why sales tax software (& AI) is not the solution

THE PROBLEM

As I say in the title, sales tax software is not the solution. What I mean is that software cannot be a 'load and leave it' solution. It cannot be used blindly without proper oversight and implementation.

Otherwise the old saying, "garbage in/garbage out" becomes all too true.

You can't assume that your point of sale system or your ERP systems are properly communicating with your tax decision software. If the systems don't understand each other, or the company is not getting proper advice from the tax decision software company or other outside consultants, errors can happen. Sales tax can be collected for states that the company isn't registered in. Sales tax can even be collected for states in which the company is registered in, but the tax doesn't get remitted because the other system doesn't report it or expect it (capture it).

If these errors go on for months or even years, the liability can be significant in several states creating a mess to clean-up. The clean-up can involve filing Voluntary Disclosure Agreements (VDAs), filing amended returns, and even going back to customers to issue refunds, and/or the paying of tax, interest and penalties out of your own pocket.

I see too many clients with sales tax problems caused by software issues, registration issues, account login issues, etc.

During due diligence, whether we are assisting the buyer or the seller, I see too many companies that have played the 'wait and see' game or were simply unaware of their sales tax obligations due to either the complexity of what they were selling and making bad assumptions, or getting bad advice, or bad software implementation.

Emerging companies and middle market companies generally don't have enough in-house staff to properly complete their sales tax compliance, let alone ensure their software systems are communicating properly. Even if they do, they may incur employee turnover that makes it difficult to keep a handle on what is going on. If the company is relying on the software company to provide that assurance, unfortunately, that trust is often misplaced as the software company is selling the software (a tool) and is not providing specific tax advice to help the company apply the tool to the company's unique facts.

IT'S JUST A TOOL

For the last several years, we have seen the creation of many new software tools for sales tax compliance and other areas of tax. Some of them are great, some not so great. However, we've also experienced that feeling of being overwhelmed by all of the software tools available that you get to the point of -

• this is all well and good, but who really understands it?

• who really implements it?

• how do I know when I need it?

• and the most important - if I need it, how do I implement it well?

All of this talk about how great AI (artificial intelligence) is and how great it can be, is ........(to be determined). However, regardless of the tool you use (and AI is a tool), you can never 'load it and leave it.'

If you expect a tool (software or AI) to be as simple as pushing a button and magic happens that you can rely on, then prepare for 'garbage' to eventually appear.

Over the past year, certain lawyers got in trouble for using AI in cases, relying on false legal support, which they call "hallucinations." That can happen in any industry or profession.

CAN'T DELEGATE DECISION MAKING

Regardless of the tool, we have to remember these are tools. We can't delegate our responsibility. We can't delegate oversight. We can't delegate decision making.

It's like doing tax research and relying on some database or chart to tell me the answer by just doing a simple search. That is not analysis. That is not looking at all of the facts, and other court cases, rulings, etc. It is looking at things in a 'vacuum.' A vacuum can only pick up what is in front of it, it doesn't see the entire room, you do (or at least you better). The vacuum has to be moved to find the other dirt in the room.

CONCLUSION

Software and AI are not the solution. You are.

don't let uncertain state tax positions surprise your company or client

Uncertain state tax positions are everywhere. Your company or your clients likely have them. Have you identified them? Have you addressed them?

During ‘busy season’ or ‘tax season, state tax questions often arise or lay there quietly in the background while federal tax issues get all of the attention.

State tax issues or the state tax impact of an issue or transaction is generally considered after the federal tax impact is addressed.

Non-state tax experts are sometimes just too busy to give state tax issues adequate time before a deadline. In other situations, non-state tax experts may simply view a state tax issue as less complicated than it really is. Consequently, state tax issues may not get addressed before the original due date of the returns and may only get addressed in late summer or early fall prior to the extended due date. This often creates a time crunch for uncertain state tax positions to get adequately addressed. That's one of the problems.

The other problem is that most state tax issues are more complex than they appear. A high-level overview or two hours of research won't cut it, especially when you are trying to determine the state tax impact of a large transaction or adequately source the gain on a sale of a partnership interest to the right state or states.

What are these 'uncertain state tax positions'?

Where can they appear?

