The onset of the pandemic forced many businesses to pivot in order to survive. Pivoting was also essential for state governments to survive. Economic turmoil directly correlates with lower state revenue collections for sales tax, corporate and personal income taxes, and fuel taxes. The direct result is significant state budget deficits.
“For many years, we’ve seen states develop discovery techniques to identify and pursue non-compliant businesses that should be filing one or more taxes in the state,” says Thomas M. Frascella, director of Tax Strategies at Kreischer Miller and leader of the firm’s State and Local Tax group. We interviewed Frascella for the April issue of Insights from Kreischer Miller about how states are increasingly seeking additional tax revenue, and why it’s important for your business to be prepared.
What are some of the most commonly-used tactics by states to identify non-compliant businesses?
Practices have ranged from reviewing employer withholding registrations to state vendor management programs. Employers that register for employer withholding should be aware that states will eventually identify you and provide you with a questionnaire to learn more about your business activity in the state. Extreme care should be taken in responding to these questions, as they are designed to elicit responses that will be favorable to the state.
Another tactic that states are becoming increasingly reliant on for discovery purposes is audits of vendor lists obtained during sales tax audits. In the last 12 to 18 months, this has become a commonly-used form of discovery as a result of most states adopting economic nexus standards. Current taxpayer vendor lists are extremely fertile ground for discovering out-of-state businesses that should be registered for sales tax purposes. Because most out-of-state businesses lack a physical presence in other states, reliance on these types of measures is becoming increasingly more important for states to identify and pursue non-compliant businesses.
Are businesses using marketplace facilitators being impacted by evolving laws?
Yes, we have recently seen several states use the audit of public warehouses to identify businesses that have inventory located in the state. As the sales tax reporting obligations of marketplace facilitators continue to evolve, states have looked to them to become the primary source of collecting and remitting sales tax from sales that they facilitate. However, states have also seen these same facilitators as a source of information that leads them to businesses that have inventory stored in their warehouses. If you are a business that utilizes the services of a facilitator or third-party public warehouse to store inventory, you should request the location where the inventory is being stored. This information is being provided to state taxing authorities and being mined for companies that are not currently registered for income tax purposes.
What advice do you have for businesses operating on a multi-state basis?
Businesses that operate on a multi-state basis either knowingly or unknowingly should take precautions to avoid unexpected and unwanted contact from states. The following steps could help a business identify potential activities that will give rise to state tax issues going forward:
- Identify those states where you have employees located and assess whether those employees are there temporarily or permanently. Many states have suspended their telecommuting rules during the pandemic for employees located in a state on a temporary basis. However, employees that have been permanently assigned to a state can create a filing responsibility;
- If you use a marketplace facilitator or third-party fulfillment distributor and store inventory at their locations, inquire about the states where the inventory is located. This represents a physical presence in the state and could result in nexus; and
- Look at sales by state activity to identify the largest customers and assess the nature of the business relationship with those customers. For example, if you have inventory on assignment at the customer, it could present an issue for the business. The largest customers are usually the biggest businesses in the state and are more likely to be audited. The audit and records produced by the taxpayer present the auditor with significant amounts of data to identify non-compliant businesses.
Diligent review of current business practices is essential to avoid state tax conflicts going forward. There are forces working against their best interest and proactive planning is necessary. Financially, states are struggling like everyone else and have had to turn their attention to longer-term strategies that will raise revenue. A significant component of a long-term fix is to identify non-compliant businesses and turn them into compliant taxpayers. Businesses should assess their activities and be prepared to respond.●
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