The vast majority of states impose some form of a corporate income tax (CIT) to raise revenue from business entities. Although CITs can be complex, most businesses are familiar with how they work since most state CITs are derived from the federal income tax. However, not all states impose CITs. In fact, Texas, Ohio and Washington, three of the largest states, currently impose a gross receipts tax (GRT) instead of a CIT. Given the differences between GRTs and CITs, it should come as no surprise that multistate businesses, especially those based outside of those three states, are often confused as to how GRTs work. Herein we provide a general overview of GRTs, a brief description of the taxing schemes in Texas, Ohio and Washington, and some key distinctions that multistate taxpayers should be aware of concerning GRTs.
What is a GRT?
As the name suggests, a GRT is a tax on business receipts rather than business income. Typically, it is imposed on all business sales and allows few or no deductions. While there was a rise in states adopting GRTs in the early 2000s, they are not a new concept as GRTs were first adopted by states in the early 1920s. Currently, Texas, Ohio and Washington are the only states that impose a GRT instead of a CIT. However, a few states do impose GRTs in addition to CITs (e.g., Delaware and New Mexico both have GRTs that function similar to sales taxes).
Texas Franchise Tax
Texas imposes a GRT in the form of a franchise tax based on a taxpayer's margin. The tax is imposed on C corporations, S corporations, limited liability companies, partnerships, and other legal entities. Taxable entities that are part of an affiliated group engaged in a unitary business are required to file a combined group report computing their franchise tax as if they were a single taxable entity.
Beginning with the 2014 tax year, an entity's taxable margin is the lowest of four amounts:
- Total revenue less $1 million,
- 70 percent of total revenue,
- Total revenue minus cost of goods sold, or
- Total revenue minus compensation.
There are several nuances specific to the Texas franchise tax computation, most notably:
- Total revenues typically reference amounts reported on the federal income tax return including gross receipts or sales (less returns and allowances), dividends, interest, etc.
- A taxable entity may subtract cost of goods sold in computing its margin only if the entity owns the goods. As a result, service companies are generally not eligible to subtract cost of goods sold.
- Due to numerous special rules applicable to computing cost of goods sold, the deduction will generally not be the same as the amount used in computing federal taxable income.
- If a taxable entity subtracts compensation in computing its margin, the deduction will include both the compensation amounts reported on the employees' Form W-2s (limited to $350,000 per person for 2014 and 2015 tax reports) and deductible employee benefits such as workers' compensation, health care and retirement benefits.
- The tax rate is 1 percent, but there is a reduced rate of 0.5 percent for taxpayers primarily engaged in retail or wholesale trade. For tax reports due in 2014 and 2015, taxpayers can elect to use reduced rates. A taxable entity with total revenue of $10 million or less may elect to calculate its franchise tax due by multiplying total revenue times the apportionment factor times 0.575 percent.
Ohio Commercial Activity Tax
Ohio's GRT is a commercial activity tax ("CAT") on a business entity's gross receipts. The CAT is imposed on many entities including C corporations, S corporations, partnerships, and limited liability companies. Commonly controlled taxable entities may be required to compute the CAT as a combined taxpayer or may elect to file as a consolidated taxpayer. Certain types of entities, including financial institutions, insurance companies, securities dealers and public utilities, which are subject to other types of Ohio taxes, are exempt from the CAT.
A minimum tax of $150 is imposed on the first $1 million in taxable gross receipts and increases in tiers until it reaches $2,600 for taxpayers with taxable gross receipts in excess of $4 million. In addition to the minimum tax, a 0.26 percent tax is imposed on taxable gross receipts in excess of $1 million. Generally, items that are treated as gross receipts for federal income tax purposes are treated as gross receipts for CAT purposes. A taxable gross receipt is a gross receipt attributed to Ohio.
Washington Business and Occupation Tax
Washington imposes a GRT called the business and occupation tax ("B&O tax"). The B&O tax applies to different types of entities including C corporations, S corporations, partnerships, and sole proprietorships. The B&O tax is imposed on a seller's gross receipts derived from business activities conducted in Washington. Generally, no deductions are allowed for cost of goods sold, salaries, supplies, taxes, or any other costs of doing business with the exception of a few exemptions, deductions and credits.
The B&O tax rate varies with the type of business activity. The four major business activity classifications include retailing, wholesaling, manufacturing, and service and other activities. There are also a number of specialized classifications. The applicable tax rates range from 0.471 percent for retailing to 1.5 percent for services and other activities.
How are GRTs different?
There are several unique features of GRTs that separate them from other taxes. Here are some considerations that taxpayers doing any sort of business with customers in Texas, Ohio or Washington should know about the GRTs imposed by those states.
GRTs are also not sales tax
While GRTs and retail sales tax both tax receipts, the sales tax applies only to final retail sales to consumers while GRTs applies to all transactions including sales for resale. As a result, GRTs have the potential to result in tax pyramiding whereby the actual taxable percentage increases as a product or service passes through its life-cycle. GRTs typically impose lower tax rates than sales tax but also have broader tax bases. Lastly, sales tax is generally imposed on the purchaser of the good or service while GRTs are imposed on the seller and are typically not passed along directly to the buyer.
Unlike corporate income taxes in most states, GRTs apply to pass-through entities, including limited liability companies, S corporations and other pass through entities, at the entity level.
Different nexus standards
Since GRTs are not considered sales tax, there is no physical presence requirement as described in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In fact, Ohio and Washington have adopted factor presence standards whereby a taxpayer will be presumed to have nexus in state if it exceeds a specific property, payroll or sales threshold in that state as follows:
The result of adopting factor presence standards is that businesses may be subject to the GRT in states where they do not have a physical presence but exceed a certain sales threshold. See our March 2011 article, State Income Tax Nexus: No Physical Presence Required, for a more comprehensive discussion on factor presence nexus
No P.L. 86-272 protection
GRTs are also not considered taxes based on income. Therefore, sellers of tangible personal property that have a physical presence in the state solely due to the presence of representatives engaged in the solicitation of sales, will not be afforded the protection of P.L. 86-272, like they are for corporate income tax purposes.
Credit for taxes paid in another state
Some states, such as Massachusetts, will not allow individual owners of flow through entities to take a credit for GRT paid by the flow-through entity since these taxes are not considered income based taxes.
Conformity with federal taxable income
GRTs do not use federal taxable income as their starting point even though some of the components of the GRT tax computation may reference specific line items from the federal return.
No provisions for entities operating at a loss
Since GRTs are not based on income, entities operating at a loss will still have a tax liability. As a result, many business entities have complained that GRTs are not sensitive to a taxpayer's ability to pay the tax.
Taxpayers engaged in multistate businesses must understand the differences between GRTs and other business taxes. Taxpayers who are unfamiliar with how these taxes work may end up with unpleasant surprises such as unwanted nexus, unanticipated tax liabilities, and additional compliance responsibilities. Therefore, we advise taxpayers to be cautious of:
- Exceeding the factor presence standards as it will result in a filing requirement,
- Creating nexus via sales solicitation by employees or independent reps, and
- The assumption that these taxes should be small because the taxpayer is operating at a loss.
If you have any questions regarding GRTs, please contact your local CBIZ tax advisor.
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