitiveness of the tax. Minnesota apportions corporate income using the Minnesota proportions of the corporation’s sales, payroll, and property factors to determine corporate franchise tax.

Minnesota is phasing in single sales apportionment

Under legislation enacted in 2005, Minnesota is phasing in single sales apportionment over an eight-year period beginning in tax year 2007. The table shows the phase-in schedule for the transition to single sales apportionment from 2010 to 2014.

Effects vary by type of business

The effects of adopting single sales apportionment vary by business. The crucial variables are the business’s Minnesota apportionment factors:

The taxes of businesses with all of their property, payroll, and sales in Minnesota will be unaffected.

Minnesota businesses whose Minnesota sales factor is lower than the average of their Minnesota property and payroll factors will receive a tax cut. The larger the disparity, the bigger the benefit is. A classic example is a business with most of its operations (headquarters, plants, and so forth) in Minnesota, but most of its sales outside of Minnesota.

Businesses with higher Minnesota sales factors than their average Minnesota property and payroll factors will have tax increases. One example is a national consumer products company with few facilities in Minnesota.

Rationale for single sales apportionment:
improve competitiveness

The principal rationale for single sales apportionment is an economic development argument: It makes Minnesota more competitive in attracting
investment in plant and equipment. Sales are determined by the buyer’s location. All other things being equal, increasing non-Minnesota sales will reduce the amount of Minnesota taxable income, since more income will be
attributed to or apportioned outside of Minnesota. Thus, increasing the weight for the sales factor creates an incentive for companies to invest in Minnesota property or to hire more employees (or reduces the tax’s disincentive to do so) to sell products outside of Minnesota. Empirical studies have found some support for the idea that single sales apportionment encourages in-state investment.

Policy concerns with single sales apportionment: equity and tax theory

Opponents of single sales apportionment argue that it shifts the burden of the tax from capital (the property factor) to consumption, reducing the progressivity of
the tax. Some also question as an empirical matter whether it has the desired effects on competitiveness. Tax theorists argue that if the corporate tax is to be a benefits tax (i.e., based on businesses’ use of government services) or if it is to be based on production of income, apportionment should take into account where the business’s property and employees are located. These factors are important contributors both to the production of income and the consumption of government services.

Sales-weighted apportionment reduces revenues

Compared with equally weighting each of the apportionment factors, weighting sales more heavily reduces Minnesota tax revenues. The Department of Revenue’s Tax Expenditure Budget (February 2010) shows an expenditure cost of $111 million for fiscal year 2010, rising to $214 million in 2013.

Trend in other states to heavier sales weighting

States have been increasingly shifting their apportionment formulas to more heavily weighted sales. Effective for tax year 2010, 14 states will use or allow single sales as their apportionment formula for manufacturers. This is up from seven states for tax year 2005. Many of Minnesota’s neighboring states use single sales apportionment: Illinois, Iowa, Michigan, Missouri, Nebraska, and Wisconsin. California and Indiana are scheduled to use single sales in 2011, South Carolina in 2013, and Virginia (in addition to Minnesota) in 2014. The map below shows the apportionment formulas for manufacturers as of tax year 2010. Some states allow elections between two formulas. The map shows these with the highest permitted sales weighting.

Estimated Tax Payments

Sole Proprietorship

The sole proprietor generally will be required to make federal and Minnesota
estimated tax payments if his or her income tax and (for federal purposes) self employment tax
will exceed taxes paid through withholding and credits by $1,000 or more. The tax is determined
on income from all sources, including income from the business. A penalty may be imposed on
underpaid estimates.

