How to stay compliant with out-of-state taxes and minimize penalties

States are hungry for revenue, which means nexus questionnaires that determine the connection required for a state to be able to levy a tax on a person or company are on the rise.

States send out these questionnaires after identifying potential non-filers. One of the ways they do this is by auditing in-state companies that do business with out-of-state vendors. In this environment, to be compliant and minimize your potential penalties, it’s important to stay proactive.

“It’s a matter of understanding your exposure,” says Deborah R. Kovachick, CPA, MT, director of tax at SS&G. “It really depends on the facts and circumstances of your unique company.”

Smart Business spoke with Kovachick about why nexus has become a hot topic and what to do about it.

How has the definition of nexus evolved?

Nexus used to require a physical presence in a state, such as owning or renting tangible property or having employees who performed services in the state. Today, not only are more companies conducting business on a multi-state basis, but taxes also may capture a broader range of activities.

In 1959, Congress enacted Public Law 86-272 to provide protection from state income tax for out-of-state sellers of tangible personal property whose activities in a state didn’t go beyond solicitation of sales. This law doesn’t apply to state gross receipts taxes, sales and use taxes or franchise taxes, so the nexus threshold is lower for these taxes.

What do Internet sales mean for nexus?

Internet sales have caused states to lose tax revenue from people who previously purchased products from in-state retailers and paid sales tax. At some point, federal legislation on Internet sales will even out the playing field, but it’s still stalled in Congress.

Today’s situation puts a spotlight on nexus and filing responsibility. It has caused some states to change tax statutes or how they interpret statutes to recapture lost revenue. For example, a company may have no other contact with a state, but if sales go over $500,000 or apportionment factors in that state are greater than 25 percent of total apportionment, nexus could be established.

Will states ever have uniform rules?

No, the country is just too vast, both geographically and culturally. The states and their constituents need and want to control how they generate tax revenue.

How can businesses stay in compliance?

When initiating business in a state or starting a new business line, a company must consider the ramifications on its state tax filing requirements.

As for old activities, there may be no statute of limitations. If no returns have been filed, states can go back to when a company started doing business there and assess tax, interest and penalties. The penalties can be severe — 25 percent or more in some states on top of the tax assessed — and interest can really add up.

Those at risk should consider investing in a nexus study to determine their exposures. This includes:

  • Businesses with a heavy concentration of sales in a state where they are not filing.
  • Companies providing services to clients and conducting activities in a state that go beyond the solicitation of sales of tangible personal property.
  • Owners who are considering selling, to see if eliminating or reducing exposure can provide a clean bill of health to potential buyers and prevent reductions in the business selling price. State tax exposures are a hot topic during due diligence.

How does a nexus study work?

Nexus studies start with fact gathering to understand where and how a company is conducting its business and the volume of business in various jurisdictions.

After tax experts determine where there are filing requirements, they can help calculate potential exposure — tax, interest and penalty — in each jurisdiction. Then, you can make an informed decision about whether or not to take action. If you decide to reduce or eliminate that exposure, a third-party can approach the state to minimize the look back period and generally get any penalty abated by negotiating a voluntary disclosure agreement with the state.

Only by being proactive and determining where you have nexus can you understand any tax exposure.

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