Instant Unity: A critical concept in state tax

ARTICLE | April 08, 2024

Authored by RSM US LLP

Executive Summary: Instant unity requires a critical analysis

When a business acquires another entity or acquires the assets of another entity, questions arise as to whether the combined entities are unitary and when the unitary relationship begins. There are many considerations to being unitary as well as planning opportunities. Businesses should understand the ramifications prior to a merger or acquisition. The follow discussion highlights why instant unity is a need-to-know concept for state tax purposes.

Determining instant unity

Determining whether related companies must file on a combined basis is one of the most fundamental exercises in state taxation. If a unitary business exists, then generally the taxable income or loss of each member of the combined group is aggregated to arrive at taxable income. The ability to use combined reporting versus separate reporting can have costs and benefits, depending on the circumstances. The filing requirements can also affect both administrative costs and burdens of tax compliance. The determination of whether a newly acquired company may be instantly unitary with another corporation or group of legal entities adds a layer of complexity for every transaction.

The indicia of a unitary business, the prerequisite to related companies fling combined reports, are well known. They include, but are not limited to functional integration, centralization of management, or economies of scale. There are many aspects to these indicia such as interlocking directors, centralized operations (e.g., accounting and advertising), and intercompany transactions.

When a transaction results in the combination of two are more businesses under common ownership, questions arise as to whether the entities are unitary and thus subject to combined reporting for state purposes. In many cases, but not all, the entities will be unitary. Another important question is when the unitary relationship begins for financial reporting and compliance purposes. An instant unitary analysis is the determination of whether that unitary relationship exists immediately on the date of acquisition, or whether the indicia of a unitary relationship (e.g., centralized management, intercompany transactions) develop at a later point in time subsequent to the transaction.

Fourteen states that require combined reporting do not provide any guidance as to when the unitary relationship begins. Three states (California, Illinois and New Mexico) recognize that instant unitary is possible provided that the indicia of a unitary business are present. Four states (New Jersey, New York, Rhode Island and Texas) have issued guidance stating that there is a rebuttable presumption that a unitary relationship exists immediately after a merger or acquisition. Finally, seven states and the District of Columbia (Colorado, Connecticut, Massachusetts, Oregon, Vermont, West Virginia and Wisconsin) have issued guidance stating there is a rebuttable presumption a unitary relationship does not exist in the first year of a merger or acquisition. The rules for each of these states should be examined closely to determine whether the combined entities are unitary and when that relationship begins.

Planning ahead

An analysis should be performed to determine the point in time when the integration between two or more entities has developed to the extent that the unitary tests are met. This may include reviewing the purchase agreement related to the acquisition which may indicate terms and conditions of the sale. A unitary analysis will also involve review of any other relevant documents, such as board minutes, business integration plans, and conducting interviews with relevant members of the business to understand the level of functional integration (for example) that has occurred and when it occurred. Once a determination has been made, there are many other questions that arise, such as how the state income tax returns are filed, how losses and other attributes are tracked and utilized, and how the use of depreciation or amortization may change as a result of a step-up in basis.

Regardless of state law, there are numerous actions and dates to consider when planning for a unitary relationship. A brief and non-exhaustive list of items may include the following:

• Reviewing positions of officers, directors and key managers of the newly acquired subsidiary in context of the parent corporation (or from one of its existing subsidiaries)
• Providing centralized services such as accounting, legal services, pension plans or computer services to the newly acquired subsidiary
• Transferring funds through intercompany financing
• Imposing the parent company's policies and procedures on the newly acquired subsidiary (e.g., requiring a standard chart of accounts, standardized approval procedures for expenditures, etc.)
• Assessing whether to discontinue certain product lines or to target new markets

Takeaways

There are many tax and business impacts that result from a unitary business relationship, many of which will affect the first year of a merger or acquisition. Some states have special apportionment for certain industries or specific rules for foreign operations that should be considered in advance. The presence of holding companies and partnerships may also require more nuanced analysis. Asserting instant unity can have a significant impact on a company’s tax liability, as well as the administrative costs and burdens of tax compliance.

It is important that businesses understand the ramifications of being or not being instantly unitary with an acquired entity prior to a merger or acquisition. At a minimum, businesses contemplating a merger or acquisition should know the jurisdictions in which the group does business and the instant unity rules pertinent to each jurisdiction.