First, Class Actions, and Now Whistleblowers

Penalties for Sales Tax Errors May Skyrocket                                                   

Isn’t Staying in Business, Keeping the Customer Happy while Earning at least a Modest Profit, Hard Enough Already?

The Greatest Tragedy in Sales Tax

If a company even slightly overcharges sales tax to a customer, they run the risk, if there are many such customers, of a possible class action lawsuit. On the other hand, if they even slightly undercharge sales tax, they run the risk of that item being assessed in an audit with possible penalties and interest and paying that assessment out of their own pocket. We call this “The Greatest Tragedy in Sales Tax.” 

That’s why it's always been important to be as accurate as possible in charging the right rates on the right products and services. New developments in New York and Illinois may mean the penalties for undercharging sales tax have just skyrocketed.

Troubling Developments in the Sales Tax World 

Now, when times are as tough as ever, companies are facing another threat. So-called “whistleblower” lawsuits are being used in Illinois and New York against companies allegedly undercharging sales tax. Illinois and New York are the first states where these whistleblower lawsuits are being filed, and there may be whistleblowers in more states waiting to pounce. Whistleblower lawsuits can cost a bundle both in terms of the actual judgment and of negative publicity. Such was the case with Sprint, which was recently sued by the Attorney General of New York for $300,000,000 of treble damages for allegedly slightly undercharging sales tax to its customers in the state, but the negative publicity stemming from the grand announcement by the A.G. may have led to a precipitous drop in Sprint’s stock price costing perhaps $500,000,000 in market cap. And all of that on top of the audit assessment. We’ll discuss that case in detail and also some even more troubling developments in Illinois. The bottom line?  Whereas in the past (the good old days?) you worried about sales tax audit assessments by the Department of Revenue with penalties and interest, now you have that worry plus treble damages and damaging publicity. 

Whistleblowers Not Bad Per Se, But Not Everything is Fraud

We’re not against the concept of whistleblowers. States have the laudable goal of eliminating fraud and wasteful spending. They can’t find all of it on their own, so they offer a bounty to people who do find it. We can all agree that when used as most people would assume, as in uncovering Medicare fraud or abuse, that these statutes are beneficial to everyone. We’ve all heard the stories of medicaid and medicare fraud in which companies send in claims for providing services to thousands of people who don’t exist. And we’ve heard of people who file a tax return on behalf of 1000 dead people and claim they each have 10 dependents and have the refunds sent to a bank in the Caribbean somewhere. These are clear cases of fraud that cost the government real money and most reasonable people can agree, this should be eliminated if possible. If the New York Federal Reserve uncovered manipulation of LIBOR, now that would be something to pursue. Uncovering and proving real fraud is real work, but it’s a real benefit to society also.

Fining companies who engage in truly fraudulent behavior in the form of trebling the damages seems justifiable. Treble damages can mean some big bucks and will certainly discourage bad behavior. But when the state offers a 25 percent bounty to find it, the urge might -- and, in my opinion, has -- created a monster. Like all programs where large sums of money are involved and the amount of work is small, the potential to push the envelope in terms of broadening what is called fraud can be extreme. And the sums of money are large while the amount of work needed is small in these sales tax cases. Additionally, fraud cases make great political theater for the A.G., who gets to make the big announcement. The result of this environment is that reasonable judgments on whether and to what extent an item is taxable can be seen as fraud.

Charging the Right Tax Should be Easy -- In Theory

The “easy” answer to this new level of risk is to make sure you charge the correct amount of tax in every situation. Seems simple enough. But as we’ve heard others say: Sales tax isn’t rocket science -- it’s not that easy. The taxability of products and services as well as the determination of rates is a moving target. In addition, each state and local taxing jurisdiction, of which there are more than 7,600 in the United States alone, may have their own rates or taxation rules. Sometimes company just make mistakes, but plenty of the time, the answer is just not clear and judgments must be made. As a result of all of this, it’s very common for companies to overcharge sales and use tax on some items and undercharge tax on others.

Whistleblower Lawsuits

I’m not an attorney nor do I play one on TV, nor do I try to play one in real life. So I’ve had to educate myself on the matter of the False Claims Acts in general. Please don’t assume I’m an expert on legal proceedings; what follows is my understanding, and I’m indebted to several authors who have written articles about these matters, who I will cite where appropriate. 

In seeking to eliminate fraud, states have enacted statutes that allow private people to bring civil actions against other people or companies in the state’s name for “defrauding” the state. These actions are referred to as qui tam or “whistleblower.” It’s important to understand that in a qui tam action, the party filing the lawsuit does not have to be the injured party. An attorney can file a lawsuit on behalf of the state, basically because the state is deemed to be the victim. Attorneys don’t even have to do all the work involved of chasing the ambulances or even compete with the other ambulance chasers to convince the victim to hire them. They just circle overhead until they become aware of possible undercharges of sales tax and then pounce. The powerful incentive of bounty fees meshed with the removal of the barrier of needing to find an injured party makes these whistleblower opportunities lucrative indeed -- for the attorney and the state. They don’t even have to wait for an accident. They can just watch court cases. Anytime a DOR position is overruled and the result is that companies who followed the DOR are now undercharging tax, here come the lawsuits. Or, even easier still, they need only look for grey areas in the tax law -- like dropshipping, taxation of cloud computing, or the taxation of telecom charges, just to name a few -- where the laws are either difficult to apply or just barely evolving and where companies are all over the board in terms of how transactions are taxed, and they will find opportunities galore.

