Will Congressional Business Actitvity Tax Nexus Reform Spur Tax Sheltering?

June 16, 2005

The Federation of Tax Administrators (FTA) recently adopted a resolution opposing business activity tax nexus reform in Congress. H.R. 1956, the current legislative vehicle for such reform in Congress, would require a company to have an in-state physical presence to pay business activity tax (e.g. corporate income, franchise, gross receipts, etc.). The FTA opposes the bill because, in the words of executive director Harley Duncan, it would create “the opportunity to engage in a variety of tax planning activities so you can shelter more and more income from taxation.”

There is a common belief among tax administrators, and their organizations such as the FTA and the Multistate Tax Commission (MTC), that corporate tax sheltering is eroding state corporate income taxes. They are fearful that the adoption of a nationwide physical presence standard would further this erosion, despite the fact that many state court decisions already require in-state physical presence to establish nexus.

The Nelson A. Rockefeller Institute of Government, which does a remarkable job of tracking state tax revenues, reports that state corporate income tax receipts rose by 61 percent in the first quarter of 2005 (buoyed by California’s tax amnesty program). Corporate income taxes outpaced all other major sources of state revenue, including personal income taxes and sales taxes. It’s hard to believe that tax sheltering is causing a major dent in state corporate taxes when they are growing so robustly.

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A sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.