Missouri and Arkansas Leading Way in Tax Reform

It was bound to happen. As state revenues plummet, state legislatures are getting creative on how to implement long term tax structure changes that will potentially create a less volatile revenue base and reflect the transformation of their state's economic base.  Whether these changes will actually happen is a wild card, but once the process has been set in motion, it can be hard to stop.

In Missouri, a resolution has been introduced to establish a 5.11% "fair tax" on sales of tangible property and on selective services.  The tax would replace the current state sale and use tax, corporate and individual income tax, withholding and Bank franchise tax and local earnings taxes.  The measure would still need to be approved by voters and would not be effective until January 2012. 

This is certainly a unique tactic playing off the much discussed federal "fair tax" plan that has been languishing in Congress for many years.  The trick with these taxes is getting the rate set at a level that is revenue neutral. What is not clear about this bill, is how local sales tax would be handled.  As you may know, Missouri has a myriad of local taxes and a cumbersome procedure for local sales tax administration.

In Arkansas, a ballot for a constitutional amendment to replace all current state taxes with a 12% flat sales tax rate has been approved by the Attorney General.  If passed, the amendment would take place in July 2012.  The Arkansas plan has a plan for the state to provide "refunds" to lower income taxpayers of the flat tax.  If passed, this tax would replace other income based taxes.

While I applaud the creativity of the state legislatures on finding new ways to raise revenue, there may be some significant implementation issues in moving to this format.  While the current sales tax collection and remittance system may not be perfect, the multistate business community has, for the most part, developed an understanding of how the system works and when tax must be collected.  As more state begin to develop state specific taxes and collection rules, there could be some chaos in converting all of the existing businesses to the new formats.  Further, what would be the nexus standard used for a "fair tax" or a "flat tax"?  Are these just sales taxes being labeled something new or are they new taxes that would potentially have new nexus rules. 

As this year's legislative sessions progress, I would not be surprised to see more states put up some trial balloons similar to Missouri and Arkansas.

The Auditor says "Prove it"!

A software client of mine is working with a client to secure a refund of tax erroneously charged on downloaded software.  There is no question that the state does not tax downloaded software.  The state has said they have no problem approving the refund once my clients "proves" they downloaded the software. 

Sounds easy enough until you start to evaluate the documents in place to track downloaded software.  The customer says it was downloaded but can't provide any electronic record of the process.  My client says it was downloaded but they can't provide any detail either.  There was no "shipping" charge on the invoice, but that is not conclusive.  We have implemented new procedures to document these transactions.

As states continue to be aggressive on sales tax collections they will likely start demanding proof of every type of non-taxable transaction.  Don't forget credit card receipts and slips.  This can be a gold mine for many auditors because lots of companies don't keep these detailed records.

The point here is that the taxpayer has the burden of proof to support any non-taxable transaction it makes.  Whether its downloaded software or a non-taxable service, the taxpayer has to have the documentation and "proof" to withstand an audit.

Your thoughts please!!

Happy New Year

Massachusetts Tax Amnesty in 2010

During 2009, numerous states had tax amnesty programs that prompted a good response from taxpayers who knew they owed taxes but were afraid to come forward without some type of protection. 

For 2010, Massachusetts seems to be the first state to announce its intention to have an amnesty program for 2010.  The details have not been published yet, but here is what we know:

1. All payments for tax must be made by June 30, 2010

2. The program will only last for 2 months.

3. Penalties will be abated.

4. Taxpayers who are eligible but fail to participate in the amnesty program will be assessed an additional $500 penalty if they are audited or attempt to come forward after the program expires.

What to do now?

Because this program expires June 30, 2010 that must mean the actual amnesty program will be early in the year. Maybe March, April, or May).  With only a two month time frame, companies must be ready to go once the state announces the details of the program. There will be little time for gathering data and for identifying the risks.  Without a disclosed "look back" period, it will remain a bit uncertain how much data you will need to process to determine the correct exposure.

I would also expect other states to be announcing amnesty programs or other incentives for companies to come forward during 2010.  We will keep you posted as we hear of additional opportunity. 

If you have liabilities, don't wait for an amnesty.  Consider the voluntary disclosure.  You may get the same or even better treatment under the VDA as you would the amnesty programs.

Happy New Year!!-Preparing for 2010

2009 has been a real roller coaster for state governments.  As the year started, they knew it would be bad. As the year progressed, it began looking worse than expected in terms of total state revenue.  As it concludes, the landscape of state revenue is pretty bleak. In the 2nd quarter of 2009, total state revenue was down by over 16% and that trend will probably continue for the 3rd and 4th quarters of 2009.  Income tax receipts are down the most but sales tax is off by at least 10%.  

Why should you be concerned?  Let me outline the reasons.

1. increased enforcement (more audits) on registered and unregistered businesses. 