According to information published by the False Claims Act Legal Center, approximately 28 states, three municipalities, a county, and the District of Columbia have enacted their own False Claims Acts. Many of these statutes follow the federal False Claims Act, which excludes tax fraud. Some of these jurisdictions have false claims laws that apply only to fraud involving Medicaid or other state health care funds. Other jurisdictions have laws that apply to a broad range of state-funded programs. The states we are most concerned about are those that allow whistleblower actions for tax fraud. According to the article, New York’s Qui TamLaw: Jackpot Justice or Creative Tax Tool—or Both?, some of the states to be concerned about are California, Delaware, Florida, Illinois, Indiana, Nevada, New York, Rhode Island, and Texas.  It will be interesting to see how many more states amend their existing statutes to allow for tax fraud in the coming years.

A winning lawsuit could potentially involve treble damages. When it comes to sales tax, that means three times the back taxes, penalties, and interest owed plus attorney’s fees. The whistleblower could potentially receive up to 30 percent in certain cases.  This is quite an incentive and the lure of potential hundred-million-dollar-plus settlements in the sales tax arena means companies have to be more careful than ever to charge the correct tax.

Walmart Survives Class Action; Whistleblowers Spring to Action

We mentioned that businesses with many customers have to be careful not to overcharge taxes even by a little, lest they be the subject of a class action lawsuit. Walmart would be the type of company that would have to be very careful with something like this because of their deep pockets. It’s interesting, and more than a little ironic that the most recent spate of whistleblower lawsuits in Illinois seems to have had its beginning as a result of a class action lawsuit against Walmart. In 2009, the Illinois Supreme Court decided on a class action lawsuit by the name of KEAN v. WAL-MART STORES, INC. 919 N.E.2d 926 (2009), 235 Ill.2d 351. Kean vs. Walmart was originally filed in 2006. The plaintiff in the case claimed they were improperly charged sales tax on a shipping charge for a purchase on Walmart.com. They based this claim on prior Illinios DOR guidance.  In fact, sales and use regulations promulgated by the Illinois DOR, state that, “If the seller and the buyer agree upon the transportation or delivery charges separately from the selling price of the tangible personal property which is sold, then the cost of the transportation or delivery service is not a part of the ‘selling price’ of the tangible personal property which is sold, but instead is a service charge, separately contracted for, need not be included in the figure upon which the seller computes his Retailers' Occupation Tax liability. Delivery charges are deemed to be agreed upon separately from the selling price of the tangible personal property being sold so long as the seller requires a separate charge for delivery…” (86ILAC 130.415(d))

Walmart basically claimed that there was no “separately contracted for” delivery option. While they offered different methods of delivery with separate charges, the purchaser on Internet transactions does not have a choice to not have the product delivered. Because delivery was a mandatory condition of the purchase, it could not be separately contacted and was therefore part of the purchase price and taxable.

The case eventually made its way to the Illinois Supreme Court, which ruled in late 2009 in favor of Walmart. In deciding for Walmart, I do not believe the court could have foreseen what the Law of Unintended Consequences had in store. Because the court ruled that Walmart, who had not followed Department guidance, was not overcharging sales tax, then that guidance must be invalid. Enter now the opportunistic, whistleblowing plaintiff’s attorney, circling above in the sky, ready to swoop in on the unsuspecting business. The whistleblower realizes that most companies would likely have followed the DOR’s guidance, and as as result could now be said to be undercharging sales tax. Aha! Fraud Alert! Actually, what really is happening is Aha! Huge Fee Opportunity! So, the Whistleblower sues in behalf of the state of Illinois and nails the “fraudsters.” Nevermind that the “fraudsters” were the ones who were simply following the guidance of Ilinois’ own DOR.

These Cases Should be Dismissed

We understand that in qui tam actions, the state usually has a process to dismiss these lawsuits. It has not exercised that right so far. In addition, the Illinois DOR is reviewing the regulation on this issue but as of now has not given any guidance on how to move forward. This illustrates the point of how tough it is to figure out the correct amount of tax when the state can’t even decide themselves how it should be taxed.

It is distressing to say the least that a company could be targeted by a whistleblower for not charging tax on something for which even the Illinois DOR doesn’t have the answer, but that is the current state of affairs in Illinois.Your stomach may be already turning, but wait... in some respects, things may be even worse in New York.

New York Whistleblowers

New York has now jumped on the whistleblower bandwagon. On April 19, 2012, the New York Attorney General, filed the first New York Sate whistleblower tax fraud lawsuit against Sprint-Nextel Corp. under the amended New York False Claims Act. The suit alleges that Sprint deliberately under-collected and underpaid millions of dollars in New York state and local sales taxes on flat-rate access charges for wireless calling plans. Sprint disputed the claims, releasing a statement saying the case is "without merit" and on June 14, 2012, asked a judge to dismiss the lawsuit on the grounds the state was attempting to levy taxes on services that are legally excluded from sales tax.

