Recent Overtime Pay Law Blocked

Generally, employees must be paid time and a half their regular pay for overtime worked above 40 hours per week. Existing DOL (Department of Labor) regulations under the Fair Labor Standards Act generally require each of the following three tests to be met for employees to be considered exempt from this overtime pay law:

1. Salary basis test: the employee must be paid a predetermined and fixed salary that is
    not subject to reduction because of variations in the quality or quantity of work performed.
2. Salary level test: the amount of salary paid must meet a minimum specified amount.
3. Duties test: the employee's job duties must primarily involve executive, administrative or 
    professional duties as defined by the DOL regulations. 

Highly compensated employees earning an amount above an annual threshold of $455 per week or $23,660 per year are exempt. A Texas judge recently ruled that the DOL cannot simply apply salary levels in determining an employee's exempt status and as such, it's recent regulations that were set in place to increase the threshold (double) was blocked and was sent back to the DOL's drawing boards. 

There are, for example, other exempt classifications such as airline employees, outside sales persons, most people working with advanced education and skilled trades, and administrative and operations-type management type employees.

Nevertheless, it is a good idea to check with your State's laws and review these overtime laws to make sure you are in compliance. 

Bulk Land Sale Generated Ordinary Income To Developer - Your Actions and Intentions Often Determine Your Tax Fate

One should always respect one's intentions when it comes to classifying for tax purposes transactions contemplated for business.  

In Boree, CA-11, September 12, 2016, the Eleventh Circuit Court of Appeals affirmed that the subject taxpayers were liable for tax on ordinary income with respect to the bulk sale of a parcel of land following its development rather than capital gain treatment for property held for investment purposes.  

In this case, the taxpayers were found to have acted as developers with respect to the land, and the income attributed to the land sale was to reflect that position, and as a result it was ruled that the taxpayers failed to act in accordance with their claimed intentions. Given the facts and circumstances, the taxpayers’ behavior with respect to the bulk sale (like that of their behavior with that of other parcels of land they sold to individuals) was in line with that of a developer, and, not an investor, and therefore, the sale, resulted in ordinary income.

Background

The taxpayers owned a real estate business. The taxpayers acquired nearly 1,900 acres of vacant real property. The taxpayers engaged in development activities with respect to the property, to include submitting development plans, deducting business expenses related to the property, and selling several lots to buyers between 2002 and 2006. In 2007, the taxpayers sold its remaining lots, nearly 1,100 acres, in a bulk sale to a development company.

For the 2007 tax year, the taxpayers sought capital gains treatment with respect to the bulk sale. The IRS determined that the sale resulted in ordinary income. The taxpayers were also assessed accuracy-related penalties. The Tax Court ruled in favor of the IRS, finding that the sale resulted in ordinary income, as the property was held for sale in the ordinary course of business.

Circuit Court’s analysis

The Eleventh Circuit affirmed the Tax Court’s decision, finding that income from the taxpayers’ bulk sale of property resulted in ordinary income. The taxpayer asserted that the later imposition of land use restrictions was so adverse that it led them to hold the property for investment and not for sale.  But the court said the restrictions did not act as a bar of all development of the property. The court's decision was also based upon the fact that the taxpayer's continually requested for exceptions from the subsequent land use restrictions so that they could continue with their proposed subdivision.

Additionally, the court found that the Tax Court appropriately determined that the taxpayers continued to sell, or make attempts to sell, lots to individuals after the land use restrictions were in place, and deducted, as opposed to capitalized, expenses related to the property. This activity suggested that the taxpayers engaged in development activities even after the restrictions were imposed. 

The Appeals court also found that the Tax Court’s determination that the sale of 600 acres, which equaled one-third of the property, amounted to "frequent and substantial" sales, regardless of the fact that the taxpayers sold fewer lots after the land restrictions were in place. The "frequency and substantial(ity)" of sales is a factor used to determine whether property is being held as a capital asset. Frequent sales tend to suggest that property is not held for investment.

Also, the court noted the taxpayers’ failure to distinguish the parcels of land that they intended to use for development purposes from those they intended to hold as investment property. In addition, the court found that the early maps and later plans for the property envisioned a project that included, and continued to include, the property in its entirety, further undermining the taxpayers’ contentions that their primary purpose with respect to the property changed. 

References: CCH Tax Bulletin 2016-2 ustc ¶50,406; TRC SALES: 15,104.15.

Capital Gain Income and its Effect on Income Tax Brackets

I have often been asked this question: what is the capital gains rate?  Well, the answer is "it depends". 

