Don't let state taxes play the villain in your business story

Our lives are like a book. A story. A journey. Each day is a new page, a new paragraph, a new sentence, a new word. There are chapters to our lives. There is a preface, a foreword, an introduction. There are many plot lines, unexpected twists and turns. Sometimes we are the hero, sometimes we are the villian. Sometimes we know exactly what to write and other times, we just stare at the blank page. Too many options, not enough options. Do we rewrite the story? Do we turn the page? Is it time to start a new chapter or do we keep going down the same road. When good times happen, we want it to last forever. When bad things happen, we can't wait to turn the page or move into the next chapter. Sometimes we cause change and sometimes change is forced upon us. We grow, we age, we hopefully learn. We adapt, we improvise and hopefully overcome. We learn what we like, what we don't like. Our personal and professional lives intertwined. Working to focus, to achieve, to realize goals and dreams while balancing time with families and friends. Obsession leads to great things, when obsession is focused on the right things without sacrificing the most important things (which aren't things).

I'm not quite sure why I started with that intro, but hopefully it means something to you.

As business owners, business and/or tax professionals, our work takes up a lot of our time, our lives. Thus, business is personal and should be taken seriously. It is how we support ourselves and our families. It is a big part of our story. They often say that what you do is not who you are. That what you do doesn't define you. I don't think that's necessarily true. It is often difficult to separate what you do from who you are. We all take on the identity of what we do or atleast for some part of the day. Or maybe we take on an alter ego. Regardless, we have our bios that tell people some of who we are, but not the whole picture.

Right about now, you are probably asking, "how does any of this relate to state taxes?" Well, as I have done in many of my blog posts over the last decade, I will attempt to bring this back to state taxes.

Companies have a story. They have a lifecycle. They start out with an idea, a vision, a dream, a goal. Then they get capital and make investments. They pick a location, buy or build a facility, hire people, start selling, start shipping, in one state, in multiple states. Then they grow - hire more, build more, sell more. Maybe they create new legal entities, new ownership structures. Maybe they start selling different products and services. Maybe they build new facilities and hire more employees in multiple states. Maybe the entities sell to each other. Maybe the entities start selling to customers in foreign countries. Maybe they create foreign entities that sell into the U.S. Maybe they acquire another entity or they are acquired by another entity. Maybe the owners simply sell their ownership interest and move on to begin another venture.

All of the above changes, stages, activities create different state and local tax issues, risks and opportunities. Some companies plan ahead before making a decision or taking action, but often the action happens before the state tax impact is taken into consideration. This results in potential tax exposure or liabilities that arise and can grow if they are not discovered or investigated. Sometimes planning ahead could have eliminated any exposure and perhaps even created tax savings or refund opportunites. Some state tax issues related to the above are:

• knowing when to file returns in a state (i.e., having a taxable presence or nexus)

• knowing when to collect sales tax on the company's sales (sales taxability study)

• identifying tax credits and incentives related to building/investing in a specific state, county or city

• identifying any sales tax exemptions related to the company's purchases

• knowing how each type of legal entity is taxed from a state income tax perspective

• knowing the state tax impact of integrating new companies, merging companies or selling interests in a partnership or S corporation

Each stage of a company's business tells a story. Is filled with various facts, plots and challenges. State taxes play a key role and impact every chapter, every page, and perhaps every sentence. State taxes can be the hero or the villain.

Being proactive is always better than being reactive or playing the "wait and see game."

conduct state tax "year-end" planning early, often & always

This is a Public Service announcement. Revealing a secret from the state and local tax underground. A secret that makes it difficult for companies to do business. To stay in compliance. To avoid compounding tax liabilities and interest and penalties.

What is this secret?

Wait for it . . . . . . . .

State taxes are a "moving target."

A "moving target" is defined as:

• something that moves while someone is trying to hit it

• something that is always changing

Some state tax rules don't change. Some state tax rules change at a certain time or in a certain tax year based on federal or state legislation. Some state tax rules change every year. Some state tax rules change suddenly based on a court case or ruling. Some state tax rules change without you knowing it based on a state's internal policy decision or change in interpretation of a statute or regulation.

• So how does a company plan?

• Conduct year-end planning?

• Conduct beginning of the year planning?

• Plan for acquisitions, mergers, divestitures?

Companies must stay on top of income tax laws on a tax year by tax year basis. Meaning, income tax laws are generally static for a specific tax year, but can change from year to year. Thus, tax pros should not follow "SALY" (same as last year) when preparing returns. This can lead to "IAP" (interest and penalties). With that said, there are situations when court case decisions or rulings happen that may have retroactive impact and create amended return / refund opportunities or may simply alter prospective returns.

In regards to sales tax, there are static rules but the interpretation of some of those static rules can change and are definitely not the same in every state. Sales tax rules and tax rates can change at different times of the year due to court cases, rulings and state legislation. Unlike income tax, sales tax periods are generally monthly, quarterly or annual

It's the lack of uniformity among state tax laws that creates risks and opportunities.