The stakes are high. The state claims that the Sprint owes $100,000,000 of back taxes plus penalties and interest. Under the Act, if Sprint is found liable, they would have to pay three times that amount. That is what you call skyrocketing penalties. The whistleblower would score 25 percent of the bounty. In addition to the harsh monetary penalties, there is the negative publicity of being labeled a “fraudster” by the Attorney General. For example, according to news reports on the day of the big announcement made by the the New York A.G. at a celebratory press conference, Sprint’s Stock price dropped almost 5 percent with a hit to its market cap approaching $500,000,000. This is not good news for a company which lost nearly $2.9 billion last year on sales of $33.7 billion.

Check out what Ted Barac who writes about Sprint’s Sales Tax Blunder in his investment newsletter and website Seeking Alpha says about Sprint. It reflects much of the popular thinking on this:

“The state claims that Sprint did this to achieve a competitive advantage, but I doubt that customers are going to even notice such a marginal difference in sales taxes and it's certainly not something that Sprint could advertise and market…  So why would Sprint take such actions when it seems clear that there were questions and grey areas in the tax law? The company didn't get any extra revenues for themselves and it really offered them no significant competitive advantages. Conversely, as a result of these actions, they are now faced with back taxes, penalties, lawsuits, headline risks, general uncertainty, etc. All things considered, it really seems like an act of very poor judgment.”

This is unduly harsh in my opinion, but it comes from a non-tax professional, who doesn’t deal in the grey of state and local sales and use tax on a daily basis. But this is evidence of the damage that can be caused to a company’s reputation and public perception when a state Attorney General makes a grand announcement to a fawning press corps. Companies making tax judgments on grey areas of the law are being labeled fraudsters and tax cheats. It’s sobering.

To add insult to injury, because of the stock market price drop (which came on the heels of the A.G.’s press conference) Sprint’s Officers and directors have been sued by a Louisiana pension fund for a breach of fiduciary responsibility and for failing to oversee the company and subjecting it to a huge liability. 

Last but not least, the stakes may also have been raised for attorneys, CPAs, and others who may be termed co-conspirators if it can be shown that they have assisted in the development of the “tax avoidance strategy” or the filing of returns if they should have known that a return was false but did not because they deliberately ignored or recklessly disregarded the truth of the matter asserted. These provisions of the law make clear that intentional deception or proof of intent to defraud is not required. While no third party has been charged in this case, it is an issue to be noted.   

What Happened With Sprint?

We don’t have special inside knowledge about Sprint. They are not a client of ours, and if they were, we wouldn’t give away any inside knowledge we had. But we know and understand how these decisions are made inside corporate tax departments, and we have done our own research of documents publicly available in this case. This whole thing with New York and Sprint arises out of a taxability decision made by Sprint several years ago. Sprint came out with a flat-rate calling plan in which you can make all the calls you want for $39.99 a month. Sprint’s internal tax department had to make a determination on how to tax that monthy charge. Under the Mobile Telecommunications Sourcing Act (P.L. 106-252; 4 U.S.C. Secs. 116—126) and under the New York’s Chapter 85 of the Laws of 2002, which effective as of August 2, 2002, wireless carriers were required to collect and pay sales taxes on the entire amount they charge for monthly access calling fees. However, interstate calls separately stated are not taxed.

INTERstate calls are not taxable but INTRAstate calls are taxable. In a flat-rate plan, how much of it is interstate vs. intrastate? Should Sprint collect tax on the whole charge each month or just on the portion that’s interstate in nature? And what does it mean for something to be “separately stated?” For example, my cell phone bill (not Sprint) includes detailed records separately identifying each call, interstate and intrastate. Is that enough to meet the “separately stated” requirement?  Would a footnote on the bill saying that 25 percent of the billing is for interstate calls constitute “separately stating” an amount? How should Sprint have done it? Hindsight may be 20/20 in many cases, but I’m not sure even in hindsight one can say for sure how it should have been done. The statute and regulations may seem to be pretty clear that lump sum billing is taxable, but there must have been some other support for Sprint choosing to tax it at 75 percent instead. I can only guess what factored into the decision. Some commentators have said that maybe they should have gotten a ruling from the New York DOR before proceeding. But how did that help companies in Illinois, when the courts ruled the Illinois DOR’s ruling to be incorrect? No one is surprised that New York would want to tax the whole charge if any part of it was intrastate in nature, but just because a person at the New York DOR says it’s taxable, that’s not always the final answer, as tax professionals know. That’s just one answer -- it’s an important answer, no doubt, but not necessarily the only or maybe even the correct answer. 

Was this a Mistake or Judgment Error or Neither?

Companies and their advisors make mistakes. Sometimes we just miss things. But this situation can’t be a simple mistake because they are taxing 75 percent of the charges. A mistake could be taxing 100 percent, or none of it, but not 75 percent. Therefore, some consideration, at some level, must have been given to how to tax it. Maybe they were worried about class action lawsuits. It’s certainly a valid concern that if Sprint taxed the whole thing, a class-action attorney would sue them for overcharging tax by arguing that Sprint was, in fact, separately stating interstate calls by detailing them on their customer invoices. Seems like a stretch, but it could have been one of their concerns. Or, it could have been something else that convinced them to tax it at 75 percent. I certainly do not know, but I do know for sure that this is not fraud.

