State Corporate Income Taxes: A Description and Analysis
State Corporate Income Taxes:
A Description and Analysis
Updated June 23, 2008
Specialist in Public Finance
Government and Finance Division
State Corporate Income Taxes:
A Description and Analysis
State corporate income taxes have become a subject of interest to both state and
federal policymakers. The cause of this elevated interest may be the expansion of
electronic commerce and federal tax policy that affects state corporate income taxes.
Congress has had a role in state corporate income taxes for at least two reasons: (1)
interstate commerce regulatory oversight and (2) federal and state corporate income
tax interaction. Congress may become more involved in state corporate tax issues
because of recent changes in interstate commerce and how states administer
The state corporate income tax is not a major source of revenue for states, but
is still a contributor to state finances. Over the last decade, state corporate income
taxes generated approximately 5% of state tax revenue. The revenue generated by
the tax — measured as a percentage of gross domestic product — gradually declined
to its lowest point in FY2002. Since then, revenue has rebounded. Several
explanations have been offered for these fluctuations including (1) state policy
decisions to lower the tax burden on corporations, (2) aggressive tax planning by
corporations, (3) broad economic cycles altering the base, and (4) federal corporate
income tax policy.
Many corporations operate in multiple tax jurisdictions which makes the state
corporate income tax a relatively complex tax to administer. The base of the
corporate income tax (net income or profits) must be fairly apportioned to all of the
states where the firm has established a presence (or nexus). A mosaic of nexus
standards has been created through multistate tax compacts, state and federal legal
decisions, and congressional actions. At present, states do not use a uniform
definition of taxable profits or use a uniform method of apportioning income.
In the 110th Congress, S. 1726 and its twin H.R. 5267 would establish more-
uniform standards — generally higher standards — for the level of business activity
that would trigger nexus (or presence) and thus state corporate income taxability.
The legislation is often identified as “brightline” legislation. In the 109th Congress,
the House Judiciary Committee approved similar legislation, H.R. 1956. The
Congressional Budget Office estimated that H.R. 1956 would have cost the states
$3.1 billion over the 2007 to 2016 budget window.
Nexus issues are also addressed in what has been identified as “streamlining”
legislation. Generally, the streamlining legislation would allow states to require out-
of-state vendors to collect sales taxes even if the out-of-state vendor does not have
nexus in the taxing state. Participating states would have to simplify sales and use
taxes before Congress would confer collection enforcement authority. Interstate
commerce has complicated the nexus issue for sales and use tax administration, and
how this issue is resolved may have broader implications for state corporate income
taxes. This report will be updated as legislative events warrant.
State Corporate Income Taxes: Overview..............................1
The Mechanics of the State Corporate Income Tax....................3
Federal Starting Point......................................3
The Uniform Division of Income for Tax Purposes Act (UDITPA)...3
The Profit Apportionment Formula............................3
State Corporate Income Tax Rates.............................7
State Corporate Income Tax Revenue: 1972 to 2007..................8
Issues for Congress...............................................11
Interstate Commerce Regulation and Oversight.....................11
H.R. 5267 and S. 1726.....................................14
List of Figures
Figure 2. State Corporate Tax Revenue as Percentage of
State GDP, 1972 to 2007.......................................10
List of Tables
Table 1. Average State Corporate Income Tax Revenue as Share
of Total Tax Revenue, 1972 to 2007...............................2
Table 2. State Corporate Income Tax Apportionment Formulas.............6
Table 3. State Corporate Income Tax Rates, 2008........................7
Table 4. State Corporate Income Tax Revenue and
Gross Domestic Product, FY1972 to FY2007........................9
State Corporate Income Taxes:
A Description and Analysis
Congressional interest in state corporate income taxes arises from two distinct
issues. First, Congress has a direct role in the oversight and regulation of interstate
economic activity. State taxation of multi-state corporations is included in this
jurisdiction. Second, federal corporate income tax policy changes have a direct effect
on state (and local) tax structure.1 Congressional activity, or in some cases inactivity,
in these two areas can have a pronounced effect on state budget and tax decisions.
After an overview of state corporate income taxes, this report analyzes both the
interstate commerce oversight and tax interaction issues. The last section of the
report describes and analyzes legislation that would affect state corporate income
State Corporate Income Taxes: Overview
For most observers, state corporate income taxes are the most familiar state tax
that businesses pay. However, corporate income taxes generated 7.1% of total state
tax revenue in 2007. In contrast, general sales and use taxes, of which businesses pay
a large portion, accounted for approximately 31.5% of state tax revenue.2 Some
estimate that businesses could have paid as much as 44% of total state and local taxes
(an estimated $577 billion).3 Even though state corporate income taxes represent a
relatively small portion of total state tax revenue in most states, the state corporate
income tax still generated $53.4 billion in 2007. And, in some states, the corporate
income tax contributes a much larger share of total tax revenue. For example, from
1972 to 2007, the corporate income tax averaged 20.3% of annual state tax revenue
in New Hampshire. In contrast, the corporate income tax contributed 3.8% of total
tax revenue in South Dakota.4 Table 1 reports the average reliance on corporate
income taxes for each state over the 36-year span, 1972 to 2007.
