Connecticut Governor Dannel Malloy recently signed a budget implementation bill which includes favorable income tax legislation for Connecticut-based businesses. Following is a brief summary of two enacted tax legislation changes: (1) utilization of a single sales factor to determine Connecticut taxable income; and (2) market-state sales factor sourcing of service and intangible property revenue.
Single Sales Factor Apportionment
Corporations and pass-through entities (such as S corporations, partnerships, and limited liability companies) will now be able to determine the portion of their taxable income subject to Connecticut income tax based solely on a single sales factor. Previously, many businesses had to consider their Connecticut-based property and payroll when determining the amount of taxable income subject to Connecticut income taxes. By removing the property and payroll factor from the apportionment percentage determination, Connecticut-based businesses should see the amount of their Connecticut taxable income and associated tax liability reduced. The following example illustrates the potential favorable impact this legislation may have for a Connecticut-based business:
For Connecticut-based businesses, the formula change to determine the apportionment percentage to be applied to the business' taxable income can result in a substantial reduction in the business' Connecticut income tax liability and should encourage businesses to invest their new-found money in employees and property within the state.
For C corporations, this legislation is effective for tax years beginning on or after January 1, 2016. For pass-through entities, the legislation is effective one year later; i.e., for tax years beginning on or after January 1, 2017.
Market-State Sales Factor Apportionment
In general, the determination of a business' Connecticut sales for purposes of determining the Connecticut sales factor has been based on the destination of the property that is sold. However, with respect to the sale of services, service revenue is not based on the destination of the service but has been based on where the work to render the service is performed. Services (and income derived from intangible assets) will now be sourced similarly to the sourcing of sales of goods; i.e., based on the destination of the service (generally, where the customer who receives the service is located). This should have favorable income tax consequences for Connecticut-based service businesses, whereas additional tax revenue should be captured from non-Connecticut-based service businesses. The following example illustrates the impact this legislation will have on Connecticut and non-Connecticut based businesses:
The so called "market-based sourcing" rule (applied to service and intangible revenue) applies to C corporations, effective for tax years beginning on or after January 1, 2016, and for pass-through entities, effective for tax years beginning on or after January 1, 2017.
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As of January 1, 2017, apportionment methodologies will be consistent among all legal entity and tax types, regardless whether the legal entity is in the form of a corporation or a limited liability company (and other entities treated as pass-through entities for tax purposes). By providing favorable income tax legislation to Connecticut-based businesses, businesses that are already here should be able to invest their dollars in Connecticut people and property without the fear of increasing their Connecticut income tax liability. Businesses that are not here, such as those looking to start-up or relocate, should find Connecticut's income tax regime a deciding factor when making its U.S. location decision.
Connecticut-based and out-of-state businesses should begin to determine how their Connecticut income tax liabilities will be affected as a result of this legislation. If you have any questions about how this legislation might affect your business or owners, please contact Tony Switajewski.
(Note: Portions of the above apportionment legislation with respect to C corporations was enacted during the 2015 and the 2016 legislative session. The apportionment legislation with respect to pass-through entities was enacted during the 2016 legislative session. The discussion is a general explanation of the new tax provisions and the examples are for conceptual illustrative purposes only; please consult your tax advisor).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.