U.S. House Mulling State-Funded Corporate Tax Boondoggle

Monday, September 4, 2006
by Marc J. Lane

Reprint permission from the September 4, 2006 issue of Crain's Chicago Business.


The U.S. House of Representatives will soon consider looting state government treasuries to enrich national businesses adept at dodging taxes.

If the Business Activity Tax Simplification Act is enacted, state and local governments would no longer collect corporate income taxes and other levies tied to sales from out-of-state businesses, or taxes on services and intangibles, from companies without a "physical presence" there. The bill's supporters argue that aggressive state and local tax collection efforts have stifled business expansion and that a bright-line federal standard would foster interstate commerce and economic growth.

But the measure defines "physical presence" so narrowly that even a company employing hundreds of workers in a state, or selling millions in services there, could escape taxation. The federal government would profit, too, gaining $1.2 billion in revenue between 2007 and 2011, according to the Congressional Budget Office (CBO), because a corporation can deduct the state taxes it pays from its income for U.S. tax purposes.

Small businesses, locally owned stores and companies without the wherewithal or expertise to game the system would pay the price. So would state and local governments left scrambling to fill the holes in their budgets.

The physical-presence test makes creative tax lawyers salivate. If the act becomes law, out-of-state banks might not be taxed in a state where they make loans on homes and hire independent contractors to process mortgage applications. Nor would out-of-state restaurant franchisors, no matter how many franchises earn profits for them in the state.

The physical-presence standard makes no sense in a global economy where being in a state and doing business there are two different things. The inevitable result would be "nowhere income," earnings that simply aren't taxed in any state at all.

The CBO estimates that the Business Activity Tax Simplification Act would cost state and local governments $1 billion the first year it's in effect and $3 billion a year by 2011, as companies concentrate operations in low-tax states, set up shell companies offshore, or rejigger their activities. The National Governors Assn. argues the act would be even more costly: It estimates $6.6 billion in lost revenue to the states in 2007 alone, of which $91 million would be forgone by Illinois.

The CBO cautions that 70% of the losses would fall on 10 states -- Illinois among them -- which would be forced either to hike other taxes or lett social and health services suffer.

If a business has significant operations or economic ties in Illinois, it's only fair that it pays taxes on the benefits of doing business here.

Marc J. Lane is the President of The Law Offices of Marc J. Lane, a Professional Corporation, and of its financial-services affiliates. He is a business and tax attorney, a Master Registered Financial Planner, and an Adjunct Professor of Law at Northwestern University School of Law.


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Copyright © 2006 by Crain Communications Inc.

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