Tax Issues for Multi-State Businesses

Hi I'm Sam Brockman I am the founder and principal attorney at Brotman law here in San Diego. Today We're going to be covering tax issues for multi-state businesses. I want to give you a little bit of a background on my background in order to better do some context to this presentation, so I am a tax controversy attorney here in San Diego which in plain English means I represent businesses and audits payroll tax sales tax and income tax and I help those who owe more money to the government than they can pay, so our firm does a variety of services but mostly we focus in on examinations and we focus in on collections work and in helping companies with compliance issues, so that they avoid those two issues increasingly a larger percentage of our business is with multi-state companies who are trying to stay out of trouble traditionally. We see a very large influx of businesses outside of California who tend to step into California tax issues, so I'm going to speak mostly from my cuts in the context of dealing with California tax issues but this applies to a variety of states California is one of the more aggressive states in pursuing businesses that are located outside of its borders for tax revenue California kind of smartened up to the fact that it can go after businesses and individuals that may have contact with the state of California, but who actually don't reside in California and do don't have voting power in California. So California has increased its base of operations and actually has offices in.

New York Texas and Illinois which serve as regional jumping off points for out-of-state California tax compliance and this is significant this is the way that. The law is trending this is the way that states are growing revenue and increasing their tax base and and quite frankly it's the world we live in you know with the advent of the internet you're having situations where businesses are able to gain contacts with States in a variety of different ways and it's creating kind of a a mess from a legal landscape because there's no administrative law or judicial law or legislative function that's really catching up to technology as fast as it's improving, so one of the big challenges for multi-state businesses is dealing with managing and mitigating risk. When laws are unclear or when you are operating in multiple states that may have different laws and how to stay in compliance and how to avoid issues without creating a huge cost burden or regulatory burden. On the organization as a whole so we're gonna be talking about some of these issues today and really going through this in a lot more detail, so that everybody gets a sense of what the issues are? and How best to avoid liability? So the first issue.

I want to talk about is with respect to multi-state sales tax issues let's paint a picture for a minute so amazon has been a wonderful thing in many people's lives you can get on Amazon you can order a variety of products and have them shipped to you in about a day or you know you have a whole wide open marketplace that has been created through Amazon. Amazon has been a big tool for business owners to transmit their products over the Internet, so through the Amazon FBA program through the marketplace a seller can take a product put it on there and rapidly increase their sales volume and a number of companies have made big business off of Amazon. At the firm we represent clients who do 10 20 40 100 million dollars in Amazon sales every year if Amazon is a very strong lifeblood of their business. Amazon has also created significant problems from a sales and use tax perspective in a state like California California had a very public fight with Amazon back in the back of a 2010 to 2013 range and a lot number of states not just California have created something that was technically referred to as an Amazon sales tax law and essentially. What the issue was is you were having the situation? Where you have a retailer located in the state called Best Buy? and you go to Best Buy and you purchase a TV.

The TV cost you a thousand dollars and then you pay sales tax on that TV well if you bought the same TV on Amazon and were shipping that product into the state of California you would not be paying sales tax on that product, so it was creating a price incentive for consumers to go online and buy products, so that they would have with sales taxes also it was cutting in significantly to the revenue budgets for the particular states so California and a number of states addressed this issue by creating nexus laws on the book which are more commonly referred to is either economic Nexus laws or click-through Nexus laws or it depends on a state-by-state basis. Most commonly they're referred to as the Amazon sales tax laws and what they are is the Amazon sales tax law? Has created a nexus standard that went beyond the traditional thoughts about Nexus and about minimum contacts with a state, so if you are a retailer that's located in New York and you don't go to California and your business is in New York and you ship products out of New York and you stay in New York you believe you're in New York company you wouldn't think twice about California and the laws that it has on its books with respect to Nexus and the question is could you avail yourself to California income tax and state sales tax just by being physically located in New York and what the Amazon sales tax laws did is they opened up.

The playing field so that California could tax businesses that weren't located physically within its borders if you have a certain number of minimum contacts with the state of California then you can be subject to state sales tax and you can also be subject to state income tax one of the things that California did is they created a rule that if you were, if you were housing inventory within California then that would constitute a nexus creating activity, so for Amazon sellers a lot of the Amazon sellers will ship their products to Amazon warehouse and then they don't really keep track of what happens when after they ship it to the warehouse? What amazon does is you could be a New York seller located it and shipping goods into a warehouse in Pennsylvania? and then in order to fulfill customer demand Amazon may send those products from intensive in your warehouse to a network of other warehouses that Amazon has by doing that and as Amazon acting as an agent for you. Amazon essentially creates Nexus in a variety of different states so we use the Amazon example as a very good thing or a very good illustration of what the problem is? But the problem is is through the actions of others or through unintended consequences businesses and other states can avail themselves to the laws of a particular State one of. The big things that we have been dealing with is representing out-of-state businesses who may not have known about these laws in California and in other places and helping them deal with the consequences of this, so for example California put this ball in the books in 2013 and its 2018 right now, so companies have been operating under the guise that they've been in tax compliance but it actually have accumulated significant state income tax liability and state sales tax liability by using the Amazon FBA marketplace. Which is really significant because when you have a company that's doing 10 20 40 hundred million dollars in sales the sales to California could be could be really really significant you know we've had situations. Where you've had potentially multiple multiple millions if not tens of millions of dollars in state sales tax liability based on an aggregate volume of sales.

I mean you think about it and can kind of do the math if the state sales tax rate is on average eight and quarter percent and you're doing a hundred billion dollars of sales annually and ten percent of your sales are in California then you have ten million dollars in sales annually in California and you're accumulating liability based on that eight and a quarter percent Which is eight hundred twenty-five thousand? that's a lot of unpaid tax not to mention interest in penalties that will continue to accumulate over a multi-year period the situation can often be worse for smaller businesses if you only do a million dollars in sales gross per year and a hundred thousand of those are to California then you may only accrue of fifty or sixty thousand dollar liability with the state of California but to a million dollar business operating on Amazon. As most Amazon sellers operate on a very low margin fifty or sixty thousand dollars could make or break the company so it's not just California that Amazon sellers need to be worried about it multiple states have followed suit and have created these economic Nexus or click-through Nexus laws that would avail businesses to different types of states briefly.

