State auditors have become increasingly aggressive in locating companies doing business in their state to generate huge tax assessments. Auditors find businesses through internet searches, audits of vendors or customers, shipping documents and a number of other ways. The biggest problem when a company is found to be doing business in another state is the potential sales and use tax liability. Without the proper planning and documentation, a sales or use tax assessment can be financially disastrous to a business.
Any company that does business in multiple states should consider a nexus study to evaluate exposure and state and local filing requirements. This is an assessment of the extent to which a company is transacting business in a particular state so as to subject itself to sales and use tax liability there. If the company is in fact doing business in a state and not registered, usually an agreement can be made to settle the liability and go forward. Without that agreement, the statute of limitations does not start to run and the state can go back to the beginning of time to make an assessment.
Another time to consider a nexus study is before selling a business. Buyers will usually require a due diligence review. If the seller has any potential state and local tax liability, the sale may fall through or the sales price renegotiated.
There are a number of factors that require a business to charge sales tax. Generally, having an agent, employee, inventory, or property in a state will cause a business to have nexus and a filing requirement. Many states are moving toward attributing unrelated third party agents to obtain nexus. For purposes of this rule, the term “agent or other representative” includes an employee, independent contractor, commissioned sales representative, or other person acting either at the direction of or on behalf of another. Each state has different rules and a minor detail will cause a tax liability.
In addition to sales tax assessments, states have been pursuing the collection of use tax from companies that purchase equipment, software, and other items with no sales tax on the invoice. Companies that may not have a sales tax requirement can still have a use tax liability. For example, law firm services are exempt from sales tax in Ohio but their purchase of medical record copies from out of state vendors resulted in over a $250,000 use tax assessment plus penalties and interest. Another example is a company assessed $48,000 of use tax after purchasing a machine costing $600,000 that was engineered and manufactured in another state and shipped into Ohio. In both situations, careful review of the use tax laws resulted in a significant reduction in the assessment. Use tax is a particularly costly expense because it is absorbed by the company and not passed along to the customer the way sales tax is. Proper planning and structuring of purchase transactions could avoid the problem altogether.
Federal IRS audits can also go down the wrong path when a company tries to represent itself or not hire an attorney with experience handling IRS matters. It is not uncommon for wrong arguments to be made. When this happens, an innocent mistake can turn into a federal tax fraud case without warning. Other times the company will provide the agent with information it thinks supports its deductions but in fact triggers the agent to open up more investigations into other tax issues and additional tax years. It is critical to head off these disasters that, as soon as an audit commences, the company consults with the right professional who has experience in tax controversy cases.
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