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Use Caution Navigating State Tax Credits

05.07.18 | SALT Chat

Just like the beautiful Sirens luring nearby sailors to a rocky shipwreck, those aimlessly navigating the waters of state tax credits can end up with a similar fate. The Sirens, in this case, are certain purveyors of state tax credit services. They will sing you songs of promises to provide you free money that your accountant doesn’t know about. And best of all, at no cost to you.

While state tax credits are a great resource as are a handful of practitioners that specialize in securing them, many have a rudimentary understanding of federal and state tax planning in general, let alone your specific circumstances. While a taxpayer may be able to secure a tax credit from a particular state, surprisingly this may have little or no impact on your overall tax burden. In fact, it may end up costing you.

Let me explain how this is possible. At Berdon, most of our clients are closely held businesses operating as some type of flow-through entity. Generally, no entity level tax is imposed and the entire tax burden flows through to the owners of the business. In an extremely oversimplified example, let’s assume individual client A and B are owners of a shipbuilding business, Sirens LLC, operating throughout the U.S. A is a resident of New York State and B is a resident of Massachusetts. Sirens LLC operates in multiple states, including California.

Both A and B are each subject to tax on their world-wide income in their resident state. A resident tax credit will be provided by the home state for income subject to tax in another jurisdiction. So assuming A and B have a healthy California tax bill, this should be mitigated to some degree by a tax credit provided by the resident state.

Monday morning arrives and I receive a frantic call from A and B that goes something like this: We didn’t tell you but Bob’s state tax credit services called us six months ago and told us about a credit we were entitled to in California based on the number of employees we have at the California plant. We just received the check today. This phone call is going to go from bad to worse.

You now have to inform A and B that while they may have received a check from California, this credit is going to reduce the credit received on their resident state returns. Not so bad, you say, as the California rate is much higher than virtually anywhere else, and maybe A and B will still come out ahead. Sadly, that will not be the case as Bob pays his fee of 30% of the credit received in California. In the end, this “credit” cost A and B real money. A shipwreck, indeed!

Should you have questions about state tax credits, please contact me at wberkowitz@berdonllp.com or your Berdon advisor.

Wayne K. Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, New York Accountants, advises clients on the unique requirements of governments and municipalities across the nation.