1 State taxation of international firms and individuals is also of interest to Congress.
International tax policy, however, extends beyond the scope of this report.
2 Data are CRS calculations based on U.S. Census of Governments data. These data are
available at the following website: [http://www.census.gov/govs/www/statetax07.html].
3 Andrew Phillips, Robert Cline, and Tom Neubig, “Total State and Local Business Taxes:
50 State Estimates for Fiscal Year 2007,” State Tax Notes, May 12, 2008. They also
estimated that businesses paid 44% of all state and local sales taxes.
4 CRS calculations based on U.S. Census of Governments data; see above for website link.
Table 1. Average State Corporate Income Tax Revenue as
Share of Total Tax Revenue, 1972 to 2007
Annual AverageAnnual Average
Corporate IncomeCorporate Income
StateTax Share of TotalStateTax Share of Total
Tax RevenueTax Revenue
(1972 to 2007)(1972 to 2007)
Alabama 4 .9% Montana 7.2%
Alaska 19.9% Nebraska 5.3%
G e o r gi a 6 . 9 % O hi o 6 . 1 %
Hawaii 3.1% Oklaho ma 4.0%
Idaho 6 .4% Orego n 7 .3%
I llino is 8 .2 % P ennsylva nia 9 .2 %
K e nt uc ky 6 . 4 % T e nne sse e 8 . 7 %
Maine 4 .9 % Utah 4 .8 %
Maryland 4.8% Vermont 5 .2%
Massachusetts 10.7% Virginia 5.2%
M i ssissip p i 5 . 1 % W i sc o nsin 6 . 9 %
Source: CRS calculations based on U.S. Census Bureau, Governments Division, Federal, State, and
Local Governments: State Government Tax Collections. These data are available at the following
As New Hampshire and South Dakota show, the dependence on corporate
income taxes varies considerably from state to state; thus, federal corporate income
tax policy does not have a uniform effect on states. The remainder of this section
describes the mechanics behind state corporate income taxes, highlighting the
differences among states. Understanding the nuances of state corporate income taxes
is necessary for a complete discussion and analysis of interstate commerce issues and
the link between federal and state tax policy.
The Mechanics of the State Corporate Income Tax
Generally, the state corporate income tax is levied on the accounting profits of
a corporation.5 The portion of profit that can be attributed to a state serves as the
base for that state’s corporate income tax. Profits are allocated to a state based on the
amount of economic activity that occurs in that state. Following is a more detailed
description of the state corporate income tax structure.
Federal Starting Point. When calculating state tax liability, most states and
the District of Columbia incorporate the federal income tax code as currently
amended or as of a specific date. The remaining states typically use a measure of
income that closely follows the federal definition of taxable income. Using the
federal starting point likely eases the compliance burden for corporations, particularly
those that have nexus in several states. Nevertheless, many states still require
corporations to “add-back” to income exclusions that are allowed under federal6
corporate income tax rules.
The Uniform Division of Income for Tax Purposes Act (UDITPA).
The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model act
drafted and adopted by the Commissioners on Uniform State Laws and the American
Bar Association. The act sets standards for separating income into business income,
which is apportioned to states, and non-business income, which is allocated entirely
to the entity’s home state.7 Generally, non-business income is defined as passive
income on corporate owned assets; income from these assets could include dividends,
rents, and royalties. Corporations could avoid paying taxes on non-business income8
by locating in states without a corporate income tax. Some states, through the
Multistate Tax Compact (MTC), have voluntarily adopted uniform rules and
procedures for the allocation and apportionment of income — as defined under
UDITPA — to ease the compliance burden on multistate businesses.9 Many of the
states that have not formally adopted UDITPA standards still closely adhere to the
The Profit Apportionment Formula. Typically, three factors of economic
activity are used in the apportionment formula to measure the economic presence of
a firm in a state: the percentage of property, the percentage of sales, and the
5 Net income is revenue less cost of goods sold and expenses, which is roughly equivalent
to pre-tax accounting profits.
6 Bureau of National Affairs, “2008 Survey of State Tax Departments,” vol. 15, no. 4, Apr.
25, 2008. The report identifies the add-backs and other special corporate income tax rules
for each state.
7 For more on UDITPA, see John S. Warren, “UDITPA — A Historical Perspective,” State
Tax Notes, Oct. 3, 2005, pp. 133-136.
8 A “throwback” or unitary accounting rules would limit this type of tax planning to avoid
taxation of non-business income.
9 According to the Commerce Clearing House (CCH) publication, State Corporate Income
Tax Guide, six states have enacted UDITPA as written and 13 more states have generally
adopted UDITPA with some modifications.
percentage of payroll. Not all states weigh factors equally; some over-weight sales
or use only sales to allocate income (often called single-factor sales apportionment).
In theory, the weighting should accurately portray the economic presence of the firm.
There is no consensus on the definition of “economic presence,” and hence there is
variation among state apportionment formulas.
