navigating the state tax "mind-field" without "burning your popcorn"

If you work in my profession, you are likely aware of The Tax Foundation, the Multistate Tax Commission (MTC), the Council on State Taxation (COST) and the Streamlined Sales Tax Governing Board. However, were you aware of some of the resources they have?

History of Sales Tax

For example, I found this lovely webpage from the Multistate Tax Commission (MTC) which talks about the history of sales tax. https://www.mtc.gov/uniformity/sales-tax-on-digital-products/history/

• According to the MTC, "this page is intended as background to aid in the review of the issues that arise when we consider a sales tax on digital goods. We begin by clarifying some of the terminology we use on this project, then move on to a brief history of the sales tax and some similarities and differences in how states treat the tax. You can use the links below to jump to a specific section."

I recommend you take a peek if you are looking for a quick and concise summary of the history of sales tax and basic terminology and some uniform rules shared by the states.

History of Indivual Income Taxes

The following link from the Tax Foundation provides a brief history of state individual income taxes. https://taxfoundation.org/data/all/state/when-did-your-state-adopt-its-income-tax/

The following link from the Tax Foundation provides additional insight into the history of state individual income taxes and the trend towards a flat tax rate structure. https://taxfoundation.org/blog/flat-tax-state-income-tax-reform/

Key State Tax Issues

The Council on State Taxation (COST) has several state tax resources. One of their webpages (https://www.cost.org/state-tax-resources/cost-policy-positions/) provides COST's policy positions regarding several key issues and areas of state taxation such as:

• alternative apportionment

• confidentiality of taxpayer informatoin

• digital service taxes

• financial reporting consequence of significant tax law changes

• Gross Receipts Taxes

• Independent Tax Appeals Tribunals

• Mandatory Unitary Combined Reporting

• Markeplace Facilitators Collection of Sales, Use or Similar Taxes

• Property tax administration systems - fair and equitable

• related company expense disallowance

• Remedies for unconstitutional or otherwise judicially invalidated taxes

• Reporting requirements for federal tax changes

• retroactive tax legislation

• sales taxation of business inputs

• simplification of the sales, use or simliar transaction tax system

• state corporate income tax filing methods

• throwback and throwout rules

• unclaimed property

Another COST webpage (https://www.cost.org/state-tax-resources/cost-studies-articles-and-reports/) provides links to COST studies, articles and reports on topics such as:

• e-invoicing for sales tax

• digital-business input exemptions

• mandatory worldwide combined reporting: elegant in theory but harmful in implementation

• COST scorecard: the best and worst of state tax administration

• state digital services taxes: a bad idea under any theory

• resisting the siren song of gross receipts taxes: from the middle ages to Maryland's tax on digital advertising

Remote Sellers and Marketplace Facilitators

The Streamlined Sales Tax Governing Board website has great sales tax information for sellers in general, but also specifically for remote sellers and marketplace facilitators.

• Remote sellers - https://www.streamlinedsalestax.org/for-businesses/remote-seller-faqs

• Marketplace facilitators - https://www.streamlinedsalestax.org/for-businesses/marketplace-facilitator

• Marketplace sellers - https://www.streamlinedsalestax.org/for-businesses/marketplace-sellers

State Tax Climate, Trends and Maps

The Tax Foundation has a great page entitled, "Center for State Tax Policy" (https://taxfoundation.org/research/state-tax/) which has several articles and tools such as:

• 2024 State Business Tax Climate Index

• State Tax trends

• State Tax maps

• State Reform guides

• State and Local Tax collections

• Excise Taxes

• Taxes and Inflation

• Cost Recovery

Be Aware

Regardless of whether you use any of these resources, you should be aware of these organizations that seek to provide support for taxpayers and/or influence state tax policy to create more uniformity and/or fairness among the states.

The "Mind-Field"

State taxation is ever changing and is influenced by many forces. Middle market companies struggle to stay on top of these changes and can't afford to litigate every matter or issue (that perhaps, should be challenged or raised by law firms as issues that should be challenged). Consequently, middle market companies are in constant need of clarity to reduce uncertainty, to mitigate risk of exposure and obtain practical solutions to navigate this "mind-field."

"Don't Burn your Popcorn"

As I've mentioned in other editions of this newsletter, the more I see artificial intelligence (AI) being used, the more I am convinced that the best "tool" or guide a company can have is human, real intelligence. The "easy button" or "microwave" may not be the most reliable tool.

Popcorn still gets burned in the microwave due to user error or incorrect correlations between the popping instructions and specs of the microwave. Don't burn your "popcorn."

