With states and localities increasingly looking to collect taxes from people and businesses that buy goods and services online, many taxpayers may not be aware that they could be overpaying sales and use taxes.
In a recent report, McGladrey LLP has identified 10 industries that frequently overpay sales and use taxes: manufacturing, engineering/research and development, biotechnology, printing/publishing, technology, telecommunications, financial services, insurance, health care and pharmaceuticals.
State and local tax authorities may try to establish there is nexus under the Supreme Court’s 1992 Quill decision, which required a physical presence for them to be taxed, even when the actual presence isn’t clear.
“From a nexus perspective, we’re watching states try to erode the Quill bright line test,” said Steve Riddle, a principal in State & Local Tax at McGladrey LLP. “They’re trying to expand their reach, testing the waters and trying to test Quill. States are looking to increase their dollars and their coffers. They need revenue for infrastructure, for schools, for everything. For many of our clients in the middle-market space, what we like to do is educate them on where you may have nexus from a sales and use tax perspective, or from an income tax perspective, because those are changing as well from an income tax perspective.”
McGladrey has found that some clients may be filing in jurisdictions where they should not be filing, while others should be filing in places where they are not filing and therefore may be subject to penalties and interest.
“Some states have the ability to set sales taxes on businesses that have not registered or filed sales taxes or use taxes, and they can go back to the beginning of the time when the company did business or that they established a physical presence in that state,” said Riddle. “These can be significant dollars. The ability for these companies to go back to their customers may not be feasible. Either the customer has gone out of business or they are concerned about damaging the relationship. This can easily be 8 or 9 percent negative impact on somebody’s bottom line.”
Manufacturing, technology, telecommunications, printing, publishing, biotech, engineering, R&D, and health care are among the industries where there may be an exemption.
“There are 7,200 taxing jurisdictions, and if you’re a telecom company you could be filing 4,000 tax returns, down to the school district level,” said Riddle. “It’s just difficult for anybody to keep up with all of the changing regulations and all of the bills that are being put forth.”
For example, while the Senate managed to pass the Marketplace Fairness Act in 2013, which tried to bring order to online sales taxes across the country, the bill failed to make any headway in the House.
Riddle pointed out that some states are now acting on their own in the absence of action from Congress.
“Colorado was a battleground, and now they have notice and reporting requirements,” he said. “A number of states have those reporting requirements for sales that occurred out of state, and the state wants to know who the customer was, what they purchased, how much it was for, and then they are matching that up and they’re expecting use tax or sales tax on those items.”
Most taxpayers don’t enter the amount of online sales taxes they might owe on their tax returns, so some states are even making assumptions about how much taxpayers might owe, Riddle pointed out.
“It used to be in some states there was a line on your personal income tax return for use tax,” he said. “Most people didn’t put anything on it, and then based on your adjusted gross income or whatever they decided to use, the state started imputing a number there. We also have shipments that are coming through, with manifests of what’s in a container, for example, and the state will cross-reference that manifest to who is purchasing it and the value that is attributable to that particular item and then they’re going after those people, expecting to get paid as well. There are a lot of different moving pieces where the state is trying to collect their dollars.”
He noted there are about 14 or 15 different states that have notice and reporting requirements. Even Amazon has begun charging sales taxes in many states as it builds local distribution centers across the country to provide faster delivery.
“Amazon, I believe, wants to be a good corporate citizen,” said Riddle. “Where they had an advantage before by not having physical presence in all of these states, they were using either an agent or a third party. They were receiving so much grief in the media that it just wasn’t worth it anymore so what they did is they spun it on its axis, if you will, and they started to put locations around the country where they would be able to have a low-cost distribution system and model that was closer to their clients. To be a good corporate citizen, they’re collecting tax and putting pressure on the other online companies to collect tax.”
If Congress ever passes the Marketplace Fairness Act, Riddle believes more states will begin to exercise their remote seller collection authority. But the question still comes back to nexus.
“When we talk to our clients about nexus, if you are collecting sales tax and you shouldn’t be, then you are putting yourself at a competitive disadvantage with your competitors, by anywhere from 6 to 10 percent,” he said. “But if you’re not collecting and you should be, then you’re running an audit lottery that’s going to cost not only the 6 to 10 percent, but also the penalties, the interest, the possible inability to collect those dollars from your customer.”
He advises accountants to ask probing questions of clients to find out if they have nexus, such as how many trade shows do they go to and do they carry inventory around in their car trunk when they go from state to state to meet with clients? But they should be wary of contacting the state tax authority to ask questions.
“The last thing you’d want to do, without seeking council from someone who practices in this space, would be to call up the state and say, ‘I’ve got this client. Client X is doing the following things in your state. Do we have an issue? Do we not?’ And of course you’re going to be on their list that they’re going to visit,” he said.
Even taxpayers who have gone through voluntary disclosure programs could find themselves in the cross-hairs. “Some of the states are going after people who have been through voluntary disclosure programs,” said Riddle. “You can enter into a voluntary disclosure program, and then after a couple of years the states expect you to be in 100 percent compliance so you will be on their list to be visited as well.”
Overall, he sees more and more states looking to enact click-through nexus, which can affect affiliate sites that steer business to larger e-commerce sites. “Overall, it’s just something that people need to be aware of because most companies are working on such thin margins that 7 to 8 percent on their bottom line is a significant number,” said Riddle.