Multi-State Tax Issues
Since eCommerce makes it so easy to do business in multiple states, many small business owners think, “Hey, great!” and like any good entrepreneur, they see it as an opportunity to increase sales and to expand their brand.
You would be surprised how little thought many small business owners give to sales tax issues, through no bad intentions on their end. It simply does not occur to them, especially if they are in charge of their own financial reporting and bookkeeping
Unfortunately, failure to file and pay sales and use tax in all the states you do business in can have serious repercussions. The last thing you want is to have the state knocking at your door wanting to examine your records and nail you for any outstanding sales and use tax.
Your business could end being prohibited from doing business in a state, you could go into collections, a number of negative consequences could occur. Many small businesses cannot survive this and end up closing up shop for good. Do not let that happen to you.
My firm, Brotman Law, specializes in helping small businesses manage their multi-state taxes. We can help you plan tax strategies to stay out of trouble as well as defend you in case you get audited. Multi-state taxes are a very complex issue and you need an expert to help you sort through them. That is why we are here for you.
The Most Common Problem of Multi-State Businesses
The most common problem I see with multi-state businesses is a failure to understand what the problem is. What I mean by that is, depending on your level of sophistication, is that you may rely on a CPA for tax advice. You may have the benefit of having an internal CFO or an internal controller or somebody else who guides you through the financial world.
The problem with most companies is when they think about taxes, they are thinking about federal income tax and possibly state income tax. If they are thinking about state income tax, they are only thinking about the state that they are in. The problem with multi-state taxation is that you are bringing in laws of different jurisdictions that may fall outside the expertise of the people that you trust for your tax reporting and advice.
Take a CPA, for example. Most CPAs firms do not specialize in multi-state taxation. If you think about your CPA, your CPA probably specializes in preparing federal and state corporate income tax returns or they may do individual returns as well.
Multi-state taxation is a different animal. In preparing your federal and state income tax returns, a lot of accountants do not realize that the activity that you are conducting is creating Nexus or subjecting you to liability in different States. When was the last time you talked to your CPA about multi-state tax consequences?
When was the last time your CFO brought up, "Hey, we are expanding in all these different states. What are the jurisdictional requirements in these different states?" Multi-state taxation is not an issue that a lot of companies think about.
Situations That Trigger Multi-State Tax Problems
States are aggressively expanding their tax bases and it is a huge area of risk for a lot of businesses. It is important to understand the many variables that go into multi-state taxation and make sure you have an appropriate and effective plan for dealing with that.
Multi-state taxes implications are far-reaching and extend into areas that you might not even think of. Here are a few examples:
- You start doing more and more business in other states
- You start sending your sales force into other states
- You sell a product that needs installation so you need to send your employees or hire independent contractors to do the installations in other states
- You need to conduct training on your product in other states
- You start adding remote employees in other states
Any of these things can happen. The problem is that as companies start to develop more and more of an interstate presence, nobody thinks about the multi-state tax consequences that the company is triggering.
The reality is that business owners and court corporate executives need to stop thinking of themselves as only being based in one state and start looking at themselves as multi-state organizations. Because to the extent that you create nexus or establish minimum contacts in a different state you are in real trouble.
The best example I can give you is what happened with Amazon two years ago. The State of California made a ruling that if you were holding inventory through a third party company in the State of California that you have state sales tax nexus and likely state income tax nexus.
Suddenly, right in the fourth quarter of 2018, California sent letters to four-and-a-half million Amazon sellers — mostly small businesses — saying, "Hey, you owe us back to sales taxes for the last five years." So, do not let that happen to you. That is why it is important to seek the advice of a qualified tax professional is you are planning to expand your business into another state or online
What is “Nexus” in California?
When talking about mutli-state taxes, nexus is a term that gets used a lot.
Nexus is code for the level of minimum contacts that you have in a state. These contacts can be physical contacts, such as employees, or contacts through third parties whether they are independent contractors or vendors.
There are also economics contacts. if your sales revenue meets an appropriate threshold, or you have other economic contacts with California, then you could be triggering Nexus within California and obligating yourself to pay tax.
