If you conduct business transactions in states other than California, you could be setting yourself up for problems, especially if you are an Amazon seller. California has been cracking down on merchants who are not accurately reporting or paying sales tax that may be owed to the state.
Determining where you owe sales tax is primarily based on nexus, that is, the location where the highest percentage of your business transactions take place. This could be the business’ physical location, an Amazon warehouse in another state or in an entirely different location where you have a telecommuting sales force.
Getting your business into multi-state tax compliance is necessary if you want to survive in the marketplace. California is not that focused on collecting back taxes as it is on seeing that businesses are in compliance. (However, that does not mean they forgive tax debt.) That is why the state has a voluntary compliance program.
Now, if you want to see if you qualify for voluntary compliance, I urge you to call me. My firm, Brotman Law, has a proven history with California tax issues and can develop a compliance plan for your business. We can also determine whether your business would benefit from a voluntary compliance program.
How to Determine Nexus
The first step in determining nexus is to look through your business’ historical sales, state by state. Review your business records from back to at least 2013 when these laws were on the books. Depending on which jurisdictions the business is most active, it may be necessary to review even older records.
For example, Washington State’s laws go back seven years See WAC 458-20-230(3). California only goes back to 2013 but other states have different time frames. With respect to historical sales, you can determine what your potential liability is based on a state by state assessment of the laws.
Step two, look at your nexus creating activities within the various states. Say for example that you do business through Amazon. You may not have had inventory in Amazon warehouses in California in 2013 when California passed the law. Based on your location and on the locales in which Amazon distributed your inventory, you may not have had contact with California.
Amazon sellers should review their Amazon seller's report and look at the location of the warehouses, where their products and services are being shipped. As for other sellers, it is important to pinpoint the nexus creating activities in each individual state and assess whether they may potentially give rise to liability.
It is helpful for all sellers to take stock of where salespeople, agents, and suppliers are located.
Additionally, if the seller is an online retailer or out of state company (from the perspective of a potential taxing jurisdiction), it is important to consider whether its suppliers have supply chains that span various jurisdictions across the United States.
If you are selling office supplies, beauty products, or anything that is manufactured and sold in warehouses (even if they are not Amazon warehouses), you may have inadvertently created nexus with the state. You need to make a tax liability risk assessment based on your economic activities and their corresponding jurisdictions.
Typically when people reach step two of this analysis, they begin to panic. They may look at their historical sales and find that many of their transactions, business connections or other activities have a multistate reach, thereby putting them at risk for tax liability in multiple jurisdictions.
The States’ Current Compliance Priority: Voluntary Compliance
Presently, states are prioritizing getting people into compliance because given the Supreme Court’s decision in Wayfair, states now have a mechanism to go after people for economic non-physical nexus creating activities within their states.
In fact, in one unfortunate case of surprise tax liability, a Pennsylvania Amazon merchant made headlines when he was sent an unexpected notice from California stating that he owed the state up to $1.6 million in back taxes.
Amazon alone has now more than two million sellers and many could be at risk for receiving unexpected tax bills for their sales on the platform. However, even if all two million of those sellers had nexus with California, it would be far from practicable for California to pursue and levy taxes on all of them.
State tax departments traditionally only received the resources to focus their compliance and collections efforts on in-state tax payers. While the laws have changed drastically to allow states to capture revenue from many out-of-state businesses that have formed nexus with their jurisdiction, the reality is that states do not have the capabilities to go after every potential entity that owes them taxes.
For this reason, there is a conflict between the way the laws are written and the way that they are actually enforced.
States, instead, are strategic about which individuals or entities they pursue.They started going after the low hanging fruit which, in this scenario, are high-revenue sellers.
Tax departments even go through lists of purchases to determine who is and is not collecting taxes. Along with gathering information through audits, those are the primary tactics that states have implemented in their enforcement efforts.
Since the states can only gain a fraction of their potential tax revenue using these methods, they are currently highly amenable to having people come forward voluntarily to pay their liabilities. Encouraging voluntary reporting is, therefore, an enforcement priority.
States are focused less on holding people liable for taxes retroactively because in order to enforce retroactively, there must be enough resources to do so. On the other hand, with their current compliance strategy, it is much easier to get people to voluntarily register with the state and pay.
