States Defend Business Tax Authority

When South Carolina small business owner Carey “Bo” Horne sold a single copy of licensed software to a New Jersey customer eight years ago, he had no idea he would owe $600 annually in New Jersey taxes and fees for as long as the software is in use.

Horne, president of the home-based software company ProHelp Systems, Inc., has become the poster child for federal and some state lawmakers who support a congressional proposal to limit state authority to collect a wide range of so-called business activity taxes from out-of-state companies.

The ” Business Activity Tax Simplification Act ” would bar a state from taxing an out-of-state company unless it has a physical presence such as an office or employees in the state. A patchwork of state policies now determine when a business located outside a state owes state business taxes. In some states – such as New Jersey — a company only has to have an economic presence, such as a customer, to owe state taxes.

The congressional proposal also would broaden an existing ban on state business taxes on out-of-state goods by exempting out-of-state services and intangible property, such as stocks and licensing agreements. Because all states now impose some type of business activity tax on out-of-state companies, all 50 states would be affected by the change, said David Quam, director of state-federal relations at the National Governors Association . Business taxes are imposed on such items as corporate receipts and income, and are different from sales taxes paid on purchases.

Business associations and the American Legislative Exchange Council , a membership organization for conservative state lawmakers, are pushing for the federal measure as a way to provide companies with increased certainty about their tax liabilities and to help states create business-friendly environments.

“It’s important that a clear and easily recognizable standard be set forth for when a company has to pay business activity taxes,” said U.S. Rep. Bob Goodlatte (R-Va.), the bill’s sponsor.

Opponents, including the NGA and the Multistate Tax Commission , a state government coalition that advocates for state tax sovereignty, say the measure runs roughshod over states’ rights, will cost states billions each year, and makes it easier for big business to avoid legitimate state taxes.

“It’s beginning to look like the federal government is trying to give a tax cut to big business using state tax dollars. Those decisions should be left to the states,” said Quam. The NGA estimates the proposal would cost state and local governments $6.6 billion a year.

Kansas Revenue Secretary Joan Wagnon, who also chairs the Multistate Tax Commission, said Kansas could lose $31.2 million a year if Congress limits state business taxes on out-of-state companies.

“We (in Kansas) are coming out of the recession slowly and are under a court order to increase funding for schools dramatically. The state cannot afford any narrowing of our tax base,” Wagnon, who testified before a U.S. House committee Sept. 27, said in a press release. “These tax breaks for a select group of large companies would only shift the tax burden back onto property taxes, sales taxes or income taxes paid by individuals and small businesses in our state. The only other option for states would be a dramatic curtailment of essential state services.”

But not all state officials agree with the states’ tax commission. Curbing state revenue collections is not a bad thing, as far as Georgia state Rep. Earl Ehrhart (R) is concerned. Ehrhart, ALEC’s national chairman, said states are overly aggressive in collecting taxes to accommodate bloated budgets. The measure’s limits on state taxing authority will help Georgia and other states create attractive business environments, he said.

“If companies are paying state taxes only where they are physically present, then we can be comfortable knowing that we can attract business to Georgia, give them the services they need, get the taxes we need in return to help pay for those services and hopefully persuade them to reinvest in our state,” Ehrhart told Congress.

Quam, of NGA, said the claims that existing state tax practices hurt states’ abilities to recruit business are ill-founded. He said cases such as Horne’s, the South Carolina business owner, are the exception to the rule. Most small business owners do not end up in such predicaments, he said.

By contrast big businesses, such as credit card companies, will gain unfair tax shelters if the proposal is enacted, Quam said.

U.S. Rep. Bill Delahunt (D-Mass.) said Congress should be wary of cutting off state revenue sources, adding that the proposal could incite businesses to design corporate structures to evade valid state taxes.

“We must strike a very delicate balance, particularly in the face of mounting unfunded mandates, to ensure that state and local governments are not stripped of legitimate revenue,” Delahunt said.

The debate over states’ ability to collect business activity taxes on out-of-state companies is just the latest battle between the states and Congress over states’ taxing authority. The shift from a manufacturing to a service-based economy coupled with the growing popularity of Internet shopping has eroded states’ tax bases in recent years. Most states do not tax services, and shoppers pay no state sales tax on the vast majority of Internet purchases.

States have been working together to coordinate their sales tax systems to make it easier for states to collect sales taxes on out-of-state purchases. But Congress would have to authorize states to require businesses to collect sales taxes on out-of-state purchases.

The “Business Activity Tax Simplification Act” is currently before the House Committee on the Judiciary. No action has been taken on it in either chamber of Congress.