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In order to claim a ‘resale’ exemption in the state of Florida, purchasers must normally only use a resale certificate issued by the Florida Department of Revenue.  These generally expire annually and are automatically renewed for all businesses registered with the Department.  As more companies use ‘drop shipments’ as a way to fulfill orders the issue of what exemption certificates are valid in the ‘ship to’ state becomes an important question. In TAA 15A-020 the Florida Department of Revenue clarifies a very important point as to how it would treat drop-shipments and what type of documentation it would require to exempt the Florida sale from being taxed by the original shipper.  https://salestaxstrategies.com/third-party-drop-shipment-analysis/

Let’s take a quick review of the Florida drop-shipment situation.  Drop-shipment’s involve at least 3 different parties.  These are the final customer, the vendor, and the shipper. Drop-shipments also involve at least 2 different states.  In the ruling, the final customer was located in Florida, the vendor (who is selling to the final customer) is located outside of Florida and the shipper is also headquartered outside of Florida but it sends salesmen into Florida and is registered for Florida sales tax. The shipper sends his invoice to the vendor outside of Florida.

The sale from the shipper to the vendor is a “sale for resale” that occurs in Florida.  The sale from the vendor to the final customer is a retail sale that may be taxable or may be exempt depending on the property.  Because the shipper has nexus in Florida and is registered with the Florida DOR, it asked the question as to whether it would be required to collect Florida sales tax on the sale to the vendor because it had nexus in Florida.

Florida law Section 212.05 states that if the shipper and the vendor are both located outside of Florida and the goods are outside of Florida when purchased, the sale between the shipper and the vendor is outside of Florida jurisdiction.  In the past I have had client situations similar to this and could not find clarification to what was meant by the phrase “located outside Florida.” Even though the shipper has nexus with Florida through the presence of salesmen in the state, this ruling concludes that does not mean that the shipper is located in Florida and must collected tax .  It does not even require that the shipper collect a Florida resale certificate from the vendor.

If either the shipper is located in Florida at the time of the sale, then Florida sales tax would need to be collected from the vendor or a valid Florida resale certificate would need to be obtained.  Florida requires that the vendor register with the DOR to issue a valid resale certificate.

Ned Lenhart, CPA
President Interstate Tax Strategies.

I was recently working with a company that was getting charged New York sales tax on 100% of the SaaS fees they were charged by their provider.  This would be correct if 100% of their SaaS usage was actually in New York, but it wasn’t.  In discussions with the provider, they said that New York tax was being charged because that was the “ship to” address set up in their billing system.  Everyone at the company agreed that some tax was due to New York because their were a few users in that state–but it was probably less than 10% of what was being charged.  When I inquired as to why New York was chosen as the “ship to” address, the response was pretty basic: “That’s where one of our developers lives!” https://www.salestaxstrategies.com/tax-consulting-services.html

Given the challenges of managing the taxation of SaaS, I suggested that the “ship to” address be changed to a state like Georgia, that does not tax SaaS, and that a use tax accrual process be implemented to pay the tax due in New York and the other states where the company has nexus and which SaaS.  The vendor was happy to oblige and the company is saving about $20,000 a year in tax.

Pay attention to the details on all of these invoice issues and be in communication with your suppliers to understand why they are charging tax.  Tax planning does not need to be difficult or expensive to implement.

Ned Lenhart, CPA
President

The Missouri Legislature passed S.B. 18 recently.  This Bill requires the Missouri Department of Revenue to notify taxpayers when the Department’s taxation position of property or service changes as a result of a certain events.  The bill states that if the taxation of items of property or of services is modified by a decision or order of:  (1) the director of revenue, (2) the administrative hearing commission; or (3) a court of competent jurisdiction and a reasonable person would not have expected the decision or order based solely on prior law, all affected sellers shall be notified by the department of revenue before such modification shall take effect for such sellers.

The failure of the DOR to notify a seller shall relieve such seller of liability from taxes that would be due under the modification until the seller is notified.  The relief only applies to sellers actively selling the type of property or service affected by the decision on the date the decision or order is made.  The Bill requires that the DOR send letters to all affected taxpayers and also that the DOR update its website for the changes.  However, this website change is not deemed to be a formal notice to affected taxpayers.