Stay smart. Do the work. Don't settle.

state taxes aren't that complicated (someone said)

I had a birthday recently and also did some traveling. Went to our firm's Altanta and Alpharetta offices. I had some great one-on-one meetings and did a little state and local tax (SALT) Q&A lunch-n-learn just talking about several current SALT issues and some common issues that always pop-up each year as companies operate, grow, change, etc. In addition to my meetings and trip, I also had some interesting calls with fellow SALT colleagues. Based on my week, I'd like to share some observations and opinions regarding the SALT profession.

One - as we discussed SALT issues during the lunch-n-learn, a few points became obvious. Most of the issues we discussed dealt with 'risk management' or areas in which companies either just missed the mark or purposely played the 'wait and see game.'

State and local tax laws or the interpretation of those laws are constantly being challenged or changed. That constant change in combination with the lack of conformity among the states creates opportunities for companies to do things incorrectly (whether by mistake or on-purpose). This puts a state tax consultant in the 'not so fun position' of telling companies bad news (i.e., large historical liabilities, etc.). However, this bad news is often told in conjunction with a solution to remedy the situation and alleviate the pain. It is still painful, but hopefully not as painful as if the company just waited for the state to catch them.

Another thought that became obvious as we discussed various state tax issues, how you analyze a company's situation, state tax law, rulings, etc. and ultimately reach a conclusion or guidance to give a company is that a state tax professional needs the ability to look at company's facts and state tax legal authority from multiple angles.

You have to be able to go to the 50,000 foot view and then be able to dig in the haystack. You have to be able to turn the facts and law upside down, sideways and then turn it right side up again. You can't just look at the picture as it is and then say 'yes or no.' If you simply rely on a 'chart' from a tax research software tool, then you will likely end up with the wrong answer or an answer that doesn't address the whole picture or a variation of the picture. A chart can be the starting point, but should never be the finish line.

Someone told me this week that state taxes aren't that difficult, but then later said they handled some very complex issues that made them scratch their head. - well, which is it? Is state tax simple or is it complex?

I've always said that state taxes are deceptively simple and endlessly complicated. Some questions are 'bread and butter.' Some questions are complicated. Actually, most questions seem to be living in the grey and require knowledge, judgement and advocacy. Responses require providing companies with options, levels of assurance and risks.

Regardless of the issue and a company's ultimate decision regarding a state tax position, documentation is key.

A company should ensure they have documented the facts, assumptions, state tax legal authority at the time of making the decision, and the conclusions reached. This is especially needed when the answer is not 'should' or 'more likely than not.'

State taxes require consultants to be technically sound and have the ability to communicate that knowledge and expertise in a practical manner so companies can make decisions and take action - "actionable intelligence."

Companies don't need 20 page memos that describe every facet of the law when those 'facets' don't apply to the situation at hand. Companies need their guidance to be thorough and brief (to the point). Clear. Concise. Supportable. Reasonable. As long as the facts and assumptions are correct; and all applicable legal authority has been reviewed and addressed, then the written guidance that contains those things should be sufficient.

Knowing - where to look, how to look, when you have looked in all the right places, how to organize the analysis, how to communicate the analysis with the right levels of assurance, how to present options and risks to a company - takes experience, judgement and skill that is developed over time.

I guess me 'getting older' isn't such a bad thing when I think of it this way. My 'older age' just means I'm more experienced and hopefully more skillful then when I was 'younger.'

Here's to you getting older, wiser and more skillful.

Stay safe out there.

why sales tax software (& AI) is not the solution

THE PROBLEM

As I say in the title, sales tax software is not the solution. What I mean is that software cannot be a 'load and leave it' solution. It cannot be used blindly without proper oversight and implementation.

Otherwise the old saying, "garbage in/garbage out" becomes all too true.

You can't assume that your point of sale system or your ERP systems are properly communicating with your tax decision software. If the systems don't understand each other, or the company is not getting proper advice from the tax decision software company or other outside consultants, errors can happen. Sales tax can be collected for states that the company isn't registered in. Sales tax can even be collected for states in which the company is registered in, but the tax doesn't get remitted because the other system doesn't report it or expect it (capture it).

If these errors go on for months or even years, the liability can be significant in several states creating a mess to clean-up. The clean-up can involve filing Voluntary Disclosure Agreements (VDAs), filing amended returns, and even going back to customers to issue refunds, and/or the paying of tax, interest and penalties out of your own pocket.

I see too many clients with sales tax problems caused by software issues, registration issues, account login issues, etc.