Some analysts have suggested that a formula that double-weights sales is the
ideal formula because it gives equal weight to input factors (property and payroll),
and an output factor (sales).10 Others have argued that the business tax should be
levied based on the business’s use of government services provided by the firm’s
resident state. For example, a corporate income tax that is levied according to the
value of one input only, such as property, could be justified because the value of
property is closely related to the level of government services provided to the
business by the home state. However, corporations also receive benefits from an out-
of-state customer’s well functioning legal system and public infrastructure. An
apportionment formula that includes just the property factor would not compensate
the out-of-state customer’s government for the benefit to the corporation of those
The general form of the apportionment formula is reproduced below. The
superscript i represents the profits (B), sales (s), property (p), and labor (l), a state
attributes to the i-th firm. The superscript T represents the total value of each factor
and profits for the firm in a given tax year. The subscript w represents the weight of
each respective factor as defined by state law; the weights sum to one.
For example, states that use an even-weight formula would use 0.33 for each w,
meaning each factor contributes equally to the determination of profits attributable
to a state. If the state were to “double-weight” sales, that means that the ws is twice
the amount of each of the other two weights. In the case of double-weight sales,
ws=0.50; wp=0.25; and wl=0.25.
i i is p l⎛ ⎞ ⎛ ⎞ ⎛ ⎞⎡ ⎤
ππiT TsTpTlw w w=×⎜ ⎟ ×+⎜ ⎟ ×+⎜ ⎟ ×⎢ ⎥
s p l⎝ ⎠ ⎝ ⎠ ⎝ ⎠⎣ ⎦
Nexus. The apportionment formula does not imply that a business that sells
goods and services into a state, owes taxes to that state. A state can levy a corporate
income tax on a business only if the business maintains a substantial nexus in the
state. The nexus rules governing the corporate income tax were partially
circumscribed by Congress through P.L. 86-272, (the Act). The Act established that
the mere solicitation of the sale of tangible goods by a firm in a state was not
substantial nexus for corporate income tax purposes. For intangible goods and
services, however, there is significant variation from state to state in how substantial
nexus is defined.
10 James Francis and Brian H. McGavin, “Market Versus Production States: An Economic
Analysis of Apportionment Principles,” in State Taxation of Business: Issues and Policy
Options, Thomas Pogue, ed. (New York: Praeger Publishers, 1992), p. 61.
The Bureau of National Affairs periodically surveys state revenue departments
about activities that could create nexus.11 The responses highlight the differential
treatment from state to state of business activities deemed to create nexus. For
example, according to the report, 15 states (and the District of Columbia) reported
that an out-of-state corporation that maintained a website on a server in the state had
established nexus whereas 24 states reported that the activity would not.12
Throwback Rule. Because of the state-by-state variation in nexus rules, the
first step for corporations before apportioning income is to determine the states where
the firm has established nexus. The firm then allocates profits to these states based
on each respective state’s apportionment formula and nexus rules. The different state
apportionment formulas and nexus rules, however, often lead to what is termed13
“nowhere income.” Nowhere income arises because not all states have the same
apportionment formula or nexus rules, and some states do not levy a corporate
income tax at all. However, if the destination state imposes a franchise tax or a
business license tax that is based on some measure of business activity, then this does
not apply. Thus, some states impose corporate income tax rules that stipulate that all
sales to customers in states in which the firm does not have nexus (and are not
obligated pay any tax based on economic activity) are “thrown back” to the home
For example, a California firm that sells goods to customers in Nevada — which
does not have a corporate income tax, nor any other tax based on business activity
— would include Nevada sales in the numerator of the sales factor component of the
California apportionment formula. If Nevada had a corporate income tax with a sales
factor in the apportionment formula and the firm had established nexus, California
would not require the firm to include the Nevada sales in the California corporate
income tax apportionment formula. The throwback rule is applied in 24 states, New
York City, and the District of Columbia; 19 states do not impose a throwback rule,
and four states do not impose a corporate income tax (see Table 2).14
Combined Reporting. Combined reporting of income from all subsidiaries
is an accounting rule states use to minimize corporate income tax avoidance arising
from income shifting (or strategic transfer pricing). Generally, there are two
“degrees” of combined reporting, water’s edge (i.e., U.S.-based subsidiaries) and
worldwide. Although combined reporting is required in roughly half the states, only
California and Idaho require worldwide reporting. Montana and North Dakota
require worldwide reporting unless water’s edge is chosen. Nebraska employs a
modified worldwide regime. From a tax compliance perspective, supporters of
11 Bureau of National Affairs, “2008 Survey of State Tax Departments,” vol. 15, no. 4, Apr.
12 Several states indicated that a server did not create nexus only if an unrelated third party
owned the server. Several states did not respond or do not have a corporate income tax.
13 The converse is also true. Income could also be overtaxed because of the variety of
apportionment formulas employed by states.