Upon reading SB 18 I’m struck by several things.  First off, the bill is poorly written.  The sentence structure is confusing and is fraught with noun and verb conflict.  That aside, the bill also provides a loophole so large that I’m not sure the DOR will ever be required to issue any notices.  The bill requires notices when a “reasonable person” would not have expected such a decision.  Missouri law already provides taxpayer relief from what are deemed to be “unexpected” decisions. That provision was imposed in the late 80s when the Missouri Supreme Court said that newspapers were taxable sales of property and not nontaxable sales of services. I remember this vividly because I was the Director of Audits for the Missouri DOR at the time.  What is the “reasonable man” theory when it comes to sales tax and who will make that determination?  This will surely open a new avenue for tax litigation as taxpayers are issued assessments and will argue that they were not notified of the policy change.

As written, the bill appears to only apply to situations when an item or service had been deemed “nontaxable” before the policy change was made to now make the item “taxable”.   At that point, the DOR needs to send letters to all the sellers of a particular item of property or to the providers of a particular service, otherwise the seller has no obligation to begin collecting tax on the item.  My real concern is how will the DOR even know who the sellers of this particular item of property or seller of service are?  The DOR’s database of company information is not robust enough to identify which sellers are selling which items of property.  Further, what if the seller is not registered with the DOR but is currently selling this “nontaxable” item.  If the item was nontaxable prior to the change of policy, the company may have decided that there was no need to even register with the DOR.  Without registering, the DOR has no opportunity to notify them.  Further, even if the seller finds out in some other way that the product or service they sell is now taxable, there is no obligation on their part to begin collecting tax.  Not until they receive a letter from the DOR are they required to begin collecting tax.   The same argument could apply to out-of-state sellers that may have nexus in Missouri but are not registered.

In the case where the Administrative Hearing Commission or a Court modifies the law to now make an item or service taxable, how does this bill impact the taxpayer subject to the litigation.  Are they the only ones affected by the change of law?  I suppose they could plead that their case provided an “unexpected” decision and that they are not liable for the tax.  This may now become a standard item in the pleadings before the Courts and AHC.

I know the frustration of taxpayers being surprised by policy changes by state departments of revenue and often times it does not seem fair.  However, the burden placed on the Missouri DOR under SB 18 seems impossible to meet.  The Bill also seems to open up an entirely new set of litigation issues for attorneys!   A similar bill was vetoed last year, so we will see what Governor Nixon does this time.

Ned Lenhart, CPA
President

Surprise!  The tax reform implemented in Kansas in 2012 has flopped.  In 2012, the state changed the way it taxes the income of farmers and small business owners.  The plan was supposed to stimulate the economy and raise revenue in other areas.  The plan has not worked out all that well. The state is projecting a $406 million revenue shortfall for the next fiscal year!  The governor still wants to phase out income tax as revenue source of the state and move towards a consumption tax.  Unlike income tax, sales tax is also paid by nonresidents that travel through the state and consume products and services while in the state.

Several options exist to solve the problem.  The first option is to repeal the tax cuts imposed in 2012.  That’s not going to happen.  The most likely plan, however, is to increase the sales tax to 6.5% on most items but drop the tax to 6% on food.  The current tax rate is 6.15%.   Kansas is one of the few states that still broadly taxes sales of food for home consumption. Under this plan, the state is proposing to increase the general sales tax by about 6% and decrease the tax on food by about 3%.  Somehow that plan is designed to increase revenue by over $470 million!

Let’s hope Kansas figures this mess out soon.

Ned Lenhart, CPA

During the past week, I’ve been contacted by several companies located throughout the U.S. about their concern with multistate tax matters.  After asking a few pointed questions about their business operations and their current sales and use tax procedures, I’ll offer up a few general comments about their situation.  After an awkward period of silence I hear the common phrase “but that’s not what my CPA told me”!  I try to give my fellow CPAs credit and explain that multistate tax is complicated, or that the rules change frequently, or that maybe they didn’t have all the facts when you asked them the question.  What I’d like to say is “boy, did you get bad advice”!       https://www.salestaxstrategies.com/firm-overview.html

In one situation, the company offers an entertainment or amusement service and advertised their business as an amusement service.  They asked their CPA if that was a taxable service in state X.  The CPA said that because the company was not selling any tangible personal property their charges were not taxable.  A perfectly reasonable and logical answer because state X primarily taxes sales of personal property.  However, the answer was 100% WRONG!  State X also specifically taxes “entertainment and amusement services, and all forms of admission charges”.  The services provided by the company are taxable and sales tax should have been charged on the fees collected for the past 3 years.  By the way, the company is about to begin an audit and was just calling me to confirm that they were OK!!    All the CPA had to do was crack open the state code, or call the DOR, or make some extra effort to find the answer.  It wasn’t hidden.  It wasn’t buried in some set of state regulations.  The answer was in plan sight if they had only looked.  In fact, the company revealed that he called 3 CPAs and got the same wrong answer on 3 separate occasions.   Stunning.