Partnership

The partnership itself is not required to make estimated tax payments. However, for
Minnesota tax purposes, a partnership is required to pay quarterly estimated tax if its Minnesota
minimum fee is $500 or more or if it has a nonresident partner whose share of the composite
income tax is $500 or more. As with the sole proprietorship, individual partners generally will be
required to make estimated tax payments if their income tax and self employment tax will exceed
taxes paid through withholding and credits by $1,000 or more. The tax is based on taxable income
from all sources, not just the income from the partnership. If the tax is underpaid, a penalty may
be imposed on the partner. As with the sole proprietorship, both federal and Minnesota estimates
generally will be required.

C Corporation

Federal

A C corporation whose estimated tax is expected to be $500 or more is
required to make estimated tax payments. If the corporation does not use Electronic Federal Tax
Payment System (EFTPS), deposit corporation income tax payments (and estimated tax payments)
with Form 8109, Federal Tax Deposit Coupon. Mail or deliver the completed Form 8109 with the
payment to an authorized depository (that is, a commercial bank or other financial institution
authorized to accept federal tax deposits).

Minnesota

A corporation with an estimated tax of $500
or more must make Minnesota quarterly estimated tax payments. In addition, a C corporation
with more than $20,000 in tax liability must make all its tax payments via electronic funds transfer.
These payments are filed with the Minnesota Department of Revenue. For both federal and
Minnesota purposes, a penalty may be imposed for failure to pay the correct estimated tax on or
before its due date.

S Corporation

The S corporation is not subject to estimated tax on income which passes through
to shareholders. For Minnesota tax purposes, an S corporation is required to pay quarterly
estimated tax if its S corporation taxes and minimum fee is $500 or more or if it has a nonresident
shareholder whose share of the composite income.

This is part of a series of articles on How to Pick the Right Business Entity Type.  These articles help you select the right business type for your circumstances.

Previous post: Net Operating Loss

Next post: Disposition of Ownership Interest

What is the property tax refund program?

The homeowner’s property tax refund program (sometimes called the “circuit breaker” or the PTR) is a state-paid refund that provides tax relief to homeowners whose property taxes are high relative to their incomes. If property tax exceeds a threshold percentage of income, the refund equals a percentage of the tax over the threshold, up to a maximum amount. As income increases:

•  the threshold percentage increases,
•  the share of tax over the threshold that the taxpayer must pay increases, and
•  the maximum refund decreases.

The program uses household income, a broad measure that includes most types of income. Deductions are allowed for dependents and for claimants who are over age 65 or disabled.

What are recent changes to the program?

The 2008 tax law expanded the homeowner’s property tax refund program, effective for refunds based on property taxes payable in 2009. The changes lowered the maximum threshold percentage for determining eligibility from 4.0 percent of income to 3.5 percent of income and increased the maximum refund allowed from $1,800 to $2,310.

What are the maximums?

For refund claims filed in 2011, based on property taxes payable in 2011 and 2010 household income, the maximum refund is $2,370. Homeowners whose income exceeds $99,239 are not eligible for a refund.

How are claims filed?

Refund claims are filed using the Minnesota Department of Revenue (DOR) Schedule M1PR. Schedule M1PR is filed separately from the individual income tax form. Claims filed before August 15, 2011, will be paid beginning in late September 2011. The deadline for filing claims based on taxes payable in 2011 is August 15, 2012; taxpayers filing claims after that date will not receive a refund. Forms are available online at DOR’s website, under “Forms and Instructions.”

What is the average refund and total amount paid?

Statewide Homeowner Property Tax Refunds Filed in 2009 (based on 2008 incomes and payable 2009 taxes, most recent data available)

How do refunds vary depending upon the filer’s income and property tax?

The following table shows the refund amount for two example families with different incomes—one family in the metro area and one in greater Minnesota. Although the property tax refund threshold, copayment rates, and maximum refund amounts are the same statewide, the average residential homestead property tax in the metro area is higher than in greater Minnesota. The metro area family has payable 2011 property taxes of $3,325, a typical amount for the metro. The family in greater Minnesota has payable 2011 property taxes of $1,600, a typical amount for greater Minnesota. Taxpayers who are over age 65, disabled, or have dependents are allowed a subtraction from income in determining the refund.

