State tax considerations for portcos
For CFOs and controllers of portcos, an understanding of the following issues — several of which affect Portco A in the illustration — can help them address potential tax liabilities resulting from an increasingly mobile workforce.
Payroll tax
When work locations shift because of remote or hybrid working models, payroll tax liabilities may increase, and corporate officers could be held liable. Companies need to manage payroll tax obligations for all remote workers. In the illustrative example, filing obligations for the portfolio company would increase significantly, which would create additional payroll filings for the five EINs across many states.
Property tax
As companies reconsider their real estate needs, there could be excess rent expense for space that goes unused. For companies that own real estate, reductions to their footprint can trigger functional obsolescence, with costs resulting from tenant turnover and changes in the use of utilities. Economic obsolescence may result in lost revenue from downsizing or a drop in rental rates, and companies could also see a loss of expense reimbursements with an increase in operating costs, such as maintenance and supplies. Excess inventory would create depreciated unused assets, including technology. Evidence of a decline in property value would factor into a reassessment of the property for tax purposes.
For Portco A, the Massachusetts subsidiary will have decreased demand for office space, which could reduce its value in owned real estate. Personal property may also become obsolete because of the lower office headcount, which also reduces the need for new/additional equipment (existing equipment may have the potential for an idle equipment exemption). In addition, there may be an increase in operating costs for maintenance and office safety protocols.
Credits and incentives
In considering credits and incentives, companies should proactively review incentive agreements, especially those predicated on employing a minimum number of workers within a state and negotiate a revision to include remote workers. They should also determine if their shifting workforce is increasing headcount in a specific jurisdiction which may qualify them for new credits and incentives.
State income tax
States use several apportionment formulas to determine how corporate profits are taxed. Single sales factor (SSF) takes into account only sales within the state (using various methodologies to make this determination), whereas states using three- or four-factor apportionment require companies to include, in addition to sales, a percentage of property and payroll within the state. A company subject to three- or four-factor formulas should consider whether the location of its employees has changed due to telework, whether there are changes to where it performs services, or whether there are changes to the states where its costs are incurred.
In the illustrative example, Portco A is using four-factor apportionment. Within Massachusetts, payroll and property factors will be reduced significantly, and sales will remain the same. Assuming the apportionment factor is reduced by 20% and its state income tax is $100 million, the Massachusetts corporate income tax benefit is $1.6 million ($20 million × 8%). In contrast, the income tax nexus established in North Carolina would create a cost of $1.1 million ($100 million x 45% North Carolina apportionment percentage x 2.5% North Carolina rate).
Franchise tax
Companies that meet state-specific “doing business” definitions are subject to franchise tax, which may be calculated based on assets, net worth, or gross receipts. In the illustrative example, once the portfolio company established nexus in North Carolina, it became subject to a $6.8 million cost — (($10 billion net worth × 45% SSF) × 0.15%).
Sales and use tax
The location of workers can affect where the revenues they create are taxed. A company should know where employees are working because the services those employees provide may be subject to sales tax in some states but not others. Location can also affect the taxes paid on software and other items purchased for employees’ use.
Gross receipts
Multiple states and cities impose a gross receipts tax on the total gross revenue of a business. The sourcing rules may differ from sales and use taxes, but the implications for companies with remote workers are similar. Employees who work from locations with taxes on gross receipts may affect the filing obligations of their employers.
Failing to account for these state tax risks can have a dramatic impact on a portfolio company’s future plans. When potential buyers discover unaddressed tax issues, they may question the company’s business practices and the stewardship of management. They could reduce their offer or back out of the deal altogether. Longer escrow periods and more holdbacks are also possible. This potential for lower valuation makes tax compliance just as important for CFOs and controllers as it is for tax directors.
Remote and hybrid work is here to stay
As companies develop their return-to-work plans, they should aim to address the state tax challenges of remote and hybrid working. Organizations are creating new strategies to adapt to flexible ways of working, including re-evaluating their approaches to hiring, revamping policies on where and how work gets done, and adopting workplace and technology changes. Of course, there is no one-size-fits-all approach. Companies should consider their unique needs, culture and risk appetite and leverage technology-enabled solutions to reduce cost while remaining scalable to future growth.
When evaluating technology-enabled solutions, many organizations are first identifying, based on their assessment of risk tolerance for their employee population, whether they need pre-work request and approval workflows, post-work review and validation systems, or a combination of the two. In addition to improving cost efficiencies through reduced human-hours spent analyzing risks or coordinating approvals and assessments, technology-enabled solutions can also help reinforce organizational business rules around remote and hybrid work while communicating and enforcing a company’s policy in a transparent and consistent manner.
As they contend with the world of hybrid work, companies should assess whether their internal systems can track and accurately report employee work locations and state and local filing obligations. The earlier that a CFO or controller addresses these issues, the better off a portco will likely be as it plans for the future.
The following Ernst & Young LLP subject matter experts contributed to this article:
Ralph Furlo, Partner, Indirect Tax
Bridget Ahern, Principal, People Advisory Services
Christopher Hill, Senior Manager, People Advisory Services
