Bruce Nelson
Bruce Nelson

Filing Methods for Multistate Taxpayers

A simple example demystifies and distinguishes between separate, consolidated or combined filing.

October 27, 2011
by Bruce Nelson, CPA

If a corporation is, by itself or as a member of an affiliated group, doing business in more
than one state, the tax practitioner must not only grapple with questions of nexus, but also the methodology for determining the taxpayer’s tax base. In other words, for any specific state, we must determine if we are filing separate company returns, a consolidated return or a “combined” or “unitary” return.

Separate, Consolidated or Combined Filing

Separate filing means just that. Each company with nexus in the state must file its own separate return, regardless of whether it is part of an affiliated or consolidated group. A number of states that allow only separate filing, that is, each and every company with nexus must file a separate return. It is irrelevant whether the corporation is a standalone entity or a member of a controlled, affiliated or consolidated group. Those states requiring separate filing include Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Indiana, Iowa, Kentucky, Louisiana, Maryland, Mississippi, Missouri, New Jersey, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee and Virginia. In these states, consolidated or combined filing is generally not allowed. That said, there may be a trend toward combined reporting. Since 2006, seven states — Massachusetts, Michigan, New York, Texas, Vermont and West Virginia — have adopted combined reporting.

New York is an example of the recent move of some states toward combined filing. New York has traditionally been a separate filing state, but it provided for combined reporting when three factors were present:

  • Common ownership (80%),
  • A unitary business (the companies generally had to be in the same line of business, either vertical or horizontal integration) and
  • That the failure to file a combined report would lead to “distortion.”

Distortion was presumed to exist where there were “substantial” (defined as 50 or more) “intercorporate transactions” (a company’s receipts or expenses). In short, separate filing was the default, but combined filing was a possibility if it more accurately represented a taxpayer’s income. Not surprisingly, there was significant disagreement over what constituted “distortion.”

In 2007, New York, as part of its budget bill, changed the law making combination mandatory. “[R]elated corporations ... shall make a combined report covering any related corporations if there are substantial intercorporate transactions among the related corporations.” In June, the New York State Department of Taxation and Finance issued a Technical Services Bureau Memorandum, TSB-M-07(6)C, “Combined Reporting for General Business Corporations,” that provided a 10-step procedure for identifying the affiliates to be included in the combined report and detailing the tests for measuring “substantial intercorporate transactions.” Interestingly and somewhat confusedly, the intercompany transactions are now measured, not on a company by company basis, so much as among groups of companies. While the details are beyond the scope of this chapter, the important point is the dramatic change by a leading state in moving to mandatory combined reporting.

Separate filing has both advantages and disadvantages. The most obvious disadvantage is that a company is prohibited from offsetting profitable subsidiaries with subsidiaries with losses. However, separate filing states offer advantages when a multistate taxpayer can arrange its legal structure to isolate high-profit margin activities in low- or no-tax states and its low-profit margin activities in states with higher tax rates. For example, isolating a company’s sales and marketing functions from its manufacturing activities and conducting each in separate companies may allow shifting of income from high- to low-tax states.

The majority of states, while allowing separate filing, will also permit consolidated filing if certain requirements are met. To elect consolidated filing, most states require the same stock ownership requirements (80%) as that of the federal consolidated rules. In addition, a state may require that only the affiliated entities that have nexus with the state be part of the consolidated return, that is, a “nexus-consolidated” return. Consolidated filing may also be allowed or even required when separate filing does not fairly reflect a company’s income or economic activities. Connecticut, Indiana, Mississippi and Tennessee, for example, are generally separate filing states, but they will permit or require consolidated or combined filing when necessary to properly reflect income.

Combined reporting requires the members of a “unitary” group to calculate their taxable income on a combined or “unitary” basis. The combined or “unitary” reporting states include Alaska, Arizona, California, Colorado, Hawaii, Idaho, Illinois, Kansas, Maine, Massachusetts, Michigan, Minnesota, Montana, Nebraska, New Hampshire, New York, North Dakota, Oregon, Texas, Utah, Vermont, Wisconsin and West Virginia.

Combined Report or ‘Unitary’ Filing

  • The unitary or combined approach ignores legal entities and geographical boundaries and focuses on the economic unit.
  • It may be worldwide but more likely is “water’s edge.”


The following example illustrates the basic concepts of separate, consolidated and combined filing.

An Incredibly Simplified Example

Take three corporations: a parent and two wholly owned subsidiaries. The Parent files a federal consolidated return with its subsidiaries. The Parent and Sub One are both doing business in and have nexus with State X. Sub Two does not have any employees, property or sales in State X. It is not doing business in State X and, accordingly, does not have nexus with the state. Each company’s income and state apportionment factors are as follows:

(* The numerator is the sum of the corporation’s payroll, property and sales in state X and the denominator is the corporation’s payroll, property and sales everywhere.)

Separate Filing

Parent 300 x 40/400 = 30
Sub One 200 x 20/500 = 8
Total taxable income 38

If State X allows only separate filing, the Parent and Sub One will each file a separate return, including only their own separate income and factors. Sub Two will not file a return in State X, because it is not doing business in State X and does not have nexus with the state.

Consolidated Filing

Parent and Sub One 500 x 60/900 = 33 (nexus only)

If State X allows the filing of consolidated returns, but only among companies that have nexus with the State, the Parent and Sub One combine their respective income and apportionment factors to arrive at state taxable income. Again, because Sub Two does not have nexus with State X, it cannot file as part of the consolidated return.

Combined Reporting

Parent and Sub One 600 x 60/1000 = 36

If State X allows or requires combined reporting, then the income and apportionment factors of all the affiliated companies are summed to calculate the state taxable income for the Parent and Sub One. There are several key points to be noted. First, the income and apportionment factors of Sub Two are included in the calculation even though Sub Two is not doing business in State X and does not have nexus with the state. Second, combined reporting is not a return, per se, but a method for calculating the state taxable income of a “unitary” or “combined” group.

Technically, State X is only taxing the Parent and Sub One, but it is measuring the tax base and factors of those two companies by including any other companies (Sub Two) that are deemed to be a part of the “unitary” group. As the Oregon Tax Court stated, “[I]t is important to remember that including the income of a nontaxable member of a unitary group does not subject that income to taxation by Oregon.

It merely provides the base from which the taxable corporation’s share is apportioned.” State Department of Revenue v. Penn Independent Corp., 15 Or. Tax 68, 74 (1999). Combined reporting states differ in whether, after calculating the group’s combined income, the Parent and Sub One will file a single return or each file separate returns.

This article has been excerpted from The Adviser’s Guide to Multistate Income Taxation: Compliance and Planning Opportunities. The publication is available on CPA2Biz.com.

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Bruce M. Nelson, CPA, MA, has over 25 years’ experience in state and local tax and is currently employed at Ehrhardt Keefe Steiner Hottman, P.C. (EKS&H) in Colorado.