State tax nexus and voluntary disclosure agreements

Timothy A. Dudek, Director, Tax Strategies Group, Kreischer Miller

There is some good news about the economy — the recently issued “Fiscal Survey of States” reports that revenue collections are up in many states throughout the nation and fiscal conditions are continuing to improve into fiscal year 2013, although many state budgets are not fully back to prerecession levels.

“However, despite the increase, that is not enough to let down your guard when it comes to examining state tax nexus for your business enterprise,” says Timothy A. Dudek, director in the Tax Strategies Group at Kreischer Miller.

The term “nexus” as used in this article refers to what constitutes “doing business” in a state that requires the filing of tax returns.

“A large amount of revenue generated by the states in the past few years has come from aggressive enforcement measures with regard to their out-of-state nexus groups,” says Dudek.

Smart Business spoke with Dudek about why it continues to be important to address state tax nexus, even in years of improved revenue and cost-cutting actions by states.

If states have improved tax collections and are taking action on cost-cutting measures for the future, why do the aggressive enforcement measures continue with regard to state tax nexus?

Future revenue shortfalls are projected. Both the National Governors Association and the National Association of State Budget Officers warn that despite improvements in tax collections, states are now being squeezed in two different directions. First, the budget assistance provided to states via the federal American Recovery and Reinvestment Act is gone. The loss of that money alone wipes away state increases in tax collections.

Second, local governments are experiencing revenue declines due to lower housing values — a situation that will put pressure on state leaders to boost funding for cities, counties and schools.

What other factors prompt a state government to continue tax collection programs?

We tend not to think of the cost of state Medicaid programs, which continue to rise each year.  The health insurance program now accounts for nearly one of every four dollars spent by states. Over the next 10 years, total Medicaid spending is projected to increase annually by 8.3 percent.

What is state tax nexus, and how do states reap the benefits of this type of program?

Nexus, under the Commerce Clause of the U.S. Constitution, requires that a business must satisfy certain standards before a state can exercise its power to tax the business. Nexus must have a definite link — some minimum connection between the state and the business it seeks to tax.

It embodies the spirit that a state cannot impose a tax on persons unless there is a certain level of presence or activity by a business within the state seeking to impose the tax. The trick is to understand that different taxes, such as income, net worth, sales taxes, may have different standards for establishing nexus in each state.

Many businesses may unknowingly have satisfied nexus requirements long ago but have never filed the required tax returns with the individual states. State enforcement measures in the nexus arena are designed to discover and ferret out taxpayers that are not in compliance with existing state tax laws.  Once a state identifies a business through nexus discovery, the business usually must file tax returns and pay the tax, interest and penalties retroactive to when nexus was initially established in the state.

Depending on the term, that can be a very expensive proposition for a business if, for example, it has to file and pay for 15 years of back returns.

What action can a business take to address these types of state tax programs?

Businesses are well advised to become proactive and to have all of their state tax activities evaluated by a competent state tax consultant, especially knowing that increased nexus audit activity is being conducted by numerous states.

If the consultant determines that nexus exists and tax returns have not been filed, the best action to take on the taxpayer’s behalf is to minimize the exposure for prior years’ taxes, interest and penalties through use of a voluntary disclosure agreement. These agreements can be a valuable tool in resolving prior years’ outstanding state tax liabilities for unregistered businesses that have sufficient presence but have not filed state tax returns.

The benefits of voluntary disclosure agreements to the business include:

  • Years open to statute because of unfiled tax returns are generally reduced from an unlimited period to a three- to four-year look-back period.
  • Penalties for failure to file tax returns and failure to pay taxes are typically fully abated and waived, although interest continues to accrue.

Generally, the voluntary disclosure program is available to taxpayers who have not been in compliance with the state’s tax laws and who have not been previously contacted by the state department of revenue.  Once the state has identified a taxpayer on its own, it is generally too late for the taxpayer to participate in this type of program.

Virtually all states are willing to work with most taxpayers in resolving their prior years’ tax liabilities in a settlement fair to both parties. Voluntary disclosure agreements are offered as a positive, money-saving option to resolve the taxpayer’s outstanding liabilities.

 

Timothy A. Dudek is a director of tax strategies at Kreischer Miller in Horsham, Pa., and chair of the firm’s State and Local Tax group. Reach him at (215) 441-4600 or [email protected]

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