During due diligence, whether we are assisting the buyer or the seller, I see too many companies that have played the 'wait and see' game or were simply unaware of their sales tax obligations due to either the complexity of what they were selling and making bad assumptions, or getting bad advice, or bad software implementation.

Emerging companies and middle market companies generally don't have enough in-house staff to properly complete their sales tax compliance, let alone ensure their software systems are communicating properly. Even if they do, they may incur employee turnover that makes it difficult to keep a handle on what is going on. If the company is relying on the software company to provide that assurance, unfortunately, that trust is often misplaced as the software company is selling the software (a tool) and is not providing specific tax advice to help the company apply the tool to the company's unique facts.

IT'S JUST A TOOL

For the last several years, we have seen the creation of many new software tools for sales tax compliance and other areas of tax. Some of them are great, some not so great. However, we've also experienced that feeling of being overwhelmed by all of the software tools available that you get to the point of -

• this is all well and good, but who really understands it?

• who really implements it?

• how do I know when I need it?

• and the most important - if I need it, how do I implement it well?

All of this talk about how great AI (artificial intelligence) is and how great it can be, is ........(to be determined). However, regardless of the tool you use (and AI is a tool), you can never 'load it and leave it.'

If you expect a tool (software or AI) to be as simple as pushing a button and magic happens that you can rely on, then prepare for 'garbage' to eventually appear.

Over the past year, certain lawyers got in trouble for using AI in cases, relying on false legal support, which they call "hallucinations." That can happen in any industry or profession.

CAN'T DELEGATE DECISION MAKING

Regardless of the tool, we have to remember these are tools. We can't delegate our responsibility. We can't delegate oversight. We can't delegate decision making.

It's like doing tax research and relying on some database or chart to tell me the answer by just doing a simple search. That is not analysis. That is not looking at all of the facts, and other court cases, rulings, etc. It is looking at things in a 'vacuum.' A vacuum can only pick up what is in front of it, it doesn't see the entire room, you do (or at least you better). The vacuum has to be moved to find the other dirt in the room.

CONCLUSION

Software and AI are not the solution. You are.

don't let uncertain state tax positions surprise your company or client

Uncertain state tax positions are everywhere. Your company or your clients likely have them. Have you identified them? Have you addressed them?

During ‘busy season’ or ‘tax season, state tax questions often arise or lay there quietly in the background while federal tax issues get all of the attention.

State tax issues or the state tax impact of an issue or transaction is generally considered after the federal tax impact is addressed.

Non-state tax experts are sometimes just too busy to give state tax issues adequate time before a deadline. In other situations, non-state tax experts may simply view a state tax issue as less complicated than it really is. Consequently, state tax issues may not get addressed before the original due date of the returns and may only get addressed in late summer or early fall prior to the extended due date. This often creates a time crunch for uncertain state tax positions to get adequately addressed. That's one of the problems.

The other problem is that most state tax issues are more complex than they appear. A high-level overview or two hours of research won't cut it, especially when you are trying to determine the state tax impact of a large transaction or adequately source the gain on a sale of a partnership interest to the right state or states.

What are these 'uncertain state tax positions'?

Where can they appear?

The following is a summary of some of the areas or items that create uncertain state tax positions on state income tax returns:

1. Structure - intangible holding companies; REIT / RIC; buy / sell companies, management / services companies; state-specific structures; captive insurance companies; finance companies; factoring companies; check-the-box entities; pass-through entities;

2. Transactions - mergers, acquisitions, divestitures; repatriation dividends; reorganizations; bankruptcy issues;

3. Nexus - P.L. 86-272; economic nexus; attribution of activities; forced combination; foreign company nexus despite no permanent establishment in U.S.;

4. Filing Options - separate, nexus combined, hybrid nexus combined, unitary combined (waters-edge, worldwide); consolidated;

5. Apportionment - ability to apportion income; choice of formula; throwback / throwout; joyce vs. finnegan; sales factor sourcing (destination, market-based sourcing, cost of performance, commercial domicile, location of payor);

6. Tax Base - business v.s nonbusiness income vs. separate accounting; Internal Revenue Code (IRC) conformity; related party addbacks; depreciation adjustments; dividends received deduction conformity; transfer pricing; foreign source income; state specific additions/subtractions;

7. Treatment of Partnerships - entity vs. aggregate theory; unitary (tax base / factor flow-up) vs non-unitary (allocation); sale of partnership interest;

8. Tax Attributes - NOLs (pre-apportioned vs. post-apportioned); IRC Sec. 382 limitations; survivor / non-survivor limitations; credits (claw-backs; compliance with agreements);

How do you ensure these items are addressed adequately?

• Get a state tax expert involved early.

How do you know when your client has any of these issues?