Then, the third category that I would generally use is what I call internet contacts. There is a concept called click-through nexus or affiliate nexus. For businesses that principally operate online you have to be careful that you are not overly marketing to new customers who are located in California. All of those relationships would trigger nexus in a particular state. If you meet the nexus threshold, then you could owe tax in a particular state.
California has one of the broader nexus statutes of all of the states. California is a very large economy and has a very robust state revenue department. The laws in California are designed so that if a company has any number of contacts with California it is subjecting itself to tax jurisdiction within California.
If you have a sufficient amount of minimum contacts with California, then you will probably be obligated to either collect sales tax in the State of California or pay state income tax to California depending on your situation.
Risks Associated With Multi-State Commerce
When you operate in one state, your circumstances are pretty easy to control. You are only worrying about your state's laws, and it is on a much smaller scale. The problem is that a growing number of businesses are reaching out and having contacts with multiple states. There are a number of different ways that this creates risk for businesses.
Number one is shifting facts. As you widen your net and your level of contacts increases with different states, you cannot always control the facts of your situation. For example, if you have an employee in your company, and they move to a different state, now you have just created nexus in that state.
This creates circumstances that are really beyond your control. The same thing with vendors. If you are using vendors in multiple states, then you have to be worried about their contacts and their practices to make sure that their activity is not creating nexus for you in a state that you did not intend.
The next part that is really complicated and that creates a lot of risk is the changing laws. Nexus laws and the laws around multi-state businesses are rapidly changing because a lot of states are trying to broaden their tax base. They are trying to create as many taxpayers as possible to fund the revenue coffers of their state.
Remember, you could be dealing with laws for all 50 states. While a lot of states do things similarly, there are also some very pronounced differences.
There are not only the differences from the law side of things, but there are also differences from the enforcement side of things. Take a state like California, California is very, very aggressive towards out-of-state businesses and very unforgiving when an out-of-state business claims ignorance of California's laws.
That is the overall landscape of why multi-state taxation creates risk for businesses that operate in multiple states. The best thing that you can do is try and protect yourself from that risk by understanding it and taking actions to mitigate.
Specific Risks Associated With Employment
Employees, independent contractors and vendors in multiple states present another level of risk When you have employees in different states, that creates nexus. Having an employee in another state is considered doing business in that state and subjects you to paying state payroll taxes for that employee.
It also likely triggers a state income tax filing requirement in that state.
The same goes with independent contractors and vendors. You are going to be dealing with the same type of nexus-creating activity. If you are engaging people to help you make sales or provide services in a particular state, it is considered a nexus-creating activity and will subject you to tax jurisdiction within that state.
Vendors and independent contractors create audit risk for companies in the states where they may not have intended. One of the big things that we are dealing with in California is new legislation called AB5.
AB5 has essentially shifted the definition of what it means to be an employee in California. There are a lot of independent contractors that the state is reclassifying as employees and creating payroll tax or liability risk for companies that are out of state.
That has ramifications not only from a tax perspective but also from a labor perspective and from a state income tax perspective. Those are the risks for companies that may be located out of state but are using either employees, independent contractors, or vendors in a state that is not their home state.
How to Avoid Tax Liability in Multiple States
If you suspect you have tax liability in multiple states, do not contact the states. I cannot tell you how many prospective clients I talk to where they reached out to a state collections officer or somebody in the out-of-state compliance unit, and inadvertently stuck their foot in their mouth by something that they said.
The state may or may not have known ahead of time. So, it is not a good idea to call them and volunteer information. Instead, the first thing that you really need to do is assess what your risk is.
You want to look at your level of contacts and your sales volume in the states that you think you have liability in. You want to gather that information so that you can better assess what your risk is. After you assess what your risk is, you should talk to a multi-state taxation expert and have them go through and outline what your options are.
A lot of people are too quick to say, "We have nexus in a particular state. We owe money in a particular state, so we will just go ahead and pay the state all of this past-due tax liability.
What they are doing is inadvertently subjecting themselves to more liability and more risk than what they would have owed than if we had created a measured multi-state tax strategy and executed that ahead of time.
A lot of people are very quick to jump into action. What I would encourage you to do is measure twice and cut once.
Really solidify what your risk is and what your options and then pick the best option for your organization in order to minimize your liability and create a compliance path so that you can have a platform to operate off of in the future.
