These days, it is increasingly rare to find a retailer that operates in just one state, with many businesses and corporations extending their reach across state lines. While this is obviously good from revenue and employment standpoints, there are numerous risks inherent with multistate commerce.
When you operate in one state, your tax planning may be more manageable. You will only need to be informed about your state's laws so your tax compliance checklist may look straight forward.
However, chances are that like a growing number of businesses today, your business operations have a multistate reach which can be creating risks for non-compliance that you may not have considered.
If you conduct business in multiple states and want to know if you are at compliance risk, I urge you to call me. My firm, Brotman Law, has years of experience helping businesses navigate complex sales tax regulations in states across the country. It is wise to be proactive than to be surprised after the fact with an audit notice.
Could You Owe Taxes in All 50 States?
First, you must concern yourself with shifting variables in your operations. As you widen your net and your level of contacts increases with different states, it will become more difficult to manage certain aspects of your operations.
For example, if an employee of your company moves to a different state, your company could be deemed to have nexus in that state. The movement of your vendors can have a similar nexus-creating effect.
If you are using vendors in multiple states, then it is imperative that you are aware of their contacts and their practices, as they may be inadvertently creating nexus in another state through their actions.
The next risk that is created when a business gains a multistate reach is the reduced ability to stay abreast of the ever-changing laws. Nexus laws and the laws around multistate businesses are rapidly changing because many states are trying to broaden their tax base to increase revenue.
Remember, you could be dealing with laws for all 50 states. While a lot of states do things similarly, there are also some very notable differences.
Across states, there is a pronounced difference not only between the laws themselves but also their enforcement. California, for example, is known to be particularly aggressive towards out-of-state businesses and is very unforgiving towards out-of-state businesses that claim ignorance of California's laws.
Given the increased risk and compliance burden that follows from having a multistate business, it is advisable to gain an understanding of the tax considerations that may arise in the jurisdictions with which your organization has contact and to create a tax plan tailored towards compliance and risk management.
Specific Risks Associated With Employment
Employees, independent contractors and vendors in multiple states present another level of risk. Having employees in different states is one way nexus is created. By having employees in another state, your organization will be deemed to be doing business in that state, thereby subjecting it to pay state payroll taxes for that employee.
Payroll Tax Considerations
Having out-of-state employees also likely triggers a state income tax filing requirement in that state. As a general principle, you withhold state taxes including payroll for the state where the work actually occurred. You usually have to register with the tax collectors in both states: your state of primary business and the state where your employee is conducting the work.
Now, short-term work in another state such as attending a conference or a short airport meeting does not usually trigger a tax issue. However, if you send an employee to work in another state for three months, you are likely responsible for payroll taxes in that state.
Having out-of-state independent contractors and vendors also brings a similar set of challenges, as their presence in another state will also create a nexus between your company and the state(s) in question. By engaging people to help you make sales or provide services in a particular state, you are performing a nexus-creating activity which will subject you to tax jurisdiction within that state.
As such, vendors and independent contractors create audit risk for companies in the states where they may not have intended or contemplated. Despite the similar risks that out-of-state independent contractors and employees pose, it is important to keep the two classifications distinct, especially in light of the California Assembly Bill 5 (AB5).
The AB5 bill, which became effective January 1, 2020, has shifted the definition of what it means to be an employee in California. The hiring party is now required to classify workers as employees unless they meet all conditions of the ABC test:
- The person is free from the control and direction of the hiring entity in connection with the performance of the work per the contract and in actuality.
- The person performs work that is outside the usual business of the entity.
- The person customarily acts as an independent contractor in the same or similar work performed.
Under this new bill, all workers will be considered employees unless proven otherwise. The hiring entity must show that workers meet all conditions of the ABC test in order to classify them as independent contractors. As a result, the state is reclassifying many independent contractors as employees and this is creating payroll tax and/or liability risk for companies that are out of state.
Along with the income tax ramifications, these reclassifications are causing issues from a labor perspective. For this reason, a business’ use of employees, independent contractors, or vendors that are out-of-state can become costly both in terms of time, compliance effort, and tax liability.
How to Avoid Tax Liability in Multiple States
If you suspect you have tax liability in multiple states, do not rush to contact the states first. Doing so may not only cause you to inadvertently make a statement against your interest to the tax department. Further, it may also not be necessary. The state may not have known that it had jurisdiction to levy taxes against you.
Therefore, it is not advisable to call them first and volunteer information. Instead, the first step you must take is to assess your risk of being pursued for taxes due to your out-of-state contacts.
Start by looking at your level of contacts and your sales volume in the states where you suspect you may be liable. Gathering this information will help you better assess the risk that you may be contacted by the jurisdictions in question to pay taxes for your contacts within those states.
