Order Code RL32297
CRS Report for Congress
Received through the CRS Web
State Corporate Income Taxes:
A Description and Analysis
Updated May 17, 2006
Steven Maguire
Analyst in Public Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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State Corporate Income Taxes:
A Description and Analysis
Summary
Recently, state corporate income taxes have become the subject of renewed
interest to both state and federal policymakers. The cause of this elevated interest
may be the gradual decline in revenue generated by the tax, the expansion of
electronic commerce, and/or federal tax policy that affects state corporate income
taxes. Congress has had a role in state corporate income taxes for at least two
reasons: (1) interstate commerce regulatory oversight and (2) federal and state
corporate income tax interaction. Congress may become more involved in state
corporate tax issues because of recent changes in interstate commerce and how states
administer corporate taxes.
The state corporate income tax is not a major source of revenue for states, but
is still an important contributor to state finances. Over the last decade, state
corporate income taxes generated approximately 5% of state tax revenue. However,
the revenue generated by the tax — measured as a percentage of gross domestic
product — has been gradually declining. Several explanations have been offered for
this gradual decline including (1) state policy decisions to lower the tax burden on
corporations, (2) aggressive tax planning by corporations, (3) broad economic cycles
diminishing the base, and (4) federal corporate income tax policy. Most research has
identified the first two factors as the primary cause for the recent decline.
Many corporations operate in multiple tax jurisdictions which makes the state
corporate income tax a relatively complex tax to administer. The base of the
corporate income tax (net income or profits) must be fairly apportioned to all of the
states where the firm has established a presence (or nexus). A mosaic of nexus
standards has been created through multistate tax compacts, state and federal legal
decisions, and congressional actions. At present, states do not use a uniform
definition of taxable profits or use a uniform method of apportioning income.
On December 13, 2005, the House Judiciary Commercial and Administrative
Law Subcommittee approved H.R. 1956. This legislation addresses nexus issues for
state corporate income taxes, and is often identified as “brightline” legislation. H.R.
1956 would establish more uniform standards — generally higher standards — for
the level of business activity that would trigger nexus and thus corporate income
taxability. In the Senate, S 2721 was introduced on May 4, 2006,and is very similar
to H.R. 1956.
Nexus issues are also addressed in what has been identified as “streamlining”
legislation. Generally, the streamlining legislation, such as S. 2152 and S. 2153,
would allow states to require out-of-state vendors to collect sales and use taxes even
if the out-of-state vendor does not have nexus in the taxing state. Participating states
would have to simplify sales and use taxes before Congress would confer collection
enforcement authority. Interstate commerce has complicated the nexus issue for sales
and use tax administration, and how this issue is resolved may have broader
implications for state corporate income taxes. This report will be updated as
legislative events warrant.

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Contents
State Corporate Income Taxes: Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Mechanics of the State Corporate Income Tax . . . . . . . . . . . . . . . . . . . . 3
Federal Starting Point . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Uniform Division of Income for Tax Purposes Act (UDITPA) . . . 3
The Profit Apportionment Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
State Corporate Income Tax Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
State Corporate Income Tax Revenue: 1972 to 2005 . . . . . . . . . . . . . . . . . . 8
Issues for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Interstate Commerce Regulation and Oversight . . . . . . . . . . . . . . . . . . . . . 10
Tax Interaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Legislative Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
S. 2152 and S. 2153 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
H.R. 1956 and S. 2721 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
List of Tables
Table 1. Average State Corporate Income Tax Revenue as Share of Total
Tax Revenue, 1972 to 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Table 2. State Corporate Income Tax Apportionment Formulas in 2006 . . . . . . . 6
Table 3. State Corporate Income Tax Rates, 2006 . . . . . . . . . . . . . . . . . . . . . . . . 7
Table 4. State Corporate Income Tax Revenue and Gross Domestic
Product, FY1972 to FY2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

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State Corporate Income Taxes:
A Description and Analysis
Congressional interest in state corporate income taxes arises from two distinct
issues. First, Congress has a direct role in the oversight and regulation of interstate
economic activity. State taxation of multi-state corporations would certainly be
included in this jurisdiction. Second, federal corporate income tax policy changes
have a direct effect on state (and local) tax structure.1 Congressional activity, or in
some cases inactivity, in these two areas can have a pronounced effect on state
budget decisions. After an overview of state corporate income taxes, this report
analyzes both the interstate commerce oversight and tax interaction issues. The last
section of the report describes and analyzes legislation that would affect state
corporate income taxes.
State Corporate Income Taxes: Overview
For most observers, state corporate income taxes are the most familiar state tax
that businesses pay. However, corporate income taxes generated less than 6.0% of
total state tax revenue in 2005. In contrast, general sales and use taxes, of which
businesses pay a large portion, accounted for approximately 32.7% of state tax
revenue.2 Even though state corporate income taxes represent a relatively small
portion of total state tax revenue in most states, the state corporate income tax still
generated $38.7 billion in 2005. And, in some states, the corporate income tax
contributes a much larger share of total tax revenue. For example, from 1972 to
2005, the corporate income tax averaged approximately 19.9% of total state tax
revenue in New Hampshire. In contrast, the corporate income tax contributed 3.7%
of total tax revenue in South Dakota.3 Table 1 reports the average reliance on
corporate income taxes for each state and the District of Columbia over the 34-year
span, 1972 to 2005.
1 State taxation of international firms and individuals is also of interest to Congress.
International tax policy, however, extends beyond the scope of this report.
2 Data are CRS calculations based on U.S. Census of Governments data. These data is
available at the following website [http://www.census.gov/govs/www/statetax05.html].
Robert Cline, Tom Neubig, and Andrew Phillips, “Total State and Local Business Taxes:
Nationally 1980-2005 and by State 2002-2005,” State Tax Notes, May 1, 2006, estimated
that businesses paid approximately 44% of total state and local taxes. They also estimated
that businesses paid over half of total general sales tax revenue.
3 CRS calculations based on U.S. Census of Governments data; see above for website link.

