In my firm, Brotman Law, I consult with many California small business owners about their tax issues. Many of these businesses operate out of state or across the nation. Many of them have the same issues and concerns.
For this reason, I've put together 9 FAQs from small business owners that you can read for guidance in helping your business navigate multi-state tax issues. Maybe some of these situations are the same as yours.
Hopefully, you will find some answers here and maybe they will trigger additional questions you may have. In any case, if you need help with your multi-state tax issues, give me a call. With our combined years of experience, our attorneys can guide you through your tax situation.
1. I have an out-of-state business. What do I do if I owe money to California?
You need to take action. A lack of physical presence in California will not shield you from having to pay your tax liability and failure to pay can lead to serious consequences.
As soon as you understand what you owe, take prompt steps to settle the debt with the state. California has a variety of collection tools in its arsenal that it can wield against multi-state businesses, but their authority would not allow them to seize your house out of state.
Common tactics the CDTFA (California Department of Tax and Fee Administration) will utilize are the attachment of liens, added fees or fines, and penalties. Figuring out the amount that you owe and being aware of the collections methods the state can use should be the first pieces of information you gather.
Then, you must develop a strategy to either get in compliance with California or to mitigate the liability in some way. There are a variety of options for how you may settle your tax liability such as release from liens or levies on your accounts, settlements for partial payment, and release from liabilities wrongfully imposed.
Knowing that outstanding tax debt may jeopardize your business and personal finances, the last thing you would want to do is to bury your head in the sand and pretend that the problem will go away. If you owe a tax debt to California, make sure you seek help as soon as possible to get yourself back into compliance.
2. My business conducts sales through Amazon, eBay and other eCommerce sites. Do I have an obligation to file sales tax returns and/or pay tax?
The answer to this question is jurisdiction specific. You may have to file sales tax returns in states that have passed marketplace facilitator laws. If you are operating out of California, for example, you can expect to pay taxes in the state. California is one of the most aggressive states towards businesses that operate through a marketplace facilitator.
The good news is that California has created a fairly high monetary threshold for determining if a business owes taxes. If you do $500,000 less in transactions, then you neither have to file sales tax returns nor do you have to pay sales tax.
The reason you would not have to pay sales tax is because the marketplace facilitator through which you operate is collecting tax on your behalf. Thus, you do not have a filing or a reporting requirement until you cross that certain threshold.
However, if you collect any sales outside of the marketplace facilitator, then you immediately have a filing and/or an obligation to pay sales tax.
Many businesses that operate over the internet not only sell through Amazon, but they will make direct sales through their website. For example, suppose your Amazon sales represent 80-90 percent of your business.
Even if you were to sell only $10 through your website in California, you will have then gone outside of the protection of the marketplace facilitator statutes. In such a scenario, you would have to register and file a sales tax return in California.
Amazon may still be collecting the tax through the transactions that you are doing with them. However, by not filing a return, you would be out of compliance. If you have an internet-based business, it is important to understand what your channels are and how they impact your business from a tax perspective.
If your business has a filing requirement, if you owe anything in tax, or if you have a collection requirement for the states in which you are selling, you need to get in compliance.
States are getting more sophisticated in holding businesses that owe taxes accountable. They are relying on third-party data to gather information to catch businesses that are not in compliance. The important thing again, is to have a plan and execute it appropriately so that you can get back to business and stay in business.
3. I have businesses in several states and have not filed sales/use or income taxes in any of them. What should I do?
The advisable thing for companies to do is to look at their exposure in the multiple states that they have potentially created nexus in and try and peg the date that nexus was created. However, doing this can be difficult.
Where companies begin having issues is when they interact with other companies. For example, if your company is actively pitching to potential clients and none of those potential clients eventually sign up to work with you, you may not get caught.
The situations that create the most difficulties are when a vendor or customer is located in a different state. If a company has been out of compliance for a while, the state will eventually catch up to it through the audit process either on the sales tax side or the state income tax side.
One of the reasons that the CDTFA audits companies is to discover leads to then go after other companies. When they pull a company's purchase invoices, they look at all of their vendors that have not charged tax and from that list, they try to determine why.
If you are performing nexus-creating activities in a state, invoicing customers in that state, and those activities are readily apparent from the invoices, you are looking at a serious tax liability issue. If this sounds like you, stop digging yourself into a bigger hole. Measure the hole and then hire an expert to get you out of it.
