The document summarizes the results of a survey of corporate tax directors on state tax issues. It finds that California and New York are viewed as having the least fair and predictable tax environments due to their aggressive pursuit of tax revenue through tactics like asserting nexus and discretionary authority. States are increasingly looking to tax out-of-state businesses through economic nexus rules and by taxing a higher percentage of revenues from sales. The sourcing of taxable income from services is also an ongoing challenge and area of litigation as states disagree on the cost of performance vs. market-based approaches.

1. HOW TO BUY HR TECHNOLOGY
Discretionary authority, economic nexus, and the taxing of
services loom large in the state tax landscape.
BY EDWARD TEACH
SURVEY CFO
TAXING ISSUES
THE 2014 CFO
STATE TAX SURVEY

2. THE 2014 CFO STATE TAX SURVEY 1
The return of fiscal stability set the
stage in 2013 for attempts to enact
comprehensive tax reform. Significant
changes were proposed in a half-dozen
or so states, including North Carolina,
Ohio, Louisiana, Nebraska, and
Minnesota, generally either reducing
or repealing income taxes, both
business and individual, and replacing
them with sales taxes. For the most
part, these efforts failed.
But there is still a fair amount of
aggressiveness among the states in
collecting additional income tax
revenues from corporations, say
observers. One way of doing so is by
asserting economic nexus—a threshold
of business activity that makes an out-of-
state company subject to income tax
(as opposed to sales and use tax) even
without a physical presence in a state.
The most aggressive states in this
regard are California and New York,
according to the latest edition of CFO’s
survey of corporate tax directors,
followed by New Jersey, Michigan, and
Massachusetts.
“They want to ensure that companies
outside the state, whether they are
making sales into the state or are
conducting business in the state, are
paying what they consider is their fair
share of tax,” says Harley Duncan,
managing director and state and local
tax leader in KPMG’s Washington
National Tax Practice. In California,
for example, an out-of-state company
triggers economic nexus if its sales in
the state exceed the lesser of $500,000
or 25% of the company’s total sales.
Other states continue to press out-of-state
companies for income tax nexus
in various ways.
Occasionally they overreach. In May
2012, for example, high courts in
West Virginia and Oklahoma struck
down those states’ attempts to extend
economic nexus to Scioto Insurance
and ConAgra Brands, respectively,
The last time CFO magazine conducted its state tax
survey, in 2011, the nation’s fiscal condition was very
different. The Great Recession had depleted state
coffers, and legislatures were looking to companies
to pony up more tax dollars. “The states are in a pure
‘money grab’ mode,” one tax director complained at the
time.
Today, the situation is brighter. Through the third
quarter of 2013, total state tax revenues have grown
for 15 consecutive quarters, according to the Nelson
A. Rockefeller Institute of Government. Adjusted for
inflation, the simple average quarterly growth rate over
that period was 4.2%.
TAXING ISSUES

3. THE 2014 CFO STATE TAX SURVEY 2
neither of which had a physical
presence in the state. (Scioto was
licensing intellectual property to
Wendy’s, the fast-food chain, while
ConAgra was licensing the ability to
use its brands to food distributors.)
Discretionary Matters
Some of the states’ aggressiveness
can be seen in their growing use of
discretionary authority, or alternative
apportionment. “We’ve seen more
and more states using discretionary
authority, because they don’t like
the answer they get when the rules
as written in law are applied,” says
Duncan.
“Almost every state has a
provision that says if our standard
apportionment factor doesn’t fairly
reflect the extent of your business
activity in our state, we can use our
discretionary authority to adjust that,”
says Lee Zoeller, partner and practice
group leader of the state tax group at
law firm Reed Smith in Chicago. In
some instances states have used their
discretionary authority to counter
aggressive tax planning on the part of
some companies, says Zoeller. But in
others they have effectively undone
what companies view as normal
business transactions, because they
produce less tax and are therefore
considered distortive.
In recent cases involving subsidiaries
TAXING ISSUES
e What is your overall impression of the tax environment
in each state?
Survey respondents
ranked states on a
scale, with:
1 = very fair and
predictable
5 = very unfair and
unpredictable.
1 = Not Aggressive
5 = Very Aggressive
r How would you rate each state’s stance on asserting
income tax nexus when companies have only an economic
presence in the state?
■ VERY FAIR AND
PREDICTABLE
1. WY [1.89]
2. AK [2.11]
3. OK [2.26]
4. ND [2.32]
5. SD [2.33]
■ NOT
AGGRESSIVE
1. SD [2.20]
2. NV [2.31]
3. VA, WY [2.33]
4. KS [2.42]
5. ME [2.44]
■ VERY UNFAIR AND
UNPREDICTABLE
46. MI [3.33]
47. IL [3.62]
48. MA [3.67]
49. NJ [3.69]
50. CA, NY [3.82]
■ VERY
AGGRESSIVE
46. MA [3.84]
47. MI [3.88]
48. NJ [4.11]
49. NY [4.30]
50. CA [4.54]
The 2014 CFO State Tax Survey Results The charts on this page and the
following pages highlight states ranked best and worst on six key measures.