First of all, according to Wikipedia,  the tax rate depends on both the individual's tax bracket and the amount of time the asset (the investment sold) was held. Short-term capital gains are taxed at the individual's ordinary income tax rate and are defined as investments "held for a year or less" before being sold. Long-term capital gains, are gains attributable to the dispositions of assets "held for more than one year" and are taxed at a lower capital gains rate.

As of 2016, the United States taxes short-term capital gains at the same rate as it taxes ordinary income. Long-term capital gains, on the other hand, are taxed at generally lower rates with some exceptions:

• The tax on collectibles and certain small business stock is capped at 28%.
• The tax on un-recaptured Section 1250 gain — this is the portion of gains on depreciable real estate (ie. structures used for business purposes) that has been or could have been claimed as depreciation — is capped at 25%.
• Most other investments are subject to a preferential rate of 0%, 15%, or 20%, depending on the tax rate that would be assessed on the same amount of ordinary income.

The dollar amounts ("tax brackets") are adjusted each year based on inflation, and are after deductions and exemptions, which means that there is another bracket of income (that is, essentially,  below the 25% bracket for filers) that has a $0 capital gains rate. 

But secondly, the most misunderstood aspect of the capital gains rate structure is the fact that even capital gains on which the above table shows the tax to be 0% may increase an individual's overall tax liability, as it may push any capital gain income into higher tax brackets. 

What?  Come again?  Well, it appears that what happens is that (and take a deep breath) the capital gain does push an individual's total income into the next tax bracket, but the capital gain is always interpreted as the "last" income the person received, so that if that individual's non-capital-gains income is less than the threshold, it will all be taxed in the lower bracket, and only that individual's capital gain will be taxed in the higher bracket (but it will be taxed at the capital-gains rate of that higher bracket).

In short, a capital gain can only push capital gains into higher capital-gains tax brackets; it cannot push ordinary income into higher ordinary-income tax brackets. In addition, the amount of the capital gain is taxed in a marginal rate fashion, such that any portion of the gain that will "fit" into a lower bracket will be taxed at a lower level, with only the topmost portion of any gain being taxed at the top rate.

Tennessee Law and an Assignment of an LLC Membership Interest

I am not an attorney, but recently, as a result of some of my work on business valuations, I was interested in distinguishing a member of an LLC from an assignee member of an LLC, I came across the Tennessee law(s) that address(es) assigning one's interest in an LLC and the restrictions that might apply.

Why is this important from a valuation standpoint?  Well, the presence of/or absence of various benefits and restrictions can have a significant monetary impact on the value of an interest in an operating entity.

As it turns out, Tennessee Code Section § 48-218-102 (2015) states that an LLC member may assign the member's full membership interest only by assigning all of the member's governance rights coupled with an assignment to the same assignee of all the member's financial rights. That's a significant provision written into our law here since some states, for example, do not provide for this restriction and allow a member to transfer his or her financial rights without a transfer of his or her governing rights or vice versa.

The law under this code section goes on to state that any other assignment of any governance rights is effective only if all the members, other than the member seeking to make the assignment, approve the assignment by unanimous consent or if the articles or operating agreement so permit, if the assignment is approved in accordance with § 48-232-102. The consent of a member may be evidenced in any manner specified in the articles or operating agreement, but in the absence of such specification, (this) consent shall be evidenced by a written instrument, dated and signed by the member.

More importantly (and again, this is not necessarily true in other states), when an assignment of governance rights becomes effective under the statute, the assignee becomes a member, if not already a member. And with that stipulation, the assignor, the guy or gal who made the assignment, ceases to be a member, to the extent assigned, and the rights, powers, restrictions and liabilities, of a member under the articles (and any operating agreement) become the rights, restrictions and liabilities of the assignee member.  Again, this is not necessarily true in other states.

In effect, as a member, the assignee becomes liable for any obligations of the assignor under the code (§48-232-101) existing at the time of transfer, except to the extent that, at the time the assignee becomes a member, a liability might have been unknown to the assignee, and could not have been ascertained from the records maintained by the LLC.

Finally, unless otherwise provided in the articles of the LLC or in its operating agreement, a pledge of, or granting of a security interest, lien or other encumbrance in or against, any or all of the membership interest of a member is not an assignment under this statute and shall not cause the member to cease to be a member or to cease to have the power to exercise any rights or powers of a member.

So when in doubt, and you are contemplating transferring or assigning all or a part of your interest in an LLC to someone else, check with your legal advisor first.  You may not want to take the plunge. 