14 See BNA, Apr. 25, 2008. Delaware and Pennsylvania did not respond to this question and
the question is not applicable to Texas.
combined reporting claim that the regime helps close several corporate tax
loopholes.15 Critics of combined reporting suggest that the increased compliance and
administrative cost of combined reporting overshadow any increase in compliance
State Apportionment Formulas. Table 2 groups states based on their
corporate income tax apportionment formula. “Even weight” implies that the each
factor is weighted the same or one-third. The hybrid arrangements allow firms to
choose the type of apportionment scheme that minimizes tax burden or instructs the
firm to use different types of allocation based on the source of income. The most
common apportionment formula is the double-weighted sales scheme. A number of
states will be moving to a single-factor sales formula in the near future. As of 2008,
Table 2. State Corporate Income Tax Apportionment
(number of states)
Even-weight (11)Alabama, Alaska, Delaware, District of Columbia, Hawaii, Kansas,
Louisiana, New Mexico, Montana, North Dakota, and Rhode Island.
Even-weight hybrid (3)Missouri, firms choose either even weight or single factor sales;
Oklahoma, firms meeting certain investment criteria can choose
double-weight sales, otherwise even-weight; Utah, even-weight with
optional three-factor with double weighted sales.
Double-weight salesArkansas, California, Florida, Idaho, Kentucky, Massachusetts, New
(13)Hampshire, New Jersey, North Carolina, Tennessee, Vermont,
Virginia, and West Virginia.
Double-weight salesConnecticut, double-weight sales for income derived from the sale or
hybrid (3)use of tangible personal or real property, single-factor sales for other
income; Maryland, manufacturers use single-factor sales, otherwise
double-weight sales; South Carolina, double-weight sales for dealers
in tangible personal property, otherwise single-factor sales.
Single-factor sales (10)Georgia, Illinois, Iowa, Maine, Michigana (MBT), Nebraska, New
York, Oregon, and Wisconsin.
Single-factor sales in theIndiana in 2011 and Minnesota in 2014.
Other weight allocations(in percentages, sales- payroll-property) Arizonab, 60-20-20; Indiana,a
(6)80-10-10; Michigan, 92.5-3.75-3.75 (SBT); Minnesota, 81-9.5-9.5;
Ohio, 60-20-20; and Pennsylvania, 70-15-15.
15 Michael Mazerov, “State Corporate Tax Shelters and the Need for Combined Reporting,”
State Tax Notes, Nov. 26, 2007, pp. 621-638.
Other hybrids (2)Colorado, firms choose between a three-factor even-weight and a two-
factor (sales and property) even-weight; Mississippi, retailers,
wholesalers, service companies, lessors use single-factor sales,
wholesale manufacturers use even-weight three factor, retail
manufacturers use three-factor, double-weighted sales.
No general corporate netNevada, South Dakota (bank & financial corporation excise tax),c
income tax (5)Texas (gross receipts tax), Washington, and Wyoming.
Source: Commerce Clearing House, Multistate Corporate Income Tax Guide.
a. In Arizona, firms may elect 70-15-15 in 2008 and 80-10-10 after 2008.
b. Michigan has two corporate income taxes, the Single Business Tax (SBT) and the Michigan
Business Tax (MBT).
c. The Texas GRT is similar in practice to a single factor sales apportionment formula.
State Corporate Income Tax Rates. Rates on corporate income taxes vary
considerably. The state with highest rate, Iowa, taxes all taxable income in excess
of $250,000 at 12%. Iowa is also one of 10 states that use a single-factor sales
apportionment formula. The rates for each state are listed in Table 3. The highest
marginal rates listed in Table 3 do not necessarily represent the relative burden of
state corporate income taxes in each state. The best measure of the relative corporate
income tax burden for each state is the average effective marginal tax rate (AEMTR).
The AEMTR would incorporate differences among states in the definition of taxable
income and bracket amounts. Nevertheless, the marginal rates do provide some
information about the relative burden of corporate income taxes across states.
Table 3. State Corporate Income Tax Rates, 2008
StateHighestRateNumber ofRatesStateHighestRateNumber ofRates
Alabama 6 .500% one Montana 6.750% one
Alaska 9.400% multiple Nebraska 7.810% multiple
Florid a 5 .500% one Ohiof 8.500% multiple
Georgia 6 .000% one Oklahoma 6 .000% one
Hawaii 6.400% multiple Oregon 6.600% one
Idaho 7 .600% one P ennsylvania 9 .990% one
Kansas 4.000% one T ennessee 6 .500% one
Kentucky 6.000% multiple T exash 4.500% one
Lo uisiana 8 .000% multiple Utah 5.000% one
Maine 8 .930% multiple Vermont 8 .500% multiple
Maryland 8.250% one Virginia 6 .000% one
M i nne so t a d 9.800% one W isconsin 7.900% one
Misso uri 6 .250% one
Source: Commerce Clearing House, Multistate Corporate Income Tax Guide.
a. S Corporations, partnerships, and trusts are taxed at a maximum 6.3% rate.
b. Corporations also pay a surtax on property located in Massachusetts and not taxed at the local
c. According to CCH, Michigan levies the 4.95% on business income and an additional 0.8% on
modified gross receipts at and beyond $350,000.
d. Minnesota also levies a fee based on the total payroll, property, and sales of the corporation. The
fee raises the maximum tax rate and creates very slight progressivity.
e. ND instructs corporations making “water’s edge” election to pay and additional 3.5%.
f. Ohio allows firms to choose an alternative of four mills (or 0.4%) multiplied by taxable net worth.
g. South Dakota taxes only banks and financial institutions. The rates fall as net income rises from
a high of 6.0% for the first $400 million to 0.25% for the amount over $1.2 billion.
h. Texas has a revised franchise tax or “margin tax.” The margin tax increases the effective tax rate
though the details of the tax and its rate are too complicated to present in this table.