I want to talk about the legal history of this the very first case that we're dealing with is something called complete auto test the case is actually complete auto transit versus Brady was a 1977 case and what that case did it's a federal case and it establishes kind of the landscape for legal precedent in terms of what the fet? What the feds will consider interstate commerce? and What's left to the state and essentially will complete Auto does is it gives the states the power to regulate commerce that occurs in their state or impacts their state as long as it doesn't really interfere with interstate commerce and there's a fairness test associated with that and there is there's some other tests that are associated with it, but basically it creates a very large playing field for the states to interpret their own laws and create this very difficult standard to interpret meaning if as long as it doesn't interfere with the dormant Commerce Clause then the states can basically do it if they want and this has created a lot of conflicts so you have situations where states will take different interpretations on an issue and come up with two competing regulations and one regulation may be harsher than another regulation and for a multi-state business it's very difficult to navigate the landscape because if you take your company in the space in. New York again you could be subject to the laws associated with 49 other jurisdictions.

So it creates a big problem now they they kind of rein this in a little bit in the early 90s with a case called crow versus North Dakota and what quill versus North Dakota put into place was that in order to have economic Nexus within a state you need to have physical presence and quill versus North Dakota has been kind of the gold standard with respect to this is the bright-line rule in setting a limit on States abilities to tax quill was so law but with the advent of the internet the precedent that was set by quill was gradually being eroded so states were finding new ways to try and tax things that didn't involve physical presence, so the states have kind of pushed back and created this certainly series of laws of increasing and called them bravado. In order to extend their tax base for people that were having substantial contacts with the states, so for example we've gotten a lot of affiliate Nexus laws or we've gotten a lot of laws that say that you can be held liable for sales tax or sales tax if you're operating through an agent or if you're can being significant marketing activities or things like that, so it was no longer just about a company having physical presence within the states borders what it was really about and what the states made it about was?

The level contacts with the states now there has to be some level of contact the state can't impose an unnecessary burden on to an out-of-state retailer if you don't have any contacts at all with the state the state cannot tax you but as what you as what you can kind of guess at is the states have been kind of eroding this concept and making contacts with the state more and more into Nexus creating activities. The real hot topic of conversation recently is a case called Wayfarer versus South Dakota and Wayfarer eliminated quills physical presence standard and essentially has given the supreme court blessing for looser interpretations of economic Nexus so the problem is what the Supreme Court did is they remove. The physical presence requirement and quill and overturned well what the court didn't do? Is the court didn't adopt a real stringent standard on what constitutes economic Nexus? So in the South Dakota case you've got a situation where you have a state statute that said that an economic activity over I think it's $100,000 will constitute significant Nexus creating activities so it's a fairly it's a fairly significant solid statute if you're doing a certain volume of business in South Dakota you consider having economic Nexus with South Dakota and you have to meet that threshold in order to qualify.

So that was a nexus creating activity but what the court didn't do is it didn't comment on states that don't have that exact neck Nexus standard, so what it did say is that South Dakota's law was valid so you've got about eight states that use that same hundred thousand dollar economic threshold that we know those laws are good but there's a variety of other states that are out there that have different nut laws they either have clicked through Nexus laws or they don't have that hundred thousand dollar requirement for economic Nexus and as such we don't really know whether those laws are good laws or whether those laws are bad laws because without quill in place we're going back to complete auto where as long as it doesn't interfere with the dormant Commerce Clause then you're okay so what the heck does that mean well what it really means is a couple of different things number one as of right this minute there is no federal law that would free out any of the state Nexus laws, so California Texas New York New Jersey variety of different states can create their own Nexus laws and there's no doorstop on the federal level other than a very loose guideline that says you can't interfere with the dormant Commerce Clause, so the states really have controlling power over this until we get some sort of judicial restraint on state laws

So it's very possible for example the California's law could be unconstitutional but there's no current judicial challenge or no current judicial restriction in place nor is there any legislative restriction that puts a cap on California so at least for right now California's law as it applies to economic Nexus with California is the supreme law of land at least with respect to California and its jurisdiction New York and it's law is the law Glarus respected in New York and it's diction so you've created this really wide open playing field. The other thing that you're dealing with with respect to Wayfarer is Wayfarer did not address retroactivity with respect to this economic Nexus provision, so it is fairly certain that going forward that economic nexus laws will continue to be upheld at least if they meet the general guideline that South Dakota put forward what is really unclear is? Can states go back retro actively and enforce economic Nexus provisions so for example before 2018 can the states really go back and enforce state sales tax and state income tax laws against out-of-state sellers and the answer to that is again absent any legislative or judicial comment that may happen in the future the answer to that is yes and a number of states have really taken taken hold of this and have really increased their enforcement efforts California obviously is on the forefront of this we get a lot of situations where we're dealing with.

California going after out-of-state businesses California has one of the better funded departments of revenue and it's really robust and it's been really active in terms of enforcement Washington State is another state where Racine enforcement rise, but the real the real landscape after weight fair is this is that now that economic Nexus or Nexus it's not based on physical presence has been put back on the table you're going to see pretty much all the states get in and all the action, because it is such a significant way to raise tax revenue and as time passes and as more and more states it wise on their enforcement efforts you're gonna see a significant crackdown in this area, so what does that mean it means a variety of different things for businesses number one going forward you can assume that to the extent that you have activity in a state based on the level of activity that you have you will be considered to have Nexus in that state that Nexus in that state has consequences from a sales tax perspective and it also potentially has consequences for a state income tax perspective if you are considered to have Nexus within a state even if you are located outside that state having Nexus is equivalent to essentially having a branch office within that state they look at it for state income tax purposes and they look at it for state sales tax purposes so essentially what you've done by using Amazon or by using some other Nexus creating activity is you essentially you're setting up branch offices in multiple states.

