How States Identify
Misconceptions & Falsehoods –
Regarding Why Your Business Will Not be Audited
Business owners who knowingly conduct business in another state and fail to register to do business in that state are assuming a significant tax liability risk. The same holds true for owners who fail to understand the tax nexus rules and are inadvertently liable for taxes to another state. Nexus is the contact that a business has with a state that is sufficient for that state to tax the business. Unfortunately from a compliance perspective, the nexus standard differs by state and also differs by type of tax (sales, income, franchise, gross receipts, etc.). If you have not already read our July 24, 2018 blog about how the U.S. Supreme Court changed how nexus is determined, you need to read that landmark case (S. Dakota v. Wayfair).
States are always looking for new sources of tax revenues to provide services to their constituents. In-state businesses are prone to complain if legislators raise their taxes. Accordingly, states especially like out-of-state businesses because they do not have a say in state elections. Since sales tax usually comprises a very significant, if not the major component of state tax revenues, states often focus on sales tax nexus.
Some business owners when a nexus study is proposed to them tend to ignore such advice, relying upon various misconceptions and instead choose to play the audit lottery game.
Misconception #1: Our business is too small for a state to audit
It is true that large companies have a higher likelihood of being audited than a small business (states follow the money). However, if your small business is selling (providing) taxable products or services to a large company in another state, the state auditor is looking for audit leads while examining the large company. If the auditor finds that the small business is not charging sales tax, then the vendor could be placed on an audit list if there is any evidence of nexus.
For PA business owners, we suggest you read our January 27, 2015 blog about PA joining the Multistate Tax Commission to better understand how states share information among themselves.
Misconception #2: Your competitor is your friend
If a competitor gets audited and claims that “I know that my competitors do not charge sales tax and that puts me at a competitive disadvantage”; the auditor is likely to make a list of those competitors and submit them for audit examinations.
Misconception #3: No Bounty Hunter will audit my company
There are firms hired by states that receive a percentage commission for assessing taxes against taxpayers that the states are not auditing. These firms are often referred to as bounty hunter companies. They often receive a percentage of the assessment they make against your company (and not of the final tax due after appeals). Thus, it is easy to understand why these bounty companies are prone to be very aggressive in their assessments. Your company is then placed in a defensive position of proving what you really owe.
Misconception #4: Disgruntled employees are of no concern
A disgruntled employee may contact a state’s whistleblower program to claim a bounty for identifying a company not paying its fair share of taxes. Some states pay the whistleblower between 15 percent and 30 percent for information it shares about a tax dodger. That can be quite a financial incentive for a former employee to contact a taxing jurisdiction to share what it knows about your business operations.
Misconception #5: If another state finds that my business owes taxes due to nexus, I’ll simply file an amended return in my home state and offset the taxes due.
If a state finds that a business has nexus in its state, and no tax returns have been filed, there is no statute of limitations (SOL) and thus the state can assess back taxes, interest and penalties from the date that nexus is determined by the state. Thus the tax assessment could be for a multitude of tax years. You may find that in your home state the only years that can be amended are the three most tax years as the earlier years could be closed by the SOL. That means that you are paying tax twice on those taxable sales identified by the auditor. If you are thinking that double-taxation is not fair and wish to challenge that in the state where nexus was found, you need to consult with your legal counsel. Some states have ruled that if a business has failed to register to do business in its state, it has no legal standing it that state.
Here is the good news.
Business owners can engage an experienced tax professional to conduct a nexus study. The benefits of such a study include (1) identifying states for which the business has nexus and tax returns are not being filed; (2) identifying the tax liability exposure in terms of dollars owed to the state(s) where nexus is found; (3) understanding the nexus connection and where possible how to sever that nexus by changing how business is conducted in that state; (4) if nexus is found, identify any amnesty programs that the business can utilize to minimize the past due tax assessment.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.