Some state income tax laws that may differ from state to state are:

• Economic Nexus (creating a taxable presence)

• Sales sourcing of sales of tangible property and services

• Requiring throwback of sales

• Allowing or requiring combined reporting

• Allowing a pass-through entity (PTE) to make a PTE tax election (i.e., $10,000 SALT-CAP work around)

• If PL 86-272 protection applies

• Conformity to federal international tax considerations (i.e., GILTI, FDII, deemed dividends, ECI, etc.)

• Treatment of bonus depreciation

• Treatment of disregarded entities (i.e., single-member LLCs or Q-Subs)

Some sales tax laws that may differ from state to state are related to the following:

• Sourcing of sales of services (including multiple points of use)

• Sourcing of sales to/from non-US countries

• Sales of software, SaaS, and other computer services

• Sales of information services or data processing

• Sales of services

• Sales by construction contractors

• Treatment of sellers in drop shipment transactions

• Allowable or acceptable forms of exemption certificates

• Treatment of leases (lessors and lessees)

• Width and breadth of manufacturing exemption

• Occasional sale or casual sale exemption when selling assets or business

• Treatment of repairs and maintenance (labor and parts)

• Treatment of research and development activities

• Sales to governmental and non-profit entities

I could keep going, but I think you get the point.

So what is a company supposed to do?

Depending on what stage your business is (i.e., start-up, emerging, growth, mature), I recommend you inquire of your tax professional about the state tax impacts of your business. You may only have one or a few states to deal with right now. Some of you may have 20 or more states to consider. The key is to get on top of it now. To know what you don't know so you can make informed decisions. To stop problems from growing out of control and implement proper procedures and tax decisions. Be proactive. Don't let blind spots create a compound effect of problems.

Conduct year-end state tax planning, early, often and always.

QUOTES

• "In all affairs, it's a healthy thing now and then to hang a question mark on the things you have long taken for granted." - Bertrand Russell

• "Bureacracy is the art of making the possible impossible." - Javier Pascual Salcedo

• "Knowledge is the beginning of practice; doing is the completion of knowing." - Wang Yangming

"darkness is death"

Time change. Daylight savings time. Fall back. Spring ahead. However you describe it, most (if not all of us) changed our clocks recently. We either gained an hour or lost an hour (depending on how you look at it), but one thing I do know - I've lost daylight. So I'm not sure how this is "daylight savings" time. I don't like to complain, but I just do. So I'll just say that I really like sunlight and dislike darkness. As they said in a cartoon movie I can't remember the title of right now - "Darkness is Death."

Regardless of how you feel about changing your clocks or sunlight or darkness, one thing is certain, times continue to change. The way business is conducted continues to change. New technologies are created (whether that's good or bad; or will be used for good or bad is yet to be seen). And last but not least, state tax legislation continues to change; and court cases and rulings continue to be made which ultimately create certainty and uncertainty. Wait, what? What did you just say?

Yes, new legislation, court cases and rulings create just as much uncertainty as they do certainty.

Well, that's great.

Just as each company's facts and circumstances differ, state tax laws seem to have a life of their own when the answer isn't "black and white" (which is most of the time); or when each state's laws are different. This creates a world of grey (or some may say, "darkness"). This "darkness" is why I say every state tax question is a research question. (A research question that needs to be solved by a human (not A.I., AI or artificial intelligence, just saying)).

Darkness is debilitating. It's hard to drive in the dark without headlights. It's hard to walk in the dark without a flashlight. Darkness creates fear and uncertainty. Darkness creates unknown risks. Thus, light is needed to move forward with some level of assurance and confidence.

Darkness can also create unknown opportunities. You can't see them. This requires faith. A compass. A navigator. A roadmap.

"Darkness" in the state tax world surrounds several areas and questions companies continually ask:

• what states do I need to file tax returns in?

• is what I'm selling subject to sales tax?

• which entity in my affiliated group of companies is required to file the tax return?

• if I sell my interest in this partnership, to what states do I source the gain and have to pay tax?

• I'm selling services all across the United States. How do I source those sales to each state in the apportionment factor of my income tax returns?

• do I really have to get exemption certificates from my customers?

• do I have to register with a state for sales tax purposes to provide a vendor with that state's resale exemption certificate or can I use a multijurisdictional certificate?

• am I required to file combined income tax returns or does every entity file separately?

• should I make this election or that election?

• do I qualify for these tax credits?

• do I have to collect sales tax on my total gross receipts or can I deduct costs reimbursements or costs that I flow-through and pay to someone else?

• how do I know if we really meet the requirements to be protected from a state's income tax by P.L. 86-272?

• I didn't even know that state had a gross receipts tax.

• what is a franchise tax and why is the tax base so high?

• am I really selling SaaS and does the state tax it?

• should I make a state's pass-through entity tax election? How do i quantify or model the impact? Will it be beneficial for all partners and shareholders?

• should I file a Voluntary Disclosure Agreement (VDA) or simply start filing returns?