• Create a checklist that helps you identify clients or when your company may have these issues. That checklist may be based on the amount of sales a company has, the amount of taxable income, the number of states they file returns in (or the number of states they should file in), or if they have a specific structure or entered into a transaction that obviously needs reviewed.

There are multiple checklists you could create, the key is to make one that works for your company or firm that doesn't slow down the compliance process, but does allow you to reduce risk and adequately document a supportable, defendable or winnable position.

I hope you have a great tax season (now and in the fall). I hope all of your uncertain state tax positions achieve as much certainty as they can and are adequately addressed and documented.

who or what is 'rocking the boat'?

Usually 'rocking the boat' is perceived to be a bad thing, but 'rocking the boat' can be a good thing. Let me explain.

If you are riding in a boat heading into a storm and the boat starts rocking, that is usually a bad thing or scary. The boat is rocking to due to some external force or environmental change.

If someone on your boat gets up and starts jumping around without any explanation and you can't stop them or talk with them, that is usually a bad thing.

But if the the captain of the boat purposely turns the boat, changes direction and heads into the storm, then the rockiness of the boat is a good thing. It means the boat is going in the right direction. A strategic, purposeful direction. The rockiness is part of the process of reaching the chosen destination.

If someone on the boat gets up and voices a concern with the current direction of the boat, and makes a valid point why the boat should change course, the rockiness of the boat is a good thing. A necessary thing.

I'm sure we could keep going with this analogy or you could make up better analogies, but you get the point. Change, upheaval, incurring resistance or turbulance is sometimes a necessary or required part of the process of achievement or improvement.

HOW DOES THIS APPLY TO STATE TAXES?

2024 just began. January already gone. State governments have started or will be starting their legislative sessions. Proposals are flying all around. This is in addition to the state tax law changes that were enacted last year that became effective in 2023 or as of January 1, 2024. On top of the state legislative proposals, we also have federal legislation that is moving through the House and Senate that will have ripple effects on the states regarding research and development expenses and other items (appears to have a high probability of passing). The SALT CAP (i.e., state tax deduction limit of $10,000) is proposed to double to $20,000 (based on commentary, this legislation has a low probability of passing). As with all federal tax legislation, some states automatically conform, and some states don't conform until they specifically say they do.

All of these changes can 'rock the boat' of your business.

These are external changes that you don't have control over. You may be able to influence them (or some people may be able to), but for most companies, their 'boats' get rocked and they have to learn how to change course to find calmer waters.

Some state tax issues or items that are currently being challenged or expected to become bigger issues in 2024 that could 'rock your boat':

1. More states to adopt state income tax exconomic nexus thresholds

2. The protections of P.L. 86-272 continue to be challenged and worked around.

3. Gross receipts taxes (Ohio, Washington, Tennessee, Oregon, Nevada) continue to change their rules.

4. Sourcing sales of services or intangibles for income tax apportionment purposes continues to be more confusing with market-based sourcing - do you source to your customer or your customer's customer?

5. How do you source the gain on the sale of your partnership interest?

6. Should my company really make pass-through entity tax (PTET) elections in all states where we can?

7. Do I really owe the California LLC fee or minimum tax based on my ownership in a California LLC?

8. Am I required to file a state income tax combined return?

9. Should I make state income tax elective consolidated return elections?

10. Will the Washington capital gains tax survive challenges and should I pay it?

11. Does everyone have economic nexus for income tax purposes if the state has no 'factor presence' threshold?

12. Can a telecommuting employee that does 'back office' functions create nexus but a telecommuting employee that solicits sales be protected by P.L 86-272?

13. Is SaaS considered tangible personal property or a service for state income tax apportionment purposes?

14. Does P.L. 86-272 apply to sales of SaaS?

15. How can a company realistically source sales of SaaS when the users are in multiple states and the buyer doesn't provide the data?

16. Are state 'throwback' rules constitutional?

17. Should market-based sourcing really create economic nexus?

I could keep going, but I will stop.

CONCLUSION

External forces will always 'rock a company's boat.' However, even if the boat isn't currently rocking, a taxpayer or a tax consultant may need to stand up in the boat to advise or ask the captain of the boat to change directions. The goal is to adapt to the wind or to change the direction of the boat so the company can move towards calmer waters or avoid the storm altogether.

Unfortunately, the constant change in federal and state tax legislation and court cases and rulings, makes it difficult for the waters to stay calm very long.

The best strategy for a company to thrive in this type of environment is to monitor changes, make informed decisions and most of all - be proactive. Don't wait until your in the middle of the storm.