I feel confident the tax department just wanted to get the answer right and charge their customers correctly. It appears they did some analysis of actual phone calling data by people on those plans. Evidently they found that approximately 25 percent of the calls made were interstate. So they made the decision to charge tax on 75 percent of the $40 per month charge. Does that sound so bad? Does that seem like fraud? 

If you’re the Attorney General, eager to make a splashy announcement, or an attorney looking to score big fees, a company can be made to look pretty sinister. When the initial press conference was called by the NY A.G. and Sprint was assailed for its “fraudulent” actions, much of the press seemed negative toward the company. Notwithstanding the views of many other commentators on this, I have my own take on what happened here, and I come down on the side of Sprint and Sprint’s tax department. I see it much differently. And I emphasize we have no inside knowledge on this, but does making what I would call a good faith effort to tax your customers correctly under New York’s different laws, regulations, court cases, administrative decisions, and policies (which many times themselves conflict) constitute fraud? If this is fraud, then every tax professional in the U.S. that is called upon to make a judgment on how to tax transactions are in on it too. 

Keep in mind that Sprint made a decision to charge its customers less tax. By doing so, Sprint took on the risk of having to pay that tax themselves out of their own pocket later on if it was ultimately held that the total charge is taxable. There’s no allegation in this case that Sprint kept any of the money they charged to the customer, only that they didn’t charge their customers enough. One way to look at this is that the New York Attorney General apparently doesn’t think New Yorkers pay enough tax on their phone bills, and is suing Sprint in order to force them to collect more tax from New Yorkers. There’s no fraud in the sense that Sprint taxed people and put that money in its own pocket, but there’s got to be fraud somehow, right? They had to come up with something, or there’s no big announcement and no fat bounty fee. 

So How is Sprint Committing Fraud Then?

To prove fraud here, the Attorney General had to twist this into a “scheme” in which Sprint made a conscious and deliberate decision to undercharge the tax. Maybe not to enrich themselves on the actual taxes, but to give themselves a competitive advantage against the other carriers. Now that is a stretch! And by the way, just how much tax are we talking about here to each customer each month? Even that’s not an easy answer, but let’s talk in round figures. Let’s say the combined state and local rate in New York is 8 percent. That means that the tax on the monthly fee would be $3.20 if Sprint taxed it in total. But they only taxed 75 percent, so they collected $2.40 instead, or $0.80, less per customer per month under their so-called “scheme.” I find it hard to believe that the $0.80 less a month gives them a competitive advantage. In fact, I think it’s outright ridiculous. I can’t imagine a scenario where a marketing department would even make a pitch that a $0.80 cents per month would give them a competitive advantage. And certainly no tax department would go out on such a limb and expose their company to such a risk on their own. The Attorney General’s argument is ridiculously weak -- it would be laughable if the consequences weren’t so dire.

When everyone was coming out with these plans basically at the same time, how did Sprint know exactly how their competitors would tax it? Did Sprint even advertise that their taxes were lower than their competitors? How critical is it to a prospective wireless customer what rate of tax they will be charged? Do people even think about that when looking at wireless carriers? Don’t most customers focus on coverage, roll-over minutes, equipment offered, and other services? How in the world is this fraud?

Taxation is Tough for Everyone, Especially Telecom Providers

The New York State Public Service Commission website page lists all the taxes and other fees that apply to telecom providers. If you’re the Sprint tax department you not only have to decide how much of the monthly call volume is interstate in nature, but which taxes and other fees apply and which of those they owe out their own pocket and which they must collect from their customers. Here’s a list of the taxes and fees applicable to telecom providers in NY: 

• State and local sales tax,
• Federal excise tax,
• E911 surcharge,
• Public safety communications surcharge,
• Municipal surcharge,
• New York State gross revenue tax surcharge,
• FCC subscriber line charge (SLC) 2, 
• Federal universal service fund recovery charge,
• MTA tax surcharge,
• Local number portability surcharge (LNP),
• New York City franchise fee,
• and more!

Can we give the telecom providers a break here? Rocket scientists are welcome to weigh in. Just complying with the laws is nearly impossible. When laws change and judgments have to be made as to whether a given charge is taxable in part or in whole, isn’t it possible that fraud is not involved even if the judgment is later deemed to be incorrect? 

Keep in mind that this is just one state. Every other state requires a similar, but distinctly baffling array of taxes of telecom companies. I can imagine that when this calling plan came out from the marketing department. The Sprint tax department had to scramble to figure out how it should be taxed all over the nation, wherever it was offered. I’m willing also to bet that at the time the plan was offered, the law wasn’t crystal clear in every jurisdiction, including New York. So, it’s very easy to understand how they came to this conclusion. I’m not saying whether I agree or disagree with their conclusion, but I can see how they got there.