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CRS-2
Table 1. Average State Corporate Income Tax Revenue as
Share of Total Tax Revenue, 1972 to 2005
Corporate
Corporate
income tax
income tax
State
State
share of total
share of total
tax revenue
tax revenue
Alabama
4.85%
Montana
7.22%
Alaska
19.38%
Nebraska
5.29%
Arizona
5.79%
Nevada
no C.I.T.
Arkansas
6.09%
New Hampshire
19.88%
California
10.91%
New Jersey
9.70%
Colorado
5.02%
New Mexico
4.30%
Connecticut
10.45%
New York
8.59%
Delaware
9.09%
North Carolina
7.72%
District of Columbia*
5.08%
North Dakota
6.94%
Florida
5.58%
Ohio
6.21%
Georgia
7.03%
Oklahoma
4.01%
Hawaii
3.14%
Oregon
7.44%
Idaho
6.41%
Pennsylvania
9.30%
Illinois
8.19%
Rhode Island
6.51%
Indiana
6.15%
South Carolina
5.83%
Iowa
5.39%
South Dakota
3.73%
Kansas
7.74%
Tennessee
8.65%
Kentucky
6.22%
Texas
no C.I.T.
Louisiana
6.49%
Utah
4.69%
Maine
4.91%
Vermont
5.35%
Maryland
4.78%
Virginia
5.19%
Massachusetts
10.74%
Washington
no C.I.T.
Michigan
12.77%
West Virginia
5.60%
Minnesota
7.48%
Wisconsin
6.96%
Mississippi
5.04%
Wyoming
no C.I.T.
Missouri
4.60%
Source: CRS calculations based on U.S. Census Bureau, Governments Division, Federal, State, and
Local Governments: State Government Tax Collections. These data are available at the following
website [http://www.census.gov/govs/www/statetax.html].
* Data for the District of Columbia are from the District of Columbia Government, FY2006 Proposed
Budget and Financial Plan, and represent the years 1990 to 2005.
As New Hampshire and South Dakota show, the dependence on corporate
income taxes varies considerably from state to state; thus, federal corporate income
tax policy does not have a uniform effect on all states. The remainder of this section
describes the mechanics behind state corporate income taxes, highlighting the
differences among states. Understanding the nuances of state corporate income taxes
is necessary for a complete discussion and analysis of interstate commerce issues and
the link between federal and state tax policy.

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CRS-3
The Mechanics of the State Corporate Income Tax
Generally, the state corporate income tax is levied on the accounting profits of
a corporation.4 The portion of profit that can be attributed to a state serves as the
base for that state’s corporate income tax. Profits are allocated to a state based on the
amount of economic activity that occurs in that state. Following is a more detailed
description of the state corporate income tax structure.
Federal Starting Point. Most states and the District of Columbia incorporate
the federal income tax code as currently amended (15 states) or as of a specific date
(20 states).5 The remaining states typically use a measure of income that closely
follows the federal definition of taxable income. Using the federal starting point
likely eases the compliance burden for corporations, particularly those that have
nexus in several states. Nevertheless, many states still require corporations to “add-
back” to income exclusions that are allowed under federal corporate income tax
rules.6
The Uniform Division of Income for Tax Purposes Act (UDITPA).
The Uniform Division of Income for Tax Purposes Act (UDITPA) is a model act
drafted and adopted by the Commissioners on Uniform State Laws and the American
Bar Association. The act sets standards for separating income into business income,
which is apportioned to states, and non-business income, which is allocated entirely
to the entity’s home state.7 Generally, non-business income is defined as passive
income on corporate owned assets; income from these assets could include dividends,
rents, and royalties. Corporations could avoid paying taxes on non-business income
by locating in states without a corporate income tax.8 Some states, through the
Multistate Tax Compact (MTC), have voluntarily adopted uniform rules and
procedures for the allocation and apportionment of income — as defined under
UDITPA — to ease the compliance burden on multistate businesses.9 Many of the
states that have not formally adopted UDITPA standards still closely adhere to the
UDITPA standards.
4 Net income is revenue less expenses, which is roughly equivalent to pre-tax accounting
profits.
5 These 35 states directly incorporate the federal tax code, however, all states except for
Arkansas and Mississippi (and D.C.), use federal income for the starting point for purposes
of calculating income tax liability.
6 Bureau of National Affairs, “Multistate Tax Report: 2003 Survey of State Tax
Departments,” vol. 10, no. 4, Apr. 25, 2003. The report identifies the add-backs and other
special corporate income tax rules for each state.
7 For more on UDITPA, see John S. Warren, “UDITPA — A Historical Perspective,” State
Tax Notes, Oct. 3, 2005, pp. 133-136.
8 A “throwback” or unitary accounting rules would limit this type of tax planning to avoid
taxation of non-business income.
9 According to the Commerce Clearing House (CCH) publication, State Corporate Income
Tax Guide, seven states have enacted UDITPA as written and 12 more states have adopted
UDITPA with some minor modifications.

