Tag Archives: 2018

State Income Tax Filing Requirements and Economic Presence

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Scope: This memo is intended to provide general guidance on how state income tax return filing requirements are determined and to provide an explanation of the Economic Presence standard which several states are now using to determine if a business entity has a tax return filing requirement in that state. Vertical Advisors (VA) determines state tax return filing requirements based on information provided to us from our clients. However, the historic state income tax filing requirements are based on the general standard as described below but each business will ALSO need to decide whether state filing requirements under the Economic Presence standard should be considered. VA is available to be engaged to review income tax filing requirements for our clients.

General Standard: There are multiple factors that affect state tax return filing requirements. This memo is meant to provide a general overview. A detailed analysis of state tax attributes would be needed to fully understand the state tax return filing requirements for a particular business. Attributes that are considered when determining state tax return filing requirements are as follows:

  1. Sales by state
  2. Wages by state (could also include vendor or independent contractors)
  3. Fixed assets by state

Historically, when a business has two or more of the attributes listed above, a state tax return would be required for that state. However, several states are now using the more aggressive Economic Presence standard which can cause a state tax return filing requirement even if only one attribute exists which is usually sales in that state.

Economic Presence Standard: Under the Economic Presence standard, a state tax return may be required if any one of the following conditions exists:

  • Any income derived in the state
  • Sales in the state exceeding certain threshold
  • Licensed intangible properties in the state
  • Doing business or seeking profits in the state

The Economic Presence standard is not new and approximately 43 states currently have an Economic Presence standard. Although the Economic Presence standard has existed for years, the states were not aggressively enforcing tax return filing requirements under this standard. However, due mainly to the growth of the e-commerce industry, it is now common for a company to transact business in several states in which the only connection to that state may be the sales with no actual physical presence in that state. Under the general standard, without a physical presence in the state, there was no state return filing requirement and thus the states could not assess income tax on businesses that had only sales in those states.

Under Economic Presence, the sales alone can cause a tax return filing requirement. Since each state defines Economic Presence standard differently, a detailed analysis by state would be required to understand the possible state tax return filing requirements under the Economic Presence standard.

Conclusion: As mentioned earlier, Vertical Advisors reviews state tax return filing requirements consistent with the general standard and information provided by our clients. However, since states are becoming more aggressive in applying the Economic Presence standard, each business will need to decide if they want to retain us to consider their specific income tax return filing requirement, allocate their internal resources, or to disregard the laws. We recommend a diligent review of income tax return filing requirements annually.

We feel it makes sense to review state tax return filing requirements under the Economic Presence standard and the general standard approach. Ignoring state tax return filing requirements under the Economic Presence standard can result in tax notices, possible penalties and examinations. However, since not all states are aggressively applying the Economic Presence standard, a business will need to balance the risk of not filing against the cost of preparing possibly several state tax returns. For more information on how state income tax filing requirements including the Economic Presence test may affect your business, please contact us.

2018 Cost-of-Living Adjustments

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The IRS recently issued its 2018 cost-of-living adjustments. In a nutshell, to account for inflation, many amounts increased, but some stayed at 2017 levels. As you implement 2017 year-end tax planning strategies, be sure to take these 2018 adjustments into account in your planning. (However, keep in mind that, if Congress passes a new tax law, some of these amounts may change.)

Gift and estate taxes

The annual gift tax exclusion increases for the first time since 2013 to $15,000 (up from $14,000 for 2017). It’s adjusted only in $1,000 increments, so it typically increases only every few years.

The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2018 the amount is $5.60 million (up from $5.49 million for 2017).

Individual income taxes

Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $200 to $400, depending on filing status, but the top of the 35% bracket increases by $4,675 to $9,350, again depending on filing status.


The personal and dependency exemption increases by $100, to $4,150 for 2018. The exemption is subject to a phaseout, which reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold (2% of each $1,250 for separate filers).

For 2018, the phaseout starting points increase by $3,100 to $6,200, to AGI of $266,700 (singles), $293,350 (heads of households), $320,000 (joint filers), and $160,000 (separate filers). The exemption phases out completely at $389,200 (singles), $415,850 (heads of households), $442,500 (joint filers), and $221,250 (separate filers).

Your AGI also may affect some of your itemized deductions. An AGI-based limit reduces certain otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). The thresholds are the same as for the personal and dependency exemption phaseout.

AMT

The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.

Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2018, the threshold for the 28% bracket increased by $3,700 for all filing statuses except married filing separately, which increased by half that amount.

The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2018 are $55,400 for singles and heads of households and $86,200 for joint filers, increasing by $1,100 and $1,700, respectively, over 2017 amounts. The inflation-adjusted phaseout ranges for 2018 are $123,100–$344,700 (singles and heads of households) and $164,100–$508,900 (joint filers). Amounts for separate filers are half of those for joint filers.

Education- and child-related breaks

The maximum benefits of various education- and child-related breaks generally remain the same for 2018. But most of these breaks are limited based on the taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within the applicable phaseout range are eligible for a partial break — breaks are eliminated for those whose MAGIs exceed the top of the range.

The MAGI phaseout ranges generally remain the same or increase modestly for 2018, depending on the break. For example:

The American Opportunity credit. The MAGI phaseout ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2018: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.

The Lifetime Learning credit. The MAGI phaseout ranges for this education credit (maximum $2,000 per tax return) increase for 2018; they’re $114,000–$134,000 for joint filers and $57,000–$67,000 for other filers — up $2,000 for joint filers and $1,000 for others.

The adoption credit. The MAGI phaseout ranges for this credit also increase for 2018 — by $4,040, to $207,580–$247,580 for joint, head-of-household and single filers. The maximum credit increases by $270, to $13,840 for 2018.

(Note: Married couples filing separately generally aren’t eligible for these credits.)

These are only some of the education- and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible.

Retirement plans

Not all of the retirement-plan-related limits increase for 2018. Thus, you may have limited opportunities to increase your retirement savings if you’ve already been contributing the maximum amount allowed:

Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2018:

Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if the taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:

  • For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
    • For a spouse who participates, the 2018 phaseout range limits increase by  $2,000, to $101,000–$121,000.
    • For a spouse who doesn’t participate, the 2018 phaseout range limits increase by $3,000, to $189,000–$199,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2018 phaseout range limits increase by $1,000, to $63,000–$73,000.

Taxpayers with MAGIs within the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $5,500 contribution limit (plus $1,000 catch-up if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.

Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:

  • For married taxpayers filing jointly, the 2018 phaseout range limits increase by $3,000, to $189,000–$199,000.
  • For single and head-of-household taxpayers, the 2018 phaseout range limits increase by $2,000, to $120,000–$135,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)

Impact on your year-end tax planning and retirement planning

The 2018 cost-of-living adjustment amounts are trending higher than 2017 amounts. How might these amounts affect your year-end tax planning or retirement planning? Contact us for answers. We’d be pleased to help.