Important State and Local Tax (SALT) Considerations…after Wayfair · 2019-10-31 · Within the...

Important State and Local Tax (SALT)Considerations…after Wayfair

Belfint Briefing

Wednesday, October 30, 2019

Presented by:Valerie C. Middlebrooks, CPAMike D. Kelly, CPAJordon N. Rosen, CPA, AEPBelfint, Lyons & Shuman, P.A.

Valerie is a tax generalist with a strong knowledge base in providing compliance and advisory services to her clients. Valerie works closely with the many experts within the firm to address her clients’ varied circumstances. Her experience includes working with large privately-held companies, nonprofits, small businesses, high net worth families, and international businesses (and individuals), and has extensive knowledge leading an engagement team acting as a back-office tax department for a global manufacturer. Due to this background, she has specific experience working with several businesses that have nexus in every state.

Valerie values the personal approach to accounting, preferring to meet face to face as she helps her clients navigate their tax returns, and understand their tax planning, estate planning, and transactions. Her personable nature, in addition to her technical mindset, help her clients align their personal and tax goals.

Within the firm, Valerie’s priorities include team building, training, and employee advocacy. She believes individual and firm prosperity begins with teamwork. Along with internal team meeting participation, Valerie is called on to present on various tax topics for organizations such as the Delaware Tax Institute, DSCPA, and Cogency International.

About Valerie . . .

vmiddlebrooks@belfint.com302.573.4129

Michael has over ten years of experience with the firm. His focus is business and tax planning for business owners, he is also well versed in state and local income, individual taxation, trust and estate taxation, and nonprofit issues. Michael frequently assists clients with their accounting questions and has a strong understanding of QuickBooks and other bookkeeping software. Michael always tries to think of creative solutions that minimize taxes for his clients.

Within the firm, Michael is known for his ability to research and understand uncertain or unusual federal and state income tax issues. He helps train BLS Team Members and is a member of the Estate & Trust Team and SALT Team.

Michael received a master’s degree in taxation from the Villanova School of Business which was conducted jointly with the School of Law. Michael has written articles for the Delaware Bankers Association and occasionally writes for the firm’s tax and small business blog, Matter of Tax. Michael has presented tax updates at the Society of Financial Service Professionals and at the Delaware Tax Institute.

About Mike . . .

mkelly@belfint.com302.573.3955

• State Filing Obligations Before and After South Dakota v. Wayfair

• Current Status of State Legislation Related to Sales/Use and Income Tax Nexus

• How to Evaluate and Determine Your State Tax Obligations

• The Mechanics of Compliance - Record Keeping, Accounting, and Filing Considerations

Agenda

• Northwestern and Stockham were settled concurrently in 1959 due to similar nature of cases being decided differently by Minnesota and Georgia Supreme Courts

• Activity in states consisted of salesmen and orders which were filled outside of state. Companies rented an office inside the state to house the salesmen

• Net Income from the interstate operations of a foreign corporation may be subjected to state taxation if

o The levy does not discriminate

o It’s properly apportioned to local activities within the taxing state

o The activities constitute a sufficient nexus to support the tax (some definite link, some minimum connection)

Income Taxes – Northwestern States Portland Cement

and Stockham Valves and Fittings, Inc.

• Response to the Northwestern and Stockham cases

• Public Law 86-272 – A 1959 United States statute that allows a business to enter or send representatives into states to solicit or order goods without being subject to net income tax as long as the orders were filled outside of the state

• Some things Public Law 86-272 does not protect:

o Sales of real estate or intangibles

o Anything that goes beyond solicitation

Income Taxes – Federal Law

• Some examples of activities that may create nexus

o Incorporation in the taxing state or having a domicile

o Employment of property or capital in the state

o Having an office in the state

o Rendering services in the state

Income Taxes - Nexus

• Tax on the sale, transfer, or exchange of a taxable item or service

• Use tax applies if sales tax was not charged on a taxable item

Distinguishing Sales and Use

• 1977 Supreme Court ruling in Complete Auto Transit, Inc. v. Brady

o The issue surrounded the imposition of gross receipts or privilege tax (like a sales tax but levied on the seller instead of the customer)

o Auto transporter moving General Motor vehicles from Michigan to Mississippi

• Firmly established the following tests states must meet to tax interstate commerce

o Substantial Nexus – clear connection between state and taxpayer

o Nondiscrimination – putting certain restrictions on out-of-state sellers vs. in -state sellers

o Fair apportionment – taxation of activity that transpires within a taxing jurisdiction. Double taxation avoidance

o Fair relationship to services provided by the state – i.e. police protection

Important Sales Tax Ruling Surrounding Interstate

Commerce

• 1967 Bella Hess mandates the physical presence standard where only contacts were by mail or common carrier lacked substantial nexus.

