Sam Brotman, JD, LLM, MBA July 2, 2020 25 min read

Multi-State Taxation: Frequently Asked Questions

FAQs — Special Considerations for Small Businesses

I have an out-of-state business. What do I do if I owe money to California?

You need to take action. Taking action is important because no matter where your business is located, even that does not mean California cannot take action against you. A tax debt in California can transpose itself and cause you problems, even if your business is not based in California.

The very first thing to understand is how much you really owe, and then the second thing is what is your risk associated with that tax debt, what can California do? 

California has a variety of collection tools in its arsenal against multi-state businesses, but it does not mean that they are going to come into the State of Texas and seize your house. It is important to understand what they can do to you and how much you owe.

Then based on that, develop a strategy to get in compliance with California or to mitigate the liability in some way. There are a variety of different options for doing that, but you want to understand what your risk is, and then you want to devise a plan for getting back into compliance as soon as possible.

If you try to ignore the California liability or if you bury your head in the sand, that is where you are going to create problems for yourself and your business. The important thing is if you owe a tax debt to California, make sure you seek help as soon as possible to get yourself back into compliance

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 you might and "might" is a keyword here because a lot of states, as you may have heard, have passed marketplace facilitator laws. Take California, for example. California is the jurisdiction that I am in and it is one of the more aggressive states towards businesses that operate through a marketplace facilitator.

California has actually created a fairly high threshold. If you do $500,000 in transactions or less, then you do not have to file sales tax returns and you do not have to pay sales tax. 

The reason you do not have to pay sales tax is because Amazon or one of the other marketplace facilitators is collecting tax on your behalf. You do not have a filing or a reporting requirement until you cross that certain threshold.

The problem is with the way the marketplace facilitator statutes are written in California. If you collect any sales outside of the marketplace facilitator, then you immediately have a filing and/or an obligation to pay sales tax. 

A lot of businesses that operate over the internet will sell through Amazon, but they will also make direct sales through their website. For example, suppose your Amazon sales represent 80-90 percent of your business.

Even if you sell only $10 through your website in California, you have now gone outside of the protection of the marketplace facilitator statutes. Now, you at least have a filing requirement in California. 

Amazon may still be collecting the tax through the transactions that you are doing with them, but by not reporting, you are now out of compliance. It is important as an internet-based business to understand what your channels are and what your exposure is from a tax perspective through them.

Do you have a filing requirement? Do you owe anything in tax or do you have a collection requirement in the states that you are selling in? If the answer to those is yes, then you need to get in compliance. 

States are getting more sophisticated in this area. They are relying on a lot of third-party data to gather a lot of information that they are gradually working through and trying to catch businesses that are not in compliance. The important thing again, is to have a plan, put it in place, and execute it appropriately so that you can get back to business.

I have businesses in several states and have not filed sales/use or income taxes in any of them. What should I do?

The easiest 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. This can be a little difficult. 

Where companies really started having issues is when they are interacting with other companies. For example, if you are going out and doing a bunch of prospecting and none of those potential clients sign up with you, you may not get caught. 

Where we see the most headaches  is either through a vendor or a customer that is located in a different state. If a company has been out of compliance for a while, what will happen is that the chain will eventually lead back to the company through the audit process either on the sales and the use tax side or the state income tax side,

One of the reasons that the CDTFA (California Sales Tax Department Administration) audits companies is to produce the leads to go after other companies. When they pull a company's purchase invoices, they are looking at all of their vendors that have not charged tax and from that list they are trying to determine why. 

If you are performing nexus-creating activities in a state and invoicing customers there and those activities are readily apparent from the invoices, you are cruising for prison. The long and the short of it is, stop digging. Measure the hole and then hire an expert to get you out of it.

This stuff is complicated and without knowledge of how the states work and how enforcement works on the state level, this problem is not going to get fixed. Delinquent sales tax has become a huge issue with states. I guarantee you 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.

My business conducts internet sales. How do I figure out how much tax I owe?

This gets very complicated because with an internet business depending on what you are selling and where you are selling it. It also depends on your level of contacts with that particular state, whether they are physical contacts (which a lot of internet businesses do not have) or more commonly, economic contacts.

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 gets really complicated to determine the amount of tax that you owe because each state has similar rules but they are different in a lot of ways.

The first thing that you do is figure out which states you are doing business with the most and then determine the nexus rules in those jurisdictions so that you can make sure that you are appropriately collecting tax. Or, if you are not collecting tax, make sure that you are not at risk or have any liability associated with that.

With the other states, it is about planning. It is about looking at your level of contacts and sales and determining whether or not you need to collect tax in that jurisdiction. The way that you do this is you start with the top 10 or 15 states that you are doing business in, which may represent 65-80 percent of your sales, and then you look at other sub-jurisdictions where you may have less activity in.

That is the best advice I can give to internet businesses or businesses that do a lot of business over the internet in order to account for their sales. The good news is, there are a number of software programs and tools that will help you execute this part of the process. 

Software will only perform the execution part; it cannot do the planning part because software does not think independently. Software relies on the inputs it receives to spit out outputs.

What you need before you get to the execution part is a good strategy.. You need to understand where you are exposed, what the risk is, what your filing requirements are, what your payment requirements are, and then build a plan around that and then use software to automate and execute.

This does not have to be a long-drawn-out or insanely costly process. You do not have to start filing sales tax returns in all 50 states but you do want to plan going in and then make sure you can execute that plan effectively so that you are not at risk in the future.

