Saturday, February 13, 2010

Hey, Sailor, c'mere; you want a free one? II

I’ve got an example of how the interstate taxation of business income, described in the last post, works.

Let’s say that you are a traveling comedian, and you have a professional corporation. For our hypothetical example, we’ll call it Al Franken, Inc., or AFI for short. AFI is domiciled in New York, but AFI travels around the country, making appearances at comedy clubs, corporate events, etc., for a fee.

When AFI appears in a state other than New York, let’s use California as an example, and earns a fee for being funny, that fee is California income. There may be no withholding (probably isn’t) taken from the fee. But AFI should file a California return and pay taxes on the income from the appearance.

When AFI prepares its New York state income tax return, the income that it reports will include the income from the appearance in California, but it will take as a credit against the tax owed to New York the tax that it paid to California.

If New York decided to unilaterally get rid of its state income tax, AFI would still owe the tax to California for the appearance there.

This is how entertainers, and highly-paid professional athletes, too, are taxed by states in which they appear or play. But it is a pretty good analogy for how corporations are taxed when they set foot in another state, too. Corporations have to pay taxes in a state on income than can be fairly said to be attributable to that state.

There really was a flap over Al Franken and interstate taxation of his income, as many of you undoubtedly recall. Al, I’m sorry to bring it up, but it is such a good pedagogical example, and perhaps regrettably, many people have it in mind.

What happened was that Al – or rather his accountant – reported all of Al’s income in New York; as Al maintained, he did pay New York taxes on all of his income. The problem was, of course, that other states, like California in our example, didn’t get their piece.

If Al had filed the other state returns, it is unlikely that his overall tax burden would have been much different because of the credits he could have taken against his New York return. When Al made the point there was no real financial incentive for him not to file in other states, this is what he meant.

Next in the series: on to the VAT!

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