Avoiding Maryland corporate income tax is easier than shooting fish in a barrel. I should know. As a longtime tax-avoidance innovator, I led a Big 4 accounting firm’s 600-person “state tax minimization” shop, which enabled huge corporate groups to dodge multimillion-dollar state tax obligations. I defended these schemes in court around the country, ultimately becoming executive tax counsel at a well-known Fortune 10 company.
Maryland was always one of my favorite targets. Our tax avoidance here was completely legal; we simply took advantage of a loophole in state law. But just as easily as we used this loophole, which costs Maryland over $200 million a year, lawmakers could close it. This fix has already been enacted by D.C. and 28 states, red and blue alike.
That simple fix is “combined reporting” — states should tax parent companies and their majority-owned subsidiaries as the single, integrated economic enterprise they actually are, instead of treating each of them as a separate taxpayer. Del. Mary Lehman is the lead sponsor of this year’s bill to require combined reporting in Maryland, House Bill 46, and Sen. Karen Lewis Young is the lead sponsor of the identical Senate Bill 576.
To illustrate how this simple solution would end major corporate income tax avoidance in Maryland, let’s consider one of the most straightforward of these tax dodges — “transfer pricing.” Any big-box retail chain can place ownership of its warehouses in a separate subsidiary from the one that owns the stores and can locate those warehouses in a state with no or a low-rate corporate tax. The warehouse arm will buy the store inventory from manufacturers and sell it at a huge markp to the stores, shifting their profit to the no- or low-tax state. And if the corporate headquarters happens to be based in a low-rate state as well, it can siphon even more profit away by charging the stores for management, advertising and other services.
These aren’t hypothetical strategies. South Carolina has been engaged for several years now in litigation with some prominent big-box retailers — including Bed Bath & Beyond, Best Buy and Home Depot — whose distribution arms are massively marking up inventory sales to their stores. And Florida just lost a big case after it challenged charges for marketing services that the Target Corporation headquarters made to Target stores.
Corporate income tax dodging runs rampant in Maryland because of a nonsensical policy called “separate filing,” which ignores the economic reality that all members of a typical corporate group operate as a single economic enterprise, controlled from the top. Adopting a fictional alternate reality, Maryland requires each legal entity to calculate its own separate taxes — and only if that entity has its own direct contacts with the state. In my big box retailer example, the headquarters operation and warehouse subsidiary can easily avoid such contacts.
Under combined reporting, in the big box retailer scenario laid out above, the state would add together the profits of the stores, the headquarters and the warehouse operation, and tax a share of the combined profit equal to Maryland’s share of the retailer’s nationwide sales. For nearly four decades, the General Assembly has been told about this comprehensive legislative solution, which would shut down most corporate income tax avoidance schemes, follow economic reality and tax a fair share of the combined profit of the entire corporate group. But lawmakers have failed to act amid strong pressure from corporations. That can’t continue.
Maryland individual and small business taxpayers don’t have to put up with a game that’s rigged against them. They can demand that the General Assembly stop doing the bidding of the tax avoidance lobby and instead adopt combined reporting. It’s long overdue.
Don Griswold (don.griswold@justSALT.info) was a state corporate tax attorney and adviser for more than three decades; he is now a consultant to the Center on Budget and Policy Priorities, among others through his LLC, Just SALT Policy.