State Corporate Income Tax Revenue: 1972 to 2007
According to CRS calculations based on data from the U.S. Census Bureau,
state corporate income tax revenue as a portion of gross domestic product (GDP)
declined from an annual average of 0.43% of GDP over the FY1972 to FY1979 time
frame to 0.31% of GDP over the FY2000 to FY2007 time frame. The percentage
has, however, increased each year from FY2004 to FY2007. Table 4 reports state
corporate tax revenue and GDP for states that impose a state corporate income tax.16
Figure 1 exhibits the trend in state corporate tax revenue as a portion of state GDP.
Several causes were suggested for the decline in state corporate tax revenues in
FY2001 and FY2002.17 The most direct causes could be legislated changes in the tax
rate, the tax base, or the compliance rules. The decline in revenue could be the result
of state governments, in the aggregate, attempting to lower the tax burden on
corporations. The December 2003 Fiscal Survey of States reported that states, in the
aggregate, enacted net tax cuts every year from FY1995 through FY2001.18 Even
though these tax cuts were not separated into types of tax (e.g. sales and income
taxes) by the Fiscal Survey, it seems likely that state corporate income taxes were
16 The governments division of the Census Bureau collects and reports state tax collections
by type of tax based on survey information from the states. For more on the methodology,
17 William F. Fox and LeAnn Luna, “State Corporate Tax Revenue Trends: Causes and
Possible Solutions,” National Tax Journal, vol. LV, no. 3, Sept. 2002, pp. 491-508.
(Hereafter cited as Fox and Luna, State Corporate Tax Revenue Trends.)
18 National Association of State Budget Officers, December 2003 Fiscal Survey of States,
available at the following: [http://www.nasbo.org/Publications/fiscsurv/fsfall2003.pdf].
included in the tax cuts. Empirical research has reached a similar conclusion, noting
[S]tate tax bases have deteriorated further than the federal base because of a
combination of explicit state actions [emphasis added] and tax19
avoidance/evasion by businesses.
Table 4. State Corporate Income Tax Revenue
and Gross Domestic Product, FY1972 to FY2007
St a t e St a t eCo rporate St a t e St a t eCo rporate
FiscalCorporateTax RevenueFiscalCorporateTax Revenue
YearTax Revenueas PercentageYearTax Revenueas Percentage
(in billions)of GDP(in billions)of GDP
1972 $4.4 0 .36% 1990 $21.8 0 .37%
1973 $5.4 0 .39% 1991 $20.4 0 .34%
1974 $6.0 0 .40% 1992 $21.9 0 .34%
1975 $6.6 0 .41% 1993 $24.2 0 .36%
1976 $7.3 0 .40% 1994 $25.5 0 .36%
1977 $9.2 0 .45% 1995 $29.1 0 .39%
1978 $10.7 0 .47% 1996 $29.3 0 .38%
1979 $12.1 0 .47% 1997 $30.7 0 .37%
1980 $13.3 0 .48% 1998 $31.1 0 .36%
1981 $14.1 0 .45% 1999 $30.8 0 .33%
1982 $14.0 0 .43% 2000 $32.5 0 .33%
1983 $13.2 0 .37% 2001 $31.7 0 .31%
1984 $15.5 0 .39% 2002 $25.9 0 .24%
1985 $17.6 0 .42% 2003 $28.5 0 .26%
1986 $18.4 0 .41% 2004 $30.8 0 .26%
1987 $20.5 0 .43% 2005 $38.7 0 .31%
1988 $21.6 0 .42% 2006 $47.4 0 .36%
1989 $23.9 0 .44% 2007 $53.4 0 .39%
Source: CRS calculations based on U.S. Census Bureau, Governments Division and Bureau of
A second explanation, alluded to above, was that corporations were more20
effectively avoiding, or even evading taxes through aggressive tax planning. The
Multistate Tax Commission (MTC) also concluded that “...various corporations are
19 Fox and Luna, State Corporate Tax Revenue Trends, p. 498.
20 Tax avoidance is a legal means of reducing tax liability, such as buying tax-exempt bonds.
In contrast, tax evasion is illegal, such as not claiming otherwise taxable income. For more,
see Martin Sullivan, “State Corporate Tax Leakage: $14.5 Billion in 2006,” State Tax Notes,
Nov. 26, 2007, pp. 601-613.
increasingly taking advantage of structural weakness and loopholes in the state
corporate tax systems.”21 Again, the MTC study could not definitively separate the
revenue declines arising from policy changes and avoidance/evasion, but still
concluded that tax avoidance and evasion is partly responsible for the decline in state
corporate tax revenues.
