Sales Tax Non-Compliance: What’s Your Exposure?

An entrepreneur’s dream is to start her own business and witness it grow. First, she wants to see it grow locally. And then, she may see it grow statewide. Whether the company is a small retail operation or a cutting edge technology company, the next step up may be overwhelming as the business begins to operate across state lines. At that point, there are many strategic and tactical issues including hiring employees or contractors operating in other states, or the maintenance of inventory.

These can lead to nexus, or taxable presence. And now the company has potential filing issues, for state unemployment, state income tax and sales tax. Many of these items are initially overlooked and can cause significant exposure—even for small start-up companies.

Example

Let’s follow the life of ABC Company. It is based in Florida, and it is sending sales people to Texas and California. As a result they are generating sales in these other states and the company is growing. Everyone is happy; they are beginning to see a profit. However, the company is likely overlooking one key issue, which can be a very big deal: sales tax. They may not realize that they have not been collecting and remitting state sales tax in California or Texas. To make matters worse, those sales people may have territories that include other neighboring states as well. The company may not worry about it initially, but the Departments of Revenue (DOR) in these states will think otherwise.

Next, a few things can happen: the company can take action and be proactive or they can wait until the states find them. Let’s examine the alternatives.

Option 1: Be Proactive

To figure out the company’s tax liability, we help companies determine their exposure in those states where they are generating business. We help our clients answer these questions:

• Does the company have nexus in the state(s) in question, and if so, for how long?
• Are the company’s products taxable or not in the state(s) in question?
• Are there any exemptions?

We then determine the potential tax liability in each state where the company has nexus. The company can then decide if they wish to pay this tax liability and “come clean.” We can help ABC Company in requesting a Voluntary Disclosure Agreement (VDA) with the DOR. For more information on what VDAs are and how they work, click here. Under a VDA, the state will usually waive penalties and reduce the exposure lookback period.

While many states also employ limited ‘amnesty programs’ to encourage compliance, these are frequently not available when you need them. If the timing is right, the company may wish to enter into the state’s amnesty program. However, we don’t recommend waiting to correct past failures to file and pay taxes while hoping for an amnesty program to occur.

Option 2: Wait Until They Find You

If the company does not choose to come forward, ABC Company runs the risk of being identified by the various states as they generate more sales in the state. This will result in having to pay a larger tax liability, penalties, and interest down the road.

So, what is the downside of not coming forward?

• Increased penalties – if a state finds you first, they generally assess maximum penalties, which can be as high as 25% of the tax liability.
• Financial statement exposure – underreported sales tax means liabilities are misstated. Growing companies can’t afford to have erroneous financial statements.
• You are not in control – in a VDA, you work with the state to get to a mutually agreeable arrangement. If you get audited, it’s on the state’s timeline.
• Remember, sales tax is a pass through tax, meaning that it’s the burden of collections from customers that most companies hate. But, if you haven’t collected over the years, and a state finds you, good luck going back and collecting from your customers after the fact!

But you may still think, “How will a state find us?” There are several different reasons that may prompt an audit, notice, or a nexus questionnaire:

• Payroll taxes – Departments within the state may cross check. If you pay unemployment taxes but no sales taxes, that’s a flag.
• An audit of a customer or supplier who identified the company as potentially doing business in the state, yet they aren’t registered.
• Whistleblowers – angry employees/ customers,
• Random audit

We are here to help companies get out of these sticky situations concerning multistate sales tax. Obviously, we encourage companies to think about their sales tax issues before an audit occurs and choose “option 1.” We can help you determine where you have nexus, how much your company may owe in taxes and whether you should choose to file a VDA. Our aim is to relieve companies of this added stress and help everyone have a peace of mind as their business grows.

Author: Monika Miles founded Miles Consulting Group in 2002. The firm focuses on multi-state tax consulting—helping their clients navigate state tax issues such as sales tax and income tax in interstate commerce, including e-commerce.