Let's talk about how corporations file their state tax returns. Specifically let's talk about corporations who utilize multiple entities and how they file their state tax returns. Now in general, states are going to require taxpayers to file using one of the following three methods. Separate return filing, consolidated return filing, or combined return filing, and combine filing is also called unitary reporting, and we'll be using combined and unitary interchangeably. Now, these are the generally accepted terms and the ones we're going to use. But as always, be careful when looking at individual state definitions. For example, some states may call their filing method combined. Even though it's going to be closer to what we're going to learn and what would generally be considered consolidated filing. Now, let's get to the mechanics. In a separate return filing state, each entity with Nexus in that state will file their own separate tax return. For example, suppose that ABC inc is the parent corporation of Sub one Inc and Sub 2 Inc, altogether these three entities file a consolidated federal tax return. Now as a quick reminder, corporations can elect to file a federal consolidated return when certain ownership thresholds are met, that's 80 percent of the vote in value of the subsidiary for a specified number of days during the year. But unlike financial accounting, consolidation for federal tax purposes is elected but it is not mandatory. In other words, the taxpayers choose when eligible whether or not to file a consolidated federal tax return or to have their entity is file separate tax returns. Back to our example, we have ABC, the parent, sub 1 and sub 2, who together file a federal consolidated tax return. Of these three corporations, only ABC and Sub one have Nexus with state tax. How would this company file their tax return under the various state filing methods? Well, first in a separate return state ABC and Sub 1, the two entities with Nexus in state tax would each file their own separate state tax return and this is true, even though they don't file separate federal returns. The file consolidated federal return but at the state level to separate state level returns. But to prepare the separate state returns, you'll probably end up preparing what is known as a proforma federal tax return for each entity. A pro forma return is a return that you don't actually file with the IRS, but it is prepared as if that separate entity was going to file a separate federal tax return. This makes the state return preparation easier since federal numbers are usually the state starting point. In many cases, the state may require a copy of that pro forma return as well. Next, what about in a consolidated return filing state? What's our example going to look like? Well, many of the separate return filing states will also allow taxpayers to make an election to file a consolidated state tax return. Generally speaking, these states are going to impose the same ownership and control requirements for a consolidated state filing that is necessary for a federal consolidated election. The big difference here though, is that states will generally limit the entities that can be included in the consolidated return to only those entities that have Nexus with the state. In some cases, states may even require taxpayers to consolidate if it is necessary to fairly reflect the taxpayer's income. That's a general theme with return filing methods. If a state believes that the required method does not accurately reflect the taxpayer's income, they may try to impose a different filing method on the taxpayer to make sure that income is accurately reflected in their state. Going back to our example using a, b, c sub 1 and sub 2. Here, a state tax with a consolidated return filing state, the taxpayer would have the option of ABC and Sub 1 filing their own separate returns, or they could elect to file a consolidated return consisting of ABC and Sub 1. But note sub 2 would not be included in this filing, even though they are part of the federal consolidated return, they would not be included in the state consolidation because they do not have Nexus with state tax. Finally, let's take a look at combined or unitary filing. This is definitely the most complicated filing method. It also just happens to be the method that states are slowly trending towards, generally because it's also the method that provides states with the maximum permissible taxing power. Combined are unitary reporting ignores legal entities and it ignores geographical boundaries and instead focuses on the business enterprise as an economic unit. This can result in separate legal entities without Nexus in a state being included on a combine return in the state. Back to our example using a, b, c sub 1 and sub 2. Here, all of the entities that constitute a unitary business will be included and state access tax return filing, although the exact mechanism by which they are included will vary. For example, some states will still require separate returns after computing the unitary groups combined income in a portion of factors, while others may require a single combine return filing. What is a unitary business? To answer that, we're going to turn to a concept called the unitary business principle, which is the topic of our next video.
