the usual suspects rise again: economic nexus, combined reporting, market-based sourcing

State legislatures and governors continued to move in the same direction this week - economic nexus, combined reporting, and market-based sourcing. The usual suspects popped up everywhere.

1. Tennessee enacted the "Revenue Modernization Act" (HB 644 and HB 291) - implementing economic nexus (effective for tax years beginning on or after January 1, 2016), and market-based sourcing (applicable to tax years beginning on or after July 1, 2016); the bills also make changes to the affiliated intangible expense addback (applicable to tax years beginning on or after July 1, 2016) and impose a new use tax on cloud computing starting July 1, 2015.
2. Tennessee Supreme Court heard oral arguments in the alternative apportionment Vodafone case (see prior posts for details). The case may be impacted by the Revenue Modernization Act's enactment of market-based sourcing.
3. Connecticut Senate proposed mandatory combined reporting (HB 7061). General Electric and Aetna, Inc. publicly communicated their disapproval by stating they would actually consider moving their operations out of state if the bill is signed by the Governor.
4. Virginia workgroup met to discuss enacting market-based sourcing.
5. Maryland Tax Court continued to use unitary principle to establish nexus (Staples Inc. v. Comptroller).
6. California Court of Appeals held that allowing only intrastate unitary taxpayers to make a separate or combined filing election was discriminatory (Harley-Davidson, Inc. v. Franchise Tax Board).
7. New York Tax Appeals Tribunal reversed an administrative law judge's determination and decided that affiliated corporations were entitled to file on a combined basis (SunGard Capital Corp).

does state sovereignty allow states to overreach?

"Substantial nexus," "economic nexus," "physical presence nexus" - who will win?

Federalism and state sovereignty - are they in conflict or can they work in concert?

"Substantial nexus" used to mean a seller had to have a physical presence in a state before they were subject to taxation. Now, more and more states are leaning on economic nexus standards which essentially say a seller can be subject to tax simply if they have customers in a state or direct some type of activity towards the state to create or maintain a market (vague, I know). Some states have taken it a step further (to make it less vague), and have instituted "factor presence" nexus standards which simply provide 'bright-line' thresholds. Meaning, these states maintain that a seller is subject to tax in their states if the seller has a specific amount of sales, property or payroll in their state. For example, the thresholds may be $50,000 of property, $50,000 of payroll or $500,000 of sales. Some state thresholds are lower for sales, such as $350,000 in Michigan or $250,000 in Washington. Regardless of the threshold limit, factor presence nexus standards and economic nexus is the trend as states look to maintain services and their budgets while imposing tax on non-voters (out-of-state taxpayers).

This discussion regarding nexus standards and the ability of the federal government to create legislation to 'big brother' the states was the subject of the June 2, 2015 Hearing before the U.S. House Subcommittee on Regulatory Reform, Commercial and Antitrust Law. Several government officials and interested parties presented testimony either for or against the 3 pieces of federal legislation currently under review:

1. The Mobile Workforce State Income Tax Simplification Act of 2015 (HR 2315)
2. The Digital Goods and Services Tax Fairness Act of 2015 (HR 1643)
3. The Business Activity Tax Simplification Act of 2015 (HR 2584)

The title to this post insinuates that states are using economic nexus to reach (or overreach) beyond their borders and tax out of state companies based on standards that are arguably unconstitutional. Regardless of that debate and regardless of which side of the fence you stand, states do have the right to determine 'how' and 'who' they tax inside their state as long as they stay with the boundaries of the U.S. Constitution and other applicable federal laws, such as P.L. 86-272. Companies and individuals have the right to conduct business across state lines without concern that they will be subject to tax when their activities are de minimus or do not reach significant (substantial) levels. Otherwise, the burden on interstate commerce is unnecessary and misplaced.

States argue that taxpayers will avoid (evade) paying taxes if the nexus standard or threshold is too high. However, states should only be able to tax what they legally can tax. Then they should seek to adjust their rules to tax who they can tax. Consequently, avoiding taxes that taxpayers shouldn't have to pay in the first place, really isn't evasion.

The states keep wanting to change their rules so they can tax more taxpayers because the economy changes (i.e., impact of Internet, remote sellers, service companies). Fine, change your rules, just don't exceed your authority and taxpayers will comply. Taxpayers deserve clarity, and to be treated within the boundaries of the law (both federal and state), so they can function and operate effectively in what is already a multi-jurisdictional, non-uniform, complex playing field.

have you read the Wynne case?

By now, you have most likely heard about the U.S. Supreme Court case regarding Wynne. The along awaited verdict. It was close (5-4 vote), but the taxpayer won. There are many publications by several firms and the media talking about the ruling and what it means, not only for taxpayers in Maryland, but other states as well. Regardless of what each firm or publication has said, have you read the case for yourself? I encourage you to do so. Especially state tax practitioners. 

Most of the discussion in the ruling is around the application, existence and authority of the dormant Commerce Clause. The majority supports and utilizes the dormant Commerce Clause to rule in the taxpayer's favor. The minority appears to believe the dormant Commerce Clause has been twisted into something it was not created to be, and thus, the ruling is misled.