Members of an LLC and Partners of a Partnership Are Not Employees

In a recent treasury decision (TD 9766, NPRM REG-114307-15) the IRS has issued final, temporary and proposed regs that preserve a partner’s status as a partner, and not an employee. In this decision, the partner worked for a disregarded entity that was also owned by the partnership. The regulations settled herein are said to be consistent with Rev. Rul. 69-184, which concluded that members of a partnership are not employees of the partnership, even if they devote time to the partnership’s trade or business or provide services to the partnership as an independent contractor. 

The government, however, correctly noted in its discussions that it still needs a significant amount of outside assistance (particularly in the employee benefits area) to get comfortable with any such exception to the ‘partner-only’ treatment of persons who hold an equity interest (no matter how small) in a tax partnership and who also provide services to such partnership."  For example, it seems, certain members who hold say very small (incentive) amounts of an interest in the entity and who actually provides services to the entity might actually be considered as employees.  However, those situations are rare (see also Rev Ruling 69-184).

Treatment of Disregarded Entities (one-member LLCs) and Partners

An entity, such as a limited liability company, with a single owner is treated as a DE (assuming the entity did not elect to be treated as a corporation). Ordinarily, the DE is disregarded as an entity separate from its owner and is treated like a sole proprietorship, with the DE’s income and deductions attributed to the owner. However, for employment tax purposes, the IRS amended its regs previously so that a DE is treated as a corporation and is considered to be the employer of its employees. The owner of the DE is not treated as the employer.

At the same time, the owner of the DE is treated as self-employed and must pay self-employment tax on the DE’s earnings. Thus, for the owner’s self-employment purposes, the entity continues to be disregarded from the owner.

There is no distinction between a DE owned by an individual and a DE owned by a partnership. In fact, the current regulations do not discuss a DE that is owned by a partnership. Because a DE is treated as the employer of its employees, some partners have interpreted the current regs to permit individual partners to be treated as employees, if the partners provide services to a DE, even a DE owned by the partnership. Under this interpretation, partners have been treated as employees of the DE and have been allowed to participate in the partnership’s employee benefit plans.  This interpretation was not intended, the IRS indicated. There is no exception in the self-employment rules for a partnership that owns a DE. The IRS also affirmed that the regulations do not alter Revenue Ruling 69-184, which requires that partners providing services be treated as self-employed.

The New Regulations

The temporary regulations "clarify" that the rule treating a DE as a corporation for employment tax purposes does not apply to the employment tax treatment of individuals who are partners of a partnership that owns a DE. The entity continues to be disregarded from the partners for self-employment tax purposes, and the partners are still subject to self-employment tax as partners of a partnership. The partners are treated no differently from partners of a partnership that does not own a DE.

The regulations will not apply until the later of (1) August 1, 2016, or (2) or the first day of the latest-starting plan year after May 4, 2016, for an "affected" plan sponsored by a DE. Affected plans include qualified plans, health plans, and cafeteria plans. This effective date gives partnerships time to make payroll and benefit plan adjustments.

Finally Regarding Rev. Rul. 69-184

The regs do not address Rev. Rul. 69-184 and tiered partnerships. The IRS reported that stakeholders have requested guidance in this situation and, also, where employees of a partnership receive a small partnership interest as compensation. The IRS requested comments on the appropriate application of Rev. Rul. 69-184 in these situations, including when it would be appropriate to treat partners as employees, and the impact on employee benefit plans and on employment taxes.

 

References: CCH FED Paragraphs 47,024 and 49,696. 

Tax Gap Over Past Decade Has Increased

Tax Gap Estimates For Tax Years 2008-2010

The tax gap – the difference between what taxpayers owe and what they pay – widened over the past 10 years, the IRS has reported. At the same time, the voluntary compliance rate has declined slightly. However, and I'm not sure what this means: according to the IRS, the drop in the voluntary compliance rate was not attributable to changes in taxpayer behaviors.

Commerce Clearing House Take away. "The IRS makes inefficient use of what resources it does have," Contributing to the inefficiency, it's been observed, is a failure on the part of IRS supervisors. "They all read from the same script and give the agents free reign to waste whatever resources they feel like. "  All I can say is "wow".

The Tax Gap

The gross tax gap, the IRS explained, is the amount of true tax liability that is not paid voluntarily and timely. The IRS reported that the gross annual tax gap for TY 2008-2010 is estimated to be $458 billion. That's billion dollars. And I'm sure that's accurate given some of the statements I've heard from people about tax return preparation matters. 

