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April 28, 2010

As in 2009, it appears that 2010 will continue to be a roller-coaster ride for our state legislators as closing budget gaps put pressure on them to consider tax legislation. Many states continue to turn their focus to a tax concept that has been around for decades — namely, mandatory combined reporting. Since 2004, seven states have enacted combined reporting legislation: Vermont, Texas, West Virginia, New York, Michigan, Massachusetts and Wisconsin. As this approach does not seem to be losing any steam, businesses should understand just what everyone is thinking and how it will affect them.

What Are Proponents Saying?

Proponents of combined reporting give several reasons, including leveling the playing field for all businesses, closing so-called tax loopholes and increasing tax revenue. For example, through combined reporting, commentators argue, multistate corporations cannot use tax planning strategies — e.g., intellectual property holding companies, captive finance vehicles and real estate investment trusts (REITs) — to move profits out of states or legal entities in which much of the businesses assets, employees and sales are centered and into states or legal entities with lower tax rates or no taxes at all. Combined reporting, it is argued, mitigates the ability of large businesses to use complex planning that small businesses cannot use.

The Other Side of the Coin

While many states appear to agree with the arguments for mandatory combined reporting and are considering or have adopted a mandatory combined reporting regime, a large number of states are still separate-entity reporting states. Opponents of combined reporting point to numerous studies indicating that combined reporting will have no effect on revenue and will potentially have a negative impact on a state’s economy. One such study, “An Evaluation of Combined Reporting in the Tennessee Corporate Franchise and Excise Taxes,” was commissioned by the Tennessee comptroller pursuant to Senate Resolution 292 and examined data including that of New York and Vermont. This study found there was nothing conclusive in its analysis that demonstrated an increase in revenue through adopting combined reporting and that, in fact, revenue decreased in New York and Vermont in its first year of adoption.

In regards to business planning and so-called loophole closing, opponents of combined reporting argue that many separate-entity reporting states have already eliminated certain deemed planning strategies by adopting related-party add-back and other provisions that specifically address the planning in question, so there is no need for combined reporting to solve those issues. In addition, consider the situation of a taxpayer filing on a separate-company basis who is profitable but has related-party affiliates that operate at a loss. In separate filing states, the profitable business does not get to offset its profits by its related affiliates’ losses, thus creating tax revenue for the state. Clearly, mandatory combined reporting does not always result in increased tax revenues.

Yet another argument against mandatory combined reporting is that it leads to additional compliance and administrative costs. This argument provides that separate-company filing states will have to spend considerable time and resources training their audit and other staff on the rules associated with combined filing.

Current Trend

Whether you are for or against mandatory combined reporting, momentum is certainly on the side of adoption. As noted above, since 2004, seven states have enacted combined reporting legislation. Further, the District of Columbia and New York City have also passed combined reporting legislation. Additionally, throughout 2009, legislatures in 10 states considered adopting mandatory combined reporting but did not pass any legislation. Those states were Alabama, Connecticut, Florida, Iowa, Louisiana, Maryland, Missouri, New Mexico, Rhode Island and Tennessee. Despite the failure to pass new laws adopting mandatory combined reporting in 2009, several of these states have already introduced new bills in 2010 that again attempt to adopt mandatory combined reporting. These states include Connecticut, Florida, Maryland, New Mexico, Rhode Island and West Virginia.

Business Implications

Based on the large number of proposed mandatory combined reporting bills put forward in 2009 and the beginning of 2010, it stands to reason that eventually additional states will adopt combined reporting requirements. Therefore, taxpayers need to be proactive and familiarize themselves with certain challenges and changes that arise in combined reporting regimes.

The first consideration is determining which entities must be included in the unitary group. For businesses already filing tax returns in combined reporting states, this isn’t a new issue. But given the changing landscape, it is probably one worth revisiting. Determining the unitary group is not a purely subjective exercise. The requirements outlined in state statutes and mired in case law make this a very fact-specific decision process. For example, are the businesses sufficiently interdependent on each other? And do the activities actually constitute steps in a vertical process? Further complicating the determination of the unitary group is the fact that some states have adopted water’s-edge combined reporting while others have adopted worldwide reporting. While most states will allow the taxpayer to elect which method to use, these methods may still vary from state to state.

Once the unitary group is established, the taxpayer must then determine if it is different than the federal consolidated group or even the unitary groups in other states that have adopted combined reporting. The existence of different unitary groups and a different federal consolidated group may result in separate taxable income calculations and further compliance burdens.

Numerous other issues arise in the combined reporting arena. In regards to sales factor throwback, taxpayers must consider whether a state employs the Joyce method or the Finnigan method. Under the Joyce method, sales made by a unitary group member that does not have nexus with the state to customers in that state are not included in the unitary group’s sales factor for that state. Conversely, under the Finnigan method, all sales made into the state by unitary group members, regardless of whether a unitary group member has nexus with that state, are included in the unitary group’s sales factor for that state as long as at least one member has nexus.

Taxpayers must also evaluate how adopting mandatory combined reporting will impact the unitary group’s tax attributes, such as net operating losses (NOLs) and tax credit carryforwards. Businesses will need to consider whether a separate company loss or credit carryforward will now be used to offset income of the combined group or only of the separate company that created the carryforward.

Finally, businesses will need to consider the impact that a change to combined reporting will have on their income tax provision, including evaluating deferred tax assets and adjusting the deferred state tax rate.

Obviously this listing of issues only scratches that surface. But it does highlight the fact that a lot of work lies ahead each time a state makes such a drastic change in its taxing scheme.

Alvarez & Marsal Taxand Says:

Although the benefits of adopting combined reporting may or may not be reaped, states are forging down that track at full steam. As a result, taxpayers should regularly monitor new developments and consider the impacts on their business. Businesses will need to stay vigilant in understanding the accounting impact of these changes, potentially on a quarterly basis if materiality warrants. Furthermore, each state seems to have its own quirks and, as a result, taxpayers need to pay attention when navigating new rules. If taxpayers take a proactive approach and review items such as those discussed above before a state adopts combined reporting, the subsequent transition can be accomplished more smoothly.


Michael Mazerov, “A Majority of States Have Now Adopted a Key Corporate Tax Reform — ‘Combined Reporting’,” Center on Budget and Policy Priorities, April 3, 2009; Mazerov, “State Corporate Tax Shelters and the Need for ‘Combined Reporting’,” Center on Budget and Policy Priorities, October 26, 2007.

William F. Fox, LeAnn Luna, Ann Boyd Davis, Rebekah McCarty, and Zhou Yang, “An Evaluation of Combined Reporting for Tennessee,” revised October 30, 2009.

Robert Cline, “Combined Reporting: Understanding the Revenue and Competitive Effects of Combined Reporting,” Council on State Taxation, May 2008.

Jana S. Leslie, Staff Counsel, Council on State Taxation, Testimony to the Joint Committee on Revenue of the 185th General Court of the Commonwealth of Massachusetts, in Support of House No. 2694, “An Act making technical corrections to the combined reporting law,” July 8, 2009.

See Connecticut H.B. 5179, Florida H.B. 675, Maryland H.B. 584, New Mexico S.B. 90, Rhode Island S.B. 2272 and West Virginia H.B. 4240.

Lindsay C. McAfee, “Making Taxes More Certain: Iowa State Legislators’ Guide to Combined Reporting,” Iowa Law Review, 2009.



John Easterday
Managing Director, Chicago

Edward Eschleman, Senior Associate, contributed to this article

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Anthony Fuller
Managing Director, San Francisco

Brian Pedersen
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Matthew Polli
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