Question

1. Distinguish between allocation and apportionment.

2. What is the three-factor formula, and how is it calculated?

3. Describe the two tests that are often utilized to determine whether income is business income.

4. Why would a state want to characterize a business as a unitary business?

5. How do you determine whether a business is a unitary business?

6. How are S corporations taxed by states?

7. What are the competing interests of businesses and states with respect to e-commerce?

8. What is a composite income tax return?

Answer 1

1.The difference between cost allocation and cost apportionment can be drawn clearly on the following grounds: Allocation of cost means a process in which the entire amount of overhead is charged to a specific cost center. ... As against this, cost apportionment is applied when the overhead is related to various departments.

2. The three ratios are multiplied together to produce the percentage of the company's total taxable income to be allocated to the taxing state. In the classic version of this formula, each of the factors has equal weight in the calculation. Twelve states use an equal-weighted, three-factor apportionment formula.

3. In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

4. The key point in determining the state income tax for a company conducting interstate commerce is how the unitary business concept applies to the computation of taxable income. For example, the apportionment of income between business and nonbusiness income typically depends upon how a state applies the unitary business concept. States also use the unitary business concept to determine the apportionable amount of taxable business income for a corporation conducting an interstate business. Furthermore, many states use the unitary business concept to determine when corporations must file either combined or consolidated tax returns. Individual states have chosen to apply the unitary business income concept in various ways. States may either establish rules and regulations that permit or deny the taxpayer to determine when the unitary business concept requires combined reporting. Other states do not allow combined reporting. Likewise, some states apply the unitary business concept on a worldwide basis while other states permit taxpayers to make a waters-edge election. (The waters-edge election provides that taxable income is comprised only of income earned within the borders of the United States.) The rules for implementing the waters-edge approach are not uniform among the states that permit its use.