Married couple, both under age 65, two dependents
Example refunds for claims to be filed in 2011, based on taxes payable in 2011 and 2010 income

For more information: Claimants can check the status of their refund by calling DOR at (651) 296-4444 or online at www.taxes.state.mn.us.

Yes. An LLC can be taxed as an S Corp, assuming it qualifies for S Corp taxation status. An LLC can also be taxed as a C Corporation.

An LLC is a very flexible business type because it can be taxed as a corporation or S corp.

Option 1: LLC electing to be treated as a Corporation

A. Single Owner LLC:

If the LLC has only one owner, the IRS will automatically treat the LLC as if it were a sole proprietorship (a disregarded entity), unless an election is made for it to be treated as a corporation. An LLC may elect corporate tax treatment using IRS Form 8832 (Form 8832 Entity Classification Election).

B. LLC Owned by More than One Person:

If the LLC has two or more owners, the IRS will automatically treat the LLC as if it were a partnership unless an election is made for it to be treated as a corporation. An LLC may elect corporate tax treatment using IRS Form 8832 (Form 8832 Entity Classification Election).

Option 2: LLC electing to be treated as an S Corp

An LLC may elect S Corp tax treatment by filing IRS Form 2553 (Form 2553 Election by a Small Business Corporation). However, sometimes the LLC must file both Form 8832 (see Option 1 above) and Form 2553. To determine whether your LLC can file Form 2553 alone, or whether Form 8832 must also be filed, see page 1 of the Instructions to form 2553 or talk with a CPA or LLC attorney in your state.

Tips for an LLC Taxed as an S Corp:

Electing to have your LLC taxed as an S Corporation involves a couple procedural changes in paying and filing your taxes.

1. Quarterly Filings for an LLC Taxed as an S Corp

Keep in mind that if your business is treated as an S Corp, it must pay estimated taxes. But this inconvenience is often offset by the tax benefit of an S Corp (self-employment tax savings).

2. Income Taxes at the End of the Year

Also, an S Corp must file different income tax forms at the end of the year (Which Forms Must I File?).

Shareholder-employees will receive two tax documents from the S-Corporation at the end of the year: a W-2 wage statement (income as an employee) and a Schedule K-1 statement (income as an owner).

3. No Self-Employment Tax for an S Corp Owner-Employee

Shareholder-employees of an S-Corp (including an LLC taxed as an S Corp) do not pay Self-Employment Tax because their wages are reported on a W-2, with Social Security and Medicare taxes already withheld. By contrast, the owner of an LLC that is taxed as a partnership or sole proprietorship (not an S Corp) does pay Self-Employment Tax. Self-Employment Tax is figured at the end of the year on Schedule SE of IRS Form 1040.

Some people find themselves in a situation where they cannot pay their IRS tax debt. For example, a taxpayer may owe taxes but cannot pay because the taxpayer has little money compared to the taxpayer’s debts.

If the IRS is convinced that the IRS will probably not recover the amount owed, the IRS may make the taxpayer an offer to pay a reduced amount in a short period of time. This offer is called an “Offer in Compromise.”

An Offer in Compromise is subject to IRS regulations. Taxpayers who are evaluating an Offer in Compromise may be benefited by understanding these IRS regulations. Taxpayers may also benefit from knowing strategies for negotiating an Offer in Compromise.

A tax attorney can help taxpayers who are dealing with IRS debt or an Offer in Compromise. However, those with tax debt often cannot afford to hire a tax attorney. Fortunately, there are some good resources online for taxpayers who want to handle their Offer in Compromise without the assistance of a tax attorney.

Two articles provide some general help with an Offer in Compromise.

• Negotiating Offers In Compromise
• The IRS Offer in Compromise

If you decide that you would benefit from hiring a tax attorney, I would be glad to talk with you. Please call to schedule an appointment.