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State Apportionment with Multiple Entities

By Jason Watson ()
Posted May 5, 2019

Imagine you and another person want to form a business together, but you live in different states such as Minnesota and North Carolina. Where do you put the entity? In the end, it doesn’t matter since you would probably have a foreign filing registration requirement in the other state. So, you domicile the entity in Minnesota but also file as a foreign entity in North Carolina.

What’s the big deal? States get all bent out of shape on nexus and income apportionment. We have a whole chapter on this nexus stuff, but let’s do a quick preview. Generally there are two types of nexus triggers, either economic or physical. Economic refers to how much “business” is being conducted based on either a revenue, payroll or property basis. Physical nexus is commonly viewed as “boots on ground,” such as people or contractors, furthering your interests or “bricks and mortar,” such as offices.

If you trip the nexus wire, then the entity is on the hook for apportioning the taxable income among multiple states based on various formulas. One of the factors is naturally revenue, so if you trip nexus in two states, you have to source revenue to each state. Next, each owner now has an income tax obligation in multiple states and is required to file non-resident tax returns in each state outside of his or her resident state. This is unavoidable, but what is avoidable to some degree is the scrutiny. How’s that?

Using our Minnesota and North Carolina example, if the entity is domiciled in Minnesota, you might have to convince Minnesota that a big chunk of the taxable income is not theirs (i.e., the revenue earned in North Carolina). We find ourselves having to connect dots for revenue agents often since you commonly must report all revenues earned, and then split them off to other states. As such, states get to peer into your world and then make you defend it. Yuck.

Solution? We usually create an entity in Wyoming or some other “tax-inert” state, and then also create entities in each owners’ resident state. All revenues pour into the Wyoming entity which in turn pays out revenues as fees for services to the other entities (Minnesota and North Carolina, in our example). Does this allow the Minnesota owner to avoid North Carolina taxes? No. Taxable income is still apportioned between states, and each owner has an income tax obligation in multiple states. What this does, however, is reduce the scrutiny triggers since you only need to “show the cards” that are pertinent to each state.

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