21 Oct Avantisteam Writes Watch your SALT – NJBIZ
When Thomas Corrie, a principal at the accounting, tax and business consulting firm Friedman LLP, engages in a nexus study on behalf of a client, he sometimes finds that a business has sales to multiple states, but is only filing tax returns in some of them.
“When I see that, I ask them why,” said Corrie, who serves as director of Friedman’s State and Local Tax Group. “Nexus is getting more complicated, and it’s not always apparent to the business, especially smaller- and mid-size ones,” he said, referring to a connection between a business and a state or other taxing jurisdiction that triggers an obligation to file an income tax return, or collect and remit sales tax there.
One client, for example — a small shop that sells goods to multiple states through Amazon — “may have nexus in almost every one without knowing it,” he said, since Amazon’s local warehouses could establish nexus for the seller. “One way states may discover this is when they audit a ‘resident’ company and see if it’s receiving goods or services from an out-of-state company. If that’s happening, the state will check to see if the ‘foreign’ company is filing the appropriate returns locally. This happens all the time.”
Generally, “states determine income on business entities that operate in more than one state by apportioning income to a respective state, using different factors such as sales, payroll, and/or property,” according to Jason Rosenberg, a state and local tax senior manager at Withum, an advisory and accounting firm. “This is what is known as the apportionment percentage or factor. Each state has their own enacted provisions and guidance in making these computations. With respect to the ‘sales factor’ component of apportionment, states generally use either market sourcing [where the benefit is received] or cost of performance sourcing [where the service is performed], in assigning sales to a state.”
Earlier this year, New Jersey may have muddied the waters by adopting new tax rules as part of an overhaul of the New Jersey Corporate Business Tax, or CBT. Services in most states used to be sourced, or subject to tax, based on the cost of performance method, according to Corrie. “But beginning with tax years ending on or after July 31, 2019, New Jersey is following the lead of more than 20 other states that have adopted ‘market-based sourcing.’”
Under the market-based sourcing approach, out-of-state businesses subject to New Jersey’s Corporation Business Tax will generally have to source, or pay income tax on, the sale of their services to New Jersey, as long as the benefit of those services is received in New Jersey. The CBT generally applies to C corporations and some Subchapter S, or pass-through, corporations.
“This has been a trend in state and local taxation over the last several years,” said Harold Hecht, a managing director at the accounting, advisory, audit, tax, and consulting firm Mazars USA LLP, and practice leader of the firm’s State and Local Tax Services. “It’s occurring as states abandon concepts of where services are performed, or where the costs of performance take place, substituting ‘market-based’ allocations instead.”
States cast a wider net
To find out-of-state companies that should be filing tax returns but aren’t, New Jersey and other jurisdictions no longer simply rely on audits. “States have continually improved their data-mining skills to identify non-filers through various information sources,” Hecht noted. “These include company websites, and social media among others.”
Smaller businesses in particular need to be careful, he added. “Many small businesspeople are focused on growing their business and do not have the internal resources of larger organizations to monitor state taxes.”
Penalties can run “close to 50 percent of any unpaid liability that exists over a long period of time,” he added, as late filing, late payment and negligence penalties are often assessed. Also, there’s “no official limitation on the number of years they can assess, because statutes of limitations do not apply when no return has been filed. That’s why it’s critical to identify tax exposures and to engage a professional to secure voluntary disclosure agreements, before the states come knocking on the door.”
Mazars USA LLP recently assisted a financial services company in proactively cleaning up its tax act. “We helped them to identify a number of states that they should have been filing in,” said Hecht. “We also helped them to mitigate their prior liabilities by securing ‘voluntary disclosure agreements’ with several jurisdictions. These agreements typically permit a limited lookback period of three to four years, with all taxes prior to that forgiven. Penalties are also typically waived under voluntary disclosure.”
Determining which sets of rules a business is subject to — market sourcing or cost of performance sourcing — is bad enough, but the fact that there’s no uniform application between states could make the situation even worse.
“You can get whipsawed,” warned Friedman LLP’s Corrie. “Let’s say your company is based in a cost of performance state [where tax is determined by where the service is done], and you do something, in your home state, on behalf of a client located in a market sourcing state [where tax is determined on where the benefit is received] — you could end up being liable for tax in both states.”
On the other hand, a business that’s located in a market sourcing state that performs services for a client in a cost of performance state could end up not owing any state tax liability for the activity.
“Sourcing rules can change quickly, however, so it can be very difficult to plan for this,” Corrie said.
Besides potentially differing from state to state, sourcing rules can vary for different tax types within a state, “like corporate rules, compared to unincorporated business rules,” Hecht said. “It’s prudent to review the details behind any apportionment schedules that are prepared, as these [business-prepared schedules] sometimes incorrectly use the wrong allocation rules — for example based upon location of customers, when a state requires allocation based upon where services were rendered.