The ruling defines the purpose of the 'dormant Commerce Clause' as:

"prohibiting certain state taxation even when Congress has failed to legislate on the subject."

The majority of the Court said the following about the dormant Commerce Clause:

1. The clause "precludes states from discriminating between transactions on the basis of some interstate element."
2. "States may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the state."
3. "We must consider not the formal language of a tax statute, but rather its practical effect."

Justice Scalia said the following in his dissenting opinion:

1. The "negative Commerce Clause is a judicial fraud."
2. "The clearest sign that the negative Commerce Clause is a judicial fraud is that utterly illogical holding that congressional consent enables States to enact laws that would otherwise constitute impermissible burdens upon interstate commerce."
3. "Neither the Constitution nor our legal traditions offer guidance about how to separate improper state interference with commerce from permissible state taxation or regulation of commerce."
4. "Change is almost the doctrine's natural state as it is the natural state of legislation in a constantly changing national economy."
5. "Balancing the needs of commerce against the needs of state governments. That is a task for legislation, not judges."

The Ruling holds the following keys (that other firms and the media have seemed to latch onto):

1. There is no distinction between a tax on gross receipts or a tax on net income when it comes to the application of the dormant Commerce Clause.
2. There is no distinction between taxing individuals or corporations when it comes to the application of the dormant Commerce Clause.
3. The Maryland taxing regime fails the "internal consistency test" of the dormant Commerce Clause by resulting in double taxation of out of state income and discriminating in favor of intrastate over interstate economic activity.

What do I think?

I think the case is an interesting discussion about the application of the Due Process Clause (the state's sovereign right to tax), and the limitations (or lack thereof) on a state's ability tax from the dormant (negative) Commerce Clause.

I think the case has ramifications for taxpayers across the country, including corporations and individuals. I am sure some lawyers and firms will extend the ruling's verdict to other fact patterns and litigation will ensue. 

I think Quill and P.L. 86-272 may need to be re-examined as a result of this case. 

What do you think?

Read the case and let me know.

be imbalanced, but make it matter

Happy Memorial Day! 

I spend my days in the technical 'weeds' of multistate taxation, and today I felt like writing about a non-technical matter (especially, since most of you probably aren't working today).

Does success require imbalance? 

If you look at those that are successful in their career, they usually spend more time focused on it than they did on other things, such as their family. We don't like it when people sacrifice their families for their careers, yet we celebrate those who achieve success - strange? Maybe.

For years we have had discussions, seminars, books, and human resources pushing the need for 'work/life balance.' To many in the 'real world,' work/life balance seems unobtainable. Especially with our 24/7 technology. If anything, work has taken up more of our lives, not less. This is why we need to be disciplined in what we say 'yes' to. We can't say yes to everything and hope to spend our time on what matters most - it is impossible. If we do, we will be busy all the time and not accomplish anything.

I think the key to success is imbalance - doing more than what is expected. Spending more time doing something, practicing, etc. than others. However, that imbalance doesn't mean doing busy work or just being busy. It means you are working on something specific - your main objectives and priorities. Thus, when you are spending extra time on your unique goal, talent, pursuit, you will actually make progress to being the best at it.

Don't let your life be unbalanced without gaining ground. So many of us are so busy, we feel like a pin ball. Unfortunately, when that happens, we are busy, but not accomplishing anything.

Let yourself be imbalanced in a disciplined manner. Also, let yourself become imbalanced towards your family as well. The pendulum doesn't always need to swing towards work to be successful. Actually, if you say 'no' to the things that don't matter, then you will only be saying 'yes' to work that matters, giving you more time for family.

Success requires discipline, imbalance and family. When the pendulum swings towards work - make it matter.

building a sustainable state tax consulting practice takes a 'village'

what people think, but do not say

Did you ever see the movie, "Jerry Maguire"?  In the beginning of the movie, Tom Cruise (as Jerry Maguire) has a breakdown or "break-through" as he called it.  He had been working for a large sports agent firm and had grown tired of the profession, the way he treated clients, the focus on money, etc.  Hence, he woke up in the middle of the night and wrote a several page "mission statement."  The mission statement described how the firm should change everything - how it should change its focus from solely making money and treat clients like people, develop true relationships and actually care. 

The mission statement was called, "What People Think, But Do Not Say."

I have been working in the public accounting field for 20 years and most of that time I have been a state and local tax consultant.  I worked in industry at some large Fortune 500 companies and several accounting firms (large and small).  Based on my experience and from talking to my SALT colleagues at other firms, some disturbing trends exist in our profession:

1. SALT consultants tend to move from firm to firm at a high rate, with the average length of time at one firm being 2 years.
2. Accounting firms that hire SALT consultants to build SALT practices don't always know what that actually means; they don't know what it actually looks like for their size firm (or office) and target market.  They just know they want to build one.
3. SALT consultants often struggle in getting the tax and audit folks to invite them to client meetings and pull them into projects earlier rather than later.
4. Most tax and audit folks are often used to doing things themselves - hence, their first inclination is to use SALT consultants on an as needed basis or as a "help-desk."  I get it.  I am a "do it yourself" kind of guy as well.  Often times, it is a cost/benefit or materiality issue.  I understand.
5. SALT consultants struggle with their billable time getting written off by tax or audit partners because SALT consultants are often not in control of the billing process on engagements which were obtained or started by non-SALT folks.
6. Most firms recognize SALT is a growing area and need/want a SALT resource to grow their firm; however, most firms may not be able to support or sustain a full-time SALT group.

