Tax revamp targets biz climate

Lawmakers reshaped Rhode Island’s tax code this summer, cutting taxes in some areas and raising them elsewhere in a bid to improve the state’s much-maligned business climate while plugging revenue gaps.
The changes, most of which take effect Jan. 1, have an eye toward how the state is perceived nationally, but will be felt most directly by existing Ocean State companies and in some cases signal where future state tax policy may be heading.
So which industries have the most to gain from the changes and what do companies need to know when most of the changes go into effect next year?
Tax professionals say large, in-state companies able to take advantage of the 2 percentage-point reduction in the corporate tax rate and a series of shifts in how those taxes are calculated stand to benefit the most.
Although the rate cut grabs the headlines, those calculation changes – including combined reporting, single-factor apportionment and market-based sourcing – could be equally important in determining some firms’ liability.
In general, the changes in Rhode Island’s state tax structure have similarities to national proposals, such as the Marketplace Fairness Act, that would base corporate taxation more on firms’ sales than their physical facilities.
As a result, these changes may benefit asset-intensive businesses, such as manufacturers, and locally based firms more than offshore conglomerates.
“Combined reporting and some of these other changes kind of work together and are in keeping with what Congress has been noodling around with on the Marketplace Fairness Act,” said Norman LeBlanc, partner at Kahn, Litwin, Renza & Co. Ltd. in Providence. “They are going to look at these firms as one big company and tax all of the sales where they take place.”
The rate cut drops Rhode Island’s corporate rate from the highest in New England at 9 percent, to 7 percent, tied for the lowest unified rate in the region. (Vermont has three brackets with the lowest at 6.5 percent.)
Combined reporting requires large, multipart companies with a physical presence in Rhode Island to file as a single entity and bases its corporate tax bill on that larger income pool instead of a single affiliate’s income.
That larger income pool for large organizations is somewhat offset by the rate reduction and the move to single-factor apportionment in calculating the size of tax liabilities. Currently, three factors are taken into account when calculating corporate tax: sales, local property and local employees, according to R.I. Division of Taxation spokesman Neil Downing.
Under single-factor apportionment, only sales are used to calculate a corporate tax bill, freeing in-state companies of what could be considered a disadvantage in having property and employees count in the calculation.
The change to single-factor apportionment should also benefit industries like manufacturing, with large facilities and physical assets, over service-based or purely technology companies.
Like the corporate tax rate cut and combined reporting, the single-factor apportionment change only applies to C corporations and not pass-through entities whose earnings are taxed as personal income for shareholders.
That’s also the case for market-based sourcing, the new way the state is going to determine annual taxable revenue from the sale of services.
Right now when a company sells a service to an out-of-state customer, the revenue is taxed in the state where most of the work was done.
Under market-based sourcing that will change to where the customer is located.
And in a measure that appears designed to discourage establishing corporate residence in foreign tax havens, the new rules include “water’s edge treatment,” in which companies who do at least 20 percent of their business here can be subject to combined reporting.
With combined reporting and many of these tax changes, a major downside is an increase in tax complexity and resulting accounting work for companies, who have to track sales in different states and the tax rules in each of those states, LeBlanc said.
Although the biggest changes this year involved the larger companies that pay corporate tax, smaller businesses won’t go unaffected.
These changes tend to be more industry specific, like extending the sales tax exemption for wine and liquor at liquor stores for an additional three months until the end of fiscal 2015.
The exemption, along with a corresponding hike in the alcohol excise tax paid by manufacturers and distributors, was created as a pilot program in 2013 to help liquor stores competing with Massachusetts.
LeBlanc pointed out that the pilot program favors liquor stores over the hospitality industry, where drink prices are still increased by the excise-tax hike, but do not benefit from the sales tax cut. The 1 cent hike in the gas tax, which will be linked to inflation going forward, will work against the trucking industry and businesses with high transportation costs. It goes into effect next July.
One change that will impact a relatively small number of S corporations is the elimination of the franchise tax, which functioned as an alternative to the state’s $500 corporate minimum tax or identical fee for LLCs.
Downing, at the Division of Taxation, said either from historical accident going back to their incorporation or bad accounting advice, some companies had been paying more in franchise tax than identical counterparts, so the franchise tax was eliminated.
Patricia Thompson, a tax partner at Piccerelli, Gilstein and Co. LLP, said increasing the estate-tax threshold could have the largest impact on Rhode Island family-owned businesses.
“The estate tax impacts the small-business owner because all value and benefits would be an asset subject to estate tax potentially,” Thompson said. “Even for people of relatively modest means, it may not take very long before assets exceeded the threshold. And then they were taxed on the entire value, not just the amount over the threshold.”
By including a $64,400 credit against Rhode Island estate tax, the General Assembly effectively raised the threshold from $921,655 to $1.5 million and ended the “cliff.”
The other new development Thompson said business owners should, and will, pay attention to, is the creation of the Underground Economy and Employee Misclassification Task Force.
Lawmakers created the task force to investigate employers treating full-time employees as contractors, paying them under the table or other improper methods of saving on benefits and taxes.
The task force legislation, a compromise from bills that would have changed classification rules, gives participating state agencies the power to share employer and employee information to detect instances of fraud. A similar task force in Massachusetts recovered $21 million over 18 months, bill sponsors said.
“Employers are going to have to go over their workforce and make sure it follows the IRS test on classification, or they could get caught,” Thompson said. •

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