• should I request a Private Letter Ruling (PLR)?

• should I challenge (protest) this audit assessment or simply pay it and move on?

• when can I stop filing returns in a state?

• how do I dissolve or withdraw from a state?

• is registering with a state's Secretary of State's Office the same thing as registering with a state's Department of Revenue (taxation)?

• what sales tax compliance software should I use? Should I outsource the return prep to a third-party?

I could keep going, but I think you get the point. The darkness is everywhere.

Finding the light in the state tax world is not easy.

Unlike darkness in life where you can just flip the light switch and see, darkness in the state tax world takes research and analysis and judgment based on experience. And even then, the answer may not be clear (still dark or grey).

Consequently, I think the "light" is finding the right-fit state tax consultant that you trust and like working with. Someone with not only the technical knowledge and experience, but the ability to look at an issue from 2 feet and 50,000 feet. To be technical and practical. To look at the risk and provide judgment. To reduce risk. To recommend positions with the proper level of assurance. Knowledge. Judgment. Advocacy. That is the light in the proverbial darkness. The compass. The roadmap. The flashlight. The headlight.

I hope you find the light you need to move your company and clients forward.

If you are a state tax consultant, I hope you "shine brightly."

QUOTES

"The art and science of asking questions is the source of all knowledge." - Thomas Berger

"The prize goes to the person who sees the future the quickest." - William Stiritz

"We are drowning in information and starved for knowledge." - John Naisbitt

Will Your Company Owe More or Less State Tax After the Merger?

Is your company considering restructuring its business? Perhaps creating new legal entities or re-aligning its lines of business into different entities? Changing the ownership structure of the legal entities within the commonly controlled affiliated group? Or maybe it is considering acquiring or merging with a new business (unrelated third-party)?

Regardless of your company's situation, in each of the above mentioned scenarios, your company must perform its due diligence prior to completing any transaction or restructuring. That due diligence should take into consideration the impact the restructuring or transaction will have on the business operations, legal obligations, insurance, finance, and tax, etc.

Additionally, the company can't neglect state and local tax due diligence. If the transaction ends up costing the company a significant amount of state tax dollars now or in the future, you may be asked if these issues were considered or reviewed prior to completing the transaction.

The state and local tax impact can be material and varied. Some of the potential state and local taxes to take into consideration are: income tax, gross receipts taxes, franchise taxes, sales and use taxes, property taxes and transfer taxes.

Usually the biggest concern in regards to the transaction from a state and local tax perspective are:

1. Is there any sales tax on the sale or transfer of assets or change in ownership?

2. Is there any transfer tax on the transfer of assets or change in ownership?

The answers to these questions depends on the state or states involved.

In addition to the above, the impact that the restructuring will have on the business' state tax nexus (taxable presence) position across the country should be reviewed and considered before making any changes.

M&A Activity Expected to be Strong For 2017

According to a KMPG, LLP survey, 84% of those surveyed expect to initiate a deal in 2017, 75% plan on doing multiple deals. Middle market deals are expected to dominate in 2017 and 78% say their deals would be worth less than $500 million. The most active industry is technology (45%).

Not all deals made it to completion in 2016. According to the KPMG survey, deal failures were most frequently caused by valuation disagreements, a bidding loss and issues revealed during due diligence (financial, operational and management).

Here is  link to the KPMG survey.

Here is a link to a Middle Market M&A study put together by Citizens Commercial Banking.

Here is a link to a Forbes article on the 4 biggest trends in M&A for 2017.

Is your company considering restructuring its business?  Perhaps creating new legal entities or re-aligning its lines of business into different entities?  Changing the ownership structure of the legal entities within the commonly controlled affiliated group?  Or maybe it is considering acquiring or merging with a new business (unrelated third-party)?

Regardless of your company's situation, in each of the above mentioned scenarios, your company must perform its due diligence prior to completing any transaction or restructuring. That due diligence should take into consideration the impact the restructuring or transaction will have on the business operations, legal obligations, insurance, finance, and tax, etc.  

In regards to the tax implications, there can be significant tax ramifications on the transaction or restructuring itself.  In addition to the federal tax impact, the state and local tax impact can be material and varied.  Some of the potential state and local taxes to take into consideration are:  income tax, gross receipts taxes, franchise taxes, sales and use taxes, property taxes and transfer taxes.

Usually the biggest concern in regards to the transaction from a state and local tax perspective are:  

• Is there any sales tax on the sale or transfer of assets or change in ownership? 
• Is there any transfer tax on the transfer of assets or change in ownership?

The answers to these questions depends on the state or states involved.

In addition to the above, the impact that the restructuring will have on the business' state tax nexus (taxable presence) position across the country should be reviewed and considered before making any changes.

So What?

If your company is currently considering any restructuring or acquisition, don't forget about performing state and local tax due diligence.  If the transaction ends up costing the company a significant amount of state tax dollars now or in the future, you may be asked if these issues were considered or reviewed prior to completing the transaction.