Financial institutions often face targeted excise schemes — are you subject to them?
Many states impose a special tax, usually a franchise tax, on regulated financial corporations, bank holding companies, savings and loan associations, and similar
entities. In recent years, these state
franchise taxes, commonly called financial institutions taxes (F.I. T.s) often
have been drafted broadly. Because of
this, they frequently subject nonregu-lated entities to the tax — including
those that engage in making, acquiring,
selling or servicing loans.
All businesses in the financial sector
must be aware of their state F.I. T. exposure. In some cases, a business may be
subject to tax even if it has no physical
presence in a state.
State F.I. T.s come in many variations.
In some states, the F.I. T. replaces corpo-rate-tax liability. In other states, such
as Missouri, the F.I.T. is an additional
tax that financial institutions pay above
and beyond the corporate income tax,
although credits may be allowed for
other taxes paid.
“For mortgage brokers who
only act as the agent of a
borrower and who have no
relationship with a financial
institution, avoiding the tax
in some states may be as
straightforward as avoiding
ownership of mortgages.”
Most states base their F.I.T. on income. Some states, including Virginia
and Michigan, base the tax on net
capital. No matter what, every state
that imposes a F.I. T. also defines what
it considers a financial institution. The
states, however, are anything but consistent in their definition.
The Multistate Tax Commission (MTC),
which promotes uniform state-tax laws,
suggests a definition. It includes typical
financial institutions — such as bank
holding companies, national banks,
thrifts and credit unions — but also
includes any corporation more than
50 percent owned by a typical financial
institution and any business earning
more than 50 percent of its income from
Few states rely on the tax commission’s definition, instead preferring to
institute local variations. For example,
some states, such as Hawaii, specifically include mortgage-loan companies
in the definition of a financial institution.
Several states don’t give clear guidance
about whether mortgage brokers are
A constant theme
One constant theme is the inclusion of
entities that “carry on the business of a
financial institution” or do “banking activities.” For example, in Indiana, a company that derives 80 percent or more of
its gross income from making, acquiring, selling or servicing loans — including mortgages — is taxable under the
Indiana F.I. T.
In New york, “banking business” refers to any activities substantially similar to those a bank would be authorized
to do under the state’s banking law. In
California, a business performing activities that compete with some parts of
the business of national banks is considered a financial institution.
For mortgage brokers who only act as
the agent of a borrower and who have
no relationship with a financial institution, avoiding the tax in some states
may be as straightforward as avoiding
ownership of mortgages. As long as a
brokerage isn’t owned by a financial institution and doesn’t compete with the
business of financial institutions, the
risk of F.I. T. imposition may be low.
Then again, as many mortgage brokers consider transitioning into the
lending side of the business, they may
face new tax liability. Evaluation of
state F.I.T. exposure becomes critical
• Become a branch of a federally
• start or buy a bank;
• Apply for a federal housing
Administration direct-lender license;
• merge with a direct lender.
Depending on the state, your taxes
may be substantially greater than they
were during your broker days. In addition, a state’s definition of “financial
institution” may be modified through
regulation, statute or case law. Further,
an entity may become a financial institution under a state’s rules merely by
growing its income or pursuing a new
Because there is no single test for
determining whether an entity is a financial institution, awareness is important for every broker.
In some cases, a business may be
subject to a state’s F.I.T. even if the
business isn’t located in the state. For
example, a mortgage broker or lender
may be licensed in a particular state or
maintain an office in a particular state
but have loan receivables or property
interests — or other wise derive income
— from a different state that considers
the business a financial institution because of that interest or income.
In recent years, limitations on interstate tax connections for F.I. T. purposes
have been weakened. In many states,
an entity doesn’t need a physical presence in a state to be subject to its F.I. T.
One modern theory of economic nexus
holds that an entity’s mere economic
presence in a state — collecting income
from state residents, for example —
qualifies it for taxation in the state.
Several cases have challenged these
rules. State courts, including those in
Indiana and West Virginia, held that a
financial institution’s economic presence was enough to let the state charge
it F.I. T.s.
States vary on how they measure an
entity’s presence within their boundaries. Connecticut and New jersey subject corporations to tax if they derive
income from sources within the state.
A corporation will have nexus with
California if $500,000 in sales comes
from California sources. In Indiana,
a corporation is presumed to be doing business in the state if it has 20 or
more Indiana customers during the taxable year.
As states adopt increasingly expansive nexus standards, all businesses in
the financial sector, including brokers,
must be aware of the risks of taking on
new business in a state.
Although some states haven’t
dealt specifically with nexus issues,
businesses should be cautious as
states seek new sources of revenue.
Seemingly minor activities may be
enough to expose a business to tax liability. When examining state laws,
consider every state in which you have
an economic presence.
Divvying up income
Suppose you determine you qualify
as a financial institution in two states.
Clearly, you don’t owe taxes to both
states on your entire income. So how
do you determine exactly how much of
your income is taxable in each state?
This process of apportionment varies
among states, and some states have
adopted special apportionment rules
in their F.I. T.s.
Many states have variations on the
MTC’s model-apportionment statute.
That three-factor formula weighs receipts, property and payroll equally. To
determine what percent of an entity’s
income is taxable in a state under the
tax commission’s formula, you would
first determine what percent of your
receipts, property and payroll reside in
— or are derived from — sources within
each state. Then you would divide the
sum of those percentages by three.
Similar apportionment formulas are
used to determine corporate income
tax liability, but the MTC model statute
includes definitions specific to finan-
cial institutions. This includes the value
of loan receivables for inclusion in the
property factor, and loan-servicing fees
and investment interest for inclusion in
the receipts factor.
• • •
State F.I.T.s can place significant bur-
den on taxpayers in the financial sec-
tor. When considering your options
— including whether to become a
banker or branch operator or to grow
your business — pay attention to how
any such change could alter your tax
liability or tax status. The more you
know ahead of time, the less likely
you’ll be surprised later on. •
disclaimer: This article is for informational
purposes only and does not constitute tax or
Francina A. Dlouhy is a partner and the practice leader of the state and local tax group in
the law firm of Baker & Daniels LLP. She has
spent more than 30 years representing multi-state and multinational businesses in administrative proceedings, appeals and litigation,
as well as in business and tax planning.
Benjamin A. Blair, law clerk, is a 2010 graduate
of the Indiana University Maurer School of
Law. Reach the authors: francina.dlouhy@
bakerd.com and firstname.lastname@example.org.