As companies grow and find increased opportunities to conduct business in other states, they should be well informed as to their tax liability in each state.
States are becoming more aggressive and sophisticated in collecting taxes. These growing enforcement efforts are part of a strategy that maximizes tax revenue and addresses declining revenue bases and increased government spending.
“You could be doing business in a state and not even realize that you owe tax. You can accumulate years and years of liability,” says Thomas M. Zaino, JD, CPA, chair of the Multistate Tax Practice Group and member in charge of the Columbus office of McDonald Hopkins LLC.
Zaino cautions companies not to simply assume they are protected by federal public law 86-272 from being taxed in most states.
“PL 86-272 offers some protections, but they are very limited,” he says. “Basically, it only protects against taxes based on or measured by income. Plus, it is not applicable to the sale of services. In any case, it’s best to check with your tax adviser.”
Smart Business spoke with Zaino about the importance of properly calculating and paying state taxes — and what happens when you don’t.
Are state and local taxes really significant when compared with federal taxes?
State income taxes are typically about one-third of the federal income tax, but when all the different types of state and local taxes are added up (e.g., sales and use, property, and gross receipts taxes) the burden is about the same as the federal liability. Add 15 to 25 percent in penalties and above-market interest, and the potential exposure is very significant. State and local taxes are significant to most businesses, and the company’s leaders need to protect the business from unexpected liabilities that can hurt its financial prospects.
What do states do to identify companies that should be registered to pay tax in their state?
There are many tools states use to identify companies that have not been complying.
These include information-sharing agreements with the IRS and other states; review of federal information, such as 1099s and Schedule Ks; examination of cross-tax registrations; and comparing vendor lists of current taxpayers with registered taxpayers. There are also people who monitor activities of companies in their own states, which may include searching the Internet and examining public information on Web sites.
Don’t most states have a statute of limitations that limits how far back they may assess a company’s delinquent taxes?
No. Most companies assume there is a three- or four-year statute of limitations, but this is incorrect. The statute of limitations applies only if the company has been filing returns with the state. Otherwise, the state can go back decades. I’ve seen situations where the state goes back 12 to 15 years.
What mistakes do companies often make when dealing with state and local taxes?
Failing to invest the time to plan ahead and make sure transactions are structured in a way to minimize the state tax impact; not fully understanding the actual activities of the business in each state, perhaps due to rapid growth; failing to educate personnel operating in other states so as to prevent unintended tax consequences associated with their activities; and assuming that if the company is not generating taxable income that there is no state or local tax liability, when in fact, many types of taxes are accruing (sales tax, property tax, and gross receipts tax), which have nothing to do with taxable income.
If a company is contacted by a state regarding whether it owes tax, what should the company do?
If the company receives a Nexus Questionnaire, company officials should seek counsel from a state tax adviser before responding. These questionnaires ask broad ‘yes and no’ questions, when there may be no simple ‘yes or no’ answers. The letter doesn’t say so, but you can attach explanations for your answers rather than answering just yes or no. If you receive the questionnaire, take an inventory of your dealings in the specific state by talking with your sales staff and field personnel. Work with your tax adviser to calculate your potential exposure and how to respond to the questionnaire.
What if the company owes back state taxes?
Most states will allow you the opportunity to come forward voluntarily and anonymously to explain your situation and, as a result, limit the number of years you would need to comply to avoid penalties. Your tax adviser can assist you with a Voluntary Disclosure Agreement (VDA). Going this route, you can usually get the number of years of back tax reduced to three or four with no penalties, just tax and interest. Some states also offer periodic amnesty programs. VDAs and amnesty programs are not available to companies that have already received Nexus Questionnaires, so it’s prudent to be proactive and take an inventory of your historical and present activities now.
THOMAS M. ZAINO, JD, CPA, is chair of the Multistate Tax Practice Group and member in charge of the Columbus office of McDonald Hopkins LLC. Reach him at (614) 458-0030 or firstname.lastname@example.org.