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REG CPA Practice Questions: Nexus and State Income Apportionment
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May 3, 2024
In this video, we walk through 3 REG CPA exam practice questions teaching the rules around and how to calculate C Corporation NOLs and NCLs. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-nexus-and-state-income-apportionment/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:48 Question 1: Nexus 04:20 Question 2: State Income Apportionment 07:30 Question 3: Non-Operating Income 10:58 Pillar Topics
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Welcome to another reg walkthrough video
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I'm Logan, and in today's video, we're going to be going over Nexus and state income apportionment
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and we're going to be doing that in the Superfast CPA way, which is diving straight into questions to learn the material
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If you don't know much about our strategies and you want to learn more, make sure you go to superfastcpa.com
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and check out our free one-hour webinar training, where we teach the key ingredients to passing the CPA exam
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Again, it's only one hour long, it's free, and it will save you so much time in your process
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make sure you check it out. Also, if you like the idea of going through questions to learn the
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material, make sure you check out our super fast CPA app where we not only have audio notes and
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review notes, but also five question mini quizzes that you can easily access throughout your day
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to continue learning. With all that said, let's dive straight into the questions. Now, just letting you
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know, when we talk about nexus and state income apportionment in the context of the CPA exam
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pretty much it's only going to be talking about C corporations. Okay, here is question one
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Tectonic LLC is a C corporation that manufactures and sells electronic devices
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It is incorporated and headquartered in state M. Tectonic LLC engages in the following activities in other states
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In state N, it has a manufacturing plant where products are assembled
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In state O, it has a team of remote employees who work from home providing customer support
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In state P, it rents a data center to host its online services but does not have any employees or physical offices in the state
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considering the provided information, which combination of states does tectonic LLC have nexus in
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Okay, so if you're like me, Nexus has always been this kind of weird topic, and I didn't really understand it for a long time
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So let's go ahead and go straight into the answer for this to learn the basics of it for the CPA exam
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Okay, and the answer is that they would have nexus in state M, N, and O, but not in P
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So let's learn about this. Nexus is a tax term that describes the sufficient physical or economic
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presence of a business in a state that allows the state to impose tax obligations on the business
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This presence can be established through various activities, such as maintaining offices
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having employees, owning property, or significant sales activity within the state. Each state has its own criteria for what constitutes nexus, and with the advent of e-commerce
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many states have also developed standards for economic nexus, which consider the volume of transactions
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or revenue generated within the state. Okay, so essentially, nexus. is this concept where if the company has enough presence, whether that's economic or physically being
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there, then the state might be able to tax them on the income that they earn in that state
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So let's look at these. Tectonic LLC has Nexus in state M because that is the state of incorporation and its location
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of its headquarters. Nexus is present in state N due to the manufacturing plant, which is a significant physical presence
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So again, they are building and making a lot of their sales products in state end
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so that's a big part of their business. In state O having multiple remote employees working from home constitutes a physical presence and therefore establishes nexus Now this is one thing I just want to point out This can be a little tricky
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The question of having one remote employee in a state, does that make you have nexus in that state
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It would probably depend on how much money that employee is bringing into the company and a whole bunch of different factors like that
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To simplify it, this question specifically mentioned that they have a whole bunch of remote employees
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It's basically almost like an entire office worth of employees that are in that state, even though they're working remotely
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So in this question, we're constituting that as nexus as well. But again, remote work can be a little bit tricky, so sometimes it might be different than other times
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For state P, merely renting a data center does not necessarily establish nexus without additional activities or thresholds being met
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as this can be viewed as a passive investment or a service that does not require active management from tectonic LSC
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within the state. So because this is kind of a passive thing, they don't really have any employees
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there, they're not really doing anything there that's a major part of the business. They just have
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some data there. Then in this case, doesn't qualify them for Nexus. Okay, that's Nexus. Let's go
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ahead and do a couple other questions to learn how state apportionment works after you figure out
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Nexus. Okay, here's question two. Apex Tech Inc. is a C corporation with operations in states
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L, M, and N. The corporation's sales, payroll, and property are distributed as follows. So in state
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L, they have sales of $2 million, payroll of $500,000, and property of a million dollars. In state
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M, they have sales of $4 million, payroll of a million, property of $2 million. And in state
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N, they have sales of $3 million, payroll of $500,000, and property of a million dollars. So total
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they have $9 million of sales, $2 million of payroll expense, and $4 million of property
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мед. All states use an equal weighted three-factor apportionment formula. What percentage of
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Apex Tech's total taxable income should be apportioned to each state? Okay, we don't really know
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what this equal-weight three-factor apportionment formula is. So let's go ahead and look at the
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answer to learn how this is typically done. One note I want to make, different states can have their
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own apportionment rules. So unfortunately, in real life, there's a whole bunch of different
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rules, but there is a typical formula that a lot of states use, and this is the one that you're
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most likely going to see on the CPA exam, and that's what we're going to look at in the answer here
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Okay, and the answer is that they would apportion 24% to state L, 48% to state M, and 28% to state
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N. So let's learn how this works. Apex Tech's apportionment percentage for each state is calculated
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by averaging the ratios of sales, payroll, and property for that state to the total in all
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states. Here's the calculation for each state and we're just going to go over one of them
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because it's the same for all of them. So the way you would do it is you would, and it's
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pretty simple once you think about it, you would take however many sales were in the state
