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Addressing Prior-Year Tax Exposure Issues: Nexus Studies

 

Addressing Prior-Year Tax Exposure Issues: Nexus Studies

In light of the June 21 U.S. Supreme Court decision involving South Dakota v. Wayfair, Inc., it is extremely important for a business to understand any prior tax risk in a state before it registers to collect sales tax, based on the state’s economic nexus rules. Prospectively registering to collect and remit sales tax in a state, without reviewing prior periods, could prompt a state-initiated review of prior periods and potentially expose your business to filing prior returns (8 to 10 years in certain states) while disqualifying your business from participating in any voluntary disclosure programs to mitigate your risk for prior periods. That is why it is extremely important to understand the concept of nexus prior to the Wayfair decision.

Nexus is a concept that many businesses do not understand from sales/use tax and income/franchise tax perspectives or in relation to those states which impose some type of entity-level tax on business receipts. Let’s define nexus:  The degree of business activity or connection that an out-of-state business must have before a state can enforce a right to file and either collect or pay taxes. Nexus is established when a business has a physical connection with (or in some cases an economic presence in) a state through employees, property, volume of sales, or other action. The December 16, 2014, SALT-ED article, SALT-ED Q&A: When do I pay taxes in another state?, addressed the nexus topic. This article will address the remedies that are available to businesses when they have been doing business in a state in past years and not filing the proper returns. Before we get to the remedies, we must briefly cover the necessary steps that lead to quantifying potential risk for not filing the necessary multistate tax returns.

Nexus Study:  Analyzing Business Activities

The first step in understanding a business’s risk related to past noncompliance with filing tax returns is to conduct a nexus study. The primary goal of a nexus study is to identify the potential risk (tax, interest, and penalties) a business might face in not being compliant with state tax filings. A nexus study is a detailed review of the businesses activities conducted outside the business’s home state to identify potential tax filing requirements. Generally, a nexus study will identify the potential tax risk associated with the non-filing of state tax returns. Remember, if no return(s) has been filed in a taxing jurisdiction, there is no statute of limitations. If the statute of limitations has not yet begun to run, a state can require the company to file the necessary returns for as many years as it likes. Some states are allowed by statute or administrative rule to go back only for shorter periods of time such as six or eight years. The lookback period for noncompliant returns varies from state to state.

Nexus Study:  Quantifying Risk

Once the relevant states in which a business is noncompliant have been identified, it is time to quantify the potential exposure, which generally includes tax, interest, late-filing fees, and non-filer negligence penalties. It is important that any potential exposure include not only sales/use tax or income/franchise tax, but also any taxes imposed on the business’s gross receipts (i.e., Washington’s B&O tax, Ohio’s commercial activities tax, or Nevada’s commerce tax).

From a sales tax exposure perspective, it is important for a business to determine whether it has made taxable sales of products or services to customers in states where no returns have been filed.

Reach out to customers for which no certificates are on file or for which there are missing/incomplete exemption certificates. Many times, customers will not be able to provide a valid exemption certificate and will inform you they are taxable. If this situation arises, reach out to the customer and inquire about whether the customer paid use tax to the state or has gone through a sales and use tax audit and paid use tax on the transactions in question. Obtain documentation/support of your customers’ paid use tax for your files. Sales to customers for which use tax was paid directly to a taxing authority can be excluded from the exposure computation.

Nexus Study:  Follow-up Action Plan

Once the potential risk has been quantified for noncompliance, the last step is to put in place an action plan to ensure compliance not only for past years, but prospectively as well. It is extremely important for the business to understand the risks of conducting business activities in a state and not filing the required returns. At this point, a business may decide to do nothing and continue with the status quo. The tax risk, as well as added interest and penalties, for unfiled tax returns will continue to grow. A business may also decide to file tax returns on a prospective basis and not address prior years. Note that the unfiled tax returns for prior periods generally will not go away, since the statute of limitations has not begun to run. The other risk in this situation is completing a tax registration form for a state that asks for the “date began business in the state.” The registration document is generally signed by someone from the business under penalties of perjury.

Many businesses will address prior risk through either a voluntary disclosure agreement or a tax amnesty program and then register at the same time to ensure compliance on a prospective basis.

How Wipfli Can Help

Understand your unique situation as a result of the Wayfair decision by getting a SALT Assessment Review, which includes a nexus study of the top 10 states where you do business. Wipfli can also expand this initial review to all states, depending on your situation. We will help you understand in what various states you may have not only sales tax filing requirements, but also income tax and economic nexus for non-income taxes such as B&O, CAT, net worth, and minimum taxes.

Author(s)

Craig Cookle
Craig Cookle, CPA
Partner
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