If they focused on retroactive enforcement, then the states would need to enlist more staff and put in significantly more hours to carry out their work. Ultimately, the state’s examination revenue would quickly be depleted.
Even so, the states can and will still go after certain organizations and individuals retroactively. Do not think that just because the resources are limited there is not a possibility you can be held liable for taxes owed from previous years.
Generally, though, the key focus is to get businesses in compliance now and to keep them as such in the future.
The states are much less concerned about pursuing past liability although they have the power to do so. If a seller were to voluntarily register in a state and a period of time has passed since the registration, the state would likely not put much effort into digging through old records to see if taxes should have been paid for the period before the seller registered.
In summary, states offer voluntary disclosure programs to capture as much tax revenue as possible. By incentivizing taxpayers to go through the process of voluntarily remitting their tax liabilities, the states are spared from doing a lot of the heavy lifting when it comes to enforcement. The incentives that states offer for taxpayers who voluntarily come forward vary.
However, taxpayers who register for voluntary compliance programs normally are not charged penalties and will typically only pay interest on top of the principal balance they owe.
Furthermore, the state will limit the taxpayer’s liability to a certain lookback period. In California, the state will only look back to three years of records, as opposed to the statutorily permitted eight-year period.
Determining Whether to Sign up for Voluntary Compliance
Even with the incentives that the states offer, the answer as to whether it is prudent to sign up for a voluntary compliance program is not clear-cut. Voluntary compliance programs will limit your liability, negate most of the penalties associated with it, and provide you a mechanism for getting into compliance.
However, signing up for a voluntary compliance program does mean having to retroactively pay taxes. Then depending on your nexus creating activities, which could be fairly significant, you might have to consider participating in voluntary compliance programs in a number of different states.
By participating in voluntary compliance programs, you may be creating significant costs to your business and may also be actively putting yourself on various states’ radars.
While we do not advise anyone to avoid compliance, we want taxpayers to think through what the impacts of signing up for voluntary compliance programs would be on themselves or their businesses before proceeding forth.
Rather than just rushing to get into compliance immediately, you must look at the costs for doing so. Additionally, you must first consider how to mitigate risk from a business standpoint. Look at your sales and nexus creating activities when making a decision in terms of how best to manage your risk going forward.
The answer as to how one can manage their risk is highly dependent on the individual. It requires an in-depth analysis of the facts and a review of the company’s particular issues and nexus creating activities, among other factors.
With this general framework, it is our hope that you will be able to spot the issues that present compliance risks for your business and that you will be able to help yourself solve these issues moving forward.
With respect to tax liabilities, always remember that the problems will not simply go away without action on your part. States will become increasingly more sophisticated in enforcing nexus-related laws. In order to mitigate risks with respect to these issues, businesses will need to take the following two steps as part of their internal compliance efforts.
Number one, ensuring that the business is compliant henceforth is key given that states are focusing their enforcement resources on compliance from a prospective standpoint.
Number two, businesses must mitigate risks with respect to past liability. This can be achieved by registering, going through the voluntary compliance program, and getting on a payment plan in the applicable states.
In certain circumstances, it can even be achieved by restructuring which could involve changing the entity form of your business and shifting the location of physical assets, among other tactics.
There is not a singular answer for how to get into compliance or to deal with past due liability and this will continue to be the case until we get judicial or legislative guidance.
Along with having the tools necessary to get into compliance, it is important for businesses to be prepared in the event that they are contacted by a state revenue agency regarding a past due liability.
Determining Multi-state Tax Compliance
With the growing popularity of e-Commerce with consumers and sellers, it is no surprise that states are now focusing on multi-state tax compliance. California, in particular, is known for its aggressive collection tactics and many Amazon sellers have found themselves the target of sales tax audits.
The most important step that you, as a small business owner, can take is getting into compliance. There are many ways to achieve this and one is through California’s voluntary compliance program.
This gives business owners some breathing room to implement a compliance plan so they know the states where they are required to collect and remit sales tax.
California has resources to help you, such as a voluntary compliance program. If you are concerned about your situation or have already received a notice from the CDTFA, call me.
My firm, Brotman Law, has years of experience in addressing sales tax compliance issues and can help you fulfill the obligations in those states where you conduct business.