• 1992 Supreme Court for Quill Corp. v. North Dakota

o North Dakota seeking to collect sales tax on sales of floppy disks shipped into the state

o “Regular and systematic” solicitation into the state

o 6th largest seller of office supplies into the state shipping 230,000 catalogs and other mail weighing 24 tons into the state

o Reaffirms physical presence standard and effectively lays the groundwork to prevent states from collecting sales tax from retail purchases made over the internet

Important Sales Tax Ruling – The Physical Presence

Standard

• A 1993 income tax state ruling favorable to the states related to “physical

presence”

• Geoffrey was a wholly-owned subsidiary of Toys ‘R’ Us, Inc.

• Geoffrey owned the trademarks and trade names surrounding Toys ‘R’

Us, Inc.

• Geoffrey’s business headquarters were in Delaware and received fees

from Toys ‘R’ Us, Inc. based on sales

• Note, Delaware does not tax royalty income but Toys ‘R’ Us, Inc. was

receiving a deduction for those payments made to its parent company

• The court notes, “The net effect of this corporate structure has been the

production of “nowhere” income that escapes all state income taxation

• A holding company that seeks the benefit of economic contact with

South Carolina by directing its economic activity in South Carolina has

nexus with the state

Geoffrey v. South Carolina Tax Commission

• The court in Quill stated,

“Although we have not in our review, of other types of taxes, articulated the same physical presence requirement that Bella Hess established for sales and use taxes, that silence does not imply repudiation of the Bella’s Hess rule”

• Several states begin asserting economic nexus. Supreme Court never chose to review those cases.

Fallout From Quill and Geoffrey – Income Taxes

• In 2002, Multistate Tax Commission developed concept of factor presence nexus

• The proposed model statute states that substantial nexus is established if any of the following thresholds is exceeded during the tax period:

o $50,000 of property

o $50,000 of payroll

o $500,000 of sales or

o 25% of all of the above items

Fallout from Quill and Geoffrey – Income Taxes

• CT (2010)

• CO (2010)

• CA (2011)

• MI (2012)

• AL (2015)

• NY (2015)

• TN (2016)

• HI (2019)

States with Factor Presence as of 2019 for Income

Taxes (Corporate Income Taxes)

• Wayfair, Inc, Overstock.com, and Newegg Inc. were online retailers without any employees or real estate in South Dakota

• South Dakota does not have income tax and relies heavily on salesand use tax

• The court remarks that states lose between $8 and $33 billion every year because of Bella Hess and Quill

• In 2016, S.D. Senate Bill 106 was enacted where South Dakota required out of state sellers to collect sales tax if they delivered more than $100,000 or engaged in more than 200 transactions even if they did not have physical presence

South Dakota v. Wayfair, Inc. Issues

• Quill created an “online sales tax loophole” that gives out of state business an advantage

• The Court should focus on rules that are appropriate to the twenty first century, not the nineteenth

• Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the states

The Court Makes Some General Commentary on the

Physical Presence Rule

• Heavily criticizes Quill

o Remote sellers can avoid the regulatory burdens of tax collection and can offer de facto lower prices

o Discrimination among states resulted from Quill

o 41 states, 2 territories, and the District of Columbia ask this Court to reject Quill

• Wayfair advertises tax evasion “one of the best things about buying through Wayfair is that we do not have to charge sales tax”

• In 1992 when Quill was decided, less than 2 percent of Americans had internet access

South Dakota v. Wayfair Inc. - Court Commentary

• “If some small business with only de minimis contacts seek relief from collection systems deemed to be a burden, those entities may still do so under other theories. These issues are not before this court”

• Quill is unsound and incorrect

• Overrides and rejects Quill and National Bella Hess (the physical presence rule)

• Emphasizes the 4 requirements of Complete Auto still exist

South Dakota v. Wayfair Inc. - Results

• In August 2018, Oregon’s High Court rules against Wells Fargo regarding physical presence

