Complying with interstate tax laws
It is no secret that cities and states have been struggling with budgetary shortfalls the past few years. The states’ revenue problems are the result of several factors, including the federal government’s inability to provide states the funding they have in the past. As a result, many states have taken steps to increase revenue. This has not been an easy task, in light of the bad press that typically results from raising tax rates and legislators wishing to be re-elected. States have had to become creative in order to raise revenue.
Some of the methods states have used in the past few years have been unclaimed property audits, repealing credits and incentives, decoupling from newly enacted federal income tax provisions, closing “tax loopholes,” amnesty programs for non-filers, voluntary compliance for taxpayers taking advantage of listed or reportable transactions, and increasing audit activity. The increased audit activity has been felt by many industries, but none more than equipment distribution.
The equipment industry, by nature of its dealers’ size and activities, lends itself to being an easy target for assessments by states. Many dealers sell new or used high-dollar equipment and provide equipment rental and service. The taxability of these transactions usually varies by state. This discrepancy often creates unintentional errors by taxpayers. In addition, many dealers, being mid-sized companies, will attract state tax audits because they provide the auditor with the ability to turn the audits around quickly.
|Dealers often have their operations in select states; however, their customers and service cross state borders. These “cross-border” activities usually give rise to questions being posed to tax practitioners regarding whether the dealer has to file a tax return. Does the dealer have to file:|
|The answers to these questions will vary by state and type of tax, but unfortunately, many of these activities will create a filing responsibility. An unexpected tax assessment could have dire consequences for many dealers. Therefore, knowing a little bit about how to determine if you have a filing responsibility and the approach you should take can be a company’s first line of defense.|
For Which Taxes Do I Register?
Most companies are aware of and comply with the tax filings imposed in the state where they are commercially domiciled. In addition, most companies comply with employment taxes (i.e., federal/state withholdings, and federal and state unemployment) in jurisdictions where they have employees. The types of taxes that generally raise the most questions, and generate tax assessments, are franchise/net worth taxes, sales and use taxes, and income taxes.
The largest misconception is that if you register for one type of tax, you have to register for all taxes and obtain a certificate of authority to transact business within the state, thereby creating a franchise tax filing. When a taxpayer has a filing responsibility, he or she is said to be “doing business,” or to have nexus, with the state. What many taxpayers don’t realize is that the threshold for “doing business” may vary depending on the type of tax.
For instance, it is not uncommon for a taxpayer to have nexus for sales and use tax purposes but not for income tax. In some states, merely owning real or tangible personal property may not be considered “transacting business” for franchise tax purposes. However, it may be sufficient to create a sales and use tax filing responsibility.
The first step for any company is to assess the types of activities occurring within the respective states, and the frequency, regularity and the duration of these activities.
Companies that are considered to be “transacting business” within a particular state for franchise tax purposes typically are required to obtain a certificate of authority to do business with that particular state. There usually are legal ramifications to obtaining a certificate of authority, so companies should consult legal counsel whenever making this determination. State and local tax advisors usually can opine on whether they believe a particular company’s activities constitute nexus for sales and use or income taxes. Once a nexus determination is made, the next step is to determine the duration, or how long these activities have been occurring. Companies often are hesitant to start filing in a particular jurisdiction when their activities constitute nexus. Tax practitioners often are told by companies that they have been conducting the same activities for over 20 years and have never been caught.
Unfortunately, there are two problems with this approach. The first is that not getting caught is not a defendable position in the event you are caught. The second is that states have employed more sophisticated techniques to determine who is doing business within their state. For example, several states have been known to have auditors write down company names displayed on trucks on their highways. Other states obtain customer or vendor lists from companies under audit. The state then cross-checks these customer and vendor lists with current filers. One of the largest concerns for companies that have nexus but are not filing is that without filing a tax return, the statute of limitations for imposing an assessment never starts running. Alternatively, if a company files a “zero” return, the statute of limitations starts running. For companies wishing to become compliant on their filings, there usually are several ways to go about starting to file returns.
If a company’s activities are a new development, the choice is usually easy to register for the particular tax and commence filing. As mentioned earlier, the difficulty regarding how to start filing usually arises when the activities have been going on for some time. Many states have programs to assist taxpayers trying to become compliant. States usually allow taxpayers to enter into a Voluntary Disclosure Agreement (VDA), which typically provides for the payment of tax and interest but no penalty. VDAs usually have a “look back” period of three years for prior taxes. This is usually enticing to companies because if the company is contacted by the state, the look back period is unlimited. Alternatively, several states have enacted amnesty programs whereby both penalty and interest are abated. Therefore, taxpayers should consider which program is most advantageous if both are available for a particular state.
VDAs are not without pitfalls, and taxpayers should be careful when participating in these programs. One type of VDA program that taxpayers may enter into is a multi-state VDA program, which is usually administered by a state organization. Taxpayers should keep in mind that the members of these organizations are the various states, and while a taxpayer may only want to register with select states, there is nothing to prevent the organization from sharing the taxpayer’s information with other members (i.e., states). The benefit of entering into such a program is that the taxpayer only needs to contact and deal with one person at the multi-state organization versus contacting every state individually.
Taxpayers not only have to be careful with multi-state VDA programs, but with the VDA programs of the individual states. Tax advisors should be used to contact the states so that the taxpayer maintains anonymity until an agreement is reached. In addition, tax advisors should research the franchise tax implications of entering into a VDA program. The VDA programs typically are administered by the state’s Department of Revenue, making all taxes they administer eligible for the VDA. However, states have been known to contact taxpayers after the VDA is executed concerning franchise taxes, which typically are administered by the state’s Secretary of State.
The moral of the story is that while it is advisable to become compliant, don’t do so without covering all your bases. Material handling companies should contact their state and local tax consultant when analyzing whether they have nexus with a particular state and the most advantageous way to become compliant.
|Meet the Author
Shawn M. Kane, CPA, works as senior manager and Chicago office practice leader of BDO Seidman LLP, located in Chicago, Illinois, and on the Web at www.bdo.com.