As taxpayers become more sophisticated and increasingly find themselves with filing obligations in multiple states, accountants have to keep up with the varying state tax laws.
In recent years, many states have changed the rules regarding the sourcing of revenue for state income tax purposes, making it more likely businesses will have revenue sourced to various states. And, as the United States moves from a manufacturing to a service economy, states are looking to capitalize on the expanding service industry
Historically, the apportioning of revenue was largely based on the location where tangible property was delivered to customers, or where the costs of performing a service were expended. Today, however, as fewer taxpayers are selling goods, and more are providing services or selling digital goods, many states have become more sophisticated, changing their sourcing rules from a cost-of-performance methodology to a market-based sourcing methodology, according to Scott Rock, a principal in PriceWaterhouseCooper' Melville and Manhattan offices.
Market-based sourcing generally involves sourcing sales of services and digital goods to the state where the customer receives the benefit. For instance, a corporation that sells music on the Internet would have previously been sourcing its sales in whichever state its business – including employees, computers and servers – was physically located; today, revenue could be sourced based on the state in which the customer is located, Rock said.
Additionally, states are broadening their definition of nexus, or the requisite connection with which a taxpayer has to the state in order for the state to have the power to tax the taxpayer, Rock said.
The traditional concept required taxpayers to file a tax return wherever they maintained an office, or a physical presence.
“Now, it’s gone way beyond that,” said Wayne Berkowitz, partner and head of the state and local tax team at Berdon in Jericho.
Many states, including New York, have moved beyond mere physical-presence nexus concepts. In New York, as of Jan. 1, 2015, corporations will no longer need a physical presence to be subject to income tax; outside taxpayers who have more than $1 million of certain types of revenues sourced to New York will have an income tax filing obligation in the state, Rock said.
“Where a company is doing business is becoming fuzzier and fuzzier,” Berkowitz said. “Your first challenge as an accountant is to understand what your client is doing and plans to do and, essentially, figure out where they have to file.”
Accounting firms must spend time and resources to ensure their accountants remain on top of the latest tax law changes in each state, said Lilach Fisher, tax manager at Israloff Trattner & Co. in Garden City. Fisher’s firm has acquired software that sends real-time alerts about the latest tax law changes in every state.
“It’s next to impossible to keep up – it’s an uphill battle,” said Gigi Bordeaux, tax principal at Raich Ende Malter & Co., which has offices in East Meadow. “We can be trained [on multistate laws] and then the laws change the following year.”
Developing relationships with contacts in other states helps, as does being a member of a national accounting organization, such as PDI Global, which maintains affiliates across the country that can share knowledge, she said.
While accountants have to remain informed of current tax laws and inquire about their clients’ business operation in other states, taxpayers are responsible for providing information about their business transactions.
“Clients should keep good records and inform their accountants if they’re venturing into other states, so we can do something proactively as opposed to reactively,” Bordeaux said.
Taxpayers may not realize they have a filing obligation in another state until they receive a nexus questionnaire, which is generally issued after it is discovered that a business or entity registered for sales tax or had payroll in another state, she said.
“Penalties for failure to withhold are pretty stiff,” Berkowitz said.
While accountants can help their clients tailor their time and billing systems to track the location where employees are working, questions can still arise. One client had an employee who worked from home in a different state and questioned whether she would have a filing obligation in the other state, Fisher said. Meanwhile, Bordeaux has a client – a nutritionist who holds seminars in various states – who was unsure whether she would be taxed in each state she held a seminar.
“This past tax season we had a lot of clients coming and saying, ‘Do we really have to file in these states?’” Berkowitz said. “It depends – it’s very fact-specific. We’re accountants because we work with numbers; we’re advisers because we have to look at each situation. And, it’s getting less black and white.”
To further complicate matters, a business may have nexus for sales tax purposes but not for income tax purposes, Bordeaux said, noting it’s easier to have nexus for sales tax.
“Sales and use tax is a big revenue generator,” she said. “If you sell in a state, that state wants to collect sales tax.”
Bordeaux added, “There are all sorts of loopholes. States will figure out how to tax you on things other than just widgets.”
While New York, with one of the higher tax rates in the nation, is one of the toughest states to do business in; each state is aggressive in its own way, according to Fisher.
“Every state wants to collect as much as it can,” Fisher said. “Our job is to minimize what the client is paying in a legal way.”