I mean if the gammas on has warehouses in 33 states currently so if you can imagine if you use the Amazon FBA platform and are selling goods to Amazon you are creating Nexus in 33 different states which for any business small or large creates a very large compliance issue some states like Washington and Minnesota and I believe Oklahoma have created the marketplace tax rolls so increasingly places like Amazon and eBay are going to be required to collect and remit tax versus putting the burden on the business so that's been a very positive change that's come forward this because it takes the burden off the business owner for regulatory compliance and for tax benefit however these laws are in the minority and there's not a lot of states that are taking up similar laws, so going forward businesses need to concede to assume that this is going to be their burden to operate as multi-state businesses and to collect and remit tax so here is the process for making decisions on this issue number one a business needs to look at its historical sales by state it should go back at least to 2013 when these laws are on the books and depending on the state where it does the most there the states where does the most business business you might need to go back further, so for example Washington State goes back a little bit further they can go back I believe it's seven years California traditionally we will go only go back to 2013 other states have different ways of looking at it so with respect to with respect to historical sales you're going to want to look at a state-by-state basis and see what your potential liability is?

So that's step one step two is you're going to want to look at your nexus creating activities within the different states, So we use the Amazon as an example California's law went on the books in 2013 but you may not have had inventory in Amazon warehouses in California in 2013 based on the region that you're located in and based on Amazon's distribution of your inventory you may not have had contact with California, so with respect to Amazon sellers they should go through and look at their Amazon sellers report and look at where the warehouses where their products and services are being shipped with respect to other sellers they need to go through and look at their Nexus creating activities in each individual state and figure out where they could potentially have liability where do you have salespeople where do you have agents that are acting on your behalf where do you have suppliers you know are you in a situation where you may be an online retailer or an out-of-state company and you are dealing with the supplier who's got a wide supply chain throughout the United States you know if you are selling office supplies or beauty products or something that is manufactured and sold in warehouses.

Even if you use Amazon it could have the same effect on you so you need to look at what your economic activities are and make a real risk assessment with this typically when people go through steps one and two is when they start to freak out because if you look at the bulk of your activities within the different states and if you look at your historical sales chances are you have probably done a significant amount of multi-state activity and potentially created a nexus with yourself in multiple jurisdictions so now we come to .What we need to do about this? and here is here is the real answer to this question there is a priority at least moving forward within the states to get people into compliance so let's start over a little bit wafer has created this very broad landscape for states to go after people for economic Nexus creating activities within their states without physical presence just at Amazon alone I think through something the last statistic.

I renesis there's something like 3 million Amazon sellers so now you're the State Revenue Department in Alabama or in Tennessee or oming or you're in a smaller statement and your state revenue department has traditionally just been given the resources to focus on its in-state people and now you've just opened up this very big and fraud landscape with all these different tax payers who are outside of your state who have potential liability with your state so there is a conflict at least for now between the way the laws are written and the way that they're actually enforced and the fact of the matter is is that state revenue departments don't yet have the resources to go after every single out-of-state seller what they traditionally have been doing is as they have been increasing their out-of-state compliance efforts they've started going after the low-hanging fruit they go after either people on Amazon by doing shopping cart tests and they'll traditionally focus on sellers you do a higher volume or they'll go after people through their odds and they'll go after if they're auditing an out of state a an in-state business they'll go through their list of purchases and see who is charging tax and who's not and that's principally how they're gathering their information they're either going online and gathering information that way or they're doing it through the audit function a lot of states don't have very mature resources yet to go after out-of-state companies but as I mentioned, because of Wayfair the audit activity is increasing.

The out-of-state compliance activity is increasing with that said there is because states have limited resources the focus at least for now with most state revenue departments is just having ref people register and start paying in voluntarily going forward that is where the enforcement priority is it is less about retroactivity at this point because retro andorran enforced retroactivity it requires a lot of resources if you are what focused on compliance then all you need to do is get somebody to register and voluntarily pay that is something that's fairly you need to do if you're focused on retroactivity then you need to get them to go through a variety of steps to calculate what their historical liability is in the state and that creates a lot of work for these state revenue examination divisions, so the focus is really about getting people into compliance and although they will go after people for retroactivity and don't think just because the resources are limited doesn't mean they don't have any teeth but the key focus is for those businesses who are in compliance they are less worried about going back than dealing with it going for, so if a seller were to voluntarily register in a state and assuming that a period of time passes after that voluntary register then the state doesn't check the state's not really going to dive in very much - well do they owe tax before they register did not register and the way.

The fifths have dealt with this is by creating voluntary compliance programs they're concerned about people registerin, but they also want to know they also do want to collect the tax revenue, so they will offer these voluntary disclosure programs it's kind of a carrot to get businesses to go through the process of voluntarily remitting how much tax they owe and what they'll say is to say look we will depending on the program and different states have different programs but the state will say look if you come forward we will generally limit your liability to a certain look-back period I mean won't charge you anything at these we just charge interest and the key question here is is this a good idea so is voluntary compliance a good idea and there's been a couple of different things with respect to this number one is voluntary compliance programs will limit your liability it will put a cap on it they will negate most of the penalties associated with it and it will provide you a platform for getting into compliance however voluntary compliance does mean retroactivity and paying taxes going backwards and then depending on your Nexus creating activities which could be fairly significant you might have to do voluntary compliance in a number of different states and a lot of the push has been go through voluntary compliance get registered you know go from there but what you're doing there but engaging in voluntary compliance is creating a significant cost and you're putting yourself on the radar actively for all of these different states now I'm not advising anybody to stay out of compliance.

