State and Local Tax Updates and 2024 Trends Webinar Confirmation

Franklin Chow on July 2, 2024

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Understanding Franchise Tax: A Simple Explanation

Franklin Chow on May 8, 2024

What Is Franchise Tax?

It’s essential to differentiate between franchise tax and income tax. While income tax is based on the income earned by individuals and businesses, franchise tax is a unique tax imposed on businesses for the privilege of operating in a particular state or jurisdiction, not directly linked to their income. The purpose of franchise taxes is to generate state revenue and regulate businesses operating within its jurisdiction.

- Income Tax: A tax levied on a company’s net profits (income minus expenses). It applies to most businesses and corporations.
- Franchise Tax: A tax imposed by some states on the privilege of doing business within their jurisdiction. It can be based on gross receipts, capital stock, or a flat fee. Not all states have a franchise tax, and those that do might have different structures for calculating it.

As of 2023, the states that impose franchise tax are Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, Minnesota, Nevada, New Hampshire, New York, North Carolina, Oklahoma, Tennessee, Texas, Vermont, and the District of Columbia.

Who Pays Franchise Tax?

The entities required to pay franchise tax vary depending on the jurisdiction in which they operate. In general, franchise tax obligations apply to businesses that have been granted legal recognition by the state or jurisdiction where they are located.

The Types of Entities That Are Typically Subject to Franchise Tax Are:

Corporations: Most states impose franchise taxes on corporations, including C and S corporations. This applies to domestic corporations (those incorporated in the state) and foreign corporations (those incorporated in other states but doing business within the state’s jurisdiction).

Limited Liability Corporations (LLCs): Many states also require LLCs to pay franchise taxes. LLCs are often treated similarly to corporations for tax purposes and may be subject to franchise taxes based on their structure and activities.

Partnerships: Depending on the state, certain types of partnerships may be subject to franchise tax requirements.

Limited Partnerships (LPs): Some states may require LPs to pay franchise taxes, particularly if they have elected to operate as limited liability partnerships (LLPs).

Limited Liability Partnerships (LLPs): LLPs are typically subject to franchise tax requirements in states where they are recognized as a separate entity type.

Other Business Entities: Depending on the jurisdiction, franchise tax obligations may apply to other business entities, such as professional corporations, business trusts, and specific nonprofit organizations.

Some states provide exemptions and thresholds for franchise tax, which can vary depending on the jurisdiction. They are typically based on factors such as the size of the business, its revenue or assets, legal structure, and activities.

Common Exemptions and Thresholds That May Apply:

Small Business Exemptions: Some states provide exemptions or reduced tax rates for small businesses below a specific revenue or asset threshold.

Nonprofit Organizations: In many states, nonprofit organizations are often exempt from franchise taxes. However, they may still need to meet specific criteria and file appropriate paperwork to qualify for the exemption.

Start-Up Exemptions: Certain states offer exemptions or reduced tax rates for new businesses or start-ups during their initial years of operation. This is intended to encourage entrepreneurship and economic growth.

Low-Income Housing Exemptions: Some states provide exemptions or preferential treatment for businesses involved in low-income housing development or other specified community development activities.

Industry-Specific Exemptions: Some states offer exemptions or reduced tax rates for businesses operating in specific industries or sectors deemed particularly important to the state’s economy.

Franchise Tax Thresholds: Many states have thresholds for which businesses are not required to pay franchise tax. For example, a state might exempt businesses with annual revenues below a certain amount or minimal assets.

Asset-Based Exemptions: In some cases, states may provide exemptions or reduced tax rates based on the value of a business’s assets or net worth.

Failure to comply with franchise tax requirements can result in penalties, fines, and other consequences, so businesses should consult with tax professionals or legal advisors to ensure compliance.

How To Simplify Franchise Tax Compliance

Consulting with a tax professional or legal advisor can help businesses determine their eligibility for exemptions and ensure compliance with state franchise tax requirements.

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Leveraging automation tools and software for franchise tax compliance can help businesses improve efficiency, accuracy, and timeliness while reducing the administrative burden associated with tax compliance.

How State and Local Taxes Can Affect Your Business’s Exit Strategy

Franklin Chow on April 25, 2024

Exit strategies for a company involve planning and execution on various fronts, including handling state and local taxes. These strategies are crucial for minimizing tax liabilities and ensuring compliance with legal requirements. Here are three short steps for formulating an exit strategy with a focus on state and local taxes:

1. Determine the Exit Strategy Type

Assess the Type of Exit: Whether selling the business, merging, going public, or dissolving, each type of exit has unique state and local tax implications. Considerations include whether the exit is structured as an asset sale or a stock sale, as this will affect the taxation of the transaction.

Asset Sale vs. Stock Sale: An asset sale may result in different tax treatments for tangible and intangible assets across states. A stock sale may involve other considerations, such as whether there are state-level capital gains taxes.

Mergers and Acquisitions (M&A): Evaluate the tax implications of mergers or acquisitions, including how they are structured and the impact on tax attributes like net operating losses.