Had another call yesterday from a CPA colleague who called about a new client.  After a few minutes on the phone with the client, I stated what was obvious position any moderately informed CPA would give concerning the company’s nexus in multiple states.  Again, I was met with the statement “but that’s not what our old CPA told us!”  Again, you got bad advice.  The issue was around nexus for sales tax and income tax.  The company has a team of salesmen who travel throughout the U.S. soliciting sales of property for sale.  The company also has a group of technicians that perform repair and installation services in most states in the U.S.  This activity has occurred for the past eight years.  After learning this information, I made the assumption that the company was aware of their vast need for filing sales and income tax returns.  The response I got was, “our old CPA told us we didn’t have to file any tax returns in any state unless we had an employee living there”.  Again, a stunning and completely wrong answer.    If the company had been given the proper advice and had completed some type of risk analysis and concluded that they were only going to file return in certain states, that’s one thing.  That’s the right way to do this.  But to be given such incorrect information has put the company and its owners at a huge financial risk.

The list could go on.  I’m not trying to throw CPAs under the bus. We are busy and the rules are very complicated.  If you are a CPA reading this please understand that the rules around state taxation are complicated and are very different from federal tax rules.  No longer can you rely on your “gut feeling” about these matters.  Most clients don’t care if you don’t personally know that answer.  What they expect is that you have a resource you can call who does know the answer.  For the benefit of your clients and for your own malpractice risk, get the help you need on these “out of the ordinary” situations.

If you ever have a question or an issue, call me.  See my website for contact information.   Plenty of CPAs consider me to be their firm’s sales tax resource.  https://www.salestaxstrategies.com/firm-overview.html

Ned Lenhart, CPA
President

In my blog post from January 8, 2015, I outlined how the state fiscal crunch was going to catch up with the states and that tax reform would be needed to keep pace with the growing expenditures.  Well, its started.

So far this legislative session, discussion drafts, proposed legislation, and comments in “state of the state” addresses have addressed tax reform head-on.    For example, the Alabama Governor has proposed a series of income tax, sales tax, and tobacco tax measures to help bridge the state’s $700 million budget shortfall.  The Pennsylvania Governor has proposed changes to increase personal income tax and sales tax, but reduce corporate income tax and property taxes.  Nevada’s Governor has proposed legislation to impose a “hybrid” business tax system and move to a progressive fee structure away from a flat $200 per business license fee.  Nevada does not have a corporate income tax.

In Georgia, legislation has been proposed to increase sales tax rates, expand the tax base to more services, remove the exemption from food, and impose a new 5% communications tax.  Not sure if that will fly, but it does show that tax reform is being seriously considered in some corners.  The state of Louisiana has called for a study to “overhaul” the states tax system.  Many states are also considering adopting unitary reporting over the separate reporting for corporations doing business in their state.

How much progress is made this year on these initiatives is uncertain, but, as predicted, states are seriously looking at making changes to their tax structure and sales tax changes is a central part of these changes.  Stay tuned!

Ned Lenhart, President

On February 11, 2015 the Georgia Tax Tribunal issued one of the most interesting Georgia rulings during the past decade.  In the case of Inglett & Stubbs  vs Commissioner of Revenue, the Tribunal held against the taxpayer on two separate issues.  First, the Tribunal reaffirmed that contractors are consumers of the materials they purchase and are not generally retailers allowed to purchase items for resale. Second, and more importantly, the Tribunal affirmed that Georgia taxes items when them come to rest in Georgia unless they are held as inventory for resale.  That is, Georgia does not have any type of “temporary storage” exemption rule that many states have.