What I am advising people to do is rather than just rush and get into compliance?Immediately from a business standpoint you really need to look at the costs and how to mitigate your best and you can do this by looking at your sales and looking at your Nexus creating activities and making a decision in terms of how best to manage and mitigate your risk going forward you're probably going to ask me how I would advise you to do that and the answer is I don't have a single answer for everybody this is a problem that requires a in-depth analysis of the facts and go through the issues with respect to your particular company and your Nexus creating activities and things like that I want to provide a general overview of the framework so that you could understand these issues and you can spot them and help yourself deal with these issues going forward, so with respect to compliance the most important thing going forward is understanding that this issue is not going to just go away it's something that is going to continue to increase and continue to provide problems for people and the states are going to get more and more sophisticated and enforcing these types of laws, so really for a lot of businesses and in order to mitigate risk with respect to these issues you need to do one of two things well you need to do both things actually number one you need to deal with the effort to get a compliance going forward because again that's where the focus for a lot of the states is is with future compliance number two you have to find a way to mitigate your risk with respect to past liability it can mean registering and going through voluntary compliance and getting yourself out of Hana plan with. The states it can mean potentially restructuring it can mean a variety of other other different means so the point is is that there is a variety of different answers in terms of either a getting into compliance or B how best to mitigate past liability and there's none a singular answer on how to deal with this and until we get guidance either legislatively or through the courts this will continue to remain a big issue for a lot of businesses the first code is five zero one the first code is five zero one the first code is five zero one, so briefly.

I want to cover what to do if you are sent a letter by a state revenue agents and perhaps you're not prepared to deal with this number one don't panic and don't respond immediately the key thing to consider is you want to appear cooperative but you also want to control the flow of information that's being given the mistake that a lot I see a lot of CPAs make is CPAs do a really great job with trying to mitigate tax issues and CPAs are often on the front lines of things the problem is is CPAs are kind of like general practitioner lawyers were in the 80s and CPAs unless they focus in multi-state sales and use tax mostly deal with individual and corporate income tax preparation and don't have this readily available in their wheelhouse not to say that CPAs are not great advocates for their clients with respect to sales tax issues I know a number of really talented multi-state CPAs who do a lot of good work in this area. What I'm saying generally is "A lot of a lot of CPAs don't have the wheelhouse to deal with this type of issue", so there's a rush to just let get in compliance and let's give them all the information that they're asking for and let's just do a document dump and that is a mistake because a lot of times with sales and use tax you're opening yourself up to a lot more liability than you actually need to you may create an unintentional reporting period that goes beyond what you should be reporting to for example in California.

California in order to deal with this problem has something called a managed audit program on a managed audit program is limited to two years and you basically go through a sales tax on and turn your work into an auditor and the auditor will check over it and then they will stick to a two-year assessment period the problem is is if you don't know about managed audit or you don't know about other things that states have in place to deal with these issues then you may just go ahead and register for the last seven years and voluntarily report and although the state would be thrilled by you doing that you're going to substantially increase your liability and potentially put your business at risk so there's a lot of Jeopardy there and you always want to measure twice and cut once so really make sure that you're taking a very positive and deliberate action going forward so if you are contacted you do want to take a break and not respond to me they you probably should get a professional advisor involved someone who is familiar with these areas? If you do want to respond in some way shape or form you can call the number on the notice you received you get acknowledged that you receive the notice and say that you're working on a response you certainly don't want to ignore the notice so for example when California thinks that you owe tax it will send you a preliminary question err and if you crumple the questionnaire up into a ball and throw out the trash then they will probably just open up a full audit on you you know it may take some time but California or any other state if they say you'd notice means that you're on their radar and is not just going to go away so the mistake is by not doing anything you don't want to not do anything and you don't want to be over the eager, so you need to take a measured response you need to really understand what the problem is outline the way to properly deal with that and then pick the best way to deal with it and execute and that's really the way to go here if you are contacted for an audit then you are in a lot of a deeper pool but a lot of times people aren't necessarily contacted for audits the states have very limited information on the people who are outside of their borders and you have to think about it this way if California is gathering information on a company in New York it doesn't have access to any state filings because.

The New York company has not been filing in the state it doesn't have access to a variety of other information that it would normally have about a taxpayer in its state and it's really going off either third party information what's going off information that it's gathered through its own means like doing searches on the internet or something like that so the very first thing to understand when you receive a notice is what does the state have on file for you that would suggest that then they want you to get a compliance it might be a notice it might be a misunderstanding it might be information that you were selling good through another supplier that they think might have Nexus with California but you actually don't have Nexus in California it might be limited to a particular year so for example they might think you have Nexus creating activities for 2018 and if you tell them that you have Nexus creating activities going back to 2011. Then you're opening yourself up for can of worms so really the understanding point from after you make contact with them needs to be about understanding what they know about you based on what they know about you and based on your level of contacts in the state that's the framework you can really start making decisions in you can understand what your risk is you can understand what your options are and you can move through those options in terms of dealing with the problem proactively and working on getting in compliance they just may want you to register they may not want to seek retroactive penalty they may want a secret directed penalty in which case you're going to look to a managed audit program or something like that so the important thing is you really need to understand what the problem is you need to understand what the state knows about you you need to understand how big your liability is and you need to make a responsible decision on how to deal with those issues and that is really really important then you don't want to rush to judgment or rush to compliance because that's a really big mistake to make because a lot of times you're just opening up a problem without really dealing with the problem or by creating a problem that's much bigger when you get contacted by a state Revenue Agency and as you're going through the process of figuring out what your liability is another important consideration is you need to think about the ramifications of collections so eventually at the end of the examination process.

