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Question Description

You are a tax staff member at an accounting firm. Last week you and a tax partner in your office had lunch with Mike Jones, the Tax Director of XYZ Corporation, a new client of your firm. XYZ is a California corporation that manufactures high-end sports equipment at a plant in El Cajon. In addition to its own products, it sells accessories (e.g., carrying bags, water bottles, gloves) manufactured by others.

During lunch the partner asked Mike where XYZ files state corporate income tax returns. Mike responded that XYZ files only in California. XYZ maintains a warehouse in Nevada, where all finished and purchased goods are stored until sold, when they are shipped via common carrier from Nevada to distributors, retailers, and mail and internet order retail customers in all 50 states. XYZ has resident sales employees in approximately 30 states, whose activities, Mike says, are protected by P.L. 86-272.

Mike believes XYZ has a highly successful state tax planning structure in place, because although it is subject to income taxes only in California and Nevada, its sales to customers in other states are all assigned (for California tax purposes) to Nevada and are not included in the numerator of the California sales factor. The effect of this strategy is enhanced by California’s single sales factor apportionment formula, and the fact that Nevada imposes no corporate income tax. As a result XYZ pays state income tax on only about 20% of its total income.

XYZ collects and pays over use tax on all of its retail sales shipped to customers where it has sales employees, and is working on getting into compliance with a few other states where it has more than a newly prescribed level of retail sales. It is registered as an employer and pays unemployment insurance taxes and withholds state income taxes on behalf of its employees in each state.

Mike also described a successful promotional program that XYZ implemented several years ago. XYZ’s sales people solicit orders from distributors, wholesalers and retailers in about 30 states. They carry sample inventory in their car trunks, including the most advanced racquets and other equipment that XYZ produces. They attend professional tournaments and offer top players the free use of equipment for tournament play. They also frequently sell equipment from their car stock at these events, both to professional athletes and also to spectators, at prices they set “on the spot.” The result has been greatly increased awareness and acceptance of XYZ products among professional players and event spectators, which translates into increased wholesale and retail sales.

After you return to the office, the partner expresses some concern that XYZ may be subject to net income taxes in more states than Mike realizes. She asks you to research that issue and draft a short memo to her addressing the issue, citing authority for your conclusions.

Use the following outline to organize your memo, using the headings to separate the parts of your memo:

Introduction (Why are you writing this memo? Don’t put the facts here.)(who is this for and why)

Facts (this is where the facts go)

Issue (briefly stated)

Analysis

Conclusion (explaining how the authorities you cite, as applied to the facts given, support your conclusions)

See the CBA Written Communication Rubric and “Grading Standards for Written Material” for additional guidance. Also, refer to the “Weight of Authority in State and Local Taxation” and Reading and Analyzing Case Law” documents. Be sure your citations are in proper form, and remember to cite the highest level of authority available to support your argument.