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CRS-4
The Profit Apportionment Formula. Typically, three factors of economic
activity are used in the apportionment formula to measure the economic presence of
a firm in a state: the percentage of property, the percentage of sales, and the
percentage of payroll. Not all states weigh factors equally; some over-weight sales
or use only sales to allocate income (often called single-factor sales apportionment).
In theory, the weighting should accurately portray the economic presence of the firm.
There is no consensus on the definition of “economic presence,” and hence there is
variation among state apportionment formulas.
Some analysts have suggested that a formula that double-weights sales is the
ideal formula because it gives equal weight to input factors (property and payroll),
and an output factor (sales).10 Others have argued that the business tax should be
levied based on the business’s use of government services provided by the firm’s
resident state. For example, a corporate income tax that is levied according to the
value of one input only, such as property, could be justified because the value of
property is closely related to the level of government services provided to the
business by the home state. However, corporations also receive benefits from an out-
of-state customer’s well functioning legal system and public infrastructure. An
apportionment formula that includes just the property factor would not compensate
the out-of-state customer’s government for the benefit to the corporation of those
public services.
The general form of the apportionment formula is reproduced below. The
superscript i represents the profits (B), sales (s), property (p), and labor (l), a state
attributes to the i-th firm. The superscript T represents the total value of each factor
and profits for the firm in a given tax year. The subscript w represents the weight of
each respective factor as defined by state law; the weights sum to one.
For example, states that use an even-weight formula would use 0.33 for each w,
meaning each factor contributes equally to the determination of profits attributable
to a state. If the state were to “double-weight” sales, that means that the w is twice
s
the amount of each of the other two weights. In the case of double-weight sales,
w =0.50; w =0.25; and w =0.25.
s
p
l
i
i
i
⎡⎛
⎞
⎛
⎞
⎛
⎞
⎤
π
s
p
l
i = π T × ⎢⎜
⎟ × w + ⎜
⎟ × w + ⎜ ⎟ × w ⎥
T
s
T
p
T
l
⎝ s ⎠
⎝ p ⎠
⎝ l ⎠
⎣
⎦
Nexus. The apportionment formula does not imply that a business that sells
goods and services into a state, owes taxes to that state. A state can levy a corporate
income tax on a business only if the business maintains a substantial nexus in the
state. The nexus rules governing the corporate income tax were partially
circumscribed by Congress through P.L. 86-272, (the act). The act established that
the mere solicitation of the sale of tangible goods by a firm in a state was not
10 James Francis and Brian H. McGavin, “Market Versus Production States: An Economic
Analysis of Apportionment Principles,” in State Taxation of Business: Issues and Policy
Options, Thomas Pogue, ed. (New York: Praeger Publishers, 1992), p. 61.

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CRS-5
substantial nexus for corporate income tax purposes. However, for intangible goods
and services, there is significant variation from state to state in how physical presence
is defined.
The Bureau of National Affairs periodically surveys state revenue departments
about activities that could create nexus.11 The responses highlight the differential
treatment from state-to-state of business activities deemed to create nexus. For
example, according to the report, 24 states reported that an out-of-state corporation
that reimbursed its in-state salespersons had established nexus whereas 19 states
reported that activity would not. Establishing a web server in a state created nexus
in 16 states whereas 23 states did not indicate that maintaining a web server would
establish nexus.
Throwback Rule. Because of the state-by-state variation in nexus rules, the
first step for corporations before apportioning income is to determine the states where
the firm has established nexus. The firm then allocates profits to these states based
on each respective state’s apportionment formula and nexus rules. The different state
apportionment formulas and nexus rules, however, often lead to what is termed
“nowhere income.”12 Nowhere income arises because not all states have the same
apportionment formula or nexus rules, and some states do not levy a corporate
income tax. However, if the destination state imposes a franchise tax or a business
license tax that is based on some measure of business activity, then this does not
apply. Thus, some states impose corporate income tax rules that stipulate that all
sales to customers in states in which the firm does not have nexus (and are not
obligated pay any tax based on economic activity) are “thrown back” to the home
state.
For example, a California firm that sells goods to customers in Nevada — which
does not have a corporate income tax, nor any other tax based on business activity
— would include Nevada sales in the numerator of the sales factor component of the
California apportionment formula. If Nevada had a corporate income tax with a sales
factor in the apportionment formula and the firm had established nexus, California
would not require the firm to include the Nevada sales in the California corporate
income tax apportionment formula. The throwback rule is applied in 24 states and
the District of Columbia; 22 states do not impose a throwback rule, and four states
do not impose a corporate income tax (see Table 2).13
State Apportionment Formulas. Table 2 groups states based on their
corporate income tax apportionment formula. “Even weight” implies that the each
factor is weighted the same or one-third. The hybrid arrangements allow firms to
choose the type of apportionment scheme that minimizes tax burden or instructs the
11 Bureau of National Affairs, Multistate Tax Report: 2003 Survey of State Tax Departments,
vol. 10, no. 4, Apr. 25, 2003.
12 The converse is also true. Income could also be overtaxed because of the variety of
apportionment formulas employed by states.
13 Commerce Clearing House, Multistate Corporate Income Tax Guide. Texas imposes a
gross receipts tax that operates as a corporate income tax although it is not technically a
corporate income tax. Texas uses a throwback rule for the gross receipts tax.

