Section of Taxation Publications

VOL. 61
NO. 4

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Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.

California Water’s-Edge Election

Giles Sutton, Chuck Jones, Jack Hodges, and Jamie C. Yesnowitz*

I. Introduction

Many of the states that permit or require corporations to file tax returns based upon a combined report either require that such reporting be made based on the domestic group or a worldwide group or permit a “water’s-edge” election. In this respect, “water’s-edge” refers to the territorial borders of the United States, and includes corporations domiciled or doing significant business therein. A water’s-edge group is a subset of a multinational unitary business. As such, the election provides entity-based exceptions to the pure application of unitary principles. In some cases, large multinational corporate groups may be comprised of multiple unitary groups, each of which needs to make its own separate water’s-edge election. An entity that is not part of a taxpayer’s worldwide unitary group cannot be part of a water’s-edge group simply because it is domestic and commonly owned. In addition, the existence of a unitary relationship is determined by the relationship between all members of the unitary business, even though some of the members may be excluded by the election. Further, water’s-edge elections can often take on the characteristics of tax attributes in the context of certain merger and acquisition transactions.

In an era where states are increasingly adopting combined reporting, in particular unitary combined reporting to expand the number of foreign companies whose income must be reported to the state, corporations are focusing on the subtle issues pertaining to unitary reporting and water’s-edge elections. Issues surrounding the mechanics of the water’s-edge election, a taxpayer’s eligibility to make the election, the composition of the combined reporting group, the required method of making the election, the impact of making an election, how water’s-edge returns are examined, and planning issues that should be considered will of necessity assume greater importance.

This Article addresses these issues as they relate to the water’s-edge filing option available in the state of California. California’s water’s-edge law is complex and merits a thorough analysis for several reasons. Economically, California is the largest state to use worldwide combined reporting with the option to elect water’s-edge treatment. Because California’s water’s-edge law has been in effect since 1988, a substantial amount of law and authority has developed in this area. As such, California’s provisions significantly inform the topic of water’s-edge concepts as they potentially apply to other states.

*Giles Sutton is a Partner in the State and Local Tax practice of Grant Thornton LLP assigned to the Firm’s National Tax Office in Washington, DC. Chuck Jones is a Manager in the State and Local Tax practice of Grant Thornton LLP, in the Firm’s Chicago office. Jack Hodges is a Director in the State and Local practice in the Firm’s San Francisco office. Jamie C. Yesnowitz is a Senior Manager in the State and Local Tax practice in the Firm’s National Tax Office in Washington, DC.


Published by the
American Bar Association Section of Taxation
in Collaboration with the
Georgetown University Law Center


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