By Terry Barrett, CPA, Tax Senior Manager | State & Local Team Leader
State Tax Planning—What You Need to Know for the 2019/2020 Tax Season
State and local tax compliance is becoming increasingly complicated. Having customers or business activities in more than one state potentially subjects businesses to multiple state and local tax requirements.
As you look to close out 2019 and look ahead to 2020, there are several state and local tax issues worth considering for your business, including:
Over a year has passed since the South Dakota v. Wayfair ruling. Most states are now imposing sales/use tax registration requirements on remote sellers selling into their states. Thus, the requirement that a business have a physical presence in a state in order to be subject to the state’s sales/use tax requirements is no longer valid in most states. All but two states that impose state level sales tax, Florida and Missouri, have adopted economic nexus provisions with both Florida and Missouri expect to adopt such provisions next year.
Most businesses are affected by the Wayfair decision. If selling product or providing potentially taxable services to customers in other states, whether by internet, phone, fax, or otherwise, and the sales reach the state-specific filing thresholds (typically $100,000 in gross sales or 200 separate transactions in the current or previous calendar year), the business may be subject to state registration, collection, and filing requirements. However, if the businesses have physical presence in the state (and many do, through sales people, etc.) the thresholds do not apply; they have tax collection requirements – period. It is important to note that sales tax collection requirements can and do apply to providers of services in states that tax services. Further, several of the state require registration and filing of returns even if little to no taxable products or services are sold.
A majority of states have also enacted economic nexus provisions for marketplace facilitators. Thus, to the extent a business sells through a marketplace facilitator (such as Amazon or eBay) the marketplace facilitator generally is required to collect the tax on sales made through it yet the business remains responsible for the tax requirements on its own sales.
If you are not up to speed on the Wayfair case and how it affects your business, we recommend you focus on this immediately. The states’ rules regarding the tax requirements (thresholds, sales counting towards thresholds (whether retail, gross, etc.), what periods are included in the thresholds (calendar year, 12 months, four quarters, etc.) separate transaction requirements, effective dates), are different and continue to change.
2. Wayfair Implications for Income/Franchise Tax
The Wayfair case also has had an impact on state income taxes. While a majority of states have already adopted economic nexus for income/franchise tax purposes, a few states recently have adopted or clarified their policies as follows:
For taxable years beginning January 1, 2020, Pennsylvania has adopted a rebuttable presumption that taxpayers having $500,000 or more of Pennsylvania-sourced gross receipts but with no physical presence in the state must file a Corporate Net Income Tax return. Taxpayers whose activity in the state is limited to the solicitation of sales of tangible personal property and who are typically protected from state income tax requirements by federal law, Public Law 86-272, will still have to file Pennsylvania tax returns (but owe no tax) under the new provisions.
Effective October 18., 2019, Massachusetts adopted a regulation that requires corporations with no physical presence but with sales of $500,000 or more into the state to be subject to the corporate excise tax. Corporations that only solicit sales of tangible personal property in the state yet meet the $500,000 threshold may be exempt from the income tax measure of the corporate excise tax due to Public Law 86-272 but will be subject to the non-income measure or minimum excise tax.
The Texas Comptroller has proposed changes to a regulation that will require out-of-state taxpayers with no physical presence in the state but with sales of $500,000 to be subject to its franchise tax effective beginning with reports due on May 15, 2020. The Public Law protections mentioned above for Pennsylvania and Massachusetts do not apply to the Texas franchise tax.
Other states have issued tax releases confirming how the Wayfair decision support their economic nexus policies regarding their own income/franchise or gross receipts tax rules.
- Sales/Use Tax
See Wayfair above – Economic nexus rules apply in most states but as noted above do not overlook physical nexus issues. If a business has a physical presence (assets, inventory (even if stored in an Amazon fulfillment or other distribution facility), an office, warehouse, employees, or independent contractors in a state, it has sales/use tax collection requirements on sales of taxable goods and services into the state. Employees working from home (even if not engaged in soliciting sales) or occasionally traveling into states create nexus. The economic nexus thresholds noted above do not apply in situations where a business has physical nexus. We recommend you review where you have physical presence to determine potential sales/use tax requirements and take corrective measures where appropriate.
- Income/Franchise Tax
Federal law, Public Law 86-272, provides protections against income tax filing requirements if a business is solely engaged in soliciting sales of tangible personal property in a state. However, the Public Law 86-272 protections do not apply if a business goes beyond soliciting sales of tangible goods or if the business is providing services. Further, it is not applicable to franchise, gross receipts and other alternative base taxes, such as the Texas Franchise Tax, the Ohio Commercial Activity tax, the Washington B&O tax, and various others. It is important to note that most states now have economic nexus provisions meaning states may require income tax returns/payments where a business has mere sales into a state. The economic nexus provisions typically apply to income and franchise/gross receipts taxes. Thus, as noted above while the Public Law 86-272 protections apply to income tax, they do not apply to the other tax types nor do they apply to service providers. Service providers may find they have filing requirements due to economic nexus in various states.