Without having knowledge of how the states work and how enforcement is carried out on the state level, your tax woes will not be resolved. Delinquent sales tax has become a major issue for states and it is guaranteed that with the advent of technology, it is only a matter of time until you get caught. It is better to have a plan in place ahead of time than to risk being caught without knowing it is coming.
4. My business conducts internet sales. How do I figure out how much tax I owe?
This gets very complicated because for internet businesses, the amount you owe will depend on what you are selling and where you are selling it. It will also depend on your level of contacts with that particular state, whether there are physical contacts (which a lot of internet businesses do not have) or if there are economic contacts (which is more commonly the case).
Economic contacts can be defined by a dollar threshold or they can be designed by a transaction threshold. Suppose you do 200 transactions in a particular state. It would become exceedingly complicated to determine the amount of tax that you owe because each state has similar, yet distinctive, rules.
The first thing that you must do is determine which states you are doing business with the most. Then, determine the nexus rules in those jurisdictions so that you can make sure that you are appropriately collecting tax. If you are not collecting tax, make sure that you are not at risk of having taxes levied against you or have any liability associated with your business operations.
When it comes to the states in which you have less contacts, planning is key. Assess your level of contacts and sales and determine whether or not you need to collect tax in that jurisdiction.
Start by identifying the top 10 or 15 states in which you are doing the most business. These states may account for 65-80 percent of your sales. Next, look at other sub-jurisdictions where you may do less business transactions.
The good news is, you do not have to do this manually. There are a number of software programs and tools that can help you execute this part of the process. We can assist you in this decision.
What you need before the execution phase is to form a solid strategy. You need to understand where you are exposed to potential liability, what the risk is of having taxes assessed against you, what your filing requirements are, and what your payment requirements are. Thereafter, you must form a plan around the information you have gathered and use software to automate and execute it
This does not have to be a long-drawn-out or costly process. You do not have to start filing sales tax returns in all 50 states but it is important to have a plan in place so that you may prevent any potential risk of audits, penalties or other negative tax consequences in the future.
5. Should I represent myself in a multistate tax issue? What about my CPA?
First off, we strongly recommend against individuals and businesses representing themselves. As for whom you choose to represent you, however, it is dependent on your circumstances, the players on your team, and their level of experience.
Furthermore, who you hire to represent you should also be dependent upon how you want to solve the problem. CPAs, tax-preparers or the finance department within your organization most likely do not have extensive experience with multi-state issues. Their levels of expertise usually lie elsewhere.
Multi-state taxation is something that is in Brotman Law’s wheelhouse because we frequently practice in this area of law for clients who run multi-state businesses. Regardless of who you decide to hire, you want to make sure that you are hiring somebody with sufficient experience to solve the problem.
What is complicated about multi-state taxation issues is not simply the legal substance itself. Rather, having issues in this realm is complicated because there are multiple jurisdictions that must be taken into account. It is knowing the procedures for how states handle collections and enforcement actions against out-of-state taxpayers that requires experience.
Oftentimes with clients, we recommend a multi-prong approach. We believe in efficiency for companies and recommend that they first engage with a tax attorney, figure out a strategy and then outsource the execution of that strategy.
Sometimes, clients come in for a 60-90 minute paid consultation and then take the strategy we develop back to their finance department or CPA for implementation.
6. Is applying for amnesty or going through a state's voluntary disclosure program a good idea?
The answer to this question is highly fact-specific.
These types of plans are highly beneficial for the states. Since states lack enforcement mechanisms to go after many multi-state taxpayers, they implemented these amnesty programs to allow people to come forward and pay the taxes they owe. For people who come forward voluntarily, they are kind enough to waive the penalty portion.
In some cases, using these programs is a great way of mitigating liability, particularly if a company has a nexus or minimal contacts in a state for a period that exceeded the period for voluntary disclosure.
While it may sound like a good deal, from a financial perspective, voluntary disclosure may not be the best course of action for your business.
Before you make that decision, evaluate your present situation. Look at the landscape of your company, consider its sales activity, take stock of all the places that it potentially is exposed to, and make a plan based on your assessments.
If your company pays past due sales and state income taxes and eventually goes insolvent, you are also in a dire position.
The important thing to do is to create a plan and then strategically use voluntary disclosure programs and amnesty programs to accomplish your objectives. However, only use these programs if it make sense for your business
7. I have registered for sales tax or a seller's permit in a particular state. Do I have a state income tax filing requirement?