It is not just the past-due tax liability you have to worry about, it is about creating stability for your organization in the future so that they can continue to make sales in all the places that they make sales in and not have to worry whether they are going to get into trouble or not.
Number one, it is about mitigating liability. Number two, it is about creating a compliance plan going forward.
liability and more risk than what they would have owed, if we had created a measured multi-state tax strategy and executed that ahead of time. A lot of people are very quick to jump into action. What I would encourage you to do is measure twice and cut once.
If You Are Audited
The first thing that you do is not panic. The most important thing that you can do is cut off direct communication between your company and the auditor.The more information that you 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 sort of presence there via the activities of their employees, holding inventory, or whatever. You need a third party representative because a third-party representative, specifically an attorney, will be able to deflect the questions of the auditor and be able to mitigate any immediate danger.
The first thing that I would tell an auditor where I have a client that is not in compliance is to hold off while we assess the situation. It gives the company enough time to breathe, gives us enough time to investigate the data and mature how big the hole is.
This allows us to put a plan in place to strategize how we are going to control the scope of information, how we are going to minimize as much risk as possible, and how we are going to reduce the penalties from this situation.
The key in this fact pattern is, California or some other state contacted you, without you filing a return or submitting information voluntarily. If you are not submitting information voluntarily, they must have come across some piece of information to tie you to their state.
In most cases, the auditors will tell you what it is and why you are being audited if you ask them. Working off of that piece of information, it may not be necessary for you to admit liability further back than that piece of information goes. This is a delicate balance.
When you are in an audit like this, the stakes are particularly high because you are not allowed to make false statements to an auditor. There are a variety of ways to navigate through the issue and to deal with this responsibly.
If you continue to try and work things out with the auditor, or pretend like they are not going to do anything, or they are going to work with you, then you are fooling yourself.
The best strategy to take in these types of audits is defense. Defense wins championships when it comes to dealing with out-of-state audits.
How California Collects From You
What collection action can California take against you? This is a common question we get from prospective clients. I get a lot of clients who are on the East Coast, for example; they are in New York or North Carolina or Florida, or any one of those Atlantic States. They say, “I am all the way over here. I have never been to California. I do not like to travel to California. I do not plan on going to California. If I owe money in California for state sales tax or state income tax liability, what can they really do to me?"
The answer to that is they could do a whole lot to you. The reason for that is while you may not have contacts with California and you may not set foot in California, probably the people that you do business with, or the banking institutions that you use, or the third parties that you use have some nexus with California.
For example, if you live on the East Coast and you use Bank of America, we have Bank of America branches in California. California, does not need to send a levy notice all the way to Maine to liquidate your bank account. They can just walk into a branch in California or even easier, just fax it over because since 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 your financial accounts are potentially at risk. Your vendors, if there are any accounts payable or any accounts receivable, are potentially at risk. There are a variety of other things that are specific to different fact patterns with different businesses that may also be at risk of.
California does not have to send agents across the country to go after you. They can do so conveniently from Sacramento and with the advent of technology and 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, to file liens.
All of that can be done from California without getting people on a plane and flying across the country. Do not think that just because you are far away from the State of California, that they cannot do anything to harm you.
Have Us in Your Corner
Our senior attorney team, and all of our staff, and I, are very familiar with helping clients through these difficult situations. We really excel at this for a variety of reasons, but the one I would point to first and foremost is this. It is not that we just understand the tax law. Anybody can understand the law, but where we excel is we really understand the procedure.
We understand not only the way the law is written, but how that law is enforced and how enforcement varies from a state like California, to one like Alabama or Wyoming or Tennessee.
In looking at this from a landscape perspective, we can really help our clients understand and navigate risk. The other reason that we are very good at this and why we excel at multi-state taxation is our firm focuses on the business first.
Most of our clients are businesses or business owners. A lot of our clients are businesses outside of the State of California. We deal with businesses in a lot of different industries. We deal with professional services businesses, manufacturers, retail and hospitality.
We deal with all sorts of businesses across the country. We have really developed a knowledge of not only what we can do for a client from a tax perspective, but we take the time to understand our clients and their business processes so that we are recommending strategies that make sense.
