FINANCIALLY $PEAKING: Taxes
Tax planning usually focuses on minimizing federal taxes. Such emphasis while helpful, because federal and state taxes are usually linked, ignores the fact that substantial tax saving can result by paying the same careful attention to state and local taxes themselves.
The start of the New Year is the ideal time to review your state and local tax situation and make the changes that will translate into big tax savings for the year.
Apportionment. Companies that do business in more than one state may owe corporate income or franchise taxes to multiple states. The amount of tax owed to each is usually based on an apportionment of revenues. Companies can change apportionments by increasing the denominator of the apportionment fraction.
Examples: Make certain strategic investments ( buy an office building, for example ) or undertake certain commodity transactions. Watch how your receipts are factored into apportionment formulas. Again, companies can improve their apportionments with respect to certain sales.
Example: It may be advantageous to us a common carrier rather than company trucks to pick up raw materials. Check to see whether proposed transactions are extraordinary transactions.
Examples: Selling a subsidiary or dropping a line of business. These often are not considered part of business operations and, as such, are not taxable by states in which the company merely has some operations. Use a tax adviser who is an expert in the area of state taxed. Such an adviser can help a business to minimize its taxes.
Sales and use taxes. Income or franchise taxes are only one tax-planning area for businesses to explore. There are significant tax savings millions of dollars for some companies to be realized in this area of sales and use taxation. Consider conducting an intensive " reverse" audit by asking the same questions of your company that a state auditor would ask. Don't wait for the state to act. Chances are you will identify enormous refund opportunities.
Example: Look carefully at purchases of fuel, raw materials, and supplies. You may be overpaying your sales or use taxes,
Electronic Commerce. If you sell goods or services on the Internet, or are gearing up to do so this year, be aware that there are many unanswered questions about the taxation of electronic commerce. Does selling within a state create a presence that requires tax filing in that state? Probably not but beware. Also, it is unsettled for purposes of the receipts factor in apportionment, where the sale takes place.
The moratorium imposed by the Internet Tax Freedom Act merely prevents states from imposing multiple or discriminatory taxes on electronic commerce. Accordingly, states cannot force an out of state seller to collect the states sales and use taxes unless that seller has a physical presence in that state.
Business changes. Changing operations? Relocating? Check out structuring and filing options that may exist in various states. The way in which a business organizes a new venture can affect income ( franchise ) taxes dramatically.
Example: It may be advisable to set up a marketing only subsidiary or a manufacturing only subsidiary so only parts of the business would be taxable in specific states.
State tax incentives. States may offer tax incentives for relocating or for hiring certain workers. Some incentives are open to all eligible businesses. But some may require negotiation with state authorities. Look into these incentives before making any final decisions.
Individual taxpayers. For the most part, state income taxes are based on the federal income tax. So, a strategy that cuts your federal income tax bill will often translate into state income tax savings as well.
But in important ways a state's tax system may differ from federal income tax. You can cut your state income tax bill by learning these differences and then exploiting them.
Examples: Some states have a more liberal earned income credit than the federal credit. New Jersey allows more liberal medical deductions than federal law does.
Tax saving strategy: Bunch your medical expenses into one year when you can. This could be enough to give you a state deduction for medical expenses, even if you do not qualify for a federal income tax deduction.
New York permits a deduction of up to $5,000 per taxpayer for contributions to the states qualifies tuition plan. Deductible contributions can be made for grandchildren, for example who live outside the state.
If you spend time in more than one state ( for instance, you own homes in both Massachusetts and Arizona ), make sure you clearly establish your state of residency. This will determine whether you are taxed as a resident or are subject to any nonresident taxes a state may have.
Document your residency ties to your state of choice with proof, such as a driver's license, voter's registration, membership in social and religious organizations and a place where valued personal assets are kept.
If your state has a residency requirement based on the number of days you spend in the state- New York bases residency on being within the state for more than 183 days, for example keep detailed record of the days you spend in the state.
Knowing a state's rule for residency is particularly critical if you are selling your business and planning to retire to a different state. A timely relocation can minimize taxes on the sale.
Caution: States are becoming more aggressive in pressing individual income taxes issues as a way of gaining revenue.
Tax free investments. Generally, municipal bonds issued by your state of residence are free of state income taxes while those issued by other states are taxable.
However, there is a growing belief among tax practitioners that this difference in tax treatment is unconstitutional. Watch for any developments in this area. If the rule taxing out of state bonds is found to be unconstitutional more investment opportunities are opened up for you to explore.
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