Cohen & Company shares the five state and local tax trends businesses should focus on in the coming months: remote employees, state nexus via the internet, sales and use tax, pass-through entity tax elections and the upsurge of state tax audits.
By Hannah Prengler, CPA
Now is arguably an exciting time for businesses and their owners. Flexibility and innovation offer endless possibilities. But that excitement also comes with its challenges — from finding the right talent, to understanding evolving tax laws for employees who may sit in a completely different state, to identifying ways to minimize taxes and maximize profits.
In our recent Summer CPE Webinar Series, we looked at the five state and local tax trends businesses should focus on in the coming months: remote employees, state nexus via the internet, sales and use tax, pass-through entity tax elections and the upsurge of state tax audits.
1. The Far-Reaching Impact of Going Remote
Remote employees are, of course, one of the greatest areas of uncertainty from a tax, financial and operational perspective today, as employees are increasingly able, and often encouraged, to work from just about anywhere.
Whether your company is fully remote, causing you to address every detail down to the process for signing checks and where your commercial domicile will be, or you have some remote employees that will result in unique tax considerations — remote work means reengineering an entire business’ hiring process to understand the insurance, legal and security implications of remote workers. From a financial perspective, you will need to reconsider nexus, income tax, property tax, sales/use tax, sourcing, credits and incentives, and the potential impact on your financial statements to remain compliant and maximize any opportunities.
2. How Your Online Activities Are Creating Nexus in Other States
When it comes to creating nexus, or a tax obligation in another state, the important thing is to understand how your business identifies new customers, where those activities are occurring and what this means for your tax situation. While nexus does not automatically lead to a significant liability, it does mean you need to take additional action to make informed decisions.
One development to focus on is the recent updated guidance from Revised Multistate Tax Commission (MTC) on P.L. 86-272 around when online activities create nexus. Even if your company does not primarily sell products online, your internet presence could in fact trigger nexus and tax obligations in other states.
Online Activities That Do NOT Create Nexus
Let’s start with the “protected activities” that will not result in a tax bill, which are very few:
Remote employees soliciting only sales of tangible personal property (TPP) online
Posting a static FAQ on your website to assist customers
Internet cookies used for solicitation, such as reminders about items in your online cart, or cookies used to remember and input your name and credit card information
Offering TPP for sale on a searchable website
Online Activities That DO Create Nexus
Nearly everything else not on the list above falls in the unprotected category and may create nexus, subjecting your business to tax. Some may be surprising, including but not limited to:
Allowing candidates to submit an employment application online (for a non-sales position)
Using cookies on your site that gather data for product research, marketing trends, etc.
Providing chat functions on your site to assist with post sales efforts/support
Showing product repair videos on your website
Allowing customers to apply for a credit card online
Keep in mind that creating nexus may not always lead to a negative result. It can actually be a blessing in disguise. If your business is in a high tax state that imposes a throwback sale rule, such as California, creating nexus in other lower tax jurisdictions could help reduce a business’ overall tax rate. The key is understanding your business and where you are actually conducting it, and then how that impacts your tax decisions.
3. What’s Ahead for Sales and Use Tax
Below are a few specific areas to watch closely regarding sales and use tax.
The Digital Economy
As commerce changes, states looking to increase sales and use tax revenues are focused on the digital economy. We can break this out into three areas: Software as a Service (SaaS), digital goods and products, and digital advertising.
Software as a Service (Saas)
Each treat SaaS differently. Some treat it more akin to TPP, while others treat it as a service for tax purposes. It’s important to look at how a state classifies SaaS to understand how it will impact your sales tax. Also, many states are now taking into account where the software is used. With remote employees, tax obligations could span multiple states.
Digital Goods and Products
States are getting better at defining what a digital good and/or product actually is. However, those definitions can vary widely by state, from narrow to broad. In general, the delivery method — whether customers download the good or service like TPP or stream it as a service — will impact its classification/taxability.
Non-Fungible Tokens (NFTs) are also popping up on states’ radars. States are trying to understand if these are a digital good, TPP or SaaS. If your business is charging a fee for an NFT, know that it’s a gray area with limited guidance and you will need to act accordingly.
Revenues derived from digital advertising are a hotly contested area. Maryland was the first state to pursue sales tax on these revenues, and even that legislation is still being challenged in the courts. The uncertainty lies in the definition of digital advertising: does it require sales tax or a gross receipts tax? This issue will continue to play out, as other states have introduced legislation to impose a tax similar to Maryland’s digital advertising tax, which uses a person’s annual gross revenues derived from receipts in the state.
Other Sales and Use Tax Areas to Watch
Below are some other key areas states are following, so businesses should be as well.
- Expansions to the tax base. States prefer to avoid raising taxes, so, instead, they generally look to expand the tax base. Services are always a target. Computers, and digital goods and services are currently of particular interest as well.
- Increased scrutiny of tax exemption certificates. Ensure your exemption certificates are on file and up to date. States are looking at these more closely to ensure you have collected and remitted all of the required sales tax.
- Late Wayfair registrations
4. State Pass-Through Entity Tax (PTET) Elections
A trend many states are following is the enactment of legislation offering pass-through entity tax (PTET) elections. These elections fuel federal tax savings by offering a workaround to the $10,000 itemized deduction cap for state and local taxes imposed by the Tax Cuts and Jobs Act.
To date, 29 states have responded to the federal legislative cap with a PTET, including:
- North Carolina
- New Jersey
- New Mexico
- New York
- Rhode Island
- South Carolina
- While making a PTET election can help offset an owner’s partial state obligations, there are many considerations before checking the box, such as the potential to lose personal tax credits, resulting in paying more money than the benefit actually provides. And don’t forget financial statement implications, as there is now guidance on how taking a PTET election should be treated for GAAP purposes. The main takeaway is to understand your state’s election and the benefit to you BEFORE opting in, as most state elections are irrevocable.
5. Prepare for the Tax Examiners
While this isn’t necessarily a new trend, it is certainly an area that is ramping up once again. States are getting more aggressive as their revenues are impacted during slower economic times. Many states have enjoyed surpluses the past few years in spite of the pandemic, but if the economy takes a sharp downturn, history tells us states will hire even more auditors to level the playing field.
There’s more bad news: it’s easier than ever for the states to find you. With more and more information on the internet, states can use your website as well as your employees’ social media accounts to easily find scores of data about your company, its activities and even vendors that can all lead to an examination of your business. Other sources of information the state may use include:
Data shared from other state and local governments
Datamining within a state, e.g., you have a payroll tax account set up with a state, which flags an auditor to ask why you don’t have/need a sales tax account
Reviewing 1099 forms of your company’s contractors
Social media posts from employees about your services and products
Public news stories about your company (auditors are part of the general public, too)
Bottom line: Don’t underestimate the states. They will have the drive, the human capital and the technology to accomplish their goal of increasing state revenue.
Contact Hannah Prengler at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.