are states knowingly enacting unconstitutional tax laws?

States balance their budgets each year and use the revenue they receive to run programs. When laws are ruled unconstitutional and refunds are required to be paid, it puts a state in a tough position. Sometimes states enact new retroactive legislation to mitigate or eliminate the amount of refunds that would have been required to be paid out under the reversal of an unconstitutional law. 

Note:  I wrote my thesis on this very topic as part of my masters in taxation degree several years ago. However, the issue remains alive and well today.

When a state enacts legislation that later is found to be unconstitutional, what is the appropriate remedy?

• Prospective relief only?
• Retroactive refunds for all taxpayers for all years still open under statute?
• Retroactive refunds for only those taxpayers that have filed protective refund claims?
• Or better yet, should states be allowed to change the unconstitutional legislation/statute in such a way as to make it constitutional? If yes, should states be allowed to make that change retroactive to limit the amount of refunds they will have to pay to taxpayers who paid the tax in prior years (or filed protective refund claims)?

The answers to these questions have been played out in several states over the years. Unfortunately, a state is usually allowed to enact retroactive legislation and reduce the economic pain of paying refunds. 

State Budgets + Political Pressure = Unconstitutional Taxes and Fees?

When states are concerned about their budgets and face political pressures, governors and legislatures often enact, knowingly or unknowingly, unconstitutional state taxes or fees. When states need new revenue (without "raising taxes” or political “fall-out"), certain fees or taxes become attractive alternatives. However, those alternatives may be unconstitutional.

It seems not only unfair, but perhaps “illegal,” for states to collect taxes by enacting laws later to be found unconstitutional, and then refuse to give the money back to taxpayers. A state should not be allowed to profit from collecting taxes it should not have been allowed to collect in the first place.

The Current Problem

Currently, states are knowingly enacting or attempting to enact potentially unconstitutional sales tax collection laws on remote sellers (see Alabama). States are trying to overturn or 'drive around' the Quill Corp. v. North Dakota decision that requires retailers to have a physical presence in a state before the state can require the retailer to collect sales tax on its in-state sales. States are forcing taxpayers to challenge these laws with the hopes the U.S. Supreme Court will accept a case and overturn Quill.

The U.S. Court of Appeals for the Tenth Circuit recently ruled in Direct Mktg. Ass'n v. Brohl (DMA) that Quill did not apply to Colorado's sales tax reporting requirement since Colorado's law was not requiring sales tax collection. Even though the DMA decision did not fall under the application of Quill, Quill was referred to throughout the case. Consequently, if the taxpayer appeals the case, states are hoping the U.S. Supreme Court will take the case and somehow use it to overturn Quill.

The attempt to overturn Quill by enacting laws that are obviously overreaching at best, unconstitutional at worst, puts taxpayers in a difficult predicament. The options are (1) compliance, (2) comply and challenge, or (3) explicitly refuse to comply and challenge the law in court. All of these options are a win for the state and a loss for the taxpayer.

Questions Remain

1. Will Congress enact the Marketplace Fairness Act?
2. Will the U.S. Supreme Court accept a case challenging Quill? If it does, will it overturn Quill or reinforce it?
3. Will the states continue to aggressively skirt Quill regardless of the action or inaction by Congress or the U.S. Supreme Court?

Stay tuned.

Update: Nevada Commerce Tax

Nevada recently published a Commerce Tax Registration Process Informational Chart. It is a flow-chart that can help your corporation determine if they need to register.

If your corporation is organized or incorporated in Nevada, it will be registered automatically. All other corporations should make the determination based on answering a nexus questionnaire. 

At the end of March, beginning of April, corporations will receive a "Welcome to Commerce Tax" letter (how nice). The letter will have your corporation's Tax ID number on it. Go to the chart for additional details.

Also, check out Nevada's website or my previous posts on the Nevada Commerce Tax.

Is Your Auditor M.I.A.?

Where is the auditor? I haven't heard from him or her in a while.

Should I call them? Or should I just wait it out, and see if they contact me again?

Have you ever asked yourself those questions?

Some taxpayers have an audit begin where the auditors come to their place of business, ask questions, review records, and then leave. When the auditors leave, they say they will let the taxpayer know if additional information is needed or if they have any questions.

Then, months go by without any contact from the auditor.

