Proponents of a New Mexico corporate income tax change called mandatory “combined reporting” claim it will eliminate a loophole that permits large, multi-state corporations to shift income earned in New Mexico to other, more tax-friendly states. They further claim that combined reporting will require those companies to pay the same taxes that smaller local businesses pay and will raise $40 million to $100 million in additional tax revenues for the state.
This characterization omits the principal features of combined reporting, misstates the tax liability of local companies and exaggerates the likely state revenue impact of combined reporting.
The most important feature of combined reporting is that it would base the New Mexico corporate income tax on the income and losses of an entire corporate family (parent and subsidiary corporations) if any member of the corporate family operates in New Mexico and if the members cooperate in doing business. This may include, as the proponents observe, some income which was shifted from New Mexico to another state for tax purposes, but, most importantly, it would include the income of corporations that have no operations in New Mexico and have no part in any income-shifting.
Combined reporting would total all the income and losses of all the members of the corporate family throughout the country and attribute a portion of the total to New Mexico by a formula and subject it to New Mexico tax. The formula compares the payroll, property and sales in New Mexico with payroll, property and sales nationwide.
Characteristics of combined reporting
This procedure has three notable characteristics. First, any corporate family, successful elsewhere and considering opening a New Mexico subsidiary, would have to be willing to pay New Mexico corporate income tax based upon the earnings of its subsidiaries in other states, regardless of the profitability of its New Mexico operations. Second, there would be a tax price for expanding the New Mexico payroll and New Mexico investment of such a subsidiary.
Merely increasing New Mexico payroll or New Mexico property would increase, under the formula, the share of the nationwide income that is subject to New Mexico corporate income tax. Conversely, reducing New Mexico payroll or property would produce a tax cut under the formula.
Third, combined reporting might encourage a corporate family with financially marginal operations in New Mexico to close them or move them out-of-state, if the price for continuing in New Mexico is paying corporate income tax based on the profits of subsidiaries in other states.
Most local New Mexico businesses pay no New Mexico corporate income tax. Many are organized as sole-proprietorships or partnerships rather than corporations. Such businesses do not pay corporate income tax or any similar entity-level tax. Further, small businesses that are corporations frequently have owners who are also employees, and they can effectively eliminate all taxable corporate income by paying themselves salaries and bonuses. Finally, the first $1 million of net corporate income is taxed at reduced rates.
The proponents’ estimates of revenues to be gained by the state from requiring combined reporting are based on outdated information and are grossly inflated. Rather than $40 million to $100 million, the likely yield is about $25 million or less. In fact, during a recession there is a possibility that in some years the yield could be negative.
Combined reporting would have the effect of importing into New Mexico’s tax base part of the profits and part of the losses of corporations not doing business in New Mexico. If many of these corporations suffer large losses in other states, New Mexico could actually lose revenues.
Consider ‘add-back’ provisions instead
Combined reporting differs substantially from the description provided by its advocates. However, there is a type of statute adopted in many states that operates substantially like the proponents’ description of combined reporting. “Add-back” statutes eliminate the tax effect of certain transactions within a corporate family that shift income from one corporation to another for tax purposes. Under add-back statutes corporations are denied deductions for these transactions.
A benefit of add-back statutes is that they operate only in one direction. They can increase, but they cannot decrease, state revenues. Also, unlike combined reporting, add-back statutes increase a corporation’s taxes only if that corporation is operating profitably in New Mexico. This should reduce the possibility that such statutes would discourage the growth or retention of business in New Mexico.
Discussion of combined reporting should be fact-based, rather than relying entirely on misleading and emotional catch-phrases such as “loophole” and “large out-of-state corporations.” If the shifting of income earned in New Mexico to other states is a concern, add-back provisions should be considered.
Minzner is a legislative lobbyist who represents a behavioral health provider and a renewable energy company who oppose combined reporting. He previously was secretary of the New Mexico Taxation and Revenue Department and chair of the House Taxation and Revenue Committee.