Suppose you are a computer software consulting business with offices in Arlington, Virginia and Prince Georges County, Maryland. You have employees who move back and forth between the offices consulting with clients and making calls on clients. Both Maryland and Virginia have income taxes. How do you allocate the income for purposes of the Arlington County, Virginia Business Professional Occupational License Tax. The Supreme Court adopted a three part test to use to determine how you allocate that burden In Nielsen Company v. Arlington County last month.
First, you must allocate the tax based upon payroll percentages in each jurisdiction. Then you are permitted a deduction for income subject to income taxes in another state. It is this deduction that the Court is concerned with.
The Court went on to say:
“That is, “attributable” does not mandate or prohibit any particular
methodology to determine which receipts captured in the pool of
taxable gross receipts are subject to deduction.”
The means that your company can allocate sales receipts in any acceptable manner.
There is a safe harbor under Section 58.1-3732(B)(2) which the Court rules is to be interpreted in the following manner:
“The Tax Commissioner held that the following analysis
determines whether the Code ยง 58.1-3732(B)(2) deduction may be
taken by a taxpayer, and, if so, how to determine what receipts
are backed out from the pool of taxable gross receipts:
1. Ascertain whether any employees at the Virginia
definite place of business participated in interstate
transactions by, for example, shipping goods to
customers in other states, participating with
employees in other offices in transactions, etc. If
there has been no participation in interstate
transactions, then there is no deduction. If there
has been participation, then;
2. Ascertain whether any of the interstate
participation can be tied to specific receipts. If
so, then those receipts are deducted; however, if
payroll apportionment had to be used to assign
receipts to the definite place of business, then it is
very unlikely that any of those apportioned receipts
can be specifically []linked to interstate
transactions. If not, or if only some of the
participation can be tied to specific receipts, then;
3. The payroll factor used for the Virginia definite
place of business would be applied to the gross
receipts assigned to definite places of business in
states in which the taxpayer filed an income tax
return. Note that payroll apportionment would
probably be needed to assign receipts to definite
places of business in other states.”
So, if for example the employees in the Virginia office don’t deal with any interstate business there is not additional deduction. If however, the Virginia employees handled Maryland sales, then you can trace the specific receipt. If that doesn’t work, then you can allocate those according to payroll percentages for the second deduction.
Remember the business can still allocate receipts according to any reasonable formula for allocating receipts, there is just no safe harbor if challenged as unreasonable.