Inglett & Stubbs, purchased machinery and construction material for use in construction projects in Afghanistan and other countries where the U.S. military had bases.  Many large items were shipped directly to the overseas locations and these were not taxed in the U.S.  Many other smaller items were sent to Inglett & Stubbs in Georgia where it has a warehouse and distribution facility.  Many of the vendors charged Inglett & Stubbs sales tax on these items because Inglett & Stubbs could not provide any type of resale certificate.  Over $1.9 million in sales tax was paid on these purchases.  A refund claim for the tax paid was filed by the taxpayer and the Georgia DOR promptly denied the claim.  The taxpayer appealed and had its hearing before the Tribunal.

To me, the holding in this case was completely predictable given the body of law and previous rulings.  While this is a major decision by the Tribunal and one that dramatically impacts the taxpayer, I would have been more surprised if they had prevailed before the Tribunal.  The issue that I think this case addresses is how the failure of companies to make strategic decisions around sales tax can be a very costly mistake.  Very simply, had the taxpayer realized that tax was going to be due on the temporary storage of products in Georgia, they should have set up a temporary location in Tennessee which has an “import for export” exemption. Also, the company could have created a separate purchasing entity that would purchase these items “tax free’ from their suppliers and then exported them for sale to the construction company.  Two very easy and totally legal solutions to avoid every penny of Georgia sales tax.

This case will likely be appealed to the Georgia Supreme Court. Stay tuned.

Ned Lenhart, CPA
President

On December 15, 2014, the Alabama Tax Tribunal issued its decision in the case of Randy Henson vs State of Alabama. At first blush, there is really nothing earth shattering about the conclusion reached by Judge Thompson in his decision. Mr. Henson owned Friendship Automotive which was a car repair shop. The business did oil changes and other small repairs. The business performed taxable transactions and failed to collect and remit the tax. Conclusion, Mr. Henson owes $38,000 of tax and $10,000 of penalties. End of story!  http://www.salestaxstrategies.com/sales-tax-audit-defense.html

A closer review of the case facts, however, reveals a series of taxpayer errors and missteps that lead to this unfortunate conclusion. These missteps started the day he opened his business and continued through the entire audit process. By pointing out and discussing the errors Mr. Henson made, perhaps other Alabama businesses can avoid the same fate the befell Friendship Automotive.

Misstep 1: Taxpayer started his business in July 2009 but did not receive an Alabama sales tax permit in until October 2010. Even after applying, the taxpayer failed to file returns.
Misstep 2: When contacted by state as to why returns were not filed, taxpayer claimed he was not open for business (even though he was clearly open). Lying to the state is not a recommended strategy!
Misstep 3: Taxpayer charged customers a “lump sum” fee for oil changes that included the materials and labor.
Misstep 4: Taxpayer failed to maintain sales and purchase records for the complete audit period.
Misstep 5: Taxpayer failed to provide suppliers with a resale certificate which forced him to pay tax on his purchases and failed to maintain all the records showing what tax had been paid on purchases.
Misstep 6: Taxpayer allowed the auditor to set the sample period and projection method without understanding the consequences of the projection.
Misstep 7: Taxpayer claimed he did not “mark-up” the purchase price of the oil and other supplies sold to customers. Again, taxpayer had no documentation or proof to support the assertion.

The situation described above occurs countless times a year in each state that has a sales tax. Small businesses operate on the fringe of the sales tax rules either believing they are in compliance or hoping that they will never get caught. Clearly, the failure to understand the rules carries a heavy price. Here is some helpful (and perhaps obvious) advice to other small businesses in Alabama and other states based on Mr. Henson’s missteps.

1. If you register for a sales tax number, file returns-even if they are $0.00 tax due filings. Failure to file returns when due can attract penalties.
2. Don’t lie to the Department of Revenue!
3. Understand the tax rules in your state. Separately stated labor charges in Alabama are not taxable. A huge tax savings would have occurred if the taxpayer had only checked the rules.
4. Keep your records and keep them organized. The burden is on the taxpayer to provide the documentation. This applies to purchases and sales.
5. If you buy materials to resell, give your suppliers a properly executed resale certificate.
6. Understand the sampling method used by the state. The Department or Revenue auditors have one goal and that’s to collect as much revenue as they possibly can. It is not their job to educate the taxpayer on sampling methods and the consequences of these methods. If you don’t understand, get help from someone qualified. Spending a little money on professional services can really pay off if you can manage the sample and the audit process.

