April 30, 2012 The Tax Lawyer

The Unintended Consequences of Gross Receipts “Taxes”

Vol. 64, No. 4 - Summer 2011

Kathleen K. Wright

Abstract

    A gross receipts tax is a levy on a business entity’s total receipts that is typically assessed in lieu of an income tax. Gross receipts taxes are assessed on a broader base and at a lower rate than income taxes. Gross receipts taxes are also frequently assessed on all types of business, including flow through entities such as S corporations, limited liability companies (LLCs), partnerships, and limited partnerships, while income taxes are generally not assessed on flow through entities.

    States have adopted gross receipts tax structures in lieu of the traditional income tax as a means to expand their tax base under the guise of a relative ease of administration and the lack of complexity in their calculation. The movement towards gross receipts taxes has also been fueled by the trend amongst states to decouple from federal law as Congress continues the extension and expansion of tax breaks. The States cannot afford these measures.

    Taxpayers, however, are finding that these assessments are not always administratively simple and often have unforeseen shortcomings and unintended side effects. Taxpayers are also finding that traditional constitutional remedies applied to income taxes are not applicable to gross receipt taxes.

    The validity of a tax depends on its classification. The fundamental question of classification focuses on whether a gross receipts tax is more akin to an income tax, which is subject to apportionment, or a sales tax, which need not be apportioned. In addition, if the assessment is an income tax, then various state and federal constitutional and statutory requirements must be met. The question of whether a wide variety of state taxes falls under the rubric of “income taxes” has raised vexing questions. Although “fair apportionment” is arguably the area of most significant conflict, whether a state assessment is an income tax is a significant consideration for many other reasons summarized here and discussed herein.

  • If the assessment is an income tax, it may need to meet federal and state constitutional standards. Some states require the vote of the people or a supermajority vote in the state legislature if raising taxes, but, if the assessment can be characterized as a fee, it may not be subject to these requirements.
  • If the assessment is classified as an income tax, there may be different nexus standards imposed by the state—as compared to a sales tax.
  • If the assessment is classified as an income tax, it will be subject to application of Public Law 86-272, a federal statute that limits the state’s power to tax.
  • If the assessment is classified as an income tax, it may be eligible for a state income tax credit for individuals who live in states that assess income tax based on worldwide income. If the assessment is not classified as an income tax, it may be deductible on the state income tax return as a trade or business expense.

    State tax classifications in each of these areas are spawning controversy. This article analyzes each of the above issues with respect to various gross receipts taxes enacted by the states and discusses how the states have addressed these issues—if at all.

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