Five Ideas To Cut Your Maryland Corporate Income Taxes

By Joseph Flack



Income tax planning is not an activity normally associated with tax preparation time. After all, don't CPAs recommend that tax planning should be done during the tax year, not after it? From a state corporate income tax perspective, however, there are steps taxpayers can take after the end of the year to minimize their state income tax liability. These ideas can be implemented at the time the Maryland corporate tax return is prepared, or even on amended returns. These ideas are oriented toward corporations paying state income taxes. "S" corporations don't normally pay Maryland state income taxes, their shareholders do, so some of these ideas may not apply.



File in Maryland and Another State

Most CFOs and controllers don't focus on the state income tax consequences of their company's activities. They don't want to file more than their normal Maryland corporate return. However, filing in another state can substantially cut a corporation's Maryland income tax liability. This is because a corporation doing business solely within Maryland pays tax on 100% of its income, while the corporation doing business in multiple states is allowed to file on an apportioned basis. The result can be a significant cut in Maryland taxes, up to 50% for a service company and perhaps 100% for a manufacturing company. Apportionment takes advantage of certain benefits that the legislature and Comptroller's office put in place to favor Maryland businesses at the expense of non-Maryland-based businesses selling to customers located here.

Maryland's corporate tax system starts with federal taxable income, adds back to it state income taxes and other nondeductible items, multiplies the result by the corporation's Maryland apportionment factor and multiplies that result by Maryland's corporate tax rate of 7%. It's the reduction of the apportionment factor that results in tax savings. Cutting the apportionment rate in half cuts Maryland taxes in half.

In Maryland, the apportionment factor is a weighed average percentage of the corporation's Maryland sales, payroll and property to the corporation's total amounts. In Maryland, the sales factor is double-weighted, that is added twice, so Maryland uses four factors to compute apportionment. The tax savings benefit comes from the calculation of the sales factor. If a corporation has no Maryland customers, that is, it sells its product or services to out-of-state customers, the Maryland sales factor will be zero. If the corporation has all its property and payroll in Maryland (these apportionment factors are 100% Maryland), the resulting apportionment will be 50% (0% sales, double weighted, 100% payroll, 100% property equals 200% divided by 4 for an average of 50%). Therefore, simply by filing a return in another state with little sales activity, the Maryland-based corporation can cut its Maryland taxes by 50%.



Use the Correct Apportionment Method

Maryland's apportionment factor system has two built-in benefits for Maryland-based service providers and manufacturers. Service providers compute their sales factor based on where their customers are located. Most other states base the computation of the sales factor on where the activities that meet the sale contract requirements occur. A service provider in Maryland, with customers in Virginia, would be able to avoid sales in either the Maryland or Virginia factor. Virginia would classify the service sales as Maryland while Maryland would classify the sales as Virginia. For the Maryland corporation, the tax return would show a 50% Maryland apportionment factor and a 0% Virginia apportionment factor. Thus the corporate taxpayer would be able to cut its Maryland taxes by 50% without incurring a Virginia tax. (Conversely, the unfortunate Virginia based corporate taxpayer with customers in Maryland would pay both a Maryland and Virginia tax on the same sales.)

Manufactures were recently granted a benefit by the legislature with its adoption in 2001 of the single factor formula. Maryland does not include in its manufacturer's apportionment formula calculation the effect of payroll or property. Only sales are considered. This tends to favor in-state manufacturers while taxing more heavily out-of-state manufacturers. Under the old rule, a manufacturer's apportionment was based on payroll, property and sales, and the payroll and property weighted the factor high for Maryland-based manufacturers. The new formula removes these activities from the factor, basing the result entirely on where the customer is located. Since many manufacturers have low levels of in-state sales, it is entirely possible for a manufacturer wholly within Maryland not to incur a state income tax liability.



Keep Good Records

Maryland and Virginia base their payroll apportionment factor on the state unemployment tax (SUTA) reports. Generally, Maryland will consider an employee who is covered by Maryland SUTA to be a Maryland employee for purposes of computing the income tax apportionment factor. Care should be taken in this regard. Many employers are unaware of the rules regarding SUTA and sometimes report payroll incorrectly. SUTA is based on where the employee works, not where the employee lives; in the Virginia/D.C./Maryland region personal income tax withholding is based on where the employee lives, not works. Make sure that the SUTA reporting is based on the work location and not the employee's resident state. Also, make sure that the SUTA payroll data is used instead of the income tax payroll data.



Take Advantage of Maryland Tax Credit Programs

Every year legislators wonder if the are giving away the store with respect to tax credit programs. Some credits are easy to claim. Others require some paperwork. One credit that many employers miss is the Maryland research and development credit. To the extent that the corporation has federal research and development credits, there should also be Maryland research and development credits if the work is performed in Maryland. Generally, a taxpayer must apply for the credit with the Department of Business and Economic Development by September 15 of the calendar year following the end of the tax year. For example, a 2002 calendar year taxpayer must apply by September 15, 2003. Likewise, a fiscal year taxpayer whose year ends during 2002 has until the same September 15, 2003 in which to apply.

Other credits require precertification or notification. Under the Maryland Jobs Creation Credit program, a business entity that creates 60 qualified positions (or fewer if certain requirements are met) is entitled to a credit. The credit is the lesser of $1,000 per employee or 2.5% of the wages paid to qualified employees. The credit may be substantially higher for certain priority funding areas. The company must notify the Maryland Department of Business and Economic Development prior to hiring the new employees and be certified prior to claiming the credit. Fortunately, such notification may be done with a simple letter, and the formal certification can be done by the department after the employees are hired.



Track Intercompany Transactions

Many corporations decide to form separate legal corporate subsidiaries for business or legal reasons. Generally, a consolidated return is elected for federal purposes. Maryland law does not provide for consolidated tax return reporting. In many instances, newly formed corporations generate substantial tax losses, while other corporations in the group incur state tax liabilities. To avoid having profitable members of the corporate group pay taxes while incurring losses in others, consider identifying and recording appropriate intercompany charges to properly reflect the intercompany activity. For example, it is not unusual for a corporation to form a subsidiary while it acts as a holding company with top executives or financing activities. In many instances, the holding company incurs losses while the operating company is profitable. Consider charging the profitable subsidiary an arm's length charge for services rendered by the parent to the subsidiary. The loss in the parent is reduced with a corresponding reduction in income in the profitable subsidiary.

These strategies can be implemented after the corporate books are closed but prior to filing the tax returns. However, it is better to begin a tax year with a planning structure in place.



Joseph Flack is a director in Deloitte & Touche's MultiState Tax Practice. He can be reached at 410-576-7354 or JFLACKMD@ hotmail.com.