Every Other Carrier in N.Y. is Vulnerable Here

According to the A.G., all the other big cell carriers were or are taxing these calling plans 100 percent. If the A.G. wins this lawsuit, the carriers may not be at risk on this specific issue, but because of the complexity of telecom taxation, other issues where they are at risk of undertaxing customers are bound to exist. But on a more ironic twist, let’s say that Sprint is able to fight back and win a court decision that they taxed it correctly in the first place. Then, suddenly, all of the other carriers are at risk to class action lawsuits for overcharging the tax. Is this good for encouraging rational tax policy that reasonable, law-abiding companies can follow? 

How to Minimize the Risks

So what do we recommend on how to avoid these type of lawsuits against your company? Good question. I guess the best we can say is, be extra careful. We all have to be careful to charge the right rate of tax on the right items. Some ways we can increase our diligence are:

1. Education – A big part of being diligent is to continuously educate ourselves. Sales tax is not static and neither should our knowledge base be. We should also be vigilant in watching for important court cases and how they may affect what we do.
2. Don’t Assume – Your normal CPA is probably very knowledgeable when it comes to income taxes and other issues that affect your business. However multi-state sales tax issues are complex and many CPAs often do not have the bandwidth to stay abreast of all the changes. Ask your CPA how comfortable they are with multi-state issues and what they do to keep themselves educated. The same goes for your employees. Make sure they are staying current.
3. Be Agile - Once changes are spotted we have to be agile enough to implement the necessary adjustments in a timely fashion.
4. Be Proactive - The attitude of “we have always done it this way and have never had any problems” should be banished from our organizations’ mindsets. We don’t have to experience the problem ourselves prior initiating adjustments to how we operate.
5. Utilize Third Parties – There are a handful of firms that concentrate on sales tax. Peisner Johnson and Company is the largest CPA firm in the country that limits its business to state and local tax issues.

The merits of the different state False Claims Acts and whether they create unnecessary litigation when it comes to tax issues can be debated. Our position is firmly on the side of the taxpayer. In Illinois we believe that the Act clearly creates unnecessary litigation. In New York, although much remains to be discovered, we believe the fraud action to be far too drastic an option. Sprint and New York would have ultimately worked out their differences either voluntarily or in court. However, at least for the time being, qui tam or whistleblower lawsuits are potential sales tax nightmares that need to be taken seriously.

Our Prayer to Lawmakers

As it currently stands, it seems like companies take great risks if they mistakenly overcharge the tax because of class action lawsuits. But at least in Illinois and New York -- and maybe in more states as time moves on -- companies may be in even worse shape if they undercharge the tax because of the whistleblower and fraud lawsuits they may face. We hope that as this issue comes up more frequently, lawmakers will step in to change these false claims acts and leave the enforcement of the tax laws with the various Departments of Revenue. Generally, Departments of Revenue have done a creditable job over the years of developing policy, training taxpayers, and enforcing the law. Remedies for disputing how the laws are interpreted are well-developed and widely used. Companies have a realistic expectation that they will be treated fairly by Departments of Revenue. Although the system is far from flawless, the system works quite well, overall. As for fraud, there are provisions for dealing with sales tax fraudsters. Fraud does occur when it comes to sales tax, but it usually involves knowingly collecting tax and not remitting it. Fraud should not include a scenario where a company relies on a DOR’s written policy and does not collect tax, or when a company makes a reasonable judgment that part or all of a given service it provides is not taxable. We hope that lawmakers will act to change these false claims laws such that these unnecessary and ridiculously punitive provisions of treble damages are removed. We hope that lawmakers will remove the bounty fees being paid to uninjured attorneys. We do not advocate underpaying or overpaying tax, but we know it happens for a variety of reasons most of which never involve a scintilla of fraud.  

Peisner Johnson, founded in 1992, is the largest national CPA firm that is focused entirely on solving state and local tax issues. Peisner Johnson is comprised of former state auditors and other professionals with years of state and local tax experience. Peisner Johnson has worked with clients of all sizes, in all industries and currently works in all 50 states, U.S. territories and Canadian Provinces. We work with many CPAs who find us to be a perfect complement to their business since we limit our practice to state and local taxes. We do nothing else. If you would like information on any of our free webinars, free chart services or would like to learn how we may be able to help, we invite you to contact us.

Texas Tax Amnesty

Is Fresh Start the Best Start?

By Michael J. Fleming

State tax amnesties are few and far between, so when Texas Comptroller Susan Combs announced an amnesty for the state of Texas on March, taxpayers had cause for celebration. Amnesties are usually beneficial for the state as well as for many taxpayers. In general, the states offer amnesties with the hope they will get a quick revenue boost to fill their coffers immediately, as well as add new or more reliable revenue streams from the new or newly compliant taxpayers. Most states kick off their amnesty programs with a lot of fanfare to generate interest and offer a limited window of time to create a sense of increased urgency. Texas is no different. Texas’ program began on Tuesday, June 12, and will run through, Friday August 17; slightly longer than two months. To help build excitement, the state named the amnesty program “Project Fresh Start.”

Before we get caught up in the building excitement and expanding sense of urgency, let’s ask the question, “ Is Fresh Start the Best Start?” The answer, as is so often the case when it comes to sales tax, is: It depends! It depends on your particular set of circumstances. A voluntary disclosure program (VDA) is often called an “ongoing amnesty” program, which is an appropriate phrase to describe a program very similar to a state amnesty program in some ways, and different in others. The differences in the programs combined with your circumstances determine if a VDA is a better choice for you. Let’s examine both programs to help you decide what the best plan is for your fresh start.