Whether you do some sort of managed audit whether you go through a voluntary disclosure program or whether you just don't respond they send you a bill collections is going to get involved unless you full pay the liability somebody somewhere is go say you owe us money and how would you like to sell your bill there are so many issues to deal with in terms of collections both against the company and the company's officers and its shareholders it's just to talk about the California part of this would be massive but I will say this number one there's absolutely no forgiveness once this thing gets to clashes once collections determine if you have a liability its collections job to collect they will collect against the company and they will exhaust all efforts to collect against the company after they have exhausted all efforts to collect against the company or possibly simultaneously with their efforts to collectives company they will seek to hold people who are responsible for the liability responsible that means officers that could be in directors that could mean people with financial controls such as bookkeepers or controllers or CFOs and it could also mean shareholders again too broad of a topic for this and states have different laws with respect to collections and so it's very difficult to give sound advice within this framework but I want you to start thinking about this that eventually as you start going through the examination process on this issue eventually someone's going to have to pay the bill and particularly if you are a shareholder of a company or a director with some significant control of the business your personal assets could be at risk and so before measuring a response you have to walk through the chain and consider all issues on this and consider how the company is going to responsibly deal with this liability.

How it's going to protect its owners and its officers and what measures the state can use to enforce collection activity over its borders traditionally this comes down to a question of resources and again even a state with California with fairly expansive resources doesn't have unlimited resources so again there might be a gap particularly with out-of-state companies in terms of what California can do and what it will do and it's important to understand that there is a gap between the way the laws are written and the way it's enforced so I want you to think about these issues, but I also don't want you to freak out oftentimes there is a measured solution and there is a way to properly deal with these issues but you do need to start thinking about what's the worst-case scenario helping to find that and by defining what the worst-case in there you can properly assess and mitigate your risk that way so that's really important most of the ways that people have contacted or through these data state compliance notices generally speaking the states are not looking onto people they just want to bring you in compliance so a lot of times if you voluntarily will get into compliance based on a request you don't have to go through an audit you don't have to submit yourself form and it's on it there won't be any further and further investigation of your books or records you can simply just get into compliance and move on the question is is by getting into compliance you don't want to open yourself up for further liability you don't want to open yourself up for penalties or any other significant Avenue for liability that's much different than an audit if you are getting audited you will know about it ahead of time they will send you a notice saying you are under examination we would like to look at your books and records an audit and a request for compliance or two different things so you really have to read and understand what the correspondence is being sent to you by the state and understand what they're asking for you know what does the state want they do they think.

I have Nexus Korean activities do they know I have Nexus creating activities or do they want to come on at me and you know there is a variety of different responses depending on where you're at in the process what do you do if you haven't been contacted well number one. I think we've covered that you have to be proactive with respect to this situation this is not going to go away you are running out of places to hide and you have to deal with the situation responsibly so really the best position you can be in is if you haven't been contacted yet because you still have control over this process you have control over which state's out you reach out to in which states maybe don't reach out to you have can roll over the timing for getting in compliance who potentially paying off liabilities you can still maintain control even if you're not caught but the important thing to realize is it's not an endless clock of you know a free period eventually someone will catch up to you based on your based on your activities depending on your level of contacts depending on your presence outside the state either either online or otherwise there may be different ways ways to manage and mitigate risk but the important thing to realize is eventually they will try and find you and they probably will find you because of the emphasis that the State Revenue departments are placing on this issue so if you're not in compliance yet now is the perfect opportunity before the states get too sophisticated before they increase their enforcement efforts get into compliance or at least manage and mitigate the issue as soon as possible the next thing.

I would like to talk about is I want to talk about drop shipping drop shipping is a concept when you usually have three people involved in a transaction you have a customer you have a retailer and you have a supplier drop shipping gets really complicated but to the extent possible we're going to try and make it really simple let me explain what the issue is if you are a supplier and if somebody contacts you and says I am selling to a customer and I need you to ship your product I'm going to purchase it but I need you to ship your product directly to that customer on on my behalf then there are situations where the supplier or the retailer can potentially avail themselves to the taxation of the state that the customer is in so for suppliers there is a really good there's a really big risk and for retailers there's also a risk with respect to unintentionally availing themselves to the jurisdiction of a state by lieu of shipping product in there and again this gets very complicated but the issue is really focused on suppliers suppliers have a variety of liability because they are in the middle of these transactions or the retailer who's purchasing product from you and shipping it somewhere else and that creates liability in potentially both the state of the retail it could it could create liability in the state of the retailer could create stability in your state or the state of the customer more than likely it will create liability in either your state or the state of the customer but depending on the situation you want to be best prepared to properly deal with it.

So I want to go through some situations where dropshipping becomes applicable explain how to kind of look for in mitigate these issues so number one you a situation where you have a retailer in Florida and who is purchasing from a supplier in California and shipping to a customer in California so supplier and customer are located in the same state retailer is in a different state now with respect to the transaction between the supplier and the customer because a supplier is shipping product in the state of California to a customer located in the South Cal State of California that is generally going to be considered an in-state transaction and subject to California tax even with a retailer located in Florida and saying this is an interstate commerce transaction the product is originating in California it's being shipped within California and it's going to a customer in California and regardless of whether this is being shipped by comment delivered on a truck whatever this is a taxable transaction in California and as a supplier you have an obligation to collect and remit California tax the problem that most suppliers run into is that the retailer customer says I don't have to pay tax in California I have a reseller certificate for the state of Florida and if you are supplier you would take the Florida resale certificate and you would believe this transaction would be tax exempt because the for the retailer is is is purchasing something for resale the issue with that is the state of California doesn't accept Florida resale certificates so the state of California would like your retailer to register in California and obtain a California resale certificate and this often creates conflicts between suppliers and their customers because the retailer's don't understand that they have any an affirmative requirement to register and pay potentially pay taxes in California or at least have a reporting requirement in California based on engaging in transactions for resale here.

