Tax Analysts published an article by MTC Senior Counsel Bruce Fort in its May 17, 2021 publications Tax Notes State, Tax Notes Federal and Tax Notes International entitled, “Anatomy of a Domestic Tax Shelter” regarding the use of so-called 80/20 companies as a means to artificially shift profits to non-taxed entities. The article describes the genesis of the domestic 80/20 company exclusion from the states’ water’s edge combined reporting regimes in the 1980’s, when states moved away from world-wide combined reporting in response to threatened federal preemption. Currently 16 states exclude U.S. companies with predominately foreign property and payroll factors from their combined reports.
The 80/20 exclusion is problematic, Fort explains, because the federal tax code (which forms the starting point for state tax calculations) encourages tax-free transfers of assets among commonly controlled domestic corporations. Taxpayers can take advantage of this policy to transfer income-producing intangible property to these 80/20 companies, artificially reducing the reported income of the combined reporting group. Similar transfers to true foreign subsidiaries under the would trigger the recognition of a deemed royalty amount for federal tax purposes.
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