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divided by the total sales So that gives you the percentage of sales that were in that state And then you do the same thing with the payroll This is how much payroll was in state L compared to the total payroll so only 25 of the payroll was from state L
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And then the property, again, $1 million of the $4 million was in state L, so 25%
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And then you take these percentages, you add them all up, so 0.222 plus 0.25 plus 0.25
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and then you divide that total by 3, and that gives you the percentage that is apportioned to that state
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This is the actual percentage, but rounding it, this came to 24%
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And then we did the same thing for state M and state N. And so you round to these numbers
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And if you add these all up, they all add up to 100%. So the idea behind this is once you know Nexus
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like once you know what states are going to have income apportioned to them
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this is the typical and most simple way that you can apportion it
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is just by figuring out the percentage of, you know, sales, property and payroll that goes to each state, adding up all those percentages and dividing it by
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three, and that is your apportionment of taxable income that goes to that state. If only it was
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always this simple, like I said, different states might do it differently, although this is the most
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common. So this is what you'll be dealing with most likely on the CPA exam. Let's go ahead and do one
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more question. Here's question three. Zeta Corporation, a C. Corporation, conducts business in
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multiple states and must determine its state income tax liability. Below is the income breakdown
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So they have operating income of $500,000 and that was earned in the three different states of
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E, F, and G, based on the sales and services. They have dividend income of $50,000 received from
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investments in a company incorporated in state H, and they have interest income of $30,000 earned
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from a bank account in the corporation's home state of state E. So SETA Corporation has nexus
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in all three states mentioned above. Based on this information, how much income
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will be apportioned between the states. So it's not asking how much will be apportioned to each
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state. It's asking what of all this income will be the income that's apportioned to each state
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Let's go ahead and look at the answer to figure it out. Okay, and the answer is $500,000 or just the
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operating income. So let's learn a little bit about that. Operating income is typically subject to
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apportionment between the states where a corporation conducts business and has nexus. This income is
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usually divided based on a formula that considers factors such as sales, payroll, and property
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which we learned about before, within each state. However, non-operating income, such as dividends
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and interest, is generally sourced to the state where the income is received or where the payer
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is located. In this case, the dividend income is sourced to state H, where the payer corporation
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is incorporated, and the interest income is sourced to the home state of state E, where the bank
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account is located. These types of non-operating income are usually not apportioned
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across multiple states but are taxed by the state of origin. So non-operating income typically is just taxed to the state where it was earned
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So if you earned dividends in state E then those dividends would be taxed in state E You wouldn necessarily apportion them between different states based on a percentage And also let talk a little bit about things that wouldn trigger nexus that maybe you would
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think they would or just to clarify a little bit of what does and doesn't trigger nexus. Activities that
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typically do not trigger nexus within a state include passive receipt of income such as dividends or
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interest like we talked about. Placing non-targeted advertisements, so just general advertising might not
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attending trade shows temporarily without conducting sales, using independent contractors for sales or services
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employing third-party dropshippers, deliveries by general carriers, making internet sales without meeting economic nexus thresholds. So again, that one is a little bit like some states might
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use internet sales as a reason to have nexus, so that's why this threshold is there
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Processing credit card approvals, soliciting orders that are accepted out of state, and owning passive
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investment real estate. These activities generally do not constitute a significant business presence
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that would subject a company to state taxation. All right, with all that said, that's pretty much
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what you would need to know for C-Corporation Nexus and state taxable income for the CPA exam
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So let's go ahead and finish out the video by doing one more part of the superfast CPA strategy
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which is something called pillar topics. Now, the idea behind pillar topics is as you're going
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through the questions to learn the material, you will notice the things that are obviously the most
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important. These are the topics that keep coming up. They were in three or four questions or more
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You kept seeing it over and over again, and these are obviously the things that you need to know for
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the exam according to your review course. So let's go ahead and look at the pillar topics for this video
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Okay, and here are the pillar topics. Nexus is essentially having a physical presence like an office
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or a warehouse, or having an economic presence like a store and significant sales, especially
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the significant sales, in a state. Once you've determined what states have nexus, you would
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apportion income between them to determine how much income is taxed by each state. The most common
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apportionment factor formula used, though this can change in different states, is you take the state
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property, divide it by the total property, and you add that to the state payroll divided by the total
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payroll and you add that total to the state sales divided by the total sales. So add that all together
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and divide it all by three and that will give you the percentage of income that would be apportioned
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and taxed in each state. Also, there are amounts of income that typically are taxed straight to the
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state where they occurred instead of being apportioned. And these would include things like, you know
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non-operating income like interest and dividends. All right, that is it. If you liked this
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make sure you go check out our superfast CPA training webinar that we have on our website
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where we teach the key ingredients to passing the CPA exam, this being one of them, which is going through the questions as your main learning material
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Also, if you like doing questions to learn the material, make sure you check out our Superfast CPA app where we have five-question mini-quises
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that are great to use all throughout your day to continue learning. If you liked this video, make sure to like it and leave a comment
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I hope this was helpful, and I will see you in the next video
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