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CRS-6
firm to use different types of allocation based on the source of income. The most
common apportionment formula is the double-weighted sales scheme. A number of
states will be moving to a single-factor sales formula in the near future. By 2008,
eight states will use a single-factor sales formula.
Table 2. State Corporate Income Tax Apportionment
Formulas in 2006
Apportionment
scheme
States
(number of states)
Even-weight (9)
Alabama, Alaska, Delaware, District of Columbia, Hawaii, Kansas,
Montana, North Dakota, Rhode Island.
Even-weight hybrid (3)
Missouri, firms choose either even weight or single factor sales; New
Mexico, certain manufacturing firms can choose double-weight sales,
otherwise even-weight; Oklahoma, firms meeting certain investment
criteria can choose double-weight sales, otherwise even-weight.
Double-weight sales
*Arizona, Arkansas, California, Florida, Idaho, Indiana, Kentucky,
(17)
Maine, Massachusetts, New Hampshire, New Jersey, North Carolina,
Tennessee, Virginia, West Virginia, Utah, and Vermont.
Double-weight sales
Connecticut, double-weight sales for income derived from the sale or
hybrid (3)
use of tangible personal or real property, single-factor sales for other
income; Maryland, manufacturers use single-factor sales, otherwise
double-weight sales; South Carolina, double-weight sales for
manufacturers and dealers in tangible personal property, otherwise
single-factor sales.
Single-factor sales (5)
Illinois, Iowa, Louisiana, Nebraska, Oregon.
Single-factor sales in the
Georgia in 2008, Minnesota in 2014, New York in 2008, and
future (4)
Wisconsin in 2008.
Other weight allocations
(in percentages, sales- payroll-property) Georgia, 80-10-10; Michigan,
(7)
90-5-5; Minnesota, 75-12.5-12.5; New York, 60-20-20; Ohio, 60-20-
20; Pennsylvania, 60-20-20; and Wisconsin, 60-20-20.
Other hybrids (2)
Colorado, firms choose between a three-factor even-weight and a two-
factor (sales and property) even-weight; Mississippi, retailers,
wholesalers, service companies, lessors use single-factor sales,
wholesale manufacturers use even-weight three factor, retail
manufacturers use three-factor, double-weighted sales.
No general corporate net
Nevada, South Dakota (bank & financial corporation excise tax),
income tax (5)
Texas (gross receipts tax), Washington, and Wyoming.
Note: * In Arizona, for firms that commit to invest more than $1 billion in 2006, the apportionment
formula will be: 60-20-20 in 2007; 70-15-15 in 2008; and 80-10-10 after 2008.
Source: Commerce Clearing House, Multistate Corporate Income Tax Guide.
State Corporate Income Tax Rates. Rates on corporate income taxes vary
considerably. The state with highest rate, Iowa, taxes all taxable income in excess
of $250,000 at 12%. Iowa is also one of three states (Nebraska and Illinois being the

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others) that use a single-factor sales apportionment formula. The rates for each state
are listed on the following page in Table 3. The highest marginal rates listed in
Table 3 do not necessarily represent the relative burden of state corporate income
taxes in each state. The best measure of the relative corporate income tax burden for
each state is the average effective marginal tax rate (AEMTR). The AEMTR would
incorporate differences among states in the definition of taxable income.
Nevertheless, the marginal rates do provide some information about the relative
burden of corporate income taxes across states.
Table 3. State Corporate Income Tax Rates, 2006
Highest
Number of
Highest
Number of
State
State
rate
rates
rate
rates
Alabama
6.500%
one
Montana
6.750%
one
Alaska
9.400%
multiple
Nebraska
7.810%
multiple
Arizona
6.968%
one
Nevada
no tax
n/a
Arkansas
6.500%
multiple
New Hampshire
8.500%
one
California
8.840%
one
New Jersey
9.000%
multiple
Colorado
4.630%
one
New Mexico
7.600%
multiple
Connecticut
7.500%
one
New York
7.500%
one
Delaware
8.700%
one
North Carolina
6.900%
one
D.C.
9.975%
one
North Dakota
10.500%
multiple
Florida
5.500%
one
Ohiod
8.500%
multiple
Georgia
6.000%
one
Oklahoma
6.000%
one
Hawaii
6.400%
multiple
Oregon
6.600%
one
Idaho
7.600%
one
Pennsylvania
9.990%
one
Illinoisa
4.800%
one
Rhode Island
9.000%
one
Indiana
8.500%
one
South Carolina
5.000%
one
Iowa
12.000%
multiple
South Dakotae
6.000%
multiple
Kansas
4.000%
one
Tennessee
6.500%
one
Kentucky
7.000%
multiple
Texasf
4.500%
one
Louisiana
8.000%
multiple
Utah
5.000%
one
Maine
8.930%
multiple
Vermont
9.750%
multiple
Maryland
7.000%
one
Virginia
6.000%
one
Massachusettsb
9.500%
one
Washington
no tax
n/a
Michigan
1.900%
one
West Virginia
9.000%
one
Minnesotac
9.800%
one
Wisconsin
7.900%
one
Mississippi
5.000%
multiple
Wyoming
no tax
n/a
Missouri
6.250%
one
Source: Commerce Clearing House, Multistate Corporate Income Tax Guide.
a. S Corporations, partnerships, and trusts are taxed at a maximum 6.3% rate.
b. Financial institution net income is taxed at 10.5%. Corporations also pay a surtax on property
located in Massachusetts and not taxed at the local level.
c. Minnesota also levies a fee based on the total payroll, property, and sales of the corporation. The
fee raises the maximum tax rate and creates very slight progressivity.
d. Ohio allows firms to choose an alternative of four mills (or 0.4%) multiplied by taxable net worth.
e. South Dakota taxes only banks and financial institutions. The rates fall as net income rises from
a high of 6.0% for the first $400 million to 0.25% for the amount over $1.2 billion.