Probably. By purposely availing yourself to a state, registering yourself for a seller's permit and/or as a foreign (out-of-state) entity, and qualifying to do business in a state, you have more than likely subjected yourself to state income tax jurisdiction.
Now, does that mean if you are registered for seller's permits in 35 or 40 states that you should just file 35 or 40 state income tax returns? No. The objective of compliance is to understand what your exposure to tax liability is in different states and then registering or filing returns appropriately in order to meet the needs of your business.
There is a balance that you must strike between being compliant and making savvy business decisions. It is crucial to sit down, look at the operations of your company, look at where you are making sales and craft an appropriate multi-state tax strategy.
When we have worked with our clients historically, the liability, filing requirements and what they end up being a lot less in scope than they initially thought. It is important to have a plan in place and to understand that registering in one jurisdiction for sales tax purposes is probably going to create a filing requirement in that jurisdiction.
8. My corporation has been suspended by the State of California. What do I do?
You probably received some sort of notice, and/or you went to the California Secretary of State website and noticed that your corporation was suspended. If you have a corporation in California, that means you took the necessary steps to create that corporation and the same goes for a partnership or LLC.
There are generally two reasons why corporations get suspended. One is the failure to file a statement of information. A statement of information is a record that you must update on an annual basis with the secretary of state which reaffirms the address and identity of the officers of the corporation.
If there have been no changes to any of these pieces of information, you may file this statement through an online form. Whether or not your corporation has changed, you are still required to file a statement of information on a yearly basis. Filing this statement of information can be a quick fix for getting your corporation out of suspension.
The second and most common reason that corporations get suspended is because of unpaid taxes. When you owe income tax or franchise fees, then the FTB will suspend you.
The nice thing is if you go on the California Secretary of State's website it will tell you whether the Secretary of State or FTB suspended you. This information will at least point you to the right direction on who to contact to fix your suspension status.
If your corporation was suspended by the FTB, they are going to demand that all the back taxes be paid before the corporation can return to being in good standing. If you owe a significant amount of back taxes for a suspended corporation, you might want to get an attorney involved to negotiate a resolution.
Having your corporation suspended is at the least problematic if you are going through a transaction or if you are engaged in active contracts.
The best thing that you can do is ferret out the reason why you were suspended and then get a professional involved, or deal with the situation internally in order to get a resolution in place.
9. What is drop shipping and what are the tax consequences?
A drop shipping transaction is one in which a seller sells a product to a buyer but also ships that product to the buyer's customer. In a drop shipping transaction, the customer may or may not be located in a different state.
Drop shipping is an incredibly complicated concept from a tax perspective because you may have one or multiple parties in multiple jurisdictions.
For example, the seller may be in California, selling to a buyer in Florida, whose customer is in New York and will ultimately receive the product there. The biggest challenge for tax professionals in this situation is determining to which jurisdiction the client will have to pay taxes.
For customers, this is really important to determine because there are a variety of issues around which state has jurisdiction to collect the tax revenue.
In a drop shipping transaction, you must be sure to understand the various jurisdictions that are involved and then create a plan for compliance both from a tax filing and sales tax purposes. You want to make sure that you are collecting the appropriate documentation to prove you are in compliance and that you are doing what you can to mitigate your risk.
The problem with drop shipping transactions is that companies assume they are not obligated to collect tax simply because the product is going to another jurisdiction or their customer is located out of state.
Unfortunately when it comes to drop shipping transactions, the client is likely responsible for tax liability if they are not collecting resale certificates from that particular state or if they are not taking other appropriate measures to mitigate their risk.
There are many tax consequences and variables that go into drop shipping transactions. You want to make sure that if you are engaging in drop shipping or are in any way involved in a drop shipping process, you understand the tax consequences and are taking appropriate action to avoid future tax woes.
Create a Plan to Answer Your Tax Questions
These questions are representative of what we get asked on a daily basis by our clients. As you can tell, dealing with multi-state taxation issues can get messy.
This is why I recommend that a taxpayer never try to “go it alone” when trying to figure out which jurisdictions they owe sales tax to and how much.
E-commerce can be a double-edged sword; it should be convenient for buyers and profitable for sellers. And it can be if you have made a play for multi-state sales tax compliance. That is why I encourage you to check in with me.
We can create a plan so your business will be in compliance with numerous states’ sales tax regulations and you can prevent problems down the road such as sales tax audits.