By Jonathan Liss

It happens every year: just as we finish celebrating the New Year, we jump right into planning for the upcoming tax filing season. If federal tax is the Oscars of the filing season, state and local income tax returns (state returns) are more like the Critics Choice Awards. Somehow, preparing hundreds of state returns isn’t nearly as glamorous. Well, shake off that perception and let’s get to work. There are many steps you can take now to help the preparation and filing process go more smoothly.

First, the most obvious item on your to-do list is to prepare a calendar of state return due dates. Most importantly, make sure you understand the states’ rules and requirements for extension requests. Many states automatically grant a six-month extension of time to file your state return if you file a federal extension.

It is always wise to review the company’s state returns for the prior year. The workpapers typically contain review notes that may identify issues relevant to the current tax year. A review also could disclose potential refund opportunities (or additional tax due) to be presented on amended state returns, within the applicable statute of limitations of course.

As a rule, always keep contemporaneous records of significant corporate transactions and reorganizations during the year that may have an impact on state returns. In particular, you should carefully analyze the details of any mergers, acquisitions, and divestitures. These transactions may result in new filing requirements, changes in the composition of combined filing groups, apportionment issues, and the analysis of tax attribute carryover rules by state. In addition, if a relocation or expansion of corporate facilities has occurred during the year, it will be necessary to determine the company’s eligibility for income tax credits and other tax incentives. Finally, make certain you consider recent state tax law changes and court decisions and how they may affect the current year’s returns.

Most states have either expanded their doing-business statutes to adopt economic nexus or have established a “factor-presence” nexus standard for corporate income tax nexus. Since the Wayfair decision,¹ Hawaii, Maine, Massachusetts, Pennsylvania, and the City of Philadelphia have shifted toward this standard. In preparation for the upcoming filing season, you must determine whether the company has exceeded a factor threshold in any of these economic nexus states that would create a state income tax filing obligation. Your investigation also should include an analysis of whether P.L. 86-272 applies – particularly in those states that have adopted the Multistate Tax Commission’s updated guidance² regarding activities conducted over the internet (i.e., California, New Jersey, New York).

When it comes to state income tax filing methods, it is prudent to review the composition of the company’s unitary business groups in combined reporting states. If an acquisition occurred during the year, it will be necessary to establish whether “instant unity” has occurred. In the context of an acquisition, a unitary analysis must consider the steps taken to integrate the companies leading up to, during, and immediately following the acquisition to determine when unity is established. Further, in those combined reporting states that allow taxpayers to make filing elections, you should also evaluate whether it is beneficial to elect to prepare the company’s corporate income tax return on a different filing method.

Another critical area that should be addressed in preparation for state income tax filing season is apportionment and allocation. Depending on the nature of the corporate transactions that occurred during the tax year, it may be appropriate to characterize certain income as allocable “nonbusiness income.”³ For example, a company may have recognized a substantial gain from selling the stock of a non-unitary subsidiary. This type of transaction should be thoroughly analyzed to determine whether it should be reported as apportionable business income or nonbusiness income, allocable to a specific state.

Since most states have shifted to single-sales-factor apportionment (or increased the weight of the sales factor), the sourcing of income from the sale of services and sale/licensing of intangibles is a critical task in state income tax return preparation. Generally, states that have shifted to single-sales-factor apportionment have also adopted market-based sourcing. However, the application of the states’ market-based sourcing rules, depending on the number of revenue streams and state filings, may be quite time consuming. Additionally, states differ in how they define a company’s “market” for services and intangibles. Typically, sales apportionment data is available early in the year, so you will be able to get a jump on this challenging task. The information and data needed to calculate throwback sales should also be readily available. In states that have throwback rules, sales of tangible property that are not taxable in the destination state are “thrown back” into the numerator of the origin state’s sales factor.

There is no disputing the fact that the state income tax filing season can be daunting. There will always be the unexpected, last-minute issue that pops up. While one cannot fully eliminate the stress of the filing season, I hope this article has addressed several state tax return preparation functions that can be completed upfront and alleviate at least some of the pressure in your 2024 filing season.

¹ South Dakota v. Wayfair Inc., 138 S. Ct. 2080 (2018).
² Multistate Tax Commission, “P.L. 86-272 Statement of Information.”
³ UDITPA Section 1(e).

Jonathan Liss is an adjunct professor at Drexel University and Villanova University School of Law. He can be reached at jal436@drexel.edu.

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^{Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.}