But wait, three weeks before the statute of limitations is about to expire on one of the tax years within the audit period, the state contacts the taxpayer and asks the taxpayer to sign a waiver of the statute of limitations, usually a year extension (you should attempt to negotiate a smaller extension; some states have a minimum of 6 months).

After the extension is signed, the taxpayer may receive another information request or list of questions from the auditor, with a short timeline or due date for the taxpayer to respond. After the taxpayer responds, another 6 months go by without any contact from the auditor.

Then, once again, one month before the statute of limitations is about to expire, the taxpayer receives a preliminary audit assessment. This time the state won't extend the statute, and the taxpayer has less than a month to dispute the audit assessment's findings before a final assessment is received.

QUESTIONS
If your auditor goes M.I.A. in the middle of an audit, what should you do?

Should you just play the "wait and see game"? Or should you contact the auditor sooner to find out what the status is?

If you contact the auditor sooner, you may or may not receive a response earlier? It really could go either way.

The same is true if you don't contact the auditor. You could get "lucky" and the statute of limitations could expire without receiving an assessment. On the other hand, you could receive an audit assessment with a short amount of time to respond.

What do you think? Have you experienced this?

2016 State Tax Amnesty Programs

The Council on State Taxation (COST) has released a chart reflecting state tax amnesty programs scheduled to occur in 2016. Here's the link.

If you are curious as to what states had amnesty programs in 2015, go here. 

Is amnesty the way forward? Does your company have past liabilities that need paid without paying penalties or interest? Should your company participate in a state's amnesty program or utilize the state's Voluntary Disclosure Program?

These questions plague companies when faced with identified compliance exposure and failures for multiple tax years. Some states offer one-time, short time-frame amnesty periods allowing companies to come forward, file prior year tax returns, and pay tax with the promise of future compliance. Depending on the specifics of the state's amnesty program, penalties and/or interest may be abated.

Key to remember: if your company has exposure and does not come forward, then the state may assess more significant penalties and interest when it finds your company later.

If you would like to read more about amnesty, check out my previous posts here.

Specifically, you may like: Amnesty and Voluntary Disclosure Agreements: What, When, Why?

Alabama Goes Rogue (but result could surprise you)

'I dare you. I double-dog dare you.' 

This is exactly what Alabama is saying with its new sales and use tax rule (No. 810-6-2-.90.03) which takes effect January 1, 2016. The new rule considers out-of-state sellers who lack an Alabama physical presence, but who have sold more than $250,000 in retail sales of tangible personal property in the previous calendar year and conducts certain activities, to have a substantial economic presence in Alabama for sales and use tax purposes. Consequently, the new rule requires the out-of-state sellers who meet the $250,000 and 'activities' threshold, to register for a license with the Department and to collect and remit tax. 

NOTE: The $250,000 threshold is not the only test. The out-of-state seller must also be conducting specific activities as referenced in the Rule. Please see the Rule for all of the details.

The new rule flies in the face of U.S. Supreme Court precedent (Quill Corp v. North Dakota, 504 U.S. 298 (1992)) which requires collection of sales and use tax by companies that have a physical presence in a state.

Many media articles have stated the Alabama Governor and Revenue Commissioner want a large online retailer (i.e., Amazon) to challenge the law and force the U.S. Supreme Court to take the case in the hopes the Court will rule in the state's favor.

Will Amazon make the challenge?

Should Amazon take the bait?

If Amazon does challenge it, there is probably a 50/50 chance of winning. If Amazon doesn't challenge it, Alabama wins and other states will consider enacting similar legislation.

But who does the law hurt? Amazon, maybe not. Amazon used to fight sales tax collection legislation, now it just builds large distribution centers (and collects sales tax) in states to provide faster service to clients and create stronger competition for brick and mortar stores. I can personally confirm that this strategy is working. This Christmas season, I definitely preferred to shop from the comfort of my living room, rather than combat the crowds and traffic at a store for items that may or may not be in stock. 

NOTE: Amazon is currently collecting sales tax in 26 states (Alabama is not one of them). 