True Amnesties?

Whether we are talking about amnesties or VDAs, note that neither is a full pardon or “true amnesty.” In both cases, you still have to pay the back taxes. Amnesties typically only waive penalties and all or part of the interest owed on the back taxes. True amnesties do exist, though.

The Streamlined Sales and Use Tax Agreement allows for the waiving of all payment of back sales taxes, penalty, and interest. From the time a state becomes an associate member until 12 months after it becomes a full member, participating states must offer a true sales tax amnesty. Ohio, Tennessee, and Utah currently offer amnesty as associate members, and Georgia will continue to offer amnesty as a full member until July 31, 2012. These amnesties do not expire until 12 months after the states become full members. However, utilizing these amnesties is very complicated. Before using this program, we suggest you learn more about it, as it has some drawbacks. A good place to start is with an article by Andrew Johnson, founding partner of Peisner Johnson & Company, “Are You For or Against Amnesty?”

The Rationale Behind the Programs

States are looking for ways to close budget gaps and increase revenue, so offering amnesty may seem counter-intuitive because they forgo penalties and interest revenues. You may be thinking, “If it sounds too good to be true, then it probably is.” However, with state amnesty programs that adage is wrong. To understand why this is wrong we should realize that states expend a good deal of effort and money tracking down and auditing non-registered and non-compliant companies. By encouraging companies to step forward voluntarily, this allows states to redirect their efforts in other directions. When a company comes forward, the state receives an immediate lump-sum cash infusion consisting of numerous years of back taxes and perhaps some interest. Revenues from VDAs or amnesty programs is basically a windfall. Not only does the state receive a lump sum payment of back taxes owed, but it now has a taxpayer that will likely continue to pay taxes on a going-forward basis.

Texas Voluntary Disclosure Program

One of the most advantageous features of a VDA to a taxpayer is the limited look-back feature. If a company has not been registered, then there is no statute of limitations. In theory, in an audit, a state could go back to the first day the company began to do business in that state. In practice, most states go back only seven to 10 years. VDA agreements are attractive to taxpayers because the states agree to limit the look-back period, typically to three or four years. Each state is different. Texas has a look-back period of four years.

The second greatest feature of a VDA is the waiving of penalty and possibly some interest. While just about all the states waive 100 percent of the penalty, only a handful waive any interest. Texas is unique in that it waives 100 percent of the penalty and 100 percent of the interest. This feature more than makes up for the slightly longer look-back period of four years.

One of the major drawbacks of a VDA program is that most states will not enter into a voluntary disclosure agreement if they have already contacted you. A handful of states -- like Michigan -- will, but the majority will not. Texas falls into the majority and generally will not allow you to enter into a VDA once they have contacted you. Companies that have already registered in most states, including Texas, are ineligible for a voluntary disclosure agreement. VDAs have several other benefits and drawbacks, but for the purposes of our Fresh Start comparison, we will concentrate on these. If you would like to learn more about VDAs or amnesties, read “You Missed the Tax Amnesty Express”

Texas Fresh Start Amnesty Program

The biggest reason we generally prefer VDAs over amnesties, as mentioned in a previous tax amnesty article, is because many amnesties don’t allow for a limited look back period. Texas offers no look-back protection. If you have not registered in the state previously, then the state will require you to file and pay taxes for either how long you have been doing business in Texas, or seven to eight years, whichever is lesser and depending on tax type. Waiver of penalty and interest are the same. The Fresh start program waives 100 percent of the penalty and 100 percent of the interest.

The greatest advantage the Fresh Start program offers over the VDA is that it is more flexible for existing taxpayers. Texas VDA excludes registered companies for the tax in question, but the Fresh Start amnesty program may allow you to participate. The exceptions are: You cannot have already reported the tax on a return, be under audit, be identified for an audit, or have signed a settlement or VDA agreement.

The Fresh Start amnesty program covers all state and local taxes and fees administered by the Comptroller's office, with the exception of Public Utility Commission gross receipts assessments, and is available for those periods where the filings were due prior to April 1, 2012.

Conclusion

Could a VDA be a better start when considering a fresh start in Texas? Although the answer depends on your circumstances as discussed, in most -- but not all -- scenarios, we believe that a VDA program will be the better choice.

If you have exposure, now is the time to step forward. In many states, we have seen a concerted effort to step up discovery and enforcement activities in the periods following an amnesty. Texas has a very large department of auditors and is aggressive in assessing interest and penalties, which can add up very quickly. I recently spoke with Daniel Holcomb, a former state auditor with almost 30 years of service in the Texas Comptroller’s office and now a CPA with Peisner Johnson, and he said, “Amnesties come very infrequently, so between the VDA and the Fresh Start, we currently have some great options and incentives for companies to become compliant.” I couldn’t agree more.