So as a supplier you have to understand that if you are located in the same state that is that where you are shipping to you have an obligation to collect the tax unless you usually obtain a valid resale certificate in the state where you are located now some states are different than California so some states will accept resale certificates from other states or they'll accept multi-state resale certificates some states like California are specific though and want a resale certificate for each individual transaction some states will let you do batch transactions some states will that you do it will only let you individual transactions and want you to certify transaction by transaction that you're doing it for resale so the suppliers need to be cognizant of what the rules are in their particular state and all the situations that have dropshipping implications because oftentimes the seller is the one that they're the supplier is the one that is going to be left on the hook for this so with respect to the supplier run through the following things does the supplier have the obligation to collect tax is this a tax-exempt transaction does the retailer have an obligation if there's a sale for resale to present a resale certificate in the state where the supplier is located those are questions that the supplier needs to ask themselves on the retailer side of things is this truly a tax exempt transaction or is my supplier acting as an agent on my behalf am I going to be considered to have Nexus creating activity within the state because my supplier might be considered a holy inventory for me or might be acting as an agent to facilitate the business that I'm doing in a particular state this is a state-by-state analysis because states have different ways of looking at these possible things but uniformly whether you're the retailer the supplier you need to know where the tax goes so situation number two we have the retailer and supplier in the same state and the customer in another state so whether you're the supplier the retailer in this particular situation you need to understand what the nexus creating activities are with the shape the state that you're shipping if you're shipping through common carrier usually there is not a nexus creating activity.

So you're using the post office or FedEx or UPS you usually there's not Nexus creating activities and this is an in-state transaction however if you are a retailer and using a supplier who has Nexus in that particular state that the customer is in then you might having you might be having a Nexus creating situation as the supplier is there anything that you are doing that is creating Nexus or you are you shipping product through your own trucks and driving them into the state of California. Where is title to the goods passing is it passing in the state that you are located in as the supplier or is it passing where the customer is and that's really important we're good passing title or the is the supplier or is the retailer creating any Nexus bearing activities very important things to consider and very important questions to answer number three you have a customer a supplier and a retailer and they're all engaging in a drop shipping transaction and they are all in different states typically this is going to be an interstate commerce transaction and not subject to tax so there usually is not going to be a situation where tax is going to be imposed by the customers home state the customer will probably have a use tax requirement but we're not really worried about the customer at this point this situation changes when in depending on where inventory is being held so if inventory is being held in the state the customer is located in then you're going to have to look at the sales and use tax laws with respect to that state if inventory is being held where the supplier is then you're gonna have to look at the inventory you're gonna have to look at the laws with respect to that state and then more uncommon ly if first if the inventory was located where the retailer is you would look at that state so particularly Soup for suppliers there's a lot of danger in this area because they're shipping to somebody that may not be their customer and the state may take the position that you need to collect a resale certificate from the retailer's customer and you go we'll wait how do I collect a resale certificate from the retailer's customer and so there's a number of situations where this creates a lot of problems it also creates a lot of friction between suppliers and their customers because the retailer's don't understand the tax implications for what they're doing with these types of dropshipping transactions.

So what we've done in the past for our clients is we've created like a letter for the suppliers customers explaining what the laws are in the state of California or in other jurisdictions that they're located in or we've created a system for suppliers in or retailers to implement that they're doing things from an efficiency standpoint the problem is is that all this back and forth from a dropshipping perspective creates havoc in a business I mean it's so hard to be the the shipping department in the company or to be the sales department in a company and have to go back and forth on these issues and most the time the employees that work in the sales department are not going to be wise to what the consequences for this are but there are potentially very major consequences for these transactions we've had companies with millions of dollars in liability as a result of drop shipping emissions where they believe that they have been in compliance so if you're in a situation where you're running a company or you're advising a company on these particularly issues you have to be aware of this because states are in getting increasingly aggressive about drop shipping as well because of the potential for unclaimed liability so always be aware about drop shipping always make sure that you're in compliance with whatever state's laws you're availing yourself to and that's the best way to handle the situation the next thing I'd like to cover is with respect to taxable labor so this is an area of confusion particularly in a lot of manufacturing settings, but I want to kind of distill out what the really the main issue is and then got to go from there so the very broad concept is during the manufacturing process or during the selling process let's use a baseball bat as an example so you're manufacturing a baseball bat order to manufacture a baseball bat you gotta buy the lumber you gotta cut down the tree and then you have to you take the tree trunk and you cut that into baseball bat size pieces and then you take the baseball bat size pieces and you shape that into a baseball bat and then you have to finish the baseball bat and then maybe you add some other things to the baseball bat so that it's ready for final sale in a retail store or maybe you maybe you are manufacturing baseball bats new sell them to a distributor that sells them to a retailer that'll locally the cells into a customer the point is no matter how complicated the supply chain gets there is value added at each step of the way and when they're in situations where there's value added each step of the way those transactions are generally taxable unless a resale certificate is presented.

So the big misconception with respect to this is when you take a product like a piece of wood and turn that into a baseball bat most companies operate under the precipice the labor is not taxable and that is not always true in a lot of states California being one of them fabrication labor is with considered taxable labor when you are manufacturing something or when you have Cree native input into a process so for example if you are selling bloop it prints the mmm service that you charge for the architect coming up with the idea for the blueprint that would be considered taxable labor so there's a value-added component to a product that would increase its value and make it subject to tax design fees with respect to the constructions of signs are taxable labor manufacturing labor the cutting was sizing altering in any way even assembly labor if you get a bunch of parts and charge the labor college tax for recharging any labor charge we're putting on those parts together assembly labor is considered taxable in certain situations so just remember if you have an item and you alter that item and it creates a step in the production chain or it creates a new item that is more than likely going to be viewed as taxable labor and it's going to add a value added to point to it the exceptions for taxable labor are repair labor cost fixing something or installation labor and installation labor and assembly labor can be particularly tricky so you're going to have to make the distinction whether something is being installed or beer that is being assembled and that can be tricky at times delivery labor is also generally taxable unless it meets certain provisions and delivery labor especially can get very complicated depending on what industry you're in or what you say so and it really depends on how your invoicing particularly so not going to cover delivery labor.