The following is a summary of some of the areas or items that create uncertain state tax positions on state income tax returns:

1. Structure - intangible holding companies; REIT / RIC; buy / sell companies, management / services companies; state-specific structures; captive insurance companies; finance companies; factoring companies; check-the-box entities; pass-through entities;

2. Transactions - mergers, acquisitions, divestitures; repatriation dividends; reorganizations; bankruptcy issues;

3. Nexus - P.L. 86-272; economic nexus; attribution of activities; forced combination; foreign company nexus despite no permanent establishment in U.S.;

4. Filing Options - separate, nexus combined, hybrid nexus combined, unitary combined (waters-edge, worldwide); consolidated;

5. Apportionment - ability to apportion income; choice of formula; throwback / throwout; joyce vs. finnegan; sales factor sourcing (destination, market-based sourcing, cost of performance, commercial domicile, location of payor);

6. Tax Base - business v.s nonbusiness income vs. separate accounting; Internal Revenue Code (IRC) conformity; related party addbacks; depreciation adjustments; dividends received deduction conformity; transfer pricing; foreign source income; state specific additions/subtractions;

7. Treatment of Partnerships - entity vs. aggregate theory; unitary (tax base / factor flow-up) vs non-unitary (allocation); sale of partnership interest;

8. Tax Attributes - NOLs (pre-apportioned vs. post-apportioned); IRC Sec. 382 limitations; survivor / non-survivor limitations; credits (claw-backs; compliance with agreements);

How do you ensure these items are addressed adequately?

• Get a state tax expert involved early.

How do you know when your client has any of these issues?

• Create a checklist that helps you identify clients or when your company may have these issues. That checklist may be based on the amount of sales a company has, the amount of taxable income, the number of states they file returns in (or the number of states they should file in), or if they have a specific structure or entered into a transaction that obviously needs reviewed.

There are multiple checklists you could create, the key is to make one that works for your company or firm that doesn't slow down the compliance process, but does allow you to reduce risk and adequately document a supportable, defendable or winnable position.

I hope you have a great tax season (now and in the fall). I hope all of your uncertain state tax positions achieve as much certainty as they can and are adequately addressed and documented.

who or what is 'rocking the boat'?

Usually 'rocking the boat' is perceived to be a bad thing, but 'rocking the boat' can be a good thing. Let me explain.

If you are riding in a boat heading into a storm and the boat starts rocking, that is usually a bad thing or scary. The boat is rocking to due to some external force or environmental change.

If someone on your boat gets up and starts jumping around without any explanation and you can't stop them or talk with them, that is usually a bad thing.

But if the the captain of the boat purposely turns the boat, changes direction and heads into the storm, then the rockiness of the boat is a good thing. It means the boat is going in the right direction. A strategic, purposeful direction. The rockiness is part of the process of reaching the chosen destination.

If someone on the boat gets up and voices a concern with the current direction of the boat, and makes a valid point why the boat should change course, the rockiness of the boat is a good thing. A necessary thing.

I'm sure we could keep going with this analogy or you could make up better analogies, but you get the point. Change, upheaval, incurring resistance or turbulance is sometimes a necessary or required part of the process of achievement or improvement.

HOW DOES THIS APPLY TO STATE TAXES?

2024 just began. January already gone. State governments have started or will be starting their legislative sessions. Proposals are flying all around. This is in addition to the state tax law changes that were enacted last year that became effective in 2023 or as of January 1, 2024. On top of the state legislative proposals, we also have federal legislation that is moving through the House and Senate that will have ripple effects on the states regarding research and development expenses and other items (appears to have a high probability of passing). The SALT CAP (i.e., state tax deduction limit of $10,000) is proposed to double to $20,000 (based on commentary, this legislation has a low probability of passing). As with all federal tax legislation, some states automatically conform, and some states don't conform until they specifically say they do.

All of these changes can 'rock the boat' of your business.

These are external changes that you don't have control over. You may be able to influence them (or some people may be able to), but for most companies, their 'boats' get rocked and they have to learn how to change course to find calmer waters.

Some state tax issues or items that are currently being challenged or expected to become bigger issues in 2024 that could 'rock your boat':

1. More states to adopt state income tax exconomic nexus thresholds

2. The protections of P.L. 86-272 continue to be challenged and worked around.

3. Gross receipts taxes (Ohio, Washington, Tennessee, Oregon, Nevada) continue to change their rules.

4. Sourcing sales of services or intangibles for income tax apportionment purposes continues to be more confusing with market-based sourcing - do you source to your customer or your customer's customer?

5. How do you source the gain on the sale of your partnership interest?

6. Should my company really make pass-through entity tax (PTET) elections in all states where we can?

7. Do I really owe the California LLC fee or minimum tax based on my ownership in a California LLC?

8. Am I required to file a state income tax combined return?

9. Should I make state income tax elective consolidated return elections?

10. Will the Washington capital gains tax survive challenges and should I pay it?

11. Does everyone have economic nexus for income tax purposes if the state has no 'factor presence' threshold?

12. Can a telecommuting employee that does 'back office' functions create nexus but a telecommuting employee that solicits sales be protected by P.L 86-272?

13. Is SaaS considered tangible personal property or a service for state income tax apportionment purposes?

14. Does P.L. 86-272 apply to sales of SaaS?

15. How can a company realistically source sales of SaaS when the users are in multiple states and the buyer doesn't provide the data?

