Now is the perfect time to determine whether your business is in compliance with the state and local tax laws of the jurisdictions where you are selling your goods and services. This may be the last thing you are thinking about or want to be thinking about right now, but given the current tax climate – states are aggressively expanding filing requirements, looking to broadening the tax base and stepping up audit efforts – it is critical to know where you have exposure. By reviewing the following areas now, you can take the necessary steps to manage your state and local tax risk and minimize this exposure, before things spins out of control.
Identifying where your company is “doing business” is critical to determining its filing responsibilities for state and local tax purposes. Nexus is the minimum connection or link between your company and a state seeking to tax your company. This minimum connection is typically established by having a physical presence in a state, such as owning or leasing property…offices, a warehouse or distribution center or a manufacturing facility. However, nexus can also be established by just the presence of employees, independent contractors and/or other affiliates who are soliciting sales or performing services (i.e., installation, repair, maintenance, consulting, etc.) on behalf of the company.
In recent years, states have been aggressively moving to expand the scope of their nexus provisions, in order to require more out-of-state companies to register and collect/pay taxes on their sales and other business activities. Many states believe that simply having an economic presence within their borders is sufficient to establish nexus for income tax purposes, while other states are passing tax laws based on alternative theories that stretch the meaning of physical presence and seek to create nexus based on your connection with people and other companies within their jurisdiction. Unfortunately, each state has varying standards or tests for determining nexus, which are typically different depending on the type of tax in question…income tax, sales & use tax, property tax, etc., making this an especially difficult issue to navigate and address.
In addition to determining where else you should be registered and filing tax returns, you need to be concerned with the returns you are already filing in various state and local jurisdictions across the country. Your company may have monthly, quarterly, semi-annual or annual filing requirements for sales & use, income/franchise, gross receipts, licensing, excise, payroll and/or property tax purposes that require an extensive amount of data and other information that needs to be generated and prepared by your financial reporting system and your employees. Who is making sure that the data being used is correct and reconciles to your books and records, that your employees are preparing the returns correctly, and that the returns are being filed and your taxes are being paid in a timely manner?
Aside from the procedural aspects of the compliance process, is your company following the tax laws of the state or locality in which you are filing? Are you charging tax on your sales correctly or sourcing your revenue or income according to the state’s rules or taking advantage of exemptions or credits that might be applicable to your business. Not having an understanding of the tax laws of a state in which you’re filing returns, can lead to potential liabilities or missing opportunities to reduce the amount of tax your company is paying. If the first indication that your tax compliance process is not working is a large tax assessment from a state due to calculating your tax due on sales incorrectly or having your CFO ask you to explain why he and the CEO received tax liens from a state due to the non-filing or non-payment of tax returns, your problems are just beginning.
Finally, you need to prepare yourself for the inevitable fact, that at some point, your company will be audited for state and local tax purposes. States are desperately trying to close budget gaps and looking to generate additional revenue to fund their programs, and audits are one way to accomplish this. Audits are not fun, but they shouldn’t keep you up at night either, as long as you are organized and prepared for the auditors, their information requests and sometimes endless questions. One of the ways to do this is to verify that you have proper documentation (exemption or resale certificates) to substantiate non-taxable sales. Another way is to review the supporting documentation for your tax returns to determine that it is complete and actually reconciles to your financial reporting system. Know where you may have taken an aggressive position on a return and prepare your arguments to support that position and likewise know where you may have the opportunity to utilize refunds or credits to offset any tax that maybe assessed.
Most importantly, know when it is time to consult a third party who may more experience than you or your employees in a particular tax or potential issue. The last thing you want to do is let an auditor discover a large deficiency and not be able to explain what happened or try to haphazardly explain the matter. This will not only hurt your relationship with the auditor but will lead to mistrust and doubt about the company’s business activities.
The steps described above may not be easy and may require some research, discussions with sales, IT and accounting personnel and an extensive review of a large number of tax returns and related information to determine whether your company is sufficiently in compliance with state and local tax laws. However, given the nature of the economy today and the aggressiveness of state and local tax auditors, how can you not take the time to assess your potential exposure and address the financial implications and risk of noncompliance?
If you have any questions about this or other SALT issues, please email Tom Mazurek at . For additional State and Local Tax insights and resources, or to subscribe to our quarterly newsletter, visit tsacpa.com.