Enforcement activities and late payments resulted in an additional $52 billion in tax paid, which resulted in a net tax gap for the 2008-2010 period of $406 billion per year. In comparison, the gross tax gap for TY 2006 was $450 billion and the net tax gap for TY 2006 was $385 billion.

The gross tax gap is composed of three components: (1) non-filers, (2) under-reporting, and (3) just not paying (underpayment). The IRS reported that the estimated gross tax gaps for these components are $32 billion, $387 billion, and $39 billion, respectively. Further, the gross tax gap estimates can be grouped by type of tax. The estimated gross tax gap for individual income tax is $319 billion, $91 billion for employment taxes, $44 billion for corporate income tax, and $4 billion for estate and excise taxes combined.

"It is not possible to eliminate the tax gap completely," IRS Commissioner said at a news conference in Washington, D.C. "Getting to 100 percent tax compliance would require a huge increase in audits, and significantly greater third-party reporting and withholding than we have now. Realistically, that wouldn’t work, because the burden on taxpayers and the strain on IRS resources would be too great."

And as one could imagine, the tax gap typically moves with changes in the economy. Gross collections were $2.52 trillion in FY 2006, $2.69 trillion in FY 2007 and $2.75 trillion in FY 2008. Reflecting the economic downturn, gross collections declined to $2.35 trillion in FY 2009 and remained at that level in FY 2010.

Voluntary compliance rate

The IRS reported that the voluntary compliance rate is estimated at approximately 81.7 percent. After accounting for enforcement and late payments, the net compliance rate is 83.7 percent. The prior estimated voluntary compliance rate, calculated in 2006, was 83.1 percent, the IRS reported.

Reference: taken from CCH (Commerce Clearing House) Tracker News letter, dated May 5, 2016. 

Business Licenses In Tennessee and the Gross Receipts Tax

Generally, if you conduct business within any county and/or incorporated municipality (city) in Tennessee, you are required to register it (each location) for a business license in both the county and in its municipality.  Each location's license is supported by a gross receipts tax assessed upon both the industry (classification) in which your business operates and the amount of revenue that location has received during each annual reporting period (calendar year).  

Under these circumstances, you must file two separate tax returns for each location; one for the city and one for the county. Click here for a comprehensive list of cities that have enacted the business (gross receipts) tax and that require a city license. In some cases, for example, construction contractors, may be required to have multiple city and county licenses.  

 

With a few exceptions, the requirement to have a business license extends to those businesses with a physical location in the state as well as out-of-state businesses that operate in the state.  If you are an out-of-state business, you must have a license and pay the tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease tangible personal property in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Finally, if you decide to close your business or close a particular location, you must file a final business tax return for that location with the Department of Revenue within 15 days of its closing.  (a minimum tax of $22 will be due).  Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business or location is closed.

Most licenses and renewals are due on or before April 15th (unless the business closed mid year). And these returns and/or the renewals for licenses are now filed online.  

If you have any questions, contact me.  

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Due Date for Calendar Year 2015 Tax Returns

The due date for calendar year 2015 federal individual income tax returns is Monday, April 18, 2016, this tax season rather than April 15, 2016.  The due dates for certain Tennessee franchise and excise tax returns, business tax returns and Hall income tax returns will be Monday, April 18, 2016, rather than Friday, April 15, 2016, consistent with the Internal Revenue Service (“IRS”) federal income tax filing deadline change for most of the country.

This change in the due dates is due to our Nation's Emancipation Day which will be celebrated on Friday, April 15, 2016, in Washington, D.C., making it a legal IRS holiday.  Emancipation Day is a local public holiday in Washington, D.C., that commemorates the day in history when President Abraham Lincoln signed a declaration freeing slaves living in the city.

In accordance with Tennessee law, whenever the due date for filing the return occurs on a legal holiday for IRS purposes, the Commissioner of Revenue is allowed to extend the due date of state returns to the next workday, in this case, Monday, April 18, 2016.

Accordingly, Tennessee franchise and excise tax returns, Hall income tax returns and business tax returns with a tax period ending on December 31, 2015 will be considered timely if they are filed (and any tax due is paid) on or before April 18, 2016.

States New Market-Based Appoach

One of the current shifts in state and local income taxation has been recent adoption of market-based sourcing for assigning service-based revenue and its related income from the use of intangibles to a particular state. Many states have enacted new legislation to adopt market-based sourcing for state franchise and excise (income), creating additional tax revenue from out-of-state service providers servicing in-state customers.
 