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CRS-8
f. Texas taxes “net taxable earned surplus” and adds a surtax of 0.25% on net taxable capital.
State Corporate Income Tax Revenue: 1972 to 2005
According to CRS calculations based on data from the U.S. Census Bureau,
state tax revenue from state corporate income taxes grew (in nominal dollars) in all
fiscal years except for 1982, 1983, 1992, 1993, 1999, 2001, and 2002. As a portion
of gross domestic product (GDP), however, corporate tax revenue has declined from
an annual average of 0.43% of GDP over the FY1972 to FY1982 time frame to
0.32% of GDP over the FY1995 to FY2005 time frame. State corporate income tax
revenue has become a significantly smaller part of the economy over the last decade.
Table 4 reports state corporate tax revenue and GDP for states that impose a state
corporate income tax.14
Table 4. State Corporate Income Tax Revenue
and Gross Domestic Product, FY1972 to FY2005
State
State
State
State
corporate tax
corporate tax
Fiscal
corporate tax
Fiscal
corporate tax
revenue as
revenue as
year
revenue
year
revenue
percentage of
percentage of
(in billions)
(in billions)
GDP
GDP
1972
$4.4
0.36%
1989
$23.9
0.44%
1973
$5.4
0.39%
1990
$21.8
0.37%
1974
$6.0
0.40%
1991
$20.4
0.34%
1975
$6.6
0.41%
1992
$21.9
0.34%
1976
$7.3
0.40%
1993
$24.2
0.36%
1977
$9.2
0.45%
1994
$25.5
0.36%
1978
$10.7
0.47%
1995
$29.1
0.39%
1979
$12.1
0.47%
1996
$29.3
0.38%
1980
$13.3
0.48%
1997
$30.7
0.37%
1981
$14.1
0.45%
1998
$31.1
0.36%
1982
$14.0
0.43%
1999
$30.8
0.33%
1983
$13.2
0.37%
2000
$32.5
0.33%
1984
$15.5
0.39%
2001
$31.7
0.31%
1985
$17.6
0.42%
2002
$25.9
0.24%
1986
$18.4
0.41%
2003
$28.5
0.26%
1987
$20.5
0.43%
2004
$30.8
0.26%
1988
$21.6
0.42%
2005
$38.7
0.31%
Source: CRS calculations based on U.S. Census Bureau, Governments Division and Bureau of
Economic Analysis.
14 The governments division of the Census Bureau collects and reports state tax collections
by type of tax based on survey information from the states.

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CRS-9
Several causes have been suggested for the relative decline in state corporate tax
revenues in FY2001 and FY2002.15 The most direct causes would be legislated
changes in the tax rate, the tax base, or the compliance rules. The decline in revenue
could be the result of state governments, in the aggregate, attempting to lower the tax
burden on corporations. The December 2003 Fiscal Survey of States reported that
states, in the aggregate, enacted net tax cuts every year from FY1995 through
FY2001.16 Even though these tax cuts were not separated into types of tax by the
Fiscal Survey, it seems likely that state corporate income taxes were included in the
tax cuts. Recent research has reached a similar conclusion, noting that “[S]tate tax
bases have deteriorated further than the federal base because of a combination of
explicit state actions [emphasis added] and tax avoidance/evasion by businesses.”17
A second explanation, alluded to above, is that corporations are more effectively
avoiding, or even evading taxes through aggressive tax planning.18 The Multistate
Tax Commission (MTC) concluded in a recent study that “...various corporations are
increasingly taking advantage of structural weakness and loopholes in the state
corporate tax systems.”19 Again, the MTC study cannot definitively separate the
revenue declines arising from policy changes and avoidance/evasion, but still
concludes that tax avoidance and evasion is partly responsible for the decline in state
corporate tax revenues.
A third explanation is that cyclical economic changes have led to the decline in
state corporate tax revenues. Note that cyclical economic effects are unrelated to the
behavior of policymakers or corporations. The effect of economic cycles on revenue
is difficult to identify because the legislated changes and the corporate behavior
described above likely exacerbated (or attenuated) the cyclical economic changes.
Recent research into the causes of state budget deficits, suggested that “the current
[cumulative state] deficit is largely structural....”20 The implication of this finding is
that policy (structural) changes like tax cuts and discretionary spending increases
generated state budget deficits in FY2002 and FY2003, not the machinations of the
economic cycle.
Finally, changes to the federal corporate income tax code, which have reduced
the base of most state corporate income tax systems, could explain part of the decline
in state corporate income tax revenue. A recent report, however, noted that “nearly
15 William F. Fox and LeAnn Luna, “State Corporate Tax Revenue Trends: Causes and
Possible Solutions,” National Tax Journal, vol. LV, no. 3, Sept. 2002, pp. 491-508.
(Hereafter cited as Fox and Luna, State Corporate Tax Revenue Trends.)
16 National Association of State Budget Officers, December 2003 Fiscal Survey of States.
17 Fox and Luna, State Corporate Tax Revenue Trends, p. 498.
18 Tax avoidance is a legal means of reducing tax liability, such as buying tax-exempt bonds.
In contrast, tax evasion is illegal, such as not claiming otherwise taxable income.
19 Multistate Tax Commission, “Corporate Tax Sheltering and the Impact on State Corporate
Income Tax Revenue Collections,” July 15, 2003, from the Executive Summary.
20 Brian Knight, Andrea Kusko, and Laura Rubin, “Problems and Prospects for State and
Local Governments,” paper presented at Urban Institute Seminar, State Fiscal Crises:
Causes, Consequences, and Solutions, Apr. 5, 2003.