Peisner Johnson, founded in 1992, is the largest national CPA firm that is focused entirely on solving state and local tax issues. Peisner Johnson is comprised of former state auditors and other professionals with years of state and local tax experience. Peisner Johnson has worked with clients of all sizes, in all industries and currently works in all 50 states, U.S. territories and Canadian Provinces. We work with many CPAs who find us to be a perfect complement to their business since we limit our practice to state and local taxes. We do nothing else. If you would like information on any of our free webinars, free chart services or would like to learn how we may be able to help, you may email Michael Fleming or call him at 972-277-4820.

New chart: Sales Tax VDAs by State

Voluntary disclosure agreements are a useful way to mitigate past liabilities while becoming compliant for sales tax purposes. Nearly every state offers a VDA program for sales tax, and if you qualify and take advantage, it could save quite the headache. One of the challenges is that VDA programs vary widely by state, and keeping up with the changes and variations between the states is a handful.

In the state of Texas for example, a VDA will waive all penalties and interest associated with any back taxes you may owe, and they will limit themselves to a four-year look-back period. Hawaii, however, will waive penalties but will require a 10-year look-back period and no interest waiver.

Oklahoma offers a VDA program with a three-year look-back, and the department will also grant a full penalty waiver and will reduce the interest by half. Compare that with the state of Iowa, whose look-back period is dependent on the amount of time your business has been operating in the state and can be up to five years, while offering a penalty waiver with no interest waiver.

In addition to what they offer, states vary in their requirements to qualify for a VDA. The state of California for example, will only enter into a VDA with a taxpayer if they have not been contacted by the state or any of its offices, and the taxpayer cannot be under audit.

Contrast this position with Maine’s VDA, where taxpayers who have been contacted by the state are not automatically disqualified from the program unless they are under a criminal investigation.

Because of the variations between states, tracking down this information would be incredibly time consuming. To save you from the hassle we have composed a chart detailing the differences between the state VDA programs. This is not meant to be exhaustive, but it can give you some helpful information on how best to proceed in your situation. If you would like a copy of the chart, just click here and let us know.

Peisner Johnson & Company Turns 20

Twenty years ago today, Jerry Peisner and Andy Johnson formed Peisner Johnson & Company with a clear mission: Solve clients’ state tax problems. 

As the newest member of the PJCo team, I’d like to wish Jerry, Andy, and the rest of the team a happy 20th anniversary! Congratulations, Team, and here’s to many more years of continued excellence!

Certificates of Authority to Transact Business: Do I Really Need to Ask for “Permission” To Do Business?

By Michael J. Fleming

A number of states ask about Certificates of Authority on their sales and use tax registration forms and/or during their voluntary disclosure agreement (VDA) programs. While the potential need for a Certificate of Authority is certainly not new, it appears that some states have taken a more aggressive stance in ascertaining who should be registered and then holding firm on compliance in their efforts to identify additional revenues. As a result, we are seeing an increased number of questions about the topic. A frequent question that arises in one form or another is, “Do I really need to ask for ‘permission’ to do business?” The short answer, at least according to the states, is yes. However, the short answer may not be the right answer for you. Before addressing how you get to the “right” answer, let’s review some of the basic concepts underlying a Certificate of Authority. What is it? What is the process to procure it? What is the basic theory behind it? What are the potential ramifications of electing not to secure it? And, what are the costs associated with obtaining and maintaining a certificate? Then, with a better understanding of certificates, we’ll return to our central question. 

What is a Certificate of Authority?
A Certificate of Authority to Transact Business is the proof that a state has granted you the authority to transact business within its borders. The process of asking for permission is usually called “foreign corporation qualification” or “foreign corporation registration.” It is called foreign corporation qualification because you are considered a domestic corporation in the state in which you are incorporated, and a foreign corporation everywhere else. Contrary to the somewhat common misconception, it has nothing to do with being from another country. The governmental agency that regulates the process is usually the Secretary of State. It is important to note that while we are mainly addressing corporations in this article, most states have the same requirements for the other types of business entities as well.

The process to obtain a certificate.
The process to obtain a Certificate of Authority is slightly different in every state. The majority of states require that you get a Certificate of Good Standing (COGS) or its equivalent from your state of incorporation. The certificates may or may not have to be certified depending on the state. Some states require certified copies of the Articles of Incorporation instead of the COGS.

Another requirement is checking for name availability. In other words, you need to find out if the name of your corporation as registered in your home state is available in the target state. If your name is not available, you will have to use an assumed name that is available. You will also need to find a registered agent. Each state has different rules on the guidelines for registered agents. A registered agent is your official representative in a state for purposes of receiving service of process and any official Secretary of State correspondence.

Once you have designated a registered agent, you will need to fill out your application and submit it to the state with the COGS and the application fee. State fees vary, but usually average around $100. There are companies that can assist with this process including Peisner Johnson & Company.

The theory behind Certificates of Authority.
The rationale the states have put forth for the requirement to obtain authority to do business is the need to protect domestic organizations from unfair competition. They also want to place domestic and foreign organizations on equal footing. The states’ ability to do so is apparently well settled and dates back to the 1869 U.S. Supreme Court Case of Paul v. Virginia, 75 U.S. 7 Wall. 168. In this case, the court found that “corporations are not citizens ... They are creatures of local law, and have not even an absolute right of recognition in other States, but depend for that and for the enforcement of their contracts upon the assent of those States, which may be given accordingly on such terms as they please.” It is specifically important to take notice of the language of the statement that refers to the enforcement of contracts.