Old Cost of Performance vs. the new Market-Based Approach

Frankly, this makes sense. Most states have historically utilized a cost of performance method for purposes of apportioning service revenue to a particular state. The cost of performance method is defined in the Uniform Division of Income for Tax Purposes Act (UDITPA). The rule states service revenue is apportioned to the state where the income-producing activity is performed. It is important to note that it must be the taxpayer’s income-producing activity and not someone else, such as an independent contractor, acting on behalf of the taxpayer. If the income-producing activity is performed across multiple states, the revenue is apportioned entirely to the state in which the greatest proportion of the revenue was earned.

The greatest proportion is determined by the cost incurred to generate the revenue. Often, cost of performance is looked at as an all or nothing type sourcing rule because the majority state gets assigned all of the revenue whereas the   minority state receives no allocation. Generally, the cost of performance method was not difficult to follow as it only focused on the efforts and locations of the taxpayer’s own employees. The location of the recipient client is not a factor in apportioning service revenue. 

Market-based sourcing, on the other hand, brings about a complete shift in methodology and allocates the service revenue to the state in which the benefit of the service is received and will subsequently be used. Service revenue is defined as any revenue other than sales of tangible personal property and does include revenue from and sales of intangible assets in some states. Under this method, the destination of the service revenue is the driving factor rather than the location where the revenue was actually earned. Market-based sourcing allows states to tax out-of-state service providers. 
 
It is important to note the statutory language used in determining and assignment of the service revenue for each state. States access service revenue in various ways. Samples of the criteria can be the state where the “benefit of the service” is received; the state where “the service is received”; the state “where the customer is located”; or the state where the “service is delivered.”

The income-producing activity of a particular company can also impact the tax implications that market-based sourcing covers.  Service companies generally must look at the criteria cited above. Holding companies often hold intangible assets, which can be treated differently across various states.  For example, royalty receipts are traced to where the IP is used. Software, which often is categorized as a type of service, does not follow the same cost of performance and market-based sourcing rules and are often treated differently. 

Many of the states that have adopted market-based sourcing regulations have also adopted a single factor sales apportionment method now rather than the old two-factor and three-factor appointment methodologies (ie. sales assigned to the state and divided by total sales in all states). Single factor apportionment can create a loophole (or a headache – see later) in which a taxpayer pays no tax on a portion of their service revenue.  This scenario can occur when the home state uses the market-based sourcing approach with single sales factor and the destination state uses the cost of performance approach with single sales factor apportionment.  In this case, the revenue would not be assigned to the home state since the service was delivered to an out-of-state customer.  Additionally, the revenue would not be sourced to the destination state since the company's income-producing activity was performed outside of that state.  Effectively, this is a tax-free transaction.

The aforementioned headache could occur producing double taxation across various states. For example, a taxpayer located in a cost-of-performance state could provide a service for a customer located in a market-based sourcing state where both states happen to use a single sales facto apportionment methodology. If the majority of the income-producing activity is performed in the home state, the taxpayer would be forced to source the entire service revenue from that transaction to its home state, while also being forced to source the same transaction to the state of the customer.

Performance of Services and Nexus

Market-based sourcing obviously has a direct impact on the allocation of tangible personal property sales.  Long-established Public Law 86-272 governs sales of tangible personal property and the assessment of sale taxes throughout the United States. Generally, P.L. 86-272 says that no state has the power to impose its income (excise) tax on an out of state seller of tangible personal property, if the only activity that the seller has in the respective state is sales to customers located in that state and that the company’s activities do not exceed “mere solicitation”.  

If the company has no other activity in the state, it is said to not have “nexus.” States have battled as to what types of activities may exceed the protection afforded under P.L. 86-272 but that is beyond the scope of this article. Under P.L.  86-272, a merchant located in Illinois, for example, would not be subject to income tax on a sale of tangible property to a customer in Indiana as long as it has no connection to or presence in Indiana other than this sale.

The impact of the market-based sourcing is twofold. For states that have adopted market-based sourcing, they are now able to tax out-of-state service providers, as mentioned previously.  In essence, states are eliminating the loophole of the all or nothing scenario that occurs with cost of performance and ensuring themselves a portion of any service revenue generated from customers within their state.  In addition, since the sales factor within the home state drops as a result of market-based sourcing methods, in-state companies enjoy smaller tax burdens within their home state by higher overall bills when taxed by other states.  States lose out on income tax revenue from in-state companies due to the lower apportionment factors, but the states generate more income tax revenue from out-of-state companies performing services within their boundaries. 

When coupled with the continued presence of cost of performance regulations, the new market-based approach has made tax treatment of service revenue more much complex. It is important to note nexus must be established first before market-based sourcing rules may be applied.