We talk a lot about how states are expanding their tax reach like never before, finding new and creative ways to establish nexus with out-of-state companies. Once that happens, your company now becomes a target for enforcement proceedings.
But the question we hear from you is, “Even if a state finds me, what right do they have to collect from me?”
- Lawsuits. Generally speaking, states won’t allow other states to sue their residents over unpaid taxes. So if you live in Nevada and owe California taxes, the California government can’t necessarily file a lawsuit against you in Nevada. Does that mean you’re off the hook, free and clear? No. If you fail to defend yourself, or if you defend yourself in California and lose, the state CAN take that judgment and come to Nevada to have it enforced.
- Reciprocity Statues. Many states depend on reciprocity statutes instead. A reciprocity law essentially says that states will uphold each other’s laws, unless doing so would be unconstitutional or directly conflicts with existing state laws. It also means that where two states have reciprocity statutes, you could find yourself defending a collection lawsuit in either state, where normally a lawsuit wouldn’t be allowed.
States with Reciprocity Laws include: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, west Virginia, Wisconsin and Wyoming.
- Collection Agencies. States can and will send judgments to collection agencies, as well as engaging attorneys to begin collection actions. California recently set aside a large sum of money earmarked for out-of-state legal fees to begin collection actions over its new economic nexus laws that started on January 1, 2011. If your state sends your judgment to collection, you can also expect it to increase. Agencies are typically authorized to add another 20% onto the total bill as part of their collection fee.
- Seizure, Business Closures. Once a state has a legal right to collect from you, they have a wide range of ways to enforce that collection. It’s not uncommon to see businesses closed down for failure to pay sales taxes. In Rhode Island, for example, some 1200 businesses were recently shut down by tax collectors over unpaid debts. The shut down procedure involved tax collectors appearing at the business location, with a lock and chain, to shut down and secure the doors. Even businesses that had paid their taxes were closed down until they could prove that the taxes had been received by the state.
- Help from Unexpected Sources. In a recent ruling, the U.S. Securities and Exchange Commission got into the tax collection and penalty act. A public company, which had spun off from its parent company in 2003, had some major sales tax collection issues, due to outdated and inadequate tax software. They cleaned up their act in 2007, and paid a total of $4 million in taxes and penalties, before being pronounced fully compliant in 2008. But some 3 years later (in January of 2011), the SEC got involved and fined the company another $200,000, for failure to comply with securities laws that require companies to obey all state laws and pay taxes on time.
- A famous seminar promoter, who worked in all 50 states, recently received a $1 million bill for penalties and interest. He and his business had been conducting seminars across the country, selling tickets and products at the events, yet hadn’t collected a dime in sales tax outside of the business’s home state.
- Chicken giant KFC was just fined $250,000 for not paying income taxes on royalties received from Iowa franchisees. Even though the company has no physical presence in the state, it fell victim to the “substantial economic nexus” rules that states have been rushing to implement. These rules basically allow states to arbitrarily determine companies have sales or income tax nexus within a state, based on the amount of income earned from state sources.
- A New Hampshire tire retailer was fined $109,000 by the state of Massachusetts. The reason? The retailer was selling tires to Massachusetts residents, who were crossing state lines to buy tires in sales tax-free New Hampshire. This one wound up in court. It also resulted in a new NH law prohibiting outside state tax departments from trying to force NH retailers into collecting taxes on sales to non-New Hampshire residents.
- Borders Online was found to have sales tax nexus for California residents, even though the online retailer had no physical presence in the state. However, the fact that California residents could return books to local Borders stores that they had originally purchased online, was enough to create nexus. Borders Online paid more than $150,000 in tax and penalties for failing to collect California sales tax.
- In New York State, some 33 businesses and individuals were charged with criminal tax fraud and prosecuted during the fiscal period 2006-2007. In 2009-2010, that number increased to 327.
- Wholesalers beware! States are targeting you for audit. Why? Because many wholesalers don’t have the proper exemption certificates in place for all states in which they are operating, or aren’t keeping up with proper exemption certificate reporting and confirmation.
When you buy something at wholesale, you typically will have an exemption certificate that allows you to avoid paying sales tax, because you will be reselling the item yourself, and will collect the tax from the end consumer. But many wholesale companies have been lax on making sure they receive a valid copy of the exemption certificate from customers. So, when a sales tax audit is performed, these companies are being hammered with taxes and penalties, because they can’t prove that their sales were properly tax-free. It doesn’t matter to an auditor that the sale may have been perfectly valid, and the purchaser properly collected sales tax down the line, when it sold the goods to the end consumer. As far as that auditor is concerned, the first sale is also taxable, unless the wholesaler can produce that valuable exemption certificate.
As a business owner today, your challenge will be finding a CPA or tax advisor who can help you to stay up-to-date on changing tax laws and plan ways to reduce your overall tax exposure. If you need help, why not contact us to explore ways we can help you to design a tax and nexus strategy that works for your business. Get started today! Simply drop Thomas Mangum a line at Thomas@USTaxAid.com, or call him at 866.829.2368, Ext 2.