Proper tax planning and tax preparation may alleviate the anxiety when a small business owner opens the envelope from a state taxing authority and learns that the state wants to conduct an audit of his/her business operations. Heck, you say to yourself that your business does not even operate in that state and have a tendency to ignore the notice. Giving it a second thought, you remember that your CPA has instructed you to send all notices from tax authorities to the CPA’s office.
In our Exton PA CPA office, we know that many business owners are reluctant to share their company’s business activities with anyone because the business owner wants to keep things simple. The thought process is that the owner does not want to share that the company may be doing business in other states to keep taxes and tax compliance costs to a minimum. The business owner often applies his/her logic to the tax rules and unilaterally decides that the company is not subject to other states’ taxes. If only state taxation were that simple. A state is always looking for companies outside of its state to tax because its in-state constituents prefer that over them being taxed more.
When a company has sufficient “nexus” in a state outside of its operations, it becomes subject to that other state’s taxes. The word “nexus” refers to the amount of contact a company can have with a state before becoming taxed by that state. Unfortunately, there is no red line defining nexus. Nexus differs by the type of tax (income, franchise, sales, gross receipts, etc.) and also differs by state. A company could be performing certain activities in various states and may find itself subject to tax in some states and not others. This is why it is so important for the business owner to review its business operations with its tax advisor at least annually to determine if the company has nexus in another state.
What can happen if nexus is established and the taxes are not paid? Mattress World was a company located in Portland, OR who delivered mattresses to customers in Washington State. Oregon does not have a sales tax; Washington does. Mattress World had no employees or property located in Washington. All mattresses were stored in Oregon and all of its employees were located within Oregon. Thus, Mattress World believed it had no physical contact with Washington. Mattress World used an outside contractor to deliver its mattresses to residents in Washington . . . free of any sales tax.
The Washington Dept. of Revenue (DOR), learning of this activity within its state, notified Mattress World that the company qualified as a Washington business under the legal concept of “nexus.” The DOR determined that Mattress World had “Economic Nexus” in its state. The DOR acknowledged that Mattress World did not occupy any physical space within its state or deliver goods into the state. However under the “Economic Nexus” theory, the DOR determined that if a business is delivering products in Washington, that the company must collect the sales tax from its Washington customers, even if the business hires a separate contractor to make the deliveries. Washington found that even if the contractor was responsible for collecting the WA sales tax and failed to do so, Mattress World was ultimately responsible for the tax.
Mattress World owed Washington about $2.0 million, comprised of $800,000 in sales tax and $1.2 million in penalties. After entering into an installment plan, the company could not pay its vendors, reneged on its installment agreement with the DOR, failed to pay its federal payroll taxes, and was evicted by its landlord. All of this forced the company to close most of its stores and to lay off most of its employees. The owner of Mattress World claims that she lost her home and vehicle because of unpaid taxes.
Could Mattress World have avoided Washington’s sales tax? The answer is likely “yes” if the company had used a common carrier (e.g., UPS & Fedex) rather than a subcontractor. How meaningful would it have been for Mattress World to have that discussion with its CPA to discuss its business operations? The answer is obvious and unfortunately too many business owners operate just like Mattress World rather than openly discussing their business operations with their tax professional.
Note: Because each business has unique factors that need to be examined when determining its tax situation, we invite you to call 610-594-2601 today to make an appointment to discuss your company’s situation. You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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