2. more challenges by auditors to issues that are vague or questionnable

3. more legislation to increase rates or to eliminate exemptions

4. expansion of tax base to impose tax on untaxed services and other nontaxable transactions

5. more pressure on corporate officer liability for unpaid tax.

What can you do now to prepare for 2010?  Plenty.

1. Look at what changed in your business during 2009.  Did you expand your sales footprint, change systems, change customers, change products or services.  All of these things can impact your 2010 sales tax liability.

2. Review any completed sales tax audits for 2009.  Have you made the required changes?  Are these same issues going to re-occur during 2010? 

3. Begin a periodic review of exemption certificates.  Missing or incomplete certificates is one of the most common audit issues companies see.

4. Complete a quick assessment to see if you are filing in the correct jurisdictions.

5. Perform a reconciliation of your tax liability accounts.  Have you paid all that is due?  Have you paid more that what is due?

6. Look ahead to 2010.  Are there unusual events (expansions and contractions) that are scheduled to take place.  Evaluate the tax impact of these and begin to put processes in place to deal with these changes.

Conclusion

The best defense is a good offense.  Be proactive in analyzing where your issues are and start to take responsibility for correcting these mistakes.  It will far more costly in the future to pay the tax, interest, and penalty than to deal with them now when they are small.

What Makes Sales Tax Audits so Frustrating?

Have you recently been notified of a sales tax audit?  Are you under audit now?  I have never seen so much sales tax audit activity in my 23 years of tax consulting.  Auditors are coming out of the woodwork and are contacting companies who have been off the radar for years.  Further, the audit findings being proposed by these auditors are outlandish.  I'm not sure what type of instructions these folks are getting, but there must be some moratorium on using logic and reason when conducting sales tax audits.  I've been dealing with several audits where the auditor is altering the facts and the law to suit his own position.  He is imposing his own "judgment" in place of the contract, written responses from clients, and a substantial body of other documentation that shows him to be flat out wrong.  His response, "if you don't like it, you can fight it".  I'm afraid that is the new auditor mantra!

So why are audits so frustrating and how can you minimize this frustration?  Here are some thoughts based on the audits I have worked on over the years.  As you can see, the problem with audits may not always be with the auditor.  You may actually be the problem.  If so, step out of the way or get some training specific to dealing with auditors.

Common issues leading to problematic audits:

1.      Bad auditor:  Auditor doesn’t know what they are doing, isn’t taking time to understand the business, doesn’t listen to what client says, has own agenda, overloaded and no time to do a good job.
2.      Company not ready:  person in charge of audits is too busy to attend to the auditor unless it is at a critical point, Company not ready when auditor arrives and is forced to quickly gather info for audit, company waits until audit is complete before questioning the methodology, company constantly asks for delays and is still not ready when auditor arrives, inexperienced person assigned to handle audits, company takes adversarial position with auditor.
3.      Data:  company records are not clear, data is not accurate or is hard to understand, tax systems not capable of developing clear audit trail, multiple data feeds make it difficult for auditor to work.
4.      Business Model: Company does a variety of things, sells a variety of products and does not do a good job at developing the tax rules, invoices, and support documents to present a clear picture to the auditor.
 
In any audit situation, it is normally a combination of these items.  They tend to compound one another.  A hurried auditor combined with bad data and incompetent company personnel will lead to a really bad conclusion.  A good auditor who is treated like dirt will not be overly cooperative when issues arise.

If you have not been audited brace yourself.  They are coming to get you.  Be ready and be on your defense.  Know your issues before the auditor arrives

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Higher Pennsylvania Local Taxes

The "City of Brotherly Love" is about to get a bit more loving as it increases is local tax by 100%. That's right, a doubling of the local Philadelphia City tax from 1% to 2%.  This change is effective December 17th, 2009. Who in their right mind has a tax increase in the middle of the month?  Make it either December 1 or January 1, NOT December 17th. 

In addition to this increase in Philadelphia taxes, the city of Pittsburgh is also getting into the act by increasing its local municipal parking tax up to 40% from the current 37.5%.  A decrease planned for this month has been canceled. 

As I've been blogging for the past 18 months, we are witnessing a paradigm shift in the administration of state and local sales tax.  Although these rate increases have sunset provisions, once they are in place and the revenue starts flowing in, it is very hard to reverse course and reduce the taxes  Since 2000, state and local tax rates have increased over 11% and we are just beginning to see some momentum to these increases.  In many larger cities, the tax rate can exceed 10%.  With rates this high, sales tax is now becoming a serious factor in large ticket purchases.  When rates were 5% or 6% you could accept sales tax and a necessary evil but not something that would necessarily keep you from purchasing an item. At 9% or 11% sales tax is a major issue and could keep folks from committing to purchasing items.  In some cases, it could even drive folks to purchase items over the Internet since there is not tax and no one ever pays the use tax due on the purchase. 