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two-thirds [of states] refused to go along with President Bush’s 2001-2004 ‘bonus
depreciation.’....”21 The next section discusses the interaction between federal and
state corporate income taxes in more detail.
Issues for Congress
State corporate income taxes are of interest to Congress for primarily two
reasons: interstate commerce oversight and tax interaction. The following section
analyzes these two aspects of state corporate income taxation that are most directly
affected by congressional action.
Interstate Commerce Regulation and Oversight
The interstate commerce regulation and tax interaction issues have attracted
interest for three principal reasons: (1) the complex Internet sales tax debate; (2) the
recent federal business tax cuts; and (3) state fiscal issues. The link between the
Internet sales tax debate and state corporate income taxes is complicated and centers
on the prohibition on states reaching beyond their borders to compel out-of-state
vendors to collect sales and use taxes.22 As a general rule, a state can require a
vendor to collect sales and use taxes only if the vendor has “substantial nexus” in the
state.23 Typically, the substantial nexus standard is satisfied if the vendor has a
physical presence in the state.24 Thus, remote Internet transactions, where the vendor
has no physical presence in the customer’s home state, do not have the sales and use
tax added to the price of the good by the vendor. These types of transactions have
grown considerably over the last several years and have contributed to the erosion of
the sales and use tax base of most states.25
In an effort to persuade Congress to allow states to compel remote vendors to
collect use taxes, a coalition of states has been working together to establish a
uniform sales and use tax agreement. The coalition of states identifies this agreement
21 McIntyre, Robert S and T.D. Coo Nguyen, “State Corporate Income Taxes 2001-2003,”
State Tax Notes, March 7, 2005, pp. 685-712.
22 A sales tax is levied at the time of transaction and is tax on the sale. The companion use
tax is a tax on the use of a good or service. Technically, remote vendors would collect a use
tax because the product is going to be used in the customer’s home state.
23 The limitation arises from the due process and commerce clauses in the U.S. Constitution.
24 For more on the sales tax issue, see CRS Report RL31252, Internet Commerce and State
Sales and Use Taxes, by Steve Maguire.
25 Donald Bruce and William F. Fox, “State and Local Sales Tax Revenue Losses from E-
Commerce: Estimates as of July 2004,” Center for Business and Economic Research,
University of Tennessee, July 2004. Bruce and Fox estimated this erosion from electronic
commerce alone will result in states losing between $21.5 billion and $33.7 billion in 2008.
There is considerable debate, however, about the size of the revenue loss.

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as the “Streamlined Sales and Use Tax Agreement” (SSUTA).26 States that sign onto
the sales tax compact would have already implemented uniform definitions and
compliance rules, thus easing the administrative burden of remote vendor collection.
Two bills in the 109th Congress would grant states these rights.27 If either of these
bills were enacted and the states satisfied the requirements for qualification, remote
vendors in the compact states would collect use taxes for shipments to states where
the vendor does not have a substantial nexus.
Some vendors are concerned that collecting use taxes for a state in which they
do not have nexus, could trigger income or other business tax liability. However,
past court decisions and the landmark P.L. 86-272 established physical presence as
the standard for sufficient nexus for corporate income taxes for firms selling tangible
goods. The law, P.L. 86-272, was passed shortly after the Supreme Court issued a
ruling that seemed to offer an ambiguous definition of “sufficient nexus.” The
Supreme Court language that generated this concern (as cited in the Senate report on
S. 2524, the Senate version of what became P.L. 86-272) is reproduced below:
We conclude that the net income from the interstate operations of a foreign
corporation may be subjected to State taxation provided the levy is not
discriminatory and is properly apportioned to local activities within the taxing
State forming sufficient nexus to support the same. [Emphasis added] (358 U.S.
450 at 452)28
The term “local activities” was deemed too ambiguous by policy makers and
businesses. The Senate report provided the following as reasoning behind the
enacted legislation (P.L. 86-272) that clarified the definition:
Persons engaged in interstate commerce are in doubt as to the amount of local
activities within a State that will be regarded as forming a sufficient “nexus,” that
is, connection, with the State to support the imposition of a tax on net income
from interstate operations and “properly apportioned” to the State.29
The legislation passed by Congress clarified nexus by identifying those activities
which would not establish nexus. Generally, soliciting sales of tangible goods in a
state for shipment by common carrier from locations outside the state into the state,
would not be sufficient to trigger nexus. Thus, for tangible goods shipped across
state lines, state net corporate income taxes are levied at the source not the
destination of the product. The home state of the customer receiving the goods
cannot levy a state corporate income tax on the remote business by virtue of the
transaction. The issue of intangible goods and services was not addressed directly
by P.L. 86-272.
26 For more on the SSUTA, see CRS Report RS22387, The Streamlined Sales and Use Tax
Agreement: A Brief Description, by Steven Maguire.
27 S. 2152 and S. 2153.
28 U.S. Congress, Senate Committee on Finance, State Income Taxes — Interstate
Commerce, Senate report to accompany S. 2524, S.Rept. 658, 86th Cong., 1st sess.
(Washington: GPO, Aug. 11, 1959) p. 2549.
29 Ibid.