If it doesn't hurt Amazon, then why should it challenge the law and incur the costly legal battle? Simply negotiate incentives to build a large distribution center in Alabama and reap the business benefits of crushing the brick and mortar competition. Perhaps this is exactly what Alabama wants. Perhaps Alabama doesn't care about collecting sales tax from every online retailer, only Amazon or similar companies. Perhaps it would be better for everyone if Amazon simply built distribution centers in every state - it definitely would provide better customer service, and states would receive increased sales tax revenue. If Amazon took this path, perhaps the national debate of taxing remote online retailers would go away.

Perhaps. 

pre-packaged state tax planning is dead, maybe

I hope everyone had a great Thanksgiving holiday week and adventurous Black Friday. Cyber Monday (or week) is upon us - we shall see if any great deals really exist.

As we approach Christmas, we are also approaching the end of another year which causes tax departments and accounting firms to review end of year tax planning options. Specific state tax planning can be done at any time during the year; however, I am curious as to what state tax planning your corporation and clients implemented this year. Was it an idea a consulting firm brought to you? Was it a restructuring idea built on the firm's application to other clients? Was it an idea based off of a court case, a ruling, or simply your company's unique fact pattern (i.e., apportionment, combined v. separate reporting, etc.)?

Legitimate Loopholes

I recently read an article entitled, "Nuances in State Constitutions Can Aid Taxpayers" by Jeff Day at Bloomberg BNA which included comments from Kenneth T. Zemsky, a managing director at Andersen Tax LLC. Mr. Zemsky's comments were taken from a presentation he made at the November 3, 2015 American Institute of Certified Public Accountants (AICPA) conference. If you have a subscription to Bloomberg BNA, I recommend you read it.

One comment that Mr. Zemsky made stood out to me - "legitimate loopholes" exist for many corporate taxpayers, but only customized planning will allow companies to take advantage of them." Custom planning for each client? I think this is something we all know, but Mr. Zemsky is correct. Public accounting firms are well-known for creating planning ideas that they package and utilize at numerous clients over and over. Albeit, the facts may be slightly different, but the idea being implemented is the same. This is not necessarily a bad thing, as the idea may have merit and application. In addition, most clients generally ask if the firm has implemented the idea at other companies. Clients want to know if the idea has been successful and withstood state challenges or audit. However, is this the best way to mitigate tax and risk? 

An article by Charles F. Barnwell, Jr. back in 2009 for Tax Analysts entitled,  "State Tax Planning - What's Left?" is a great article about the history of state tax planning and its current and future opportunities. The article discusses how the 'great' structural planning ideas of the 1990s (i.e., intangible holding companies, sales companies, purchasing companies, etc.) are no longer viable. According to Mr. Barnwell, planning ideas are now based on the 'nuts and bolts' of state taxes such as apportionment factor planning, industry-specific characteristics, and maximizing state offered incentives. Mr. Barnwell says, "the best offense may be a good defense" for companies that have "base-shifting type planning" still in tact." Mr. Barnwell is correct. Since 2009 (when the article was published), we have seen companies unwind previous tax planning to reduce exposure. We have also seen states win litigation against corporations and enact new 'guard rails' to limit state tax planning such as related party add-back provisions, combined reporting and discretionary transfer pricing analysis.

What is a legitimate loophole? If you read the Bloomberg BNA article by Jeff Day, it appears Mr. Zemsky believes legitimate loopholes are found by digging deeper into the state's law and procedures to identify clearly applicable opportunities for clients. This approach definitely makes sense, but how is this different from prepackaged planning? Once consultants identify a strategy or 'legitimate loophole' that works for one client, the next step is to see what other clients could also use the strategy? Thus, turning customized planning into a commodity? In other words, legitimate loopholes do exist. However, once found, they may become 'pre-packaged tax planning.'

Perhaps the question isn't whether the planning is customized or pre-packaged, the question is whether the idea is legitimate tax avoidance or something else (Mr. Zemsky describes this 'something else' as a "scam"). I addressed this question in an article I wrote for Tax Analysts back in 2013 entitled, "What Level of Tax Avoidance is Acceptable?" For details, go here.

This brings me back to the question - what tax planning have you recently implemented? What are you thinking of implementing? What questions are you asking before you take the position? What will the FAS 109 / FIN 48 impact be? Will tax return disclosures be required? Are you prepared for an audit? Will the firm be there to defend the position upon audit? Did the position create more risk than benefit?

For more posts on state tax planning in general and specific ideas, check these posts out.