Brace yourself folks.  I'm fearful we are just at the beginning of a rash of "temporary" tax increases. 

Taxation of Internet Sales-Level 1

I was at a technology executive breakfast this morning.  As usual, I was the only sales tax person there which can make striking up a interesting discussion with the CFO or CEO of a technology business a bit challenging.  Out of curiosity, I was asked what TaxConnex is and how we work with technology companies.  To keep matters moving or just to be polite, I was then asked "when will states start taxing Internet sales?"  I was taken back a bit, but then I stated that states have always been able to tax Internet sales just as they have always had the ability to tax mail order catalog sales.  He then replies " I thought the seller had to have a physical presence before the item was taxed?"  At that point, I knew where the confusion was.  This person, as well as 90% of other people, are confusing the taxation of the property purchased over the internet with the party who has the responsibility for collecting or paying the tax.  These are totally separate and independent issues.  The taxation of the property has nothing to do with the ability or requirement of the seller to collect the tax. 

That's when I started talking about "use" tax and how each purchaser has the requirement to pay the use tax to the state if we buy something on the net that isn't taxed by the seller.  He looked astonished and asked when that rule was imposed.  I said "early 60s".  He then proceeded to tell me about all the high-tech Stern and TV systems he had purchased from various on-line retailers who didn't charge him tax. To prod him a bit, I asked if he wanted me to send him a use tax return?  He smiled, and politely declined!! 

Over the years, I've had this discussion countless times.  Mostly with businesses but often with individuals.  For the sake of repetition, the taxation of the property or service purchased on the net is independent from the responsibility of who has to pay the tax.  Given the shortage of cash by the states I think it is just a matter of time before there is some broad based requirement for remote retailers to collect and remit sales tax on sales regardless of the actual contact they have with a state.  I don't know what that will look like or whether that will have any connection with the SSTP initiative underway, but I just sense some movement will take hold within the next few years.

What was North Carolina Thinking?

If you have taxable transactions in North Carolina, you will have 3 tax rates in 3 months.  In August the rate was 4.5%, in September the rate is 5.5% and in October the rate is 5.75%.  Forget the point that this is a 27% tax rate increase in 3 months, the bigger issue is that this process seems overly confusing.  In an effort to get more consistent sales tax compliance from non-resident businesses states need to keep the compliance as consistent and easy as possible. North Carolina has done a lot of juggling to stay in compliance with the SSTP when it comes to tax rates.  A few years ago, they had to re-label the reduced tax on manufacturing items so that they would not violate the SSTP rule on only having single sales tax rate.

Increasing sales tax rates is certainly an easy way to generate some additional tax revenue.  At some point, though, sales tax rates may become so high that they actually begin influencing purchasing decisions.  When that happens, tax revenue could decline which will put further pressure on states to find other ways to increase revenue or decrease services.

Facebook and Sales Tax...What's the Connection?

I recently saw that tax authorities in Wisconsin were using Facebook to track down delinquent taxpayers and to look for unregistered businesses that were being advertised or promoted on Facebook and other social network sites.   I've never heard of this before.

Have you heard of any other techniques being used by states to identify individuals or businesses that under pay tax? 

What will the States Think of Next?

If you watch the news at all, you know that the sates are suffering from revenue losses.  In Georgia where I live, there have been significant reductions in education and social services and more cuts are on the way.  If you also watch or read the news you will also see that states are coming up with some creative and not so creative ways to generate more money for state programs. 

The most obvious sales tax change that will occur in many states (CA, NY, NC, IL, etc) is an increase in either the state or local tax rate.  In some cases the rate of tax is increasing from 4.5% to 5.5%.  That's a 22% increase in tax rate.  That's 22% more money going to the government and away from other consumption. 

States are also active in increasing their contact with non-registered businesses and trying to get more out-of-state companies to collect sales tax.  Just look at the commotion around the so-called Amazon affiliate nexus statutes that have been passed in many states.  I would suspect that next legislation session would be even more active in these areas. 

States are also trying to expand the tax base by stretching the limits of existing statutes and by passing new statutes to tax services or different types of property.  Some are removing exemptions or having other sunset provisions on exemptions.

To me it seems like this is all out warfare by the states to collect as much tax as possible from everyone they can. I understand the need for state revenue and the benefit of the goods and services it can provide.  I also understand that the more aggressive states become in collecting tax the more creative companies can become at finding ways (some legal and some not legal) to avoid paying the tax.  Having a complex and ever changing set of rules does very little to expand the long term tax base that states depend on.  

It will take a while for the state revenues to return to the levels they were in 2008.  In the mean time, I would expect states to become very creative at how they extract tax revenue from us as consumers and from non-compliant businesses.  Ignoring the rules could cost businesses a significant amount of money.