The potential ramifications of electing not to obtain the Certificate of Authority.
The potential ramifications of electing not to obtain the Certificate of Authority vary by state, and each state usually has multiple ramifications. Perhaps the most serious ramification relates to a company’s ability to use the courts in that state to enforce their contracts, and the other ramification relates to potential assessments of fines and penalties. Many states will say that without their particular Certificate of Authority, you are prohibited from using the state court system. Some states go a step further and say that contracts you have entered into are invalid and unenforceable. Most states also have civil fines and or penalties, and a few have criminal fines and penalties. Some states cap the dollar amounts of these, but a large number do not. We have seen some fines and penalties add up to the $50,000 - $75,000 range. This can be a serious issue.

The downside of obtaining a Certificate of Authority.
After hearing the negatives of not getting a certificate, you may ask if there are any downsides of compliance, and the answer is yes. The most obvious downside of obtaining certificates is the costs associated with doing so and their maintenance. Once you have your Certificate of Authority, you will need to renew it annually in most cases. The renewal process usually consists of filing an annual report and paying a fee.

Also, the holding of a certificate in and of itself could be a nexus creating event in some states and could subject you to other taxes; most notably income and franchise taxes.

Do I really need to ask for “permission” to do business?
Again, the short answer to the permission to do business question, at least according to the states, is yes. The long answer, however, takes into consideration that each state defines “doing business” -- or as some call it, “transacting business” -- differently. The problem is that those definitions sound more like, “I’ll know it when I see it,” rather than a true definition. To the best of my knowledge, no state publishes a list of activities that are considered doing business for purposes of requiring a Certificate of Authority. Some states have a very limited list of activities that are not considered doing business. Most often, the only guidance that most states will give you is that you should consult with your attorney about your activities and whether they constitute doing business in the state.

In summation, the answer to the question is: it depends. If a state determines that your activities fit their interpretation of doing business, then their answer would be yes. We do not intend to take on the role of your attorney, nor can we state whether or not your activities definitely cross the threshold. But we do believe, given the downsides of failing to obtain a Certificate of Authority when when one was required, that a conservative approach may be desirable. Many clients of ours after considering the possible downsides, decided to err on the side of caution and tend to get registered in their larger states. But, by all means, do feel free to check with your attorney.

Peisner Johnson, founded in 1992, is the largest national CPA firm that is focused entirely on solving state and local tax issues. Peisner Johnson is comprised of former state auditors and other professionals with years of state and local tax experience. Peisner Johnson has worked with clients of all sizes, in all industries and currently works in all 50 states, U.S. territories and Canadian Provinces. We work with many CPAs who find us to be a perfect complement to their business since we limit our practice to state and local taxes. We do nothing else. If you would like information on any of our free webinars, free chart services or would like to learn how we may be able to help, you may email Michael Fleming or call him at 972-277-4820.

Think the “Haunted House of Horrors” on Halloween is Scary? Try Appealing Your Audit Assessment in Texas!

As a CPA firm focusing on state and local taxes, we speak with many taxpayers going through audits. A recurring theme that we often hear is that the auditor, audit supervisor or even the entire state audit division are being totally unreasonable or unfair. They can’t wait to appeal their audit, because once they get in front of an “impartial third party”, they feel that they will be treated more justly and receive a different outcome. While these taxpayers are often correct that they are being treated unreasonably, they are far from correct in their belief they will receive a different outcome in appealing their audit; especially in the state of Texas.

Should You Appeal Your Assessment in Texas?

Probably, especially if you disagree with it, but before you do, understand the odds are stacked against you. In addition you should know the audit process and try to resolve any issues at the appropriate levels during the process. Do not give up in trying to work with the auditor. If need be bring in someone to work on your behalf. Here are some reasons why.

Big Changes with Texas Certificates

Are You A Rancher/Farmer in Texas or Do You Have A Rancher/Farmer Customer?  If so, the Texas Sales Tax Law Has Changed for You.

Do you sell to farmers or ranchers in Texas? Then a new law in Texas applies to you. Starting in January, 2012, you’ll have to collect a new certificate from them with their new Comptroller-issued exemption number.

The Comptroller is currently working on the application for a registration number. A farmer/rancher in Texas enjoys a very broad-ranging exemption and until now, there was no need to register. You just buy an exempt item at Home Depot or Lowes or Tractor Supply and sign a statement that you're a rancher and no tax is charged. Now, any store who sells to a rancher will need to collect and manage a new certificate.

Certificate Management Just Got Harder

Many of our clients are experiencing increased sales tax audit liabilities because of missing resale and other exemption certificates. This is an area that states are targeting with laser-like focus. Exemption certificates have always been a problem in most sales tax audits, but as long as you had something on file that you “accepted in good faith”, or if you came up with the missing certificate, the auditors would usually give you a pass. If the item was clearly exempt, they were pretty lenient about the certificates. But states are getting very aggressive; focusing on the technicalities to the extreme. The item may clearly be for resale or exempt like these agricultural items, but it you don’t have the right form completely filled out and signed with a valid id number and the right date, they will tax you all day long til the cows come home. It’s easy, low-hanging fruit.