16. Are state 'throwback' rules constitutional?

17. Should market-based sourcing really create economic nexus?

I could keep going, but I will stop.

CONCLUSION

External forces will always 'rock a company's boat.' However, even if the boat isn't currently rocking, a taxpayer or a tax consultant may need to stand up in the boat to advise or ask the captain of the boat to change directions. The goal is to adapt to the wind or to change the direction of the boat so the company can move towards calmer waters or avoid the storm altogether.

Unfortunately, the constant change in federal and state tax legislation and court cases and rulings, makes it difficult for the waters to stay calm very long.

The best strategy for a company to thrive in this type of environment is to monitor changes, make informed decisions and most of all - be proactive. Don't wait until your in the middle of the storm.

You can always navigate out of the storm, but the damage to the boat will differ based on how quickly you change course.

Here's to smooth sailing.

when state tax laws change, tax pros & taxpayers respond like my cats

Like several parts of the country, this week we got abnormally cold temperatures and about 6 to 7 inches of snow in Nashville. We live on a hill on 16 acres. We don't normally get this much snow and definitely not this cold (zero or negative temps). Oh, did I mention we live on a hill.

So, when this level of 'winter' occurs, we basically don't go anywhere and just wait for it to melt. I do a little shoveling where I can. Actually, I did shovel my road on my hill so I could attempt to get out if I wanted to. Most people would have just played the waiting game. Not me. (Let's attempt to hurt my back for the sake of a clean road.)

My family calls this week - "snow week." A time where work pauses and my wife gets to play games, do art, and fun stuff with our daughters. In other words, a time where everyone is trapped at home.

While I continue to work from home as if nothing has happened.

THE CATS

We have three outdoor cats that we gathered up and put in our heated garage to protect them from the extreme cold. When I go in the garage every morning, one cat is content and just wants to be left alone, one cat is a little confused, but then immediately starts to eat and seems relaxed, and the last cat follows me around, wanting petted non-stop, looking like he wants to jump on my head (he's the anxious one). He keeps acting like he wants out of the garage. Our garage doors are glass. He will sit at our garage doors and just look outside and whine.

Sidenote - when he is outside and winter comes (starts to get colder), he will often come to our windows or doors and look in - like he wants to be inside. In other words, you can't make him happy. He always wants the opposite of what he has (sound familiar?). He thinks he wants out of the garage so he can play in the snow and cold, but he would immediately want back in.

Why do I share all of this in a newsletter about state taxes?

Well, I think life has a lot of great analogies for state taxes (or it's just because that's my profession).

JANUARY IS "SNOW MONTH" FOR THE TAX PROFESSION

We are in the middle of January and it is the calm before the storm for most tax practitioners. In the state and local tax (SALT) profession, there really isn't any off-season. It's busy season year-round. With that said, we do experience "higher call-volumes" during tax 'busy season.'

In addition to tax 'busy season' getting ready to kick-off, state government legislative season or sessions will be starting soon. Governors and others are already making their proposals or ideas known. Every year, states change their tax laws via these sessions. These changes can be unique to the state or they can be related to conforming or not conforming with federal tax legislation. These changes are in addition to the daily non-legislative changes that occur due to new interpretations of current law, court decisions, private letter rulings, audit adjustments related to grey areas of tax law that taxpayers did not expect to be interpreted in a certain way.

Some state tax policy organizations that are great resources for monitoring law changes or being involved in impacting policy changes are:

• The Tax Foundation

• Council on State Taxation (COST)

• Multistate Tax Commission (MTC)

• National Conference of State Legislatures

• Federation of Tax Administrators

The Tax Foundation published an article about State Tax Changes taking effect January 1, 2024.

COST has a lot of great resources that only members can obtain, but they also provide some great FREE resources such as their Policy Position Statements, Amicus Briefs, other studies and reports, etc.

The MTC has a number of uniformity working groups that you can participate in or attend that can be enlightening.

WHEN STATE TAX LAWS CHANGE, TAX PROS AND TAXPAYERS RESPOND LIKE MY CATS

Just like my cats, tax pros and taxpayers respond differently to tax law changes and this time of year.

Some tax pros and taxpayers will greet tax law changes like its no big deal, not realizing the impact or the reason why they should care.

Some tax pros and taxpayers will understand what is going on and be cautious and take a 'wait and see' approach, calmly waiting for guidance so they can make informed decisions and move on.

Some tax pros and taxpayers will be anxious, will want guidance immediately, even if the tax law change has just been proposed and not enacted. They will pace and want to know what to do (even if the law change never happens).

Regardless of what cat you feel most like, this is an annual, recurring event where state tax law changes can feel like an 'avalanche' of snow.

An effective state tax pro, daily monitors state tax law changes in addition to the annual state legislative sessions.

