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COMBINED CORPORATE RETURNS: A GOLD MINE FOR IOWA?

February 14, 2003

States like to tax out-of-staters; non-residents don't vote. With tax revenues sagging, it is not surprising that the Governor is eyeing non-resident corporations to help pay the bills. The Governor wants legislation to require commonly-controlled corporations to file "combined returns" as a way to bring in extra tax revenue.

WHAT IS A "COMBINED RETURN?"

While the details vary by state, a combined return typically adds the income of commonly-controlled corporations together and taxes a portion of the combined income to Iowa. For this purpose, most states consider corporations with 50% or more common ownership to be under common control.

Corporations are combined if they are "unitary." The meaning of "unitary" is elusive; corporations that sell to one another, like a commonly owned manufacturer and distributor, will be unitary; commonly controlled corporations that have no interaction may not be.

Iowa apportions income to in-state and out-of-state activities based only on gross receipts; most states also factor in payroll and property in their apportionment. In a "combined" return, Iowa members of a unitary group would pay tax based on the ratio of their Iowa sales to all Iowa sales of corporations required to pay Iowa income tax.

WHY DOES THIS BRING IN REVENUE?

Consider two mythical commonly-controlled unitary corporations: Desmoinesco of Des Moines, and Siouxfalls Corp. of South Dakota. 1% of Desmoinesco $1,000,000 sales ($10,000) are in Iowa. Its taxable income is $100,000.

Desmoinesco sells into a nationwide market, and it has a satellite operation in South Dakota. Siouxfalls Corp. has no Iowa operations and is not required to file an Iowa return; its $4,000,000 sales are 25% each in Iowa, Nebraska, South Dakota and Minnesota ($1,000,000 each). Its taxable income is $400,000.

Without combined reporting, Desmoinesco's Iowa taxable income is $1,000: 1% of its total taxable income.

If the factors are computed on a combined basis, using California's system as a model, Desmoinesco will report $5,000 in taxable income. Why? Because Desmoinesco's 1% sales factor is applied to the unitary group's $500,000 combined taxable income. You can find the details at this link.

Of course, the math can work to reduce Iowa tax, as well as to increase it. State tax officials assume (correctly) that without combined reporting taxpayers have (sensibly) structured their affairs to minimize Iowa taxes; therefore, the overall result of requiring combined reporting will be to increase revenues.

WHAT DO OTHER STATES DO? Several neighboring states -- Illinois, Kansas and Nebraska -- require combined reporting. Missouri and Wisconsin forbid it. South Dakota has no corporate income tax.

WHAT WILL HAPPEN? Given its need for new revenue, Iowa is likely to enact some form of combined reporting. There is no way to tell what it will look like until the Governor or the legislature draft a bill.

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