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