A state tax pro looks for risks and opportunities to taxpayers.

A state tax pro provides technical and cost-effective practical guidance. Identifying the grey areas. Explaining the issues and options. Providing navigation. A compass. A roadmap. Direction.

In the context of thinking of state tax law changes as snow, a state tax pro provides a 'shovel' or 'snow plow.'

CONCLUSION

Regardless of how you feel about state tax law changes or snow, winter comes every year. I hope you don't get trapped at home for too long when winter comes. I also hope you find your shovel or snow plow to move forward when the avalanche of state tax law changes occur.

Here's to spring.

the BIGGEST STATE TAX ISSUE companies face today

The first question a kid asks before starting to play a game that it has never played before is - what are the rules?

Seems like a simple question and one that should be easily answered.

Over the holidays, my family played games. We didn't have to ask about the rules for games we had played several times before, because the rules hadn't changed. For some of the games we hadn't played in a while, we needed to read the instructions to refresh our memory of the rules, but again, the rules hadn't changed. For games we had never played before, we had to ask - what are the rules? But once we learned them, we could play the game and even WIN the game.

Let me ask you this?

Do you know the state tax rules? Income tax rules? Sales tax rules?

Are the rules different depending on the state?

Once you know the rules for that state, do they ever change?

If you stop doing business in a state and then re-enter the state to do business in a later year, will the rules still be the same? Will you simply need a refresh or will you have to learn all new rules?

State taxes is like playing a game where the rules keep changing during the game. The rules don't stay the same year after year, and they may not even be clear when you start the game.

BIGGEST ISSUE

At this time of year, many firms will release reports on the top issues of 2023 and/or what they think the top issues of 2024 will be. However, I think the BIGGEST ISSUE is the lack of clarity and ability to rely on state tax statutes, regulations, court decisions and rulings. In other words, the BIGGEST ISSUE is simply the ability to know how much tax to pay, and how to avoid interest and penalties.

The 'greyness' or lack of clarity and certainty create confusion (and yes, opportunity), but in a world where companies simply need to walk before they run (i.e., comply), knowing the baseline can be the most important line.

Not only are there many 'grey issues' when it comes to multistate income tax and sales tax, there are many issues where there is simply 'discretionary authority.' Again this can be positive, but when a company needs to make decisions and take positions on tax returns, it can be frustrating. The lack of clarity and certainty creates risk and unintended consequences.

BRIGHT LINE TESTS

Bright line tests or straight forward thresholds for nexus, taxability, etc. are great in most cases. However, then the argument becomes about the bright line and how it is arbritary or should be changed. Bright line tests quickly create winners and losers.

Greyness or discretionary authority provides opportunities for each player to determine on their own if they are a winner or loser (atleast until the referee throws a flag).

PRIVATE LETTER RULINGS

When in doubt, file a private letter ruling. Get certainty. Correct??

Well, it's not that simple. An effective private letter ruling can provide certainty and help a company avoid additional tax, interest and penalties. An ineffective private letter ruling can be a waste of time. What do I mean?

Many taxpayers choose NOT to do a private letter ruling because of the following concerns:

• Taxpayers must disclose their identify before obtaining an answer from the state.

• Facts may not be accurate, or disputed later, making the answer invalid.

• Ruling may be revoked at any time.

• Timing of the proposed and prospective transaction with obtaining an answer from the state.

• Rulings are binding unless the facts are not accurate.

• Unsure as to how deep of an analysis of the law the corporation is required to provide.

• The length of time to obtain a ruling.

• Consequently, there is even uncertainty in the process of attempting to obtain certainty.

AMENDED RETURNS

Sometimes the best way to gain certainty is to simply pay the additional tax (or tax that you disagree with) and then file a refund claim (amended return) to challenge the state's position.

I don't love this option since the taxpayer has to pay the tax first, but it does eliminate risk and makes the state declare their position. However, if the state's position is contrary to the taxpayer's, then the taxpayer won't love this option. But this option does avoid interest and penalties.

TAKING THE POSITION QUIETLY

Some taxpayers may choose to simply do their own research, document their position, identify the appropriate levels of assurance and then take the position on the tax return and wait. Wait to see if the state ever comes calling (audits or sends a notice). If the state does send a notice or audits the taxpayer, then the taxpayer will have to challenge the state and make its case. If the taxpayer loses, then they may have to pay additional tax, interest and penalties. So this option can cost more.

CONCLUSION

Uncertainty is not going anywhere. The rules keep changing and will continue to change. Therefore, each company or taxpayer must make informed decisions, exercise good judgment, receive wise counsel and document their positions. Then they must decide and take appropriate action based on all of the facts and applicable authority. That appropriate action may be different in each situation, but the key is for taxpayers to do the analysis and make the best decision they can so they "know how much tax to pay and avoid interest and penalties."

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