Figure 2. State Corporate Tax Revenue as Percentage of State GDP,
0.30%enPercentage of GDP
ercLinear (Percentage of GDP)
1972 1977 1982 1987 1992 1997 2002 2007
Source: CRS calculations based on U.S. Census Bureau, Governments Division and Bureau of
A third explanation was that cyclical economic changes led to the decline in
state corporate tax revenues. Note that cyclical economic effects are unrelated to the
behavior of policymakers or corporations. The effect of economic cycles on revenue
was difficult to identify because the legislated changes and the corporate behavior
described above likely exacerbated (or attenuated) the cyclical economic changes.
Recent research into the causes of state budget deficits, suggested that “the current
[cumulative state] deficit is largely structural....”22 The implication of this finding
was that policy (structural) changes like tax cuts and discretionary spending increases
generated state budget deficits in FY2002 and FY2003, not the machinations of the
21 Multistate Tax Commission, “Corporate Tax Sheltering and the Impact on State Corporate
Income Tax Revenue Collections,” July 15, 2003, from the Executive Summary.
22 Brian Knight, Andrea Kusko, and Laura Rubin, “Problems and Prospects for State and
Local Governments,” paper presented at Urban Institute Seminar, State Fiscal Crises:
Causes, Consequences, and Solutions, Apr. 5, 2003.
Finally, changes to the federal corporate income tax code, which changes the
base of most state corporate income tax systems, could explain part of the decline in
state corporate income tax revenue. A report published in 2005, however, noted that
“nearly two-thirds [of states] refused to go along with President Bush’s 2001-2004
‘bonus depreciation.’....”23 The Center on Budget and Policy Priorities reported that
“...some 18 states have disallowed the [domestic production] deduction....” in part
to avoid the associated revenue loss.24 The next section discusses the interaction
between federal and state corporate income taxes in more detail.
Issues for Congress
State corporate income taxes are of interest to Congress for primarily two
reasons: interstate commerce oversight and tax interaction. The following section
analyzes these two aspects of state corporate income taxation that are most directly
affected by congressional action.
Interstate Commerce Regulation and Oversight
The interstate commerce regulation and tax interaction issues have attracted
interest for three principal reasons: (1) the complex Internet sales tax debate; (2) the
recent federal business tax cuts; and (3) state fiscal issues. The link between the
Internet sales tax debate and state corporate income taxes is complicated and centers
on the prohibition on states reaching beyond their borders to compel out-of-state
vendors to collect sales and use taxes.25 As a general rule, a state can require a
vendor to collect sales and use taxes only if the vendor has “substantial nexus” in the
state.26 Typically, the substantial nexus standard is satisfied if the vendor has a
physical presence in the state.27 Thus, remote Internet transactions, where the vendor
has no physical presence in the customer’s home state, do not have the sales and use
tax added to the price of the good by the vendor. These types of transactions have
grown considerably over the last several years and have contributed to the erosion of
the sales and use tax base of most states.28
23 McIntyre, Robert S and T.D. Coo Nguyen, “State Corporate Income Taxes 2001-2003,”
State Tax Notes, March 7, 2005, pp. 685-712.
24 Nick Johnson, “State Revenue Losses from the Federal ‘Domestic Production Deduction’
Will Double in 2007,” Center on Budget and Policy Priorities, Jan. 2, 2007.
25 A sales tax is levied at the time of transaction and is tax on the sale. The companion use
tax is a tax on the use of a good or service. Technically, remote vendors would collect a use
tax because the product is going to be used in the customer’s home state.
26 The limitation arises from the due process and commerce clauses in the U.S. Constitution.
27 For more on the sales tax issue, see CRS Report RL31252, State and Local Sales and Use
Taxes and Internet Commerce, by Steve Maguire.
28 Donald Bruce and William F. Fox, “State and Local Sales Tax Revenue Losses from E-
Commerce: Estimates as of July 2004,” Center for Business and Economic Research,
University of Tennessee, July 2004. Bruce and Fox estimated this erosion from electronic
In an effort to persuade Congress to allow states to compel remote vendors to
collect use taxes, a coalition of states has been working together to establish a
uniform sales and use tax agreement. The coalition of states identifies this agreement
as the “Streamlined Sales and Use Tax Agreement” (SSUTA).29 States that sign onto
the sales tax compact would have already implemented uniform definitions and
compliance rules, thus easing the administrative burden of remote vendor collection.
Two bills in the 110th Congress would grant states these rights.30 If either of these
bills were enacted and the states satisfied the requirements for qualification, remote
vendors in the compact states would collect use taxes for shipments to states where
the vendor does not have a substantial nexus.