We try to minimize risk. We try to minimize waste. We try to minimize cost and we try to maximize efficiency and value. We are looking at it through a business lens versus a legal lens. That is very important. That is one thing that really, I think distinguishes us as a firm because a lot of lawyers do not know how to run a business.
A lot of lawyers are not sensitive to cash flow. They are not sensitive to the fact that a company may be operating with limited resources or that certain things just do not make sense for an organization.
When we approach a multi-state tax issue, we are really goal-focused first. That is a philosophical difference that we have with a lot of law firms and why we have been so successful in this arena.
We can have a conversation where we sit down and talk about where your company is at. We can talk about some of the challenges that you think that you are facing and let me offer my input.
Costs to Defend Multi-State Tax Issues
How much is it going to cost obviously depends on the facts. It depends on how much trouble you are in and how much work we are going to do. My hourly billing rate is $525 an hour and our junior paralegal bills at $150 an hour. Then the rest of our attorneys and staff are somewhere in between.
For most multi-state taxation issues, the important part is the strategy. A lot of clients come to us and we do a paid consultation. We will sit down for 60 or 90 minutes and develop a strategy. In some cases, that client can just go off and execute that strategy and they do not need us any further.
After that strategy session, some clients want us to stay and help execute the plan for one reason or another. In those situations, we usually divide the work between our senior attorneys, which bill anywhere between $350-$525 an hour, and our paralegals’ rate is between $150-$225 an hour.
From a cost perspective, the most important thing that I like to stress is efficiency. I certainly do not want to bill anybody any more than I have to. I do not want to bill them for any less than what it takes to get the job done, but I am a small business owner myself and trust me, I understand cost.
What I tell you is we take this thing in phases. The first thing is we get a strategy together. Then from developing that strategy, we figure out what the most appropriate way to execute it is. That is the plan that makes the most sense to the clients. That is the most cost effective for clients. More importantly, it provides the most value out of the brain power that you are going to get when you hire our firm.
Get Ahead With Proper Planning
While it may sound like there is nothing positive about multi-state taxation, there actually is. The reality of the situation is there are tremendous opportunities that exist because most people are not handling multi-state taxes correctly.
What we have seen at our firm is a huge lapse in the number of CPAs who are catching these issues when they are filing their clients’ federal income tax returns. Everybody is focused on the federal and compliance in the state that they are in and nobody is concerned about potential planning opportunities that exist outside of that state's borders.
We deal with this a lot in California because there is a 13 percent tax rate for state income. Everybody is trying to get out of paying that level of income tax, either on the corporate of individual level. Most companies in California want to divert as much of their sales outside of the State of California as they can.
California makes it really tough for a variety of reasons, but the reality of the situation is that most entities have presence in different states in one way or the other and you might have an argument that the nexus of your company goes beyond your state's borders.
There are a variety of planning opportunities just based on an arbitrage of your state tax rates. Instead of paying 13 percent, what if we paid a blended tax rate of seven percent? That is a six percent savings on corporate income, which who knows in the millions how much that would add up to?
We have been doing a lot of this work with the companies in terms of compliance, but the optimization factors that occur because of all this multi-state activity are really great. Companies, and owners, and officers have been able to really take advantage of this situation because it cuts both ways.
It cuts in favor of the state because the state is collecting more revenue from more people touching its borders, but also you are touching more states' borders. If you have nexus with the State of Georgia, and you are earning income in the State of Georgia, and you are utilizing Georgia's roads, and you are utilizing Georgia's resources, you should pay the State of Georgia tax.
Guess what? Georgia’s tax is a lot lower than in California. Also, it is a really good opportunity to try and plan things out from a long-term perspective so that you can scale as your business operations grow.
As more contacts come into play, as the laws get stricter, and as the states get more capable of tracking this stuff very easily, it is best to have a plan in place to deal with this.
Not only are you optimizing the business from a tax-saving perspective but you are optimizing the business from a risk-reduction perspective, which is equally as valuable. There are a lot of opportunities involved in multi-state planning.
If you or your company has a presence in multiple states, I would highly encourage you to investigate this issue. Talk to a tax attorney or a multi-state tax expert to really dive into the situation and see if there are tax optimization strategies that you can take advantage of.