You can always navigate out of the storm, but the damage to the boat will differ based on how quickly you change course.

Here's to smooth sailing.

when state tax laws change, tax pros & taxpayers respond like my cats

Like several parts of the country, this week we got abnormally cold temperatures and about 6 to 7 inches of snow in Nashville. We live on a hill on 16 acres. We don't normally get this much snow and definitely not this cold (zero or negative temps). Oh, did I mention we live on a hill.

So, when this level of 'winter' occurs, we basically don't go anywhere and just wait for it to melt. I do a little shoveling where I can. Actually, I did shovel my road on my hill so I could attempt to get out if I wanted to. Most people would have just played the waiting game. Not me. (Let's attempt to hurt my back for the sake of a clean road.)

My family calls this week - "snow week." A time where work pauses and my wife gets to play games, do art, and fun stuff with our daughters. In other words, a time where everyone is trapped at home.

While I continue to work from home as if nothing has happened.

THE CATS

We have three outdoor cats that we gathered up and put in our heated garage to protect them from the extreme cold. When I go in the garage every morning, one cat is content and just wants to be left alone, one cat is a little confused, but then immediately starts to eat and seems relaxed, and the last cat follows me around, wanting petted non-stop, looking like he wants to jump on my head (he's the anxious one). He keeps acting like he wants out of the garage. Our garage doors are glass. He will sit at our garage doors and just look outside and whine.

Sidenote - when he is outside and winter comes (starts to get colder), he will often come to our windows or doors and look in - like he wants to be inside. In other words, you can't make him happy. He always wants the opposite of what he has (sound familiar?). He thinks he wants out of the garage so he can play in the snow and cold, but he would immediately want back in.

Why do I share all of this in a newsletter about state taxes?

Well, I think life has a lot of great analogies for state taxes (or it's just because that's my profession).

JANUARY IS "SNOW MONTH" FOR THE TAX PROFESSION

We are in the middle of January and it is the calm before the storm for most tax practitioners. In the state and local tax (SALT) profession, there really isn't any off-season. It's busy season year-round. With that said, we do experience "higher call-volumes" during tax 'busy season.'

In addition to tax 'busy season' getting ready to kick-off, state government legislative season or sessions will be starting soon. Governors and others are already making their proposals or ideas known. Every year, states change their tax laws via these sessions. These changes can be unique to the state or they can be related to conforming or not conforming with federal tax legislation. These changes are in addition to the daily non-legislative changes that occur due to new interpretations of current law, court decisions, private letter rulings, audit adjustments related to grey areas of tax law that taxpayers did not expect to be interpreted in a certain way.

Some state tax policy organizations that are great resources for monitoring law changes or being involved in impacting policy changes are:

• The Tax Foundation

• Council on State Taxation (COST)

• Multistate Tax Commission (MTC)

• National Conference of State Legislatures

• Federation of Tax Administrators

The Tax Foundation published an article about State Tax Changes taking effect January 1, 2024.

COST has a lot of great resources that only members can obtain, but they also provide some great FREE resources such as their Policy Position Statements, Amicus Briefs, other studies and reports, etc.

The MTC has a number of uniformity working groups that you can participate in or attend that can be enlightening.

WHEN STATE TAX LAWS CHANGE, TAX PROS AND TAXPAYERS RESPOND LIKE MY CATS

Just like my cats, tax pros and taxpayers respond differently to tax law changes and this time of year.

Some tax pros and taxpayers will greet tax law changes like its no big deal, not realizing the impact or the reason why they should care.

Some tax pros and taxpayers will understand what is going on and be cautious and take a 'wait and see' approach, calmly waiting for guidance so they can make informed decisions and move on.

Some tax pros and taxpayers will be anxious, will want guidance immediately, even if the tax law change has just been proposed and not enacted. They will pace and want to know what to do (even if the law change never happens).

Regardless of what cat you feel most like, this is an annual, recurring event where state tax law changes can feel like an 'avalanche' of snow.

An effective state tax pro, daily monitors state tax law changes in addition to the annual state legislative sessions.

A state tax pro looks for risks and opportunities to taxpayers.

A state tax pro provides technical and cost-effective practical guidance. Identifying the grey areas. Explaining the issues and options. Providing navigation. A compass. A roadmap. Direction.

In the context of thinking of state tax law changes as snow, a state tax pro provides a 'shovel' or 'snow plow.'

CONCLUSION

Regardless of how you feel about state tax law changes or snow, winter comes every year. I hope you don't get trapped at home for too long when winter comes. I also hope you find your shovel or snow plow to move forward when the avalanche of state tax law changes occur.

Here's to spring.