As we progress into 2021, many state budgets will continue to feel the pain caused by the COVID-19 pandemic. In order to make up for these budget shortfalls, there will inevitably be increased audit and enforcement activity in a number of states. While an audit is never a welcomed event for any taxpayer, taking proactive steps before an audit notice is even received can help make the process as smooth as possible.
For starters, it is helpful to have an understanding of not only the location of your company’s sales but also the level of company activity in each state. Such activity may include, but is not limited to, whether or not sales are made in company vehicles, if installations are performed, the activities of salespersons in a particular state, and in some cases the state residence of employees. The level of these activities in each state will determine whether or not your company is subject to their tax jurisdiction, a concept commonly referred to as nexus.
Once you have a good understanding of sales and company activity in each state, it is important to know what tax types may be applicable to your business activity. Questions that should be considered include:
- Does the state impose sales tax on your given product/service?
- What are the income tax apportionment factors?
- Does the state impose a gross receipts or non-income based tax?
- Are there any industry-specific taxes that may be applicable to your business?
Often, many seemingly benign activities in a state could give rise to potential tax liability and create an audit risk.
In addition to reviewing business activities in states where your company is not currently filing tax returns, it is equally important to periodically review current tax filings to ensure that they are being completed properly. Changes in business practices and applicable laws can often affect a variety of state tax filings and could create additional liabilities (or even refunds!).
If you discover a potential tax liability in a state (including taxes that you may already be filing), and your company is not yet under audit, there are tools available that may help limit lookback periods, penalties and interest. The most common way to mitigate a potential liability is through voluntary disclosure. In exchange for coming forward and voluntarily disclosing tax liabilities, states may limit the lookback period and waive penalties and/or interest. Similarly, states in budget crunches may offer amnesty programs that operate much like voluntary disclosures but may offer additional incentives to participate, such as additional interest and penalty waivers. However, amnesty programs are typically offered for a limited time period and they may not offer the shortened lookback periods available with voluntary disclosure agreements. While there are many benefits of amnesty programs, taxpayers should review all options available and determine the best course of action.
State taxes are an inevitable part of a business operation, but with a little bit of planning and preparation, they can be effectively managed to mitigate potential exposure and audit risk.
Article written by:
Jeffrey Monsman, JD
Senior Manager, State & Local Tax Services