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The Internet sales and use tax debate has revived a discussion of what
constitutes nexus for a corporate income tax. Clarified nexus standards, however, do
not seem destined to fundamentally alter the administration of state corporate income
taxes. As noted above, current laws would already shield out-of-state vendors from
corporate income tax liability if the business were only soliciting the sale of tangible
goods into the state. As for intangibles goods and services, policymakers would
likely insert language to ensure that a corporation would not establish nexus by virtue
of collecting sales and use taxes.30
Tax Interaction
The “Jobs and Growth Tax Relief Reconciliation Act of 2003” (JGTRRA, P.L.
108-27), included several provisions that reduce the federal tax burden on business
investment.31 The federal tax changes also affected state taxes because of the
interaction between federal taxes and state taxes on corporations. Generally, states
use the federal tax code as the base for the state income tax (see the background
section titled “federal starting point”).32 Thus, when the federal definition of the tax
base changes, so does the state definition of income.33
JGTRRA included two temporary provisions designed to accelerate the
depreciation of capital assets purchased by businesses. The first is a temporary
increase in the amount of a capital expenditure that a small business can deduct in the
year of purchase.34 The larger deduction reduces the base of the federal corporate
income tax and thus the state corporate income tax base for those states that link
directly to the federal tax code. The change in federal law may generate a significant
revenue loss in the short run for those states that remain linked to the federal
definition of business income.35 This provision would have expired on December 31,
30 Section 7(a) of S. 1736 from the 108th Congress states that “[N]othing in this Act shall be
construed as subjecting sellers to franchise taxes, income taxes, or licensing requirements
of a state or political subdivision thereof, nor shall anything in this Act be construed as
affecting the application of such taxes or requirements or enlarging or reducing the authority
of any State to impose such taxes or requirements.”
31 For more on the business tax cuts in P.L. 108-27, see CRS Report RL32034, The Jobs and
Growth Tax Relief Reconciliation Act of 2003 and Business Investment, by Gary Guenther.
32 Many states, as noted earlier, have decided not to incorporate recent federal changes. For
more, see McIntyre, Robert S and T.D. Coo Nguyen, “State Corporate Income Taxes 2001-
2003,” State Tax Notes, Mar. 7, 2005, pp. 685-712.
33 Another issue is fiscal policy coordination between the federal, state, and local
governments. If state governments do not adopt the federal tax changes, then the fiscal
stimulus of federal tax policy is muted by state non-compliance. For more on the
countervailing fiscal stimulus effects, see CRS Report RL31936, General Revenue Sharing:
Background and Analysis, by Steven Maguire.
34 26 U.S.C. § 179.
35 According to a recent analysis by the Center on Budget and Policy Priorities, “... 17 states
stand to lose an estimated $1.1 billion in 2004 and another $600 million by the end of 2005.”
Nicholas Johnson, “Federal Tax Changes Likely to Cost States Billions of Dollars in
(continued...)

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2005, but was extended through December 31, 2007, by the American Jobs Creation
Act of 2004, (P.L. 108-357).
A second JGTRRA provision allowed for “bonus depreciation” for certain
capital expenditures. Businesses that buy qualified capital assets before January 1,
2005 could have immediately deducted 50% of the purchase price from gross
income. The combined effect of the two original provisions (not including the 2004
extension of the small business deduction described above) would cost states an
estimated $2.7 billion. If the provisions were made permanent, the cost to the states
has been estimated to rise to $17.7 billion over the 2004-2013 budget window.36
Proponents of the accelerated depreciation provisions, however, would argue
that over the long run, increased business investment would likely lead to stronger
economic growth and in turn more corporate income tax revenue. The long run net
budget outcome of the two countervailing forces is uncertain and relies on debatable
assumptions about the response of businesses to investment incentives delivered
through the federal tax code.
The JGTRRA provisions adversely affect state budgets in the short run because
the tax relief is delivered through changes in the base. If Congress were concerned
primarily with the impact of federal corporate income tax law changes on the states,
changes in corporate income tax rates would have minimal impact on the states.
Unlike changes in the tax base, a federal tax rate change would not directly affect
state corporate income taxes.
Legislative Activity
Legislation in the 109th Congress would have authorized states to compel remote
vendors to collect sales and use taxes. Even though the bills address the collection
of state sales and use taxes, not state corporate income taxes, some policymakers
believe that the issues are similar to those surrounding the state corporate income tax.
Related legislation would have established a “physical presence” standard for
business activity taxes (BATs, primarily state corporate income taxes). In the 109th
Congress, H.R. 1956, which on December 13, 2005, was approved by the House
Judiciary Commercial and Administrative Law Subcommittee, addresses the nexus
standards for purposes of levying a state corporate income tax. A very similar
companion bill, S. 2721, was introduced in the Senate on May 4, 2006.
S. 2152 and S. 2153. Two almost identical bills, each given the title of the
“Sales Tax Fairness and Simplification Act” (STFSA), would authorize states to
require out-of-state vendors to collect sales and use taxes. The authority would only
be granted once “... 10 states comprising at least 20 percent of the total population
of States imposing a sales tax ... have petitioned for membership under the
35 (...continued)
Coming Years,” Center on Budget and Policy Priorities, June 5, 2003, p. 5.
36 Nicholas Johnson, “Federal Tax Changes Likely to Cost States Billions of Dollars in
Coming Years,” Center on Budget and Policy Priorities, June 5, 2003, Tables 2 and 3.