There has been trend among the states to adopt market-based sourcing for apportioning receipts for sales of services or intangibles for corporate income tax purposes. Market-based sourcing attributes the sales of services and intangibles to a state if the taxpayer’s “market for the sale” is in the state. The method for determining a business’ market varies by state based upon: (i) where the benefit is received; (ii) where the service is received or delivered; or (iii) where the customer is located. In addition, the states have different rules for apportioning receipts for specific industries.
Virginia sources receipts for services based upon the cost-of-performance approach. With that approach receipts are sourced to the state where the costs of performance is located – where the service is performed. North Carolina recently adopted market-based sourcing which will be applicable to the 2020 tax year.
Having sales, particularly of services and intangibles, to customers in states that have adopted market-based sources may have a substantial impact on a business’ income tax filing requirement, if the states have adopted economic nexus provisions. Knowing the states’ rules is key to being in compliance.
5. Pass through nonresident withholding
Many states require nonresident income tax withholding from state-source income for pass-through entities. The withholding requirements are at the entity level – the entity must pay the tax on behalf of the nonresident members. There are certain exemptions in some states from these requirements. For example, the entity may file a composite return for non-resident shareholders or partners if the state allows such composite returns. In addition, some states allow an exemption from withholding requirements if the nonresident shareholders or partners sign a waiver or certificate that they will be responsible for filing their own individual income tax returns and reporting their share of state income accordingly. Failure to comply with the state nonresident withholding or composite return requirements may be an issue during a merger or acquisition.
By law, employers are required to withhold income taxes for their employees. States’ laws vary considerably yet withholding is generally required if a business has one or more employees performing services in the state and if deriving income from doing business in that state. Some states require withholding based upon the number of days worked in the state (anywhere from 1 day to 60 days), earnings while in the state (e.g., $5,000), or a combination thereof. If you have employees living or working in states other than Virginia, whether on a full-time or temporary basis, you may be subject to withholding (and unemployment compensation) requirements in those other states. Be sure you know where your employees are living and working, and consider the state-specific rules that may be applicable.
7. USE TAX
This is an issue that businesses often overlook and really only come to terms with when a state tax auditor audits their business. All businesses should be paying sales/use tax on their purchases of tangible personal property for their own use, unless a specific exemption (i.e., resale, manufacturing, nontaxable item/service) applies. Typically, if purchases are made locally, tax is collected by vendors. However, if purchases are made online a seller may or may not collect the tax. We strongly encourage you to review your online purchases (credit card statements) and purchases otherwise from out-of-state sellers to determine potential use tax that may be due. The tax that is identified should be self-assessed and reported to the Department of Taxation.
It is anticipated that some of the use tax issues will go away since Virginia adopted economic nexus provisions requiring remote sellers to collect Virginia’s use tax effective July 1, 2019. Further, Virginia, like a majority of states, has adopted economic nexus provisions for marketplace facilitators thereby requiring such facilitators to collect tax on behalf of third-party sellers selling through their marketplaces. Taxpayers should still confirm that the sellers are collecting the correct tax rate and appropriately taxing their purchases.
Local business license taxes are in effect in most localities in Virginia (may also apply in other states). If a business has moved from one locality to another during the calendar year it generally is entitled to a refund of business license taxes paid in the former locality for a portion of the year. Some localities require businesses to submit forms notifying them of the moves. If your business has moved during the year, do not overlook possible local tax refunds. Refunds generally are not allowed on payments of personal property taxes, though.
In addition, take the time to focus on your local tax requirements. Since most localities impose their BPOL tax on gross receipts, to the extent you can reduce the taxable receipts by taking advantage of the limited exemptions/deductions or by seeking a reclassification of your business if classifications with lower rates are more applicable.
Many businesses still are not aware of their requirements to report to the states AUP such as uncashed payroll checks, expired gift cards, overpayments by customers/credit balances, unrefunded deposits, etc. after the property has been dormant (unclaimed by the owner) for a specified period of time (typically 5 years). Penalties for noncompliance can be high, however many states offer voluntary compliance programs through which property can be reported and penalties waived. We recommend that businesses at a minimum start evaluating potential AUP they hold.
10. SALE OF BUSINESS
If business owners are contemplating an exit or sale in the next three to five years we suggest they consider a top level review of potential state and local tax exposure. Often we find that SALT liabilities discovered through due diligence are deal-breakers.
As a result of the Wayfair ruling, there is a heightened focus on tax compliance with regard to mergers and acquisitions.
The above are not ALL the issues businesses should consider – just some of the top ones. Where there are potential tax filing/payment oversights, the sooner measures are taken to correct them, the lesser the penalties and interest that may be applicable. At a minimum, now that you are aware of some of the issues you can develop a plan to address them. Your Keiter advisor is available to assist you with any questions or assistance you may need. Please reach out to us. Email | Call 804.747.0000
Additional State and Local Tax Resources
- 2019/2020 Tax Planning Guide
- 2019 Tax Planning for Virginia Businesses
- 2019 Tax Planning for Executives and Entrepreneurs
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.