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States get tough on sales tax compliance.

The impact of a sluggish economy and decreased federal assistance is causing many states to emphasize sales tax collection as a means of raising revenues. Brian D. Clark, CPA, senior vice-president and general manager of Solomon Software, Findlay, Ohio, cautions that as a result businesses are more likely than ever to face audits, not just from their home states but from any state in which they do business.

A 1991 study by Vertex, Inc., a sales tax consulting group in Berwyn, Pennsylvania, found companies are more likely to be audited for state sales and use tax compliance than they were just a few years ago. Also, those audits resulted in more and larger assessments for taxes owed.

The 444 companies surveyed said they faced an average of three state sales tax audits in the preceding year. Larger companies were more likely to be audited than smaller ones, but smaller companies felt a greater burden because the expense of being audited was higher relative to their revenues.

While state budget crunches are a key reason for the increased emphasis on sales tax collection, other factors also come into play. In the current economic and political climate, most state governments are under intense pressure to balance budgets without raising taxes. Also, recognizing the need to attract businesses to create jobs and raise revenues, most states are averse to instituting new taxes that could send businesses fleeing. Instead, states are becoming more aggressive in their enforcement of existing tax laws, both in terms of identifying businesses subject to liability within their states and in interpreting statutes and regulations currently in place.

Another reason states are taking a hard line on sales taxes is it's becoming easier for them to do so. Computer tracking technology is becoming more sophisticated and less expensive, making enforcement significantly easier. Increased cooperation with other states also is making state auditors more thorough. States are sharing information and teaming up to help themselves by helping each other.

For example, some states are dispatching teams of joint auditors to review the records of companies in targeted geographic areas. In Chicago alone, 24 states have set up field offices and joined to form the Chicago Area State Tax Administrators.

COMPLEX COMPLIANCE

In short, many companies underestimate the impact of state and local taxes on their bottom lines. With audits on the increase, this exposure is becoming greater. Knowing this, why aren't more companies taking aggressive action to limit exposure? Probably because it's not easy to do. There are 66,000 state and local governments that levy taxes on businesses. According to an Arthur Andersen & Co. survey, the average company operates in 32 states and deals with approximately 200 different taxing authorities.

To complicate matters further, states have differing filing requirements. Some states require monthly filings, while others allow quarterly reporting. Some states even require prepayment of a quarterly sales tax estimate and then settle with businesses at the end of the quarter. Some states offer a .5% discount for on-time filings, with penalties for filing late.

Add to this the fact that some companies aren't even certain in which states they are required to file (due to the potential for differing interpretations of nexus) and it's easy to see why confusion is more commonplace than thorough monitoring of state sales taxes. Nexus is the physical presence within a state that creates a definite link between the state and the transaction it seeks to tax. Physical presence is defined as an actual store location, company-owned property, delivery vehicles or one or more agents or independent contractors employed by the company.

While the definition of nexus may sound simple, states interpret it differently. In the past six years, 36 states have expanded their definitions of nexus to include companies with a purely economic presence in their states--for example, companies that broadcast, publish, display or distribute advertising in their states. These expanded laws were recently challenged in the U.S. Supreme Court case Quill v. North Dakota Department of Revenue.

In Quill, the states essentially lost. The Court ruled direct marketers must have "substantial nexus" within the taxing state, as opposed to the "minimum contacts" standard states were using. However, there still are some gray areas. For example, does licensing 5, 10 or 100 copies of a computer software program within a state constitute nexus? Does exhibiting at 3, 5 or 10 trade shows in a state constitute nexus?

While there are no clear-cut answers, here are a few questions to consider:

* Is the business selling goods or soliciting orders in the state?

* Does the business maintain a sales or other office in the state?

* Does the business provide continued service, inspection and repair of property within the state?

* Does the business negotiate and execute contracts in the state?

* Does the business operate an affiliate within the state that acts on its behalf?

If the answer to any of these questions is yes, nexus may exist. Examples of activities within a state that are considered incidental and are not sufficient to constitute nexus include

* The initial installation or adjustment of equipment.

* The use of an expert to oversee leased equipment.

* An agreement to repair the equipment.

* Collection of rent.

* Holding directors' or shareholders' meetings.

* Maintaining bank accounts.

* Conducting an isolated transaction completed within a 30-day period, and not in the course of a number of similar repeated transactions.

It's important to remember that whenever there is confusion over nexus, states may pursue a business simply as a test case.

MANAGING SALES TAX COMPLIANCE

What can be done to better manage state and local tax liability? CPA firms need to advise their clients about the increase in state sales tax audits and become more knowledgeable themselves about state and local taxes. Top corporate executives need to understand that state and local tax liabilities can and should be actively managed; failure to do so could cost their companies a great deal of time and money.

Once sales tax compliance becomes a priority, improved computer systems for collecting, analyzing and filing state and local tax information must be put in place. Currently, sales taxation software programs are available, but most are quite expensive.

As sales tax compliance becomes increasingly important, look for general accounting packages to add support for sales taxation. CPAs who recommend accounting software will need to add sales taxation to their list of considerations in evaluating software for client use.

EXECUTIVE SUMMARY

* A SLUGGISH ECONOMY and decreased federal assistance are causing states to depend more on sales tax collection to raise revenues. The result is companies are more likely to be audited for state sales and use tax compliance, both at home and in other states where they do business.

* IMPROVED COMPUTER technology now makes it easier for companies and states to track sales tax compliance. Compliance enforcement also is enhanced by increased cooperation between states. States are sharing information and conducting joint audits of companies in targeted areas.

* ONE OF THE KEYS to determining if a company owes sales tax in a particular state is nexus, a physical presence in the state that creates a definite link between the state and the transaction it seeks to tax.

* CPAs SHOULD MAKE clients aware of the increase in sales tax audits and advise them on how to manage these tax liabilities.
COPYRIGHT 1993 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Author:Clark, Brian D.
Publication:Journal of Accountancy
Date:Apr 1, 1993
Words:1216
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