After you assess this risk, it is beneficial to speak with an experienced multistate taxation attorney who can outline your options moving forward.
Many people are too quick to declare that they have nexus in a particular state and that they therefore owe money to that state for current and past-due taxes.
While such actions may appear proactive, they may cause individuals to burden themselves with a higher tax liability than they would have owed had they created a measured multistate tax strategy and executed that ahead of time.
Rather than being quick to act, take a moment to measure your risks, rethink your options based on your assessed risk, and create a compliance plan that you can implement in your organization moving forward.
Taking these steps is not only important for addressing concerns regarding past-due tax liability, but rather, it is crucial for the future growth of your organization as operations continue or extend to other jurisdictions.
What to Do If You Are Audited
If you receive a letter stating that your organization is being audited, the first thing that you must do is remain calm. Although perhaps counterintuitive, the most important thing that you can do is cut off direct communication between your company and the auditor.
The more information that your company provides the auditor, the more likely that the auditor will issue an assessment that is not in your favor.
This is particularly true for companies that have historical nexus in a state for multiple years, and have maintained some level of presence there, whether it be via the activities of their employees, by holding inventory within that state, or other means.
During an audit, it is necessary to have a third-party representative because such a representative, specifically an attorney, will be able to deflect the questions of the auditor and mitigate any immediate danger.
The first thing that we would tell an auditor when we have a client that is not in compliance is to hold off while the situation is assessed. Doing so gives the client space to breathe and gives the client and attorney ample time to investigate the data and measure the scope of the issue.
During an audit, we work with the client to put a plan in place to control the scope of information provided to the auditor, minimize the risk of liability to the extent possible, and reduce any potential penalties.
Audits happen in a variety of manners. Sometimes, a state may contact an individual without that individual having filed a return in that state or submitting information voluntarily. Other times, where information was not submitted voluntarily, auditors come across information from other sources that tie an individual or organization to that state.
In most cases, the auditors will be forthright in explaining the reason for the audit when asked. Working off of the auditor’s reasoning, it may not be necessary to admit liability further back than that piece of information goes. Being honest while being strategic in divulging information unnecessarily is a delicate balance to strike.
The stakes are particularly high in audits because making false statements to an auditor is prohibited. There are a variety of ways to navigate through the process and to resolve the issue responsibly.
Despite your best efforts to work things out with the auditor or to convince yourself that they will not pursue action against you, you will likely be disappointed.
It is best to take a defensive approach during the process of an audit, especially when it comes to confronting potential out-of-state tax liability.
How California Collects From You
Often, clients have various questions regarding what recourse California has against them in order to collect state sales or income tax. They sometimes will believe that because they have never set foot in California or perhaps have no plans to ever travel to the state, that California cannot collect taxes from them. Such perceptions, however, are erroneous.
You yourself may not have contacts with California or have ever set foot in the state. However, if the people that you do business with, the banking institutions that you use, or the third parties with whom you transact have some nexus with California, the state may levy taxes against you.
For example, if you live on the East Coast and use Bank of America, California does not need to send a levy notice to your address in order to liquidate your bank account because Bank of America has branches in California.
Instead, the tax authorities can physically deliver the notice at one of the California bank branches or simply fax it over. Given that Bank of America has nexus in California, they are obligated to follow the state's rules.
When you have nexus in California, you are submitting yourself to the laws of that jurisdiction. All of your financial accounts are potentially at risk. Your vendors and any accounts payable or receivable are also potentially at risk. Depending on the nature of your business, there may be other areas of your organization that will be at risk from a compliance perspective.
California does not have to send agents across the country to go after you. They can do so conveniently from Sacramento through technological means. With the way that the state statutes are designed in California, it is very easy to file levies against taxpayers, to garnish wages, to take property, and to file liens without you ever having to set foot in California or without the tax department coming to your jurisdiction.
Assessing Your Multistate Commerce Tax Risk
There are many advantages to multistate commerce. You can extend your reach across the country, thus growing your brand. You can also offer broader employment opportunities. However, there are numerous risks associated with doing business in multiple states, including California.
Do not become complacent thinking that you are shielded from liability just by virtue of being out of state. It is not a matter of if, but when California finds you. They have many resources at their disposal and are aggressive about using them.
My best advice to stay out of sales tax compliance hot water is to be proactive. Conduct a risk assessment of your business to pinpoint areas where you are deficient. Then, take the measures towards compliance.
If you need help identifying your business’ multistate tax risks, I invite you to reach out to me. Brotman Law has worked with many businesses to bolster their compliance efforts so they can focus on their business and not worry about state sales tax issues.