Due to current tough economic times and budget shortfalls, state taxing authorities are becoming more aggressive in identifying and collecting tax revenue.
“The states are looking for ways to maximize their tax revenue during these tough times,” says Marty Doerr, CPA, member in charge of tax services at Brown Smith Wallace LLC. One such avenue is for the state to determine that nexus exists for a nonfiling taxpayer.
It is a good idea to be prepared and proactive in this area.
“It’s important for a company to do a self-review, identify exposures and make sure everything is filed properly before the state does it for you,” says Pam Huelsman, manager of state and local tax services at Brown Smith Wallace.
Smart Business spoke with Huelsman and Doerr about what to expect during a state nexus inquiry and what to do if you think you have nexus and have not filed properly in the past.
How do you determine if your company has nexus — the minimum level of business activity subjecting you to tax in that state?
You need to know where you have employees, property and customers. You need to know what activities you’re conducting and where. You need to look at where you are performing services or soliciting orders. You should know where you are registered to do business — not just where you are conducting business. In some states, simply registering to do business can create nexus.
You can expect the state to ask a lot of questions regarding each of these areas with the aim of maximizing its tax revenue. It is important for a company with multistate operations to identify the nature and extent of its contacts with the states. Since each state’s laws for determining a filing obligation vary, a tax professional experienced in state and local tax can help you ensure that nexus is properly determined.
How does a state identify companies that have created nexus but not filed?
There are many ways to discover a footprint left in a state. On Sept. 14, California announced that the Franchise Tax Board annually reviews more than 5 million income records from government agencies and financial institutions, and matches them against tax records filed to determine whether some businesses have yet to file. As part of this annual effort, California collected approximately $31 million last year from businesses that failed to file tax returns. The states also rely on the dreaded state nexus survey. States send these directly to the company and include several pages of detailed questions regarding what type of business you do and where you do it.
Currently, more and more taxpayers are receiving such surveys. Once you receive a survey from a state in which you do have nexus, your options for a painless exit become very limited.
States may compare data among various agencies, such as payroll withholding records or secretary of state registrations, to their department of revenue records. They’re looking for a mismatch, which can then trigger a nexus survey.
The state may also use other company audits to identify vendors and customers and cross check these to make sure they are filing in the state. There’s also a lot of information auditors can find over the Internet.
Auditors may simply observe in-state activities of potential nonfilers. For example, in one instance a revenue department official rummaged through business cards dropped in local restaurant fishbowls for free meals. This let him know that the company had been in the state and would likely be back.
How far back can a state go to collect tax if nexus is determined?
Unfortunately, the state can go back to the date the company began doing business in that state. Nonfilers do not have a statute of limitations. This can result in a lengthy look-back period and assessments that include all back taxes, with costly interest and penalties.
In one of the most aggressive assessments we’ve seen, an auditor determined that a nonfiler had an income tax obligation, then issued a 20-year tax assessment with interest and penalties.
This is certainly a situation that companies want to avoid.
What should you do if you suspect you haven’t filed properly in the past?
Most states offer some type of voluntary disclosure or amnesty program. These programs encourage nonfilers to come forward and allow for a shorter look-back period, usually three to four years. The programs will typically offer a waiver of penalties and, in some cases, a reduced interest percentage. The important thing here is to stay in front of the state, because if a state contacts you first, these programs might not be an option.
What is Public Law 86-272, and does this prohibit the state from imposing a tax?
Public Law 86-272 prohibits a state from imposing an income tax if the company’s only connection to the state is the solicitation of orders sent out of state for approval and fulfillment. However, it is important to understand the limitations of this protection.
The activities protected under this law are limited to solicitation and only apply to a seller of tangible personal property.
You don’t fall under the protection of 86-272 if you’re selling services, intangibles or some other form of transaction. It applies only to income tax and not to sales tax or any type of non-income tax, such as franchise or gross receipts tax.
It is imperative for a company to understand where its business activities are taking place and how those activities impact its state tax filing obligations.
Pam Huelsman is manager of state and local tax services at Brown Smith Wallace LLC. Reach her at (314) 983-1392 or firstname.lastname@example.org. Marty Doerr, CPA, is member in charge, tax services at Brown Smith Wallace LLC. Reach him at (314) 983-1350 or email@example.com.