Some vendors are concerned that collecting use taxes for a state in which they
do not have nexus, could trigger income or other business tax liability. However,
past court decisions and the landmark P.L. 86-272 established physical presence as
the standard for sufficient nexus for corporate income taxes for firms selling tangible
goods. P.L. 86-272, was passed shortly after the Supreme Court issued a ruling that
seemed to offer an ambiguous definition of “sufficient nexus.” The Supreme Court
language that generated this concern (as cited in the Senate report on S. 2524, the
Senate version of what became P.L. 86-272) is reproduced below:
We conclude that the net income from the interstate operations of a foreign
corporation may be subjected to State taxation provided the levy is not
discriminatory and is properly apportioned to local activities within the taxing
State forming sufficient nexus to support the same. [Emphasis added] (358 U.S.31
The term “local activities” was deemed too ambiguous by policy makers and
businesses. The Senate report provided the following as reasoning behind the
enacted legislation (P.L. 86-272) that clarified the definition:
Persons engaged in interstate commerce are in doubt as to the amount of local
activities within a State that will be regarded as forming a sufficient “nexus,” that
is, connection, with the State to support the imposition of a tax on net income32
from interstate operations and “properly apportioned” to the State.
The legislation passed by Congress clarified nexus by identifying those activities
which would not establish nexus. Generally, soliciting sales of tangible goods in a
state for shipment by common carrier from locations outside the state into the state,
commerce alone will result in states losing between $21.5 billion and $33.7 billion in 2008.
There is considerable debate, however, about the size of the revenue loss.
29 For more on the SSUTA, see CRS Report RS22387, The Streamlined Sales and Use Tax
Agreement: A Brief Description, by Steven Maguire.
30 S. 34 and H.R. 3396.
31 U.S. Congress, Senate Committee on Finance, State Income Taxes — Interstate
Commerce, Senate report to accompany S. 2524, S.Rept. 658, 86th Cong., 1st sess.
(Washington: GPO, Aug. 11, 1959) p. 2549.
would not be sufficient to trigger nexus. Thus, for tangible goods shipped across
state lines, state net corporate income taxes are levied at the origin not the destination
of the product. The home state of the customer receiving the goods cannot levy a
state corporate income tax on the remote business by virtue of the transaction. The
issue of intangible goods and services was not addressed directly by P.L. 86-272.
The Internet sales and use tax debate has contributed to a revived discussion of
what constitutes nexus for a corporate income tax. Clarified nexus standards,
however, do not seem destined to fundamentally alter the administration of state
corporate income taxes. As noted above, current laws would already shield out-of-
state vendors from corporate income tax liability if the business were only soliciting
the sale of tangible goods into the state. As for intangibles goods and services,
policymakers would likely insert language to ensure that a corporation would not
establish nexus by virtue of collecting sales and use taxes.33
The “Jobs and Growth Tax Relief Reconciliation Act of 2003” (JGTRRA, P.L.
108-27), included several provisions that reduce the federal tax burden on business
investment.34 The federal tax changes also affected state taxes because of the
interaction between federal taxes and state taxes on corporations. Generally, states
use the federal tax code as the base for the state income tax (see the background
section titled “federal starting point”).35 Thus, when the federal definition of the tax
base changes, so does the state definition of income.
JGTRRA included two temporary provisions designed to accelerate the
depreciation of capital assets purchased by businesses. The first is a temporary
increase in the amount of a capital expenditure that a small business can deduct in the
year of purchase.36 The larger deduction reduces the base of the federal corporate
income tax and thus the state corporate income tax base for those states that link
directly to the federal tax code. The change in federal law would have generated a
significant revenue loss in the short run for those states that remain linked to the
federal definition of business income.37 A second JGTRRA provision allowed for
33 Section 7(a) of S. 1736 from the 108th Congress states that “[N]othing in this Act shall be
construed as subjecting sellers to franchise taxes, income taxes, or licensing requirements
of a state or political subdivision thereof, nor shall anything in this Act be construed as
affecting the application of such taxes or requirements or enlarging or reducing the authority
of any State to impose such taxes or requirements.”
34 For more on the business tax cuts in P.L. 108-27, see CRS Report RL32034, The Jobs and
Growth Tax Relief Reconciliation Act of 2003 and Business Investment, by Gary Guenther.
35 Many states, as noted earlier, have decided not to incorporate recent federal changes. For
more, see McIntyre, Robert S and T.D. Coo Nguyen, “State Corporate Income Taxes 2001-
36 26 U.S.C. § 179.
37 According to an analysis by the Center on Budget and Policy Priorities, “... 17 states stand
to lose an estimated $1.1 billion in 2004 and another $600 million by the end of 2005.”
“bonus depreciation” for certain capital expenditures. Businesses that bought
qualified capital assets before January 1, 2005, could have immediately deducted
50% of the purchase price from gross income. As of 2008, just 13 states allow firms
to fully utilize the federal bonus depreciation rules for purposes of calculating state
corporate tax liability.38
Proponents of the accelerated depreciation provisions argued that over the long
run, increased business investment would likely lead to stronger economic growth
and in turn more corporate income tax revenue. The long run net budget outcome of
the two countervailing forces is uncertain and relies on debatable assumptions about
the response of businesses to investment incentives delivered through the federal tax
The JGTRRA provisions adversely affected state budgets in the short run
because the tax relief is delivered through changes in the base. If Congress were
concerned primarily with the impact of federal corporate income tax law changes on
the states, changes in corporate income tax rates would have minimal impact on the
states. Unlike changes in the tax base, a federal tax rate change would not directly
affect state corporate income taxes.
