The April 9 issue of The Wall Street Journal reported that many states are considering major increases in taxes to fill revenue gaps caused by declines in income taxes and sales taxes. Political leaders dread the fallout from increased taxes in hard economic times, but may have little choice.
Our firm has seen difficult times such as this before. We have found that states will also pursue the "easy money", i.e., increased enforcement against out-of-state businesses that should have, but failed to, pay the proper taxes. Out-of-state businesses are good targets for several reasons. First, being out-of-state, the adverse political impact is minimal. Second, out-of-state businesses can represent substantial revenue to the state, not only in taxes but in interest and penalties.
Third, once an out-of-state business is brought into the state's tax regime, the out-of-state business represents future revenue to the state. Of course, companies should work with their tax advisers and accountants to ensure compliance with tax filings and payments. In our experience, the following points are closely watched by state tax officials in their quest for additional revenue:
- Is there proper documentation when the company claims that a transaction was exempt from sales or use tax? For example, is there a reseller's certificate, an exemption form signed by the purchaser, or some other evidence to show the transaction was exempt?
- Has the company registered for taxes in all states required? For this purpose, consultation and communication with tax advisers is critical so the company can determine if registration is required.
- Does the company have a high volume of sales or income generated from a particular state for which no tax is being paid or collected?
- Is the company failing to pay tax because it claims the state has no jurisdiction? If the company does not have sufficient contacts (i.e., nexus) with a state, the state has no jurisdiction over the taxpayer. But determining whether a company has nexus can be difficult in any specific case. It is also a high stakes decision that requires constant monitoring and policing. Many companies have taken aggressive positions with states, asserting lack of jurisdiction, only to find that, unwittingly, they have crossed the line and given the state the ability to assess large amounts in back taxes, interest, and fees.
Companies should assess their compliance earlier rather than later. It is always tempting to wait to see if the company is contacted by the state. But, by then, it is usually too late. States have less sympathy for a company who was "caught" compared to a company that voluntarily came forward. Many states have voluntary compliance programs that will reduce or waive penalties and typically provide a shorter look back period on assessing unpaid taxes than if a company is caught. However, these programs are not available once the company has been contacted by the state.