The recent article by “John Adams” promotes two pieces of misinformation. First, it claims that large out-of-state corporations do not pay corporate income tax on the income earned in New Mexico. Second, it claims that small local businesses suffer unfair competition because they do pay such taxes.
The largest payers of corporate income tax in New Mexico are large, multistate corporations and large, multistate corporate families of related corporations. Walmart is certainly one of the largest New Mexico corporate income taxpayers. Other “big box” retailers are substantial corporate income taxpayers.
Oil and gas companies and other large interstate companies and corporate families pay substantial amounts of this tax. Almost all of New Mexico’s corporate income tax is paid by about 250 companies, and nearly all of the tax is paid by multistate corporations or members of multistate corporate families.
Small, local businesses do not pay substantial corporate income tax. With few exceptions, they are organized as sole proprietorships or as partnerships or other business entities that do not pay corporate income tax. Generally, the owners of these businesses simply include the profits on their personal income tax returns.
New Mexico’s maximum personal income tax rate is 4.9 percent. The maximum corporate income tax rate is 7.6 percent. In addition, after the corporate income tax is paid, the stockholders of a large corporation face a second level of taxation when they take money out of the corporation as dividends or capital gains.
Separate versus combined reporting
The misconception that out-of-state corporations do not pay tax on their New Mexico income originates with imprecise discussion of the issue of separate reporting versus combined reporting of corporate income taxes.
Under New Mexico law, corporate families (parent corporations and subsidiary corporations) have the option to pay corporate income tax on either a separate or combined basis. Separate reporting requires that only those members of the corporate family doing business in New Mexico pay corporate income tax and requires that they pay tax on the income earned in New Mexico.
A problem with separate reporting is that some companies may avoid tax on part of their New Mexico income, usually a relatively small part, by engaging in transactions, only for tax reasons, with related companies in other states with lower tax rates.
For example, if a New Mexico subsidiary corporation borrows money from its Nevada parent, interest paid on the loan is a deduction from the New Mexico taxable income. The interest received in Nevada would be income there, but Nevada has no corporate income tax.
The possibility that this type of transaction can be used to avoid New Mexico income tax on a portion of a corporation’s income gives rise to the charge that “out-of-state corporations do not pay tax on New Mexico profits.” In fact, it is unlikely that as much as 10 percent of New Mexico’s otherwise taxable income escapes by such tax-motivated transactions. Many companies engage in no such transactions.
Combined reporting addresses the problem of perceived inappropriate deductions by abandoning entirely the effort to determine what income is actually earned in New Mexico by the companies doing business in New Mexico. Instead, it totals the entire income of all members of the corporate family that cooperate in their operations, whether or not they do business in New Mexico.
It then attributes a portion of this income to New Mexico as determined by a formula. The formula compares the payroll, investment (or property) and sales in New Mexico with the nationwide payroll, investment and sales of all the members of the corporate family. That computation produces an income figure that is taxed in New Mexico, even if the companies doing business in New Mexico appear to be losing money or breaking even.
There is a substantial downside to this approach. A corporate family could reduce its New Mexico income tax by laying off New Mexicans or reducing their pay. If it increased its payroll in New Mexico, its New Mexico corporate income tax would be increased. By the same token, a reduction in its property, or investment, in New Mexico would reduce its tax, and an increase in this factor would result in a tax increase.
NM’s higher tax rate compensates
While it is not true that out-of-state corporations pay no tax on New Mexico profits, it is true that giving corporate families the option to report on a separate or combined basis is beneficial to the corporate taxpayers. Further, the issue of inappropriately claimed deductions under separate reporting is real, although relatively minor.
There are methods to address such claims of deductions besides requiring combined reporting, and those methods do not have the same drawbacks that combined reporting has.
Many other states have mandated combined reporting. However, New Mexico’s corporate income tax rate is extremely high at 7.6 percent. Our neighboring states average about 5 percent. This difference in rates more than compensates New Mexico’s general fund for any losses it suffers through inappropriate deductions or losses that result from permitting corporations to elect between separate or combined reporting.
Further, New Mexico’s high tax rate increases the tax savings that would result under the combined reporting formula from laying off New Mexicans and increases the tax cost of hiring New Mexicans. It also increases the tax savings or tax cost that would result from changing the level of investment in New Mexico.
New Mexico’s current system of corporate income taxation taxes multistate corporate families more heavily than would a system that imposed mandatory combined reporting and also imposed taxation at the same rate as the average of our neighboring states.
Dick Minzner is a former cabinet secretary for the N.M. Department of Taxation and Revenue and currently lobbies in the legislature for a client who opposes mandatory combined reporting.