But I will tell you is it's a bright-line rule if you are charging for delivery and it's through a common carrier it's generally tax exempt if you are not charging through if you're not doing through common carrier then it may not be tax-exempt and so you're gonna have to be very careful with respect to delivery and making sure that that labor is not taxable and if it is taxable that you're charging the appropriate amount of tax a lot of our compliance motivated clients have had us review invoices and invoices are particularly important because invoicing is how the auditor looks at things so the way to fix this and to ensure you're charging the proper amount of tax is just start with your invoicing and then make sure that you're either itemizing whether you're lumping everything appropriately. I mean I can't even go into the amount of industries manufacturing construction retail where we've seen problems and challenges associated with this so make sure that things are being done correctly make sure that you're looking at your invoicing make sure you're going to understand how the auditor is going to look at those invoicing and then just get your procedures in place and make sure that you're in proper compliance and that's really the Westway to mitigate any issues associated with tactical labor with respect to taxable labor as it affects multi-state companies. I want to talk about another issue which is state payroll taxes so there is a lot of misunderstanding and a lot of confusion with respect to the ways the companies are reporting their payroll tax obligations so it want to be very clear and this is a very complicated area but let me distill things into a manner that's gonna make it much more simple to the extent that services are being provided in a state then that particular state where the services are being provided is going to want to collect payroll taxes associated with those services there are some exceptions to this.

But generally speaking where services are being performed is where tax is going to be permitted and paid so if you have a situation where you have somebody in California and they are flying to the state of Florida and they are performing services exclusively within Florida you are not going to file California payroll tax returns you are going to file for the payroll tax returns even if somebody is physically living in another jurisdiction payroll tax liability will extend to the state that services are being performed and where the work is done you will fall under those states laws with respect to labor so it's very very important that you understand that and I'm reporting payroll taxes correctly payroll taxes can also be a problem when you have agents affiliates or independent contractors located in another state to the extent that you have independent contractors in multiple states you may be subjecting yourself potentially to state payroll taxes and state income tax liability a quick word about independent contractors is the relationship between an independent contractor as an individual and a business is being put under scrutiny by a variety of states in California for example this past April there's a case called Dynomax and Dynomax essentially boils down independent contractors to a three-part test which mirrors the three-part test is in in a variety of other states the states including California are making a proactive attempt to really narrow the scope of independent contractors why are they narrowing the scope of independent contractors because the collective payroll tax revenue on people who are considered employees of a business so traditionally the way that people think about independent contractors that they are only working on number of hours or they're working from their home location or they are providing services to a number of different people those may not be what a state considers independent contractors so for example in California traditionally there was a seven factor test for determining whether somebody was or was not an independent contractor Dynamix has made this a little bit simpler really it boils down to a couple of different things.

The way I look at it is twofold number one how much control does the employee employing unit have over the independent contractor number two how integral is the job function of the independent contractor to the production of revenue for the business if you have a business and the production of revenue is dictated by the services being performed by independent contractors typically those independent contractors are not independent contractors they are employees of that business to the extent that independent contractor services are integral to the core functions of the business those people are not independent contractors they are going to be considered employees to the extent that you ask an independent contractor are you in business for yourself and they answer no that person is going to be considered an employee and there are very broad reaching issues with independent contractors particularly in multiple states number one there's obviously a significant payroll tax liability depending on how many independent contractors that you're using and depending state-by-state if you're using a large pool of independent contractors in a particular state you could be cruisin for a payroll tax audit for example we had a company located in the state of Georgia that was relying on a pool of independent contractors for anthalie services to that business those independent contractors work were found to be employees within California and created a liability for that client so a very important thing to consider number two depending on the way the state statutes are read and if an independent contractor is here it is physically located in a state that you are not physically president it could create a state income tax liability it certainly will create a state income tax liability if they have ruled an employee it might be ruled with a state income tax liability if they are an agent so there are state income tax considerations not just state payroll tax considerations associated with having employees or agents in the in another state where you are not otherwise physically present and that's really really important to think about when you're thinking about the dispersion of your employees through a variety of states you want to make sure that you're looking at where your labor force is for your business what services are being performed where those services were being performed and what states you have a payroll tax liability for very important to understand the landscape so you can improperly administer those issues and really it's the bottom of where any gaps and reporting or any inconsistencies are so very important to consider when looking at employee issues for multi-state businesses the next thing.

I want to talk about is is state income tax we could spend a lot of time talking about state income tax consequences for multi-state businesses but let me just kind of give you a very broad stroke on this issue traditionally states have been looking at state income tax from an apportionment standpoint so they've been looking at where the percentage of your revenue is where your employees are and where your inventory is being held that is still true for a variety of product related businesses they're going to look at your level of contacts with a particular state and then to the extent you have Nexus within that state they're going to seek to tax all the income associated with that state so for example if you're in California and you have employees in California in Illinois. Illinois is gonna want the proportionate share of its revenue that's being earned in the state of Illinois or that's being generated by those employees so something to consider with that prevent is what is the mix of employees and or inventory and/or sales between multiple states you should not if you're a California if you are based in California principally be reporting all of your income subject to California tax what you should rather be doing is a proportioning and out among the different states that you are touching so this creates a big problem for people because what will happen is a California business will report all its income under California and then get audited by the state of Illinois for years that are now past the refund statute in California so you're essentially the consequence of this that you're going to pay income tax twice under income also speaking from an apportionment standpoint for income California and a number of the states who had also been wise to this so high tax states like California will give you a credit for income tax that you're paying in Illinois but will ultimately tax you on your on the difference between.