This is a really bad situation for Mr. Henson. I’m sure he does not have an extra $48,000 sitting around to pay the state this money. Who knows what type of effort the state will take to get their money. For other Alabama businesses and their advisors, please you can learn a lot from Mr. Henson’s mistakes.
Over the years I can’t count the number of people who tell me “it’s only sales tax, how hard could that be!” Well, it’s not very hard if you understand what to do and you do it! For businesses that don’t understand or don’t want to understand, then the consequences can be catastrophic. Just ask Mr. Henson.

Ned Lenhart, CPA

As we begin 2015, it’s a good time to pause and look at the “big picture” long-term prospects of state and local fiscal affairs. As tax professionals, we focus on the details of tax law but often fail to understand the environment in which these laws exist and the challenges that state legislators face to keep governments going. https://www.salestaxstrategies.com/index.html

The U.S. Government Accountability Office (GAO) recently released its 2014 state and local government fiscal outlook report. The report reveals some long-term systemic revenue and spending issues that will eventually impact our clients. The outlook is pretty grim! Here are just a few highlights from the GAO report:
1. Without immediate spending reductions and revenue increases, state governments will have significant budget strains for the next 50 years
2. Rising health-care costs for Medicaid and for employees/retirees is primary driver of the shortfall
3. Decline in income earned by state pension funds adds to unfunded balance. Current unfunded state pension balance is $4.7 Trillion!
4. Receipts from income tax and sales tax are set to decline as percent of GDP
5. Balancing budget will require 18% per-year in combination of spending cuts and revenue increases

The tax and spending implications of this report are significant. Here are few of the effects I predict:
1. Reduced state spending on education and other government services
2. Wage stagnation for state and local employees
3. Modification of employee retirement plans away from pensions
4. Expansion of sales tax to more services and rate increases
5. Legislation forcing e-commerce companies to collect sales tax
6. Reduction in state tax credits and incentives
7. Modification of corporate income tax structure
8. Increased enforcement activities to generate revenue

The GAO report is eye-opening. It reveals that without immediate and somewhat dramatic changes to spending and revenue, the state and local government fiscal outlook is rather bleak. Changing the ObamaCare provisions for Medicaid could also change the long-term spending curve, but who knows if that will happen!

State revenue agencies are not waiting for the legislatures to act. They are increasing collections and changing regulations to increase revenue. Now is the time for your clients to look at these issues and assess their risk. Sales tax continues to perplex many companies and this is creating a real and significant risk for these companies.

Ned Lenhart, CPA
President

On September 19, 2014, the Texas Comptroller issued its decision 106,632.  On the surface, the issues seemed fairly routine.   A Utah taxpayer was audited and assessed tax on sales of downloaded software.  The decision outlines many procedural issues but the most startling point of the ruling is the conclusion reached by the Hearing Officer that the Utah vendor had nexus with the state of Texas by virtue of the presence in Texas of software that had been downloaded onto servers located in the state. https://www.salestaxstrategies.com/sales-tax-audit-defense.html

The company did not send salesmen into the state to solicit sales and it did not conduct other types of training or support services in the state.  The decision states: “The substantial physical presence requirement is determined by the character of the rights and interest Petitioner retained in the software and digital images download by users located in Texas.”  Because Texas deems downloaded software to be tangible personal property and because the taxpayer (Petitioner) only grants a limited set of rights to the user and retains other rights for itself, that the Petitioner is deemed to own personal property in the state of Texas.  That’s right, the state of Texas has now concluded that software residing on the servers of another to which the licensing company has retained some intellectual property rights thereto, is deemed to be the ‘ownership’ of property in the state of Texas and creates nexus for the company.

The decision went on to say that based on the volume of business the company had in the state that there was “substantial physical presence”-not just a minimal physical presence in the state.  Granted, the taxpayer did not object to the assertion that the downloaded software was tangible personal property, so part of their problem may be a self-inflicted by not vigorously objecting to the characterization of their intangible property as being tangible.

Regardless of the taxpayer’s error, this is a very frightening outcome and a dramatic advancement of the theory of nexus for sales tax purposes.  For remote sellers of software they would be forced to abandon their intellectual property rights of the software sold or be forced into a sales tax compliance position that, heretofore, has not be promoted by any other state.  Just because downloaded software is taxed as “tangible personal property” does not make it “tangible personal property”.  There is nothing physical about software that is received electronically and exists only in an electronic state on a computer.  If more states pursue this dramatic and unprecedented advancement of nexus, software vendors across the country should be in fear of audits and assessments.

Ned Lenhart, CPA