Reducing Your Tax Liability and Risk

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When it comes to state and local taxes, it can be daunting to determine what tax obligations a business is subject to. 

Broad-ranging business activities such as hiring or relocating employees, using contractors, and storing inventory can trigger a tax duty. Conducting sales and visiting customers in a state can create state tax nexus for sales and use tax, income tax, gross receipts, or franchise tax.

State tax nexus — often referred to as a connection with a state — is required before a state or local tax authority may impose a tax collection or filing duty on a business. The standards and rules for what constitutes nexus differ by tax type and jurisdiction. Determining whether a business has nexus in a state or local jurisdiction is highly dependent on business facts. CFOs and finance professionals must track business activities and understand the implications of transactions — what you sell and how you are selling products and services — while staying abreast of state and local tax laws.

Failing to understand all state and local tax duties in states where a business is conducting activities and has nexus could result in significant exposure and audit risk. Activities that trigger a tax filing obligation for one tax type may also create nexus for another tax. It can be costly if CFOs isolate a single tax type from other taxes, such as filing corporate state income tax, but fail to address sales and use tax.

Sales and use taxes are generally administered and assessed at the state level on behalf of county, city, and other special district or municipal levels. A handful of states, such as Alabama, Colorado, and Louisiana, have hundreds of localities that administer their own sales and use taxes — with varying tax rules for definitions, exemptions, rates, and reporting requirements. Noncompliance in a single jurisdiction or in multiple states and localities could result in tens of thousands of dollars in uncollected sales tax and a sizable tax assessment, including penalties and interest.

Avoiding or missing required state tax filings creates significant liability because the statute of limitations is triggered only when a business files a return. Without a filing, tax authorities can go back to when the company created nexus in the state, which could mean eight, 10, or 30-plus years in back taxes, penalties, and interest.

There is no such thing as forgiveness for business owners overwhelmed by confusing and complex tax laws. When nexus is established, governments can enforce their tax policy. With each filing and or registration, states become aware of a taxpayer’s business presence in their jurisdiction. When a company registers for sales tax, it alerts state authorities to investigate what else the business might be doing in their jurisdiction. Where gaps are identified, states are validly making a grab for full compliance.

As states continue rolling out “economic nexus” standards in the wake of the U.S. Supreme Court’s 2018 decision in South Dakota vs. Wayfair, and in the collective pause we have seen with COVID-19, businesses may still be able to take advantage of a grace period to catch up on tax compliance. Some strategies for managing noncompliance:

  • Assess exposure holistically and identify gaps. CFOs and finance professionals should pay particular attention to sales and use tax registrations. Businesses who used inaccurate compliance dates, registered late, or have not registered at all to collect sales tax will need a strategy to get back into the good graces of tax authorities.
  • Participate in amnesty programs. States may offer amnesty programs to encourage taxpayers to voluntarily come forward, disclose prior tax liabilities, and register or file returns to comply with the state tax requirements. Taxpayers are still responsible for the outstanding tax, but penalties are generally waived or abated. Interest may still be assessed. Tax authorities often pre-announce the dates for which taxpayers will be permitted to take advantage of tax amnesty programs. When these amnesty periods are announced, however, there are strict eligibility requirements, and taxpayers must act fast because the window of opportunity is typically short. 
  • Negotiate voluntary disclosure agreements and other binding agreements. Most states also offer VDA programs for unregistered taxpayers to come forward anonymously and negotiate a legally binding settlement with the state for a limited look back period and reduced tax liabilities, penalties, and interest. In most instances, unregistered taxpayers are better positioned to negotiate settlements and enter a VDA with tax authorities than registered taxpayers. In some states, businesses who have received nexus questionnaires or registered cannot elect voluntary disclosure for the preregistration period. In this situation, registered taxpayers who do not know the facts around their sales are likely to owe interest on back payments and are responsible for uncollected taxes unless they can remediate payment from those customers or come to an agreement with the state.
  • Take advantage of automation to manage sophisticated and multijurisdictional tax profiles.
  • Document, document, document.

In all these areas, work with your tax provider to make purposeful decisions about when and where to file, how to approach a state to negotiate compliance, and how to respond to notices and inquiries from tax authorities.

Tram Le is a CPA and attorney with an LLM in Taxation. She is a state and local tax (SALT) consultant and member of the SALTovation team at TaxOps. She writes a state tax notes column entitled “Spreading SALTovation,” covering hot topics in SALT that impact business operations and growth strategies. Tram is writing this column on behalf of the Fort Worth CPAs, a regular contributor to Fort Worth Inc.