Initial Public Offering (IPO): Understand the tax considerations of going public, including state and local income taxes and sales tax obligations from increased public scrutiny.

Dissolution: If winding down, consider state and local tax clearance requirements, including final tax returns and potential taxes on the distribution of assets to shareholders.

2. Analyze State and Local Tax Implications

Each state and locality may have different tax laws affecting the exit strategy. This step involves a detailed review of the tax landscape where the company operates, focusing on:

State and Local Income Taxes: Evaluate the impact of state and local income taxes on the sale of the business or its assets. Consider the nexus and apportionment rules, which determine the portion of a company’s income that is subject to tax in a particular jurisdiction. These rules might affect where and how much income is taxed, so it’s important to understand them when formulating your exit strategy.

Sales and Use Taxes: Identify any liability for sales and use taxes, especially if the business has a physical presence or economic nexus in multiple jurisdictions.

Other Taxes: Consider other taxes, such as real estate transfer taxes, franchise taxes, and payroll taxes, that could affect the transaction.

3. Plan for Post-Exit Tax Compliance

Ensure Compliance and Leverage Tax Planning Opportunities: After determining the tax implications, the next step is to comply with all tax filing requirements and explore opportunities to minimize taxes.

Tax Clearance Certificates: Obtain tax clearance certificates where required to prove that the company has satisfied its tax liabilities.

State and Local Filings: Ensure that all final state and local tax returns are accurately filed and that any taxes due are paid. This may include final income tax returns, sales tax returns, and other relevant filings.

Tax Planning: To minimize tax liabilities, explore tax planning opportunities, such as utilizing net operating losses or credits. This proactive approach can significantly impact your tax burden. Consult with tax professionals to identify strategies specific to the company’s situation and jurisdictions.

Consult with Professionals: Engage with tax professionals specializing in state and local taxation. Their expertise can help navigate the complex tax landscape, ensure compliance, and potentially identify savings opportunities. These opportunities could include finding deductions or credits that the company may not be aware of, structuring the exit tax efficiently, or identifying potential tax planning strategies for the future.

How We Can Help

Source Advisors is committed to helping navigate the complex landscape of State and Local Taxes, ensuring that a company’s exit strategy is executed efficiently, with a clear understanding of the tax implications at the state and local levels.

Intro to State and Local Tax Webinar Download

Cameron Fino on April 24, 2024

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State and Local Tax Updates and 2024 Trends

During this session, attendees will gain insights into the current state and local tax landscape, recent legislative updates, and recommended approaches for advising clients on state and local tax matters stemming from the groundbreaking Supreme Court Case.

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Understanding Sales and Use Tax Audits

Franklin Chow on April 10, 2024

Sales and use taxes are the lifeblood of many state and local governments. But for businesses, navigating the complexities of sales tax compliance and facing a potential audit can be stressful. This blog aims to shed light on what sales and use tax audits are and how to prepare for them.

What Is a Sales and Use Tax Audit?

A sales and use tax audit is a formal examination conducted by your state or local tax authority to verify the accuracy of your sales and use tax reporting. Auditors will review your business records, including:

Sales records
Purchase records
Exemption certificates
Tax returns

The goal of the audit is to determine if you have collected and remitted the correct amount of sales and use tax. In some cases, the audit may also cover past tax periods.

What Triggers a Sales and Use Tax Audit?

There are several reasons why your business might be selected for a sales and use tax audit. These include:

Discrepancies in your tax returns: Inconsistencies or missing information on your sales tax returns can raise red flags for auditors.
High sales volume: Businesses with a large volume of sales are more likely to be audited.
Industry trends: Certain industries may be singled out for audits based on past trends of non-compliance.
Random selection: In some cases, audits are chosen randomly to ensure fairness and compliance across all businesses.

Preparing for a Sales and Use Tax Audit:

While an audit can be daunting, here are some steps you can take to be prepared:

Maintain accurate records: Keep all sales and purchase records, exemption certificates, and tax returns for the required period (typically 3-4 years).
Understand your sales tax obligations: Familiarize yourself with the sales tax laws in the jurisdictions where you do business.
Consider sales tax automation software: Using software can streamline recordkeeping and ensure accurate calculations.
Seek professional help: If you are selected for an audit, consider consulting with a tax professional who specializes in sales and use tax.

Facing the Audit:

Stay calm and cooperative: Auditors are there to do their job. Be polite and professional throughout the process.
Provide requested documentation promptly: Having your records organized and readily available will save time and frustration.
Ask questions when needed: If you don’t understand something, don’t hesitate to ask the auditor for clarification.

The Bottom Line:

Sales and use tax audits are a normal part of doing business. By understanding what they are, why they occur, and how to prepare, you can minimize stress and navigate the process more effectively.

Additional Tips:

Keep copies of all communication with the auditor during the audit process.
If you disagree with the audit findings, you have the right to appeal the decision.

Remember, maintaining good sales tax compliance practices throughout the year is the best defense against a stressful audit experience.

You Received a Sales & Use Tax Audit Notice. What Do You Do Now