• In September 2019, Pennsylvania determined there is no longer a physical presence standard limiting the ability of the state to impose a net income tax on out-of-state taxpayers. New $500,000 sale rule

• In April 2019, Tennessee emphasizes the factor test or may still have nexus if the “contact with the state is sufficient”

• In 2019, Indiana adopts law that taxes income to “the fullest extent permitted by the US Constitution regardless whether the taxpayer has a physical presence”

• In 2019, Hawaii puts Wayfair standard of 200 transactions or $100,000 on the books

States React to Wayfair – Income Tax

Economic Presence Standard Proposed or Enacted –

Income Tax

AK GA MD NE TN

AL HI ME NH UT

AR IA MI NJ VA

AZ ID MN NM VT

CA IL MO NY WI

CO IN MS OR MV

CT KS MT PA

DC LA NC RI

FL MA ND SC

Issued Guidance or Adopted Laws Centered on

Economic Nexus – Sales Tax

AL IA ME NM TX

AR ID MI NY UT

AZ IL MN OH VA

CA IN MS OK VT

CO KS MT PA WA

CT KY NC RI WI

DC LA ND SC WV

GA MA NE SD WY

HI MD NJ TN

• What is economic nexus - Language used by the states

• Income Tax

o A taxpayer has nexus by engaging in any activity from which income is received, realized, or derived in the state

o A taxpayer has nexus by deriving income from the state’s sources

o Directing its economic activity into the state

o Carrying on any business activity in the state will establish nexus

o Bright line factor presence tests

• Sales Tax

o Bright line sales or transaction tests mirrored after Wayfair

Economic Presence Standard Proposed or Enacted –

Income Tax v. Sales Tax

“Correctly calculating and remitting sales taxes on all e-commerce sales will likely prove baffling for many retailers. Over 10,000 jurisdictions levy sales taxes, each with different tax rates and different rules”

– Chief Justice John Roberts in dissent to Wayfair

A Baffling Prospect

1. Document a complete detailed understanding of your business

• WHAT you do, HOW you do it and WHERE you do it

• What products and/or services do you provide

• How and where are sales made

• Are any post sale services provided, such as warranty work

• Where is inventory stored and when and where does title pass

• Where are employees performing services for the business

• Utilize a flow chart or map to document all possible options for the flow of good and/or services from the business to customers

How to Evaluate and Determine Your State Tax

Obligations

2. Accumulate data to estimate and evaluate sales tax economic nexus

exposure

• Sales sourced by state

• Number of transactions sourced by state

• Use a historic time period for an initial analysis of state contact

• Consider the current and changing status of your customers and sales transactions

Obligations

3. Accumulate data to estimate and evaluate income tax economic nexus exposure

• Property sourced by state

• Rent sourced by state

• Payroll sourced by state

• Inventory sourced by state

• Use a historic time period for an initial analysis of state contact

• Consider the current and changing status of your customers andsales transactions

Obligations

4. Determine the sales tax status of the products/services you provide

• Are they subject to sales tax?

• Are there any legislated exemptions or exclusions available?

Obligations

5. Determine whether your business has sales tax nexus in any state

• Perform a jurisdiction by jurisdiction review

• Determine the existing statutory tax thresholds in each of the selected jurisdictions/states

• Determine if your business activity exceeds the statutory thresholds

Obligations

6. Determine whether your business has income tax nexus in any state

• Economic nexus standard for income tax purposes – generally these provisions provide that nexus can be established by having customers in a state that receive the benefit of a business’s goods and/or services

o Examples: banks issuing credit cards to state residents, law firm clients in other states

Obligations

(Continued)

• Apportionment - for income tax purposes when a business operates in and has nexus with multiple states, each state will seek to tax some portion of the business’s income. This is commonly determined by an apportionment formula

o A business’s income can be thought of as a pie with the apportionment formula determining the size of the slice applicable to each state

o Historically apportionment has been a three-factor formula –sales, property and payroll

o Currently many states have gone to or are moving to a single sales factor for state apportionment purposes

Obligations

(Continued)

• Obtain a listing of the “bright-line” tests

• Determine if your business activity exceeds any of the state bright-line tests

• For states without a “bright-line test”, establish a level of activity in a state that warrants further review and research to determine nexus

• Perform state specific research to determine each selected states rules regarding physical and economic nexus

• Determine if your business activity meets or exceeds the states nexus guidance

Obligations

7. Determine if your business has any county, municipal or other filing

requirements

• Examples include the following:

o Delaware Gross Receipts Tax

o Franchise type taxes – Ohio, Texas

o Ohio and Louisiana have county and parish level taxes in many jurisdictions

o City of Wilmington or Philadelphia levy their own taxes

Obligations

8. Evaluate data gathered and conclude

• Conclude on states the business has sales tax nexus and will file

• Conclude on states the business has income tax nexus and will file

• Trailing nexus issues – do you have filing obligations that are currently delinquent?

