Identify Nonbusiness Income and Its Benefits to Businesses

Income of any type or class and from any source can be nonbusiness income depending upon the nature and source of the income.

Please note that although only income is mentioned, losses can also be considered nonbusiness and are subject to the same rules. The concept of nonbusiness income is applicable after a determination has been made that nexus exists requiring filing.

What is Nonbusiness Income?

How do you identify nonbusiness income?

To accurately identify nonbusiness income, one would need to take a deep dive into a company’s operations to understand the characteristics of an asset's use and its relationship to the primary business activities.

Many states generally rely on two independent tests to aid in classifying items as either business or nonbusiness:

Transactional Test: This test attempts to determine if the source of the income was derived from an activity that is engaged in with regularity.

Functional Test: This test attempts to identify how integral the source of income is to the company’s regular business.

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The Complexity of Nonbusiness Income

The following examples of successful and unsuccessful tax court cases illustrate the complexity of identifying nonbusiness income.

Successful Attempt

An example of a successful attempt to classify income as nonbusiness is the case of Nicholas Turkey Breeding Farms vs. CA Franchise Tax Board.

In this case, Nicolas was in the business of breeding turkeys, with the selling of excess eggs and turkeys for meat as a secondary activity. At some point, some of the farms became unsuitable for their primary operations. Nicholas eventually leased or sold the unused farms. Both the rental income and gain from the sales of the farms were reported as nonbusiness income on their CA return.

The court disagreed with the FTB that although the farms could still be used for a similar purpose, it was not suitable for the company’s primary activity. The court further explained that the classification as nonbusiness income was appropriate as the leases made the farms further unavailable to the company’s primary operations.

Unsuccessful Attempt

An example of an unsuccessful attempt to classify income as nonbusiness is the case of American Honda vs. WI DOR.

In this case, Honda attempted to make the case that environmental credits were not part of their unitary business and should be excluded from WI apportionment.

The Tax Appeals Commission disagreed with the basic argument being that the credits were generated as a direct result of their manufacturing operations, further supported in that the credits were managed utilizing unitary business resources, making them integral and not ancillary to the unitary business.

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What Does Identification of Nonbusiness Income Mean to You?

By going through the exercise, you are better able to apportion and allocate items of income/loss to the applicable taxing authorities. The understanding of the unitary business developed while engaging in this exercise, in addition to potential tax savings, can produce opportunities to improve operations.

If you have questions or want to learn more about how your company could benefit from this, reach out to one of our professionals.