The Illinois sales tax and the California or the Illinois State tax and the California state tax and will seek to remunerate that so there's a lot of issues with respect to multi-state planning with respect to service businesses mostly states are going to tax you from a state income tax perspective on the location that's services are being performed and this gets a little bit complicated because you could have a situation where services are being performed for particular items generating revenue in a variety of different states so for example you could have a client in Arizona and you're in California and you're doing a certain amount of services in California and a certain amount of services in Arizona really what this comes down to for most states is a balancing test. I mean you're not going to be able to you know take a fee for a service project and microscopically split between California and Arizona but you can just kind of do a general balancing test the nice thing with respect to state income tax reporting because particularly if you're proactive is you get a chance to take the first position and by taking the first position you know I would client tells me that that the income tax return filing is the opening offer and there's a certain amount of tongue-in-cheek truth to that because you could stick the first position and essentially leave it up to the state to come challenge that position so without doing anything wrong or evasive or anything like that you get to take your reporting position a little best benefit you if you are a multi-state entity the one thing you really want to look at is choice of entity considerations so does it make sense if you're doing business in multiple states excuse me to be located in a high tax state like California do you have options based on the logistics of your operation to switch your headquarters to a different state you have situs of income in a different state do you have a situation we have employees spread across multiple states when you are a multi-state company even for businesses that haven't really traditionally thought of themselves as multi-state companies you have an option of where your home base is and there are certain tax advantages obviously between different states some tax businesses very high and sometimes of this was very low on where you want your home base of operations to be now you can't just pick Nevada if your California employees.

Tf all your employees work in California all your inventories in California because states have statutes in place that will essentially tax you as a if you're in Nevada Corporation and do that they'll essentially tax you as a California corporation, so but you can't have a certain amount of choice of entity and it's really important multi-state tax planning to figure out how to best navigate your state income tax liabilities additionally a lot of businesses we found are not reporting properly with respect to states that they are doing business in and they've there's you're gonna lapse or they reporting it to the wrong jurisdiction so you want to have a very good guideline of where we were pouring to. Why we were pouring to? and then take the position that's going to be most favorable to you and there are going to be situations where you're going to have conflicts and jurisdictions if you know we had a situation this is a sales tax case we had a situation where we had a Texas statute in the California statute and there was a conflict on which state was supposed to collect tax if you ask California in California says we're supposed to collect tax. If you ask Texas they said we're supposed to collect tax in that case the Texas tax was lower so we went with Texas and relied on the Texas law with respect to that but this is not necessarily going to be a black-and-white area because you're dealing with 50 states that have 50 different laws on the books that are going to be gaps in law and there's going to be gaps in the way that things are enforced so very very important to keep in mind that when dealing with multi-state issues that are going to be those types of issues the last thing I want to cover is with respect to residents say this is an individual issue but we won't talk about it because it is important to a lot of different people particularly officers or owners of companies so just as you can imagine there are multi-state issues with companies there are also multi-state issues with people from a people perspective companies don't move you don't like pick your company up and move it all around.

I mean I can think of a situation where you'd have like a traveling circus or you travel with a fare or something like that, but for the most part companies Nexus is gonna be basically where its officers live where the inventory is stored with their base of operations and where they've incorporated people move around a lot so there are situations where you get residency issues for people who are in different states than their companies or who tend to travel a lot residency laws vary from state to state it's impossible to cover every single one of them but most states are going to view that if you lived in a particular state for more than six months out of the year you're going to be deemed a resident of that state if you are a resident of a particular state like California then you are going to be taxed on your quote-unquote worldwide income so the state is going to seek to tax you based on the fact that you were resident in that state so if you live in California six months of the year and if you lived in Texas for five five months of the year for five and twenty eight days then you would be considered California resident you pay California tax on that income he would not pay Texas tax as far from an income tax perspective unless you're actually performing services that are being in Texas and even in that situation California would give you credit for any tax that you paid in.

Texas although there's no state income tax in Texas they would give you credit for the tax paid in their state and then would assess you on the balance so excuse me from a residency perspective you're going to want to pay attention to where you are we're a service where you're performing services and where you're subject to tax and there obviously are conflicts with a lot of states with respect to their taxation scheme it's just on the corporate side so if you're an officer for example of a company and you do a lot of traveling you may find it wise to move your home base to a different state other than the one you actually live in there are practical considerations for people with families or children you may not just be able to pick up your life and move it from one state to another but it gets really complicated for states like that are very close together particularly northeastern states where there's a lot of movement back and forth where you can cross two or three state lines in a given day so you want to make sure from a residency perspective you're doing things from a tax efficiency standpoint you also want to make sure that from a compliance standpoint you're not digging yourself into trouble by subjecting yourself to residency in multiple states so just be very very careful with that from an officer standpoint or from an owner standpoint and just know that those issues are out there and that with good tax planning you can usually mitigate a lot of those issues the second code is nine nine five the second code is nine nine five the second code is nine nine five so that concludes it in terms of my presentation for multi-state businesses and the tax issues that surround them. I just want to make a general comment a lot of the stuff is very complicated and there's a variety of situations this is very very fact-specific we did this to just kind of be a general overview of these issues so that you can at least be aware that they're out there let me kind of see the playing field but this does get complicated and this area in particular is something that you usually need an expert in and to help manage and mitigate your risk a lot of times even CPAs will have a hard time fully understanding issues and for situations with clients you touch multiple states.

I can't tell you how many times I've seen an issue but with a client who has residency touch points in California and Texas and who's Texas CPA will screw up the return with respect to reporting in California or with respect to somebody who is relying on a New York CPA and doesn't mitigate sales tax issues for other states so in thinking about the landscape and what just want you to be aware of all the different states that your business touches and then ask yourself the question do I have tax liability in those days and the answer is either. Yes! I do or maybe I do it's probably a good idea to talk to a tax attorney who specializes in multi-state taxation and can help kind of walk you through these issues again this is not just a from a compliance perspective this doesn't really have this does have to do with reporting but this also has to do with understand the landscape of enforcement understanding the conflict of the laws between the different states understanding the regulatory framework and understanding the enforcement framework once these issues move into collections so although this is a very complicated topic I do want you to be understanding understand that these issues are out there and do what you can and mitigate them as best as possible so if you have any questions you're more than welcome to reach out to me directly through my firm our website is WWE and Comm we've got a number of resources through our blog you're also welcome to give us call at six one nine three seven eight three one three eight until next time this is Sam Brotman and I will talk to you soon thanks so much.


Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law