• Statute of Limitations considerations

• Review state availability of Voluntary Compliance or Tax Amnesty programs

Obligations

9. Develop an action plan to get compliant

• Develop a time-line and work plan (discussed in further detail in the “Mechanics” section)

• Assign responsibility and oversight roles

• Seek assistance with accounting or software partners

Obligations

10. Determine a schedule for periodic review of business activity and

compliance requirements

• Has nexus been established is any new states by changes to your business – new customers, new locations, increased state activity

• Does nexus no longer exist in a state you have been filing in

• Have errors occurred with accounting or billing systems used to accumulate data and file returns

Obligations

11. Other Considerations

• Financial statement items – should contingent loss reserves be added or updated on your financial statements

• M&A considerations – special attention should be paid to potential state liabilities that could exist

Obligations

1. Determine what systems, processes and information is required to meet new tax filing responsibilities

• Responsibility remains with the business – you can outsource compliance assistance but not the legal obligations associated with it

• Recordkeeping – what records need to be kept

• Review and classification of current product and/or service sales for relevant state tax withholding and reporting purposes

• Will modifications need to be made in item/product classifications

• Is required customer data available to determine how to properly source sales (billing versus delivery)

• Process in place to acquire resale and exemption certificates

Mechanics of Compliance

2. Evaluate existing systems and infrastructure to determine their capacity to support proper taxability decisions and proper sourcing rules

• Systems/technology review:

o Source data needs tax sensitization

o Tax software – ability to create and maintain user defined rules in one place and allow for a single source for a transaction

o Data validation, does the extracted data reconcile back to the general ledger, is it accurate and complete, is the entire population captured

o Interface with tax software to determine tax obligations and reporting requirements

3. Determine information required to be accumulated by your

accounting system to meet your compliance requirements

• Identification and measurement of sales volume by state

• Identification and accumulation of number of transactions by state

• Customer information

• Products/services information

• Shipping/Delivery information

• Pricing and invoicing information

4. Develop a strategy to register and remit sales and/or income tax

• Filing Considerations

o Registering to do business or other state notification requirements

o Acquiring the applicable state identification numbers

o Requirements to file and deadlines – annual, quarterly, monthly, zero returns

o Requirements to pay electronically

4. Develop a strategy to register and remit sales and/or income tax

(continued)

• Periodic compliance review of tax rules, tax rates, exemptions, forms, filing and depositing deadlines and frequency

• Reporting and reconciliation – end to end reporting - reconciliation from general ledger, to return to payment back to general ledger

• Is outsourcing an option? Is it a cost-effective alternative?

5. Consideration of other potential direct or indirect tax impacts

• Other taxes obligations - franchise or gross-receipts

• Impact on financial reporting (uncertain tax positions, new liabilities and accruals required)

o Potential interest and penalties associated with non-compliance

o Effect on due diligence and M&A transactions

• Will the current sales/use tax landscape be sustained – where are we in this legislation cycle?

o Will this tax expansion raise enough congressional concern by taxpayers to result in federal legislation to “rein in” the states?

o Historically, Congress has been unwilling to get involved in these state taxation issues.

• Is this the new normal, will there be a loosening or tightening of the requirements?

• Is it possible there could be a legal challenge to the “undue burden” aspect of these requirements?

What Does the Future Hold?

• Where are we on the income tax legislation cycle – can economic nexus be upheld, will there be cases?

o The unwillingness of the Supreme Court to review these laws, coupled with the Wayfair decision that physical presence is not required to have nexus, has many believing there is sufficient support for the constitutionality of the income tax economic nexus statues

• Do we expect most if not all states to continue to pass laws asserting economic nexus in this manner?

• Do you expect a greater frequency of state income and sales tax audits in the future?

What Does the Future Hold?

Questions?

Important State and Local Tax (SALT) Considerations…after Wayfair · 2019-10-31 · Within the...

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