State and Local Tax Considerations
State and local taxation (SALT) is an increasingly important topic on the TCP section of the CPA exam. CPAs must understand nexus rules, apportionment methods, and how state tax systems interact with federal tax provisions to advise clients on multistate tax obligations and planning opportunities.
Nexus
Nexus is the minimum connection between a taxpayer and a state that gives the state the constitutional authority to impose tax:
| Tax Type | Nexus Standard | Key Case/Rule |
|---|---|---|
| Income tax | Physical presence or economic nexus (factor-based thresholds) | Public Law 86-272 protects solicitation-only activities from state income tax for tangible personal property sellers |
| Sales/use tax | Physical presence or economic nexus ($100K sales or 200 transactions) | South Dakota v. Wayfair (2018) established economic nexus for sales tax |
| Franchise/gross receipts tax | Varies by state; may use economic presence | States like Texas (franchise tax) and Ohio (CAT) use gross receipts measures |
State Income Tax Apportionment
Multistate businesses must apportion income among states where they have nexus. The traditional three-factor formula uses:
- Sales factor: In-state sales / Total sales everywhere
- Payroll factor: In-state payroll / Total payroll everywhere
- Property factor: In-state property / Total property everywhere
Many states now use single sales factor apportionment, which bases the apportionment entirely on where sales occur. This is the dominant trend and benefits businesses with significant property and payroll in a given state but sales primarily elsewhere.
Sales and Use Tax
- Sales tax: Imposed on retail sales of tangible personal property and certain services. Collected by the seller and remitted to the state.
- Use tax: Complementary to sales tax; imposed on the use, storage, or consumption of goods when sales tax was not collected. Same rate as sales tax.
- Exemptions: Common exemptions include sales for resale (resale certificate), manufacturing equipment, agricultural supplies, and certain food and medical items.
- Marketplace facilitator laws: Many states require marketplace platforms (Amazon, eBay) to collect and remit sales tax on behalf of third-party sellers.
State Conformity to Federal Tax Law
States vary in how closely they follow federal tax provisions:
- Rolling conformity: State automatically adopts federal changes as they occur
- Fixed-date conformity: State adopts the IRC as of a specific date; must pass legislation to update
- Selective conformity: State picks and chooses which federal provisions to adopt
- Common state modifications: Many states decouple from the Section 199A deduction, bonus depreciation, SALT deduction cap, and net operating loss provisions
Multistate Tax Planning
- Entity structure: Using holding companies, management companies, or separate entities to manage state tax exposure
- Transfer pricing: Setting intercompany prices for goods and services to allocate income between jurisdictions (subject to state combined reporting requirements)
- Credits and incentives: Many states offer tax credits for job creation, R&D, investment in economically distressed areas, and renewable energy
- SALT cap workaround: Many states have enacted pass-through entity tax (PTET) elections that allow partnerships and S corporations to pay and deduct state taxes at the entity level, bypassing the $10,000 individual SALT deduction cap
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