As noted earlier, two related issues have received legislative attention in the
110th Congress. One is so-called streamlined sales and use tax legislation and the
other is identified as business activity tax (BAT) nexus legislation. S. 34 and H.R.
The focus here will be on S. 1726 and its twin H.R. 5267. This legislation
would establish more-uniform standards — generally higher standards — for the
level of business activity that would trigger nexus (or presence) and thus state
corporate income taxability. The legislation is often identified as “brightline” or
H.R. 5267 and S. 1726. Under current law, sales of “tangible personal
property” into a state are not sufficient to trigger tax liability. H.R. 5267 and S. 1726
would expand the protection beyond sales of tangible personal property to include
transactions, furnishing or gathering of information, and services.40 This expansion
would have a significant effect on the 34 states where “... an employee’s solicitation
Nicholas Johnson, “Federal Tax Changes Likely to Cost States Billions of Dollars in
Coming Years,” Center on Budget and Policy Priorities, June 5, 2003, p. 5.
38 Commerce Clearing House, “Multistate Corporate Tax Guide (2008),” on-line edition.
39 For more on the “Streamline” issue, see CRS Report RL34211, State and Local Taxes and
the Streamlined Sales and Use Tax Agreement, by Steven Maguire.
40 Sec. 2(a) of H.R. 5267.
of services while in the state for six or fewer days would create nexus.”41 In addition,
the legislation is somewhat unclear on what activities would be classified as
“furnishing of information to customers” and “gathering of information.”
In addition to the expansion of protected interactions, this legislation would also
define “physical presence” as the standard for collecting business activity taxes.42
Under this proposal, physical presence would be established and a business activity
tax allowable if:
!the individual or business is physically within the state for at least 15
days (not including trips to buy goods or services for the business or
gathering and furnishing information);
!the individual or business uses the services of another individual or
business for more than 15 days and the hired individual or business
does not do business for any other entity; or
!the individual or business leases or owns tangible personal property
or real property in the state for more than 15 days.
A provision in the legislation would define “physical presence” to exclude
individuals whose activities are “limited or transient business activity.”43 Thus,
activities need only be one or the other to avoid establishing nexus and thus taxation.
This feature may prove confounding to state tax administrators as a clear definition
of “limited” is not provided and “transient” is also somewhat ambiguous.
Analysis. The BAT legislation in the 110th Congress, H.R. 5267 and S. 1726,
is intended to further modify the state taxation of businesses engaged in interstate
commerce. The legislation would impose new regulations on how states impose
taxes on multi-state businesses, through (1) imposing uniformity on the time
component of nexus determination, (2) expanding the definition of goods and
services subject to the nexus rules, and (3) creating a safe harbor for activities that
are “limited or transient.” The legislation would not directly address the complexity
of the state corporate income tax structure — in particular, the various apportionment
formulas (and allocation rules) described earlier.
Many economists and other researchers who analyze state corporate income
taxes agree that the critical issue with the current state corporate income tax structure
is the variability in the allocation and apportionment of corporate income from state
to state.44 The current mosaic of state corporate income tax rules creates economic
inefficiencies for the following reasons: (1) relatively high compliance costs, (2)
increased opportunities for tax planning by businesses, and (3) potential gaps and
41 BNA, Apr. 25, 2008.
42 Sec. 3(b) of H.R. 5267 and S. 1726.
43 Sec. 3(b)(2)(B) of H.R. 5267 and S. 1726.
44 For one such critique, see Tomalis, Matt, “Some Fatal Flaws of S. 1726, H.R. 5267, and
All BAT Nexus Bills,” State Tax Notes, Mar. 3, 2008, pp. 691-704.
overlaps in taxation. The new regulations as proposed in H.R. 5267 and S. 1726,
would exacerbate the underlying inefficiencies because the threshold for business —
the 15-day rule and the safe harbor for limited or transient activity — would increase
opportunities for tax planning and thus tax avoidance and possibly evasion. In
addition, expanding the types of activities that are covered by P.L. 86-272 would also
expand the opportunities for tax planning.
Supporters of the legislation counter that the legislation simply codifies the
existing nexus rules as applied by most states and updates P.L. 86-272 to reflect
changes in the economy and marketplace. In addition, the supporters of H.R. 5267
and S. 1726 suggest that the BAT legislation would eliminate the “double taxation”
of businesses. The double taxation, they claim, arises from the various state
apportionment and throwback rules.45
45 For more, see Rosen, Arthur R. and Jeffrey S. Reed, “Setting the Record Straight on the
Business Activity Tax Simplification Act,” State Tax Notes, May 26, 2008, pp. 653-659.