This may seem like an obvious statement, but the expansion of e-commerce and logistical support systems has made interstate commerce far more prevalent than at any other time in our history. State revenue departments are paying attention. This can be especially confusing for companies in states like Florida that don’t have a personal income tax and only tax certain kinds of corporations.
At the FICPA’s 2014 Mega CPE Conference, we had the opportunity to learn from former and current Department of Revenue auditors and experts from multiple states about current trends in state taxation. There are two trends that are important to be aware of in this state tax update.
The first is the trend toward market-sourced state tax systems. In the past, many states have used a two- or three-tiered apportionment system where they would look at sales, labor, and fixed assets in their state. In other words, you could be doing tons of business in a state, but pay a relatively small amount in tax because you didn’t have a significant physical presence. Many states are changing to a single sales factor and taxing you based on your sales sourced in their state. Be careful to identify how this affects your filing requirements.
The second trend is related to the first: States are looking to expand their definitions of “nexus” for state tax purposes. In the past, nexus had been determined based on your physical presence within a state. Do you have equipment in the state? Do you have employees in the state? As we trend more towards market-based sourcing, states will be looking at your sales and how you are acquiring them. You might have no equipment or employees in a state, but if you are receiving revenue from that state, you might have nexus. How about if you use sub-contractors in a state? Some states are looking at who your 1099 vendors are to determine if you might have sales sourced in that state.
Here are some basic pitfalls to avoid:
- If you file sales tax or employment tax returns in a state, you should probably be filing income tax returns if applicable in that state. The different divisions of state departments of revenue have computers that communicate with each other, so those agencies are identifying and notifying companies who fail to file.
- Plan to be compliant. When a company files its first state income tax return in another state, they will often receive a letter asking when their activity began in the state or asking for the prior year’s tax return. States care less about whether you are trying to do the right thing now than they do about if you may have additional tax liabilities from prior years.
- There are planning opportunities when it comes to apportionment and state income taxes, but these are harder to take advantage of after the year is over. Be proactive! Meet with your tax advisors before year-end to identify where you may be making mistakes or where you may have opportunities to take advantage of tax benefits.
- Make sure your website is up-to-date with information that accurately represents your company’s operations. State revenue departments are looking at your website and can actually select you for audit based on what they find.
- Keep excellent documentation. For example, we have seen a state revenue department try to dispute whether or not an obvious non-profit was exempt from sales tax simply because the client didn’t have the exemption certificate on file. We’ve also seen auditors ask for copies of travel and meal receipts to ensure that clients weren’t using their own resale certificate to get a tax break.
- Some states have amnesty programs in place. In other cases, a good accountant can sometimes negotiate settlements and help soften the blow of past state tax filing failures. You can save significant sums of money by dealing with any potential issues before the state comes to you.
When in doubt, talk to your tax advisor. States are looking for more revenue and are getting far more efficient at finding it. A state audit can be very costly even if no additional taxes end up being due.