The trends listed above do not apply to every firm.  Some SALT consultants have had long careers at one firm.  This is especially common in larger firms. The trends described are just a product of reality - or economic pressures on the firm or the partners themselves.  Everyone is just trying to meet their goals in the best way they can.  With that said, it is also a fact that so many SALT practices suffer from these trends.  Hence, the question is - is there a cure? 

You have probably heard the saying - "don't keep doing the same things and expect a different result."  Well, I very much agree with that statement in this area.  I am passionate about changing these trends - in helping SALT consultants get off of the "merry-go-round." 

These trends can be overcome by building strong relationships with partners, positioning the SALT practice effectively within the firm and/or office, marketing the SALT practice effectively in the marketplace and focusing on your highest and best use - the actions that will produce the most effective results. 

Another solution for firms would be to outsource their SALT function - this would allow the firm to have access to SALT resources they need, when they need it, without having to invest a great deal upfront or year after year.

What do you think?  Have you suffered from these trends?  What solutions can you think of?

connect and build community

Join with me in building a state tax community that builds real relationships and works together to help each other resolve complex state tax problems, influence state tax policy and further our careers and profession. 

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don't let state tax 'blind spots' wreck your company

WHAT IS A BLIND SPOT?

According to Wikipedia, a blind spot, also known as a scotoma, is an obscuration of the visual field. A particular blind spot known as the blindspot, or physiological blind spot, or punctum caecum in medical literature, is the place in the visual field that corresponds to the lack of light-detecting photoreceptor cells on the optic disc of the retina where the optic nerve passes through it. Since there are no cells to detect light on the optic disc, a part of the field of vision is not perceived. The brain fills in with surrounding detail and with information from the other eye, so the blind spot is not normally perceived.

Now, that wasn't exactly what I think of when I think of a blind spot.  I usually think of a blind spot when I am driving my car.

In that context, Wikipedia says a blind spot in a vehicle is an area around the vehicle that cannot be directly observed by the driver while at the controls, under existing circumstances. Blind spots exist in a wide range of vehicles: cars, trucks, motorboats and aircraft.

As one is driving an automobile, blind spots are the areas of the road that cannot be seen while looking forward or through either the rear-view or side mirrors. The most common are the rear quarter blind spots, areas towards the rear of the vehicle on both sides. Vehicles in the adjacent lanes of the road that fall into these blind spots may not be visible using only the car's mirrors. Rear quarter blind spots can be:

• checked by turning one's head briefly (risking rear-end collisions),
• eliminated by reducing overlap between side and rear-view mirrors, or
• reduced by installing mirrors with larger fields-of-view.

STATE TAX BLIND SPOTS

Now, what does this have to do with state taxes?  

Well, I believe most, if not all, companies have state tax blind spots.  These blind spots may include:

1. nexus (taxable presence) in states in which the business is not filing income tax returns or collecting sales tax
2. using the incorrect apportionment formula, including the wrong items or amounts in apportionment factors or using the wrong method to apportion different types of income (tangible, intangible, service, etc.)
3. including the wrong entities in a combined or consolidated state income tax return due to incorrect unitary group analysis
4. classifying business income as nonbusiness income (or vice versa)
5. misapplying P.L. 86-272 protection (i.e., business is not operating within limits of protection or business is applying P.L. 86-272 protection to the wrong type of tax)
6. misapplying sales and use tax exemptions
7. not self-assessing and remitting use tax on purchases of taxable items
8. assuming the business is selling is a nontaxable service, when it is actually selling tangible property
9. assuming the business is selling intangible property, when it is actually selling tangible property
10. not adding back related-party expenses on the business' state income tax return when required
11. adding back related-party expenses on the business' state income tax return when NOT required
12. when acquiring or merging entities, failing to perform state and local tax due diligence to uncover liabilities and determine a tax-efficient way to combine the entities (before and after the acquisition/merger)
13. failing to comply with state bulk-sale notification requirements
14. filing a separate return when a combined group return should be filed
15. allowing a FIN 48 reserve for state uncertain tax positions to grow year after year without attempting to reduce uncertainty

And the list goes on and on and on.

YOUR COMPANY / YOUR STATE TAX BLIND SPOTS

In regards to your company's state tax "blind spots," it usually depends on the stage your company is in and the size of your business.

As your business grows and changes, it is vital that your business examines its state tax "blind spots" before a "wreck" (audit assessment, nexus questionnaire, etc.) occurs.

Do you know what your state tax 'blind spots' are?

Do you need to install a warning system?