Should I represent myself in a multi-state tax issue? What about my CPA? 

First off, I definitely do not recommend that you represent yourself. As to whom you choose, it depends on what the situation is. It depends on the players on your team and what their level of experience is. It depends on 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 lie elsewhere. 

Multistate taxation is something that is in my wheelhouse, but the reason it is in my wheelhouse is because I practice in this area of law and I do this all the time for clients who are 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.

The problem with multi-state taxation is that they are not just about the law. The law is complicated because you are dealing with multiple jurisdictions. It is about the procedure and how states handle collections and enforcement action against taxpayers that are outside of their jurisdiction. It is about understanding the playing field and the landscape of that.

Oftentimes with clients, what I usually recommend is a multi-prong approach. I am a big believer in efficiency for companies. What I tell them is, "Look, engage with the tax attorney, figure out what the strategy is and then outsource the execution of that strategy to where it makes the most sense." 

I have had clients who come in for a 60-90 minute paid consultation, then take the strategy we develop back to their finance department or CPA for implementation.

Is applying for amnesty or going through a state's voluntary disclosure program a good idea?

It is difficult to answer that question in general terms because it is a highly fact-specific question. The way that I view state amnesty plans or state voluntary disclosure plans is kind of like a sucker's bet.

The states have created this great deal for themselves. They lack enforcement mechanisms to go after a lot of multi-state taxpayers and so they have created a program that if you come forward and you pay all the tax that you owe, they will be kind enough to waive the penalty portion. 

In some cases, it is a great way of mitigating liability, particularly if you have nexus or minimal contacts in a state that exceed or greatly exceed the disclosure period for the voluntary disclosure. 

While it may sound like a good deal, from a financial perspective, that may not be the best course of action for your business. 

Before you make that decision, before you jump in, back up. Look at the landscape of your company, look at all of its sales activity, look at all the places that it potentially is exposed to, and then make a plan based on what the best thing for your  company is.

It is not a great thing for your company if it has to pay all these past due sales taxes and state income taxes and go insolvent, you are not helping anybody. 

The important thing is to create that plan and then strategically use voluntary disclosure programs and amnesty programs to accomplish your objectives. That is the much better way to leverage them and it is the better way to know if they make sense for your business.

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 a foreign entity, and qualifying to do business in a state, more than likely you are going to subject 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 idea with compliance is understanding what your exposure is in different states and then registering or filing returns appropriately in order to meet the needs of your business.

There is a balance between compliance and then making sure you are doing the right thing for your business. The important thing to do is sit down, look at the operations of your company, look at where you are making sales and crafting an appropriate multi-state tax strategy.

When we have done this for different businesses and many times, 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 a sales tax perspective is probably going to create a filing requirement in that jurisdiction, and then managing and mitigating that situation appropriately.

My corporation has been suspended by the State of California. What do I do? 

You probably got some sort of notice and/or you went to the California Secretary of State website and noticed that your corporation was suspended and that there is a listing for it. Tf you have a corporation in California that means you took the steps to create that corporation or this can be for an LLC or a partnership. 

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 update on an annual basis with the secretary of state just saying, "Here is my corporation. Here is the address of the corporation. Here is who the officers are."

If you have not changed any of these things, you can file this form online. If your corporation has changed and even if it has not, you are still required to file a statement of information on a yearly basis. Filing this statement of information can give you a quick fix to get your corporation out of suspension.

Alternatively, the reason that most corporations get suspended is because of unpaid taxes. When you owe income tax or your 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, so it will at least give you a lead on who the right person to call is. 

If it is the FTB, they are going to demand that all the back taxes get paid before the corporation is allowed to be back in good standing. If you owe a significant amount of liability for back taxes for a suspended corporation, then you might want to get an attorney involved to negotiate a resolution. 

We have had a lot of issues with suspensions of corporations for certain things. For example, if you are going through a transaction or if you are engaged in active contracts, being a suspended entity can create a lot of problems. 

The best thing that you can do is try and ferret out the reason why you were suspended and then get somebody involved or deal with the situation appropriately in order to get a resolution in place.

What is dropshipping and what are the tax consequences?

A dropshipping transaction is where a seller is selling a product to a buyer, but shipping that product to the buyer's customer, which may or may not be located in a different state. Dropshipping is an incredibly complicated thing from a tax perspective because you may have one party or multiple parties in multiple jurisdictions.

You could have a California seller, you could have a Florida buyer and you could have a customer in New York where the product is ultimately going to. The biggest challenge for tax professionals in this situation is, who do you pay the tax to? 

With customers, this is really important because there are a variety of issues around which state has jurisdiction to collect the tax revenue that makes this incredibly complicated.

In a dropshipping transaction, you want to make sure you understand the different types of situations that your company faces, and then create a plan around how to address those, both from a tax filing perspective and then also in your sales process. You want to make sure that you are collecting the appropriate documentation and you are doing what you can to mitigate your own risk in this situation.

The problem with a lot of dropshipping transactions is many companies assume that because the product is going one place or because their customer is located in another place, that they are not obligated to collect tax. 

Unfortunately, the way that most state sales tax laws are written, particularly surrounding dropshipping transactions, is it puts the client on the hook for liability unless they are collecting resale certificates from that particular state, or they are taking other appropriate measures to mitigate their risk.

There are a lot of tax consequences and variables that go into dropshipping transactions. You want to make sure that when you are engaging in dropshipping or if you are on any part of the dropshipping spectrum that you understand the tax consequences and are taking appropriate action. 

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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