4. THE 2014 CFO STATE TAX SURVEY 3
of Wal-Mart and Delhaize America,
North Carolina required the
companies to file a consolidated
return with the corporate parent to
reflect their “true earnings” in the
state. Appellate courts upheld these
applications of discretionary authority.
Following taxpayer and trade group
discussions with the legislature, the
state has since set some parameters
for when it can use its discretionary
authority, says Duncan.
More than 20 states use unitary
reporting, automatically taxing the
combined income of the out-of-state
subsidiary, other subsidiaries, and the
corporate parent if they are deemed
to constitute a unitary business. In
November the Alaska Supreme Court
affirmed the right of Alaska to tax the
worldwide income of Tesoro, a Texas-based
petroleum company. Tesoro had
argued that some segments, like its
pipeline business, should not be taxed
by the state.
Are They Being Served?
One of the biggest current issues in
state taxation is sales-factor sourcing.
Most states have moved away from
three-factor apportionment—equally
weighting sales, property, and
payroll—to either using sales alone
or weighting sales at 80% or 90%.
“They are effectively exporting the
tax to companies outside the home
state,” says Zoeller. Doing so lightens
the tax burden on in-state companies
and takes into account the increase
in online sales by companies with
no bricks and mortar in a state. “The
states were losing a little of their tax
base,” says Zoeller, “so they had to try
to balance it out.”
TAXING ISSUES
t How would you rate each state’s stance on asserting
sales and use tax nexus?
1 = Not Aggressive
5 = Very Aggressive
1 = Not
Concerned
5 = Very
Concerned
u How concerned are you that your state’s fiscal
condition will negatively affect your company in some way
in the next 12 months?
■ NOT
AGGRESSIVE
1. NH [2.00]
2. AK [2.15]
3. DE [2.17]
4. OR [2.23]
5. ME [2.31]
■ NOT CONCERNED
1. AK, ND [1.85]
2. NH, UT [1.86]
3. SD [1.91]
4. AR, MT, NB, RI,
VT, WY [1.92]
5. OK [2.00]
■ VERY
AGGRESSIVE
46. NJ [3.78]
47. WA [3.81]
48. TX [3.85]
49. NY [4.25]
50. CA [4.26]
■ VERY CONCERNED
46. MA [3.38]
47. NJ [3.42]
48. NY [3.95]
49. CA [4.17]
50. IL [4.20]

5. THE 2014 CFO STATE TAX SURVEY 4
It isn’t difficult to determine whether
the sale of goods or tangible personal
property by an out-of-state business is
an in-state sale. But how do you source
income from the provision of services?
“That’s the hard question everyone
is wrestling with,” says Zoeller.
The conventional method is cost of
performance—where is the work done
to make a service available? If most of
the cost of performance of a service
is incurred in a given state, all of the
income from the performance of that
service is apportioned to that state, no
matter where the customers may be.
“There is a lot of litigation around cost
of performance,” says Zoeller. “Courts
have interpreted it differently. The
telecom companies are involved in
litigation all over the county to figure
out where their costs are for phone
calls.”
More than a dozen states have moved
to a market-based, or customer-based,
approach to sourcing service income,
apportioning it to the state where the
service is used or the benefits of the
service are received. The problem
is, with other states hewing to the
older approach, companies can get
whipsawed, says Duncan.
“If one state is using cost of
performance and I have my cost of
performance in that state, all of the
income from the performance of
that service goes to that state,” he
explains. “If I sell 10% of my services
into a second state using market-based
sourcing, ultimately I’m going to end
up with 110% of my service income
being taxed between those two states.”
TAXING ISSUES
i Over the next 12 months, how likely is each state to
enact a major reform of its corporate income tax?
1 = Not likely
5 = Very likely
1 = Not Aggressive
5 = Very Aggressive
o How would you rate each state’s stance on pursuing
clawbacks of business tax incentives granted to individual
companies?
■ NOT LIKELY
1. AK [1.58]
2. SD [1.59]
3. WY [1.61]
4. ND [1.63]
5. MT [1.67]
■ NOT
AGGRESSIVE
1. AK [2.27]
2. NV [2.45]
3. FL [2.50]
4. ID, KS [2.58]
5. KY, PA [2.62]
■ VERY LIKELY
46. MA [2.60]
47. NJ [2.61]
48. IL [2.68]
49. NY [2.87]
50. CA [3.05]
■ VERY
AGGRESSIVE
46. MA, MI [3.21]
47. NJ [3.23]
48. IL [3.36]
49. NY [3.50]
50. CA [3.76]

6. THE 2014 CFO STATE TAX SURVEY 5
Adversarial Attitudes
CFO’s latest state tax survey was
conducted in October and November
in cooperation with KPMG, yielding
responses from 78 tax directors and
other finance executives. Some of the
results were nothing if not consistent
with previous surveys: for example,
California, New York, New Jersey,
Massachusetts, and Michigan typically
rank as having among the least fair and
predictable tax environments, and this
time around was no exception.
Why do tax directors perennially give
California and New York such low
grades? Duncan says he can’t speak
for them, but he says California’s
“significant audit presence” may be
unnerving to some taxpayers. “They
delve into issues deeply,” he says. As
for New York, its provision regarding
combined reporting “is different than
those in other states,” points out
Duncan. “There is more flexibility in
who gets combined and when they get
combined, and I think that leads to a
sense of unpredictability.”
Zoeller says there are “many reasons”
why corporate tax directors might
dislike California and New York, but
adds that they can be summed up
as a pervasive “adversarial attitude
toward taxpayers.” A “no-holds-barred
approach to tax administration” is a
hallmark of both states, he says, with
tax officials “doing everything they can
to see that the state gets its last penny.”
But it doesn’t have to be that way,
adds Zoeller. He says that in other
states—and in pockets of California
and New York as well—a different
attitude can be discerned: “I work for
your government, I’m here as your
employee, and I’m trying to find the
right answer and do the right thing.”
TAXING ISSUES
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