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[Streamlined Sales and Use Tax] Agreement....”37 Under S. 2152, businesses with
less the $5 million in sales would be exempt from the collection requirement.38 In
contrast, under S. 2153, the Administrator of the Small Business Administration
would establish the small business exemption with input from stakeholders. Under
both S. 2152 and S. 2153, businesses that collect the tax would receive “reasonable
compensation” from the states for expenses incurred for “administration, collection
and remittance of sales and use taxes.”39
The connection to states through the sales and use tax administration has raised
concern that implementing the STFSA could pave the way for states to claim that
out-of-state vendors have established nexus. Section 7 of the legislation, however,
outlines the limitations of the proposed SSUTA. The legislation explicitly states that
“No obligation imposed by virtue of the authority granted by section 4 shall be
considered in determining whether a seller has a nexus with any State for any tax
purpose.”40
H.R. 1956 and S. 2721. Under current law, sales of “tangible personal
property” into a state are not sufficient to trigger tax liability. H.R. 1956 would
expand the protection beyond tangible personal property to include services.41 This
expansion would have had a significant effect on the 32 states where “... an
employee’s solicitation of services while in the state for six or fewer days would
create nexus.”42
In addition to the expansion of protected interactions, this legislation would
have also defined “physical presence” as the standard for collecting business activity
taxes. Under this proposal, physical presence would be established and a business
activity tax allowable if:
! the individual or business is physically within the state for 21 days
(not including trips to buy goods or services for the business;
gathering news for print or other media; meeting with government
officials for purposes other than selling goods and services;
attending training or educational purposes; or participating in
charitable events);
! the individual or business uses the services of another individual or
business for 21 days and the hired individual or business does not do
business for any other entity; or
37 Section 4(a).
38 Section 4(d).
39 Section 6(a).
40 Section 7(b).
41 Generally, H.R. 1956 strikes the “tangible personal property” identifier and inserts “or
transaction.” This change would presumably expand the “protected” activity to include
service transactions.
42 BNA, Apr. 25, 2003.

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! the individual or business leases or owns tangible personal property
or real property in the state for more than 21 days.
An important exception to the “21-day rule” is included in the legislation and
is related to live performances and sporting events. Generally, the 21-day minimum
is replaced with one day for live performances and participation in sporting events
where at least 100 spectators are present. There is not a uniform number of days
under current state laws, but, most states impose a minimum that is less than 21 days.
Analysis. The streamlined sales tax legislation, S. 2152 and S. 2153, would
require states to simplify their sales and use tax systems before granting them the
authority to compel remote vendors to collect the sales and use tax. From an
economic perspective, reduced complexity and compliance costs for businesses, not
just those engaged in interstate commerce, would likely increase the efficiency of the
tax system. To the extent that the changes imposed by the legislation would treat all
transactions neutrally, they would also increase the equity of the tax system.
The critical concern is how stringent the SSUTA enforcement will be if
implemented. If the agreement is not strictly enforced, then any gains in economic
efficiency are lost and the anticipated improved equity diminished. The de minimus
standards could be administratively difficult to enforce and could create loopholes
through which businesses could circumvent the intent of the SSUTA. These
standards could be eliminated if the SSUTA were strictly enforced and the rules on
what was taxable were truly uniform from state to state. The ease of compliance with
a truly uniform base would render seemingly arbitrary minimum sales thresholds
unnecessary.43 Even though the statutory burden of the sales and use tax falls on
consumers, the SSUTA legislation may be considered in conjunction with other
legislation that more directly addresses how states tax businesses.
The BAT legislation in the 109th Congress, H.R. 1956 and S. 2721, is intended
to further modify the state taxation of businesses engaged in interstate commerce.
The legislation would impose new regulations on how states impose taxes on multi-
state businesses, through (1) imposing uniformity on the time component of nexus
determination and (2) expanding the definition of goods and services subject to the
nexus rules. The legislation would not directly address the complexity of the state
corporate income tax structure — in particular, the various apportionment formulas
(and allocation rules) described earlier.
Many economists and other researchers who analyze state corporate income
taxes agree that the critical issue with the current state corporate income tax structure
is the variability in the allocation and apportionment of corporate income from state
to state. The current mosaic of state corporate income tax rules creates economic
inefficiencies for the following reasons: (1) relatively high compliance costs, (2)
increased opportunities for tax planning by businesses, and (3) potential gaps and
overlaps in taxation. The new regulations as proposed in H.R. 1956 and S. 2721,
43 Charles McClure and Walter Hellerstein, “Congressional Intervention in State Taxation:
A Normative Analysis of Three Proposals,” State Tax Notes, Mar. 1, 2004, p. 732.

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would exacerbate the underlying inefficiencies because the threshold for business —
the 21-day rule, higher than currently exists in most states — would increase
opportunities for tax planning leading to more “nowhere income.” In addition,
expanding the number of transactions that are covered by P.L. 86-272 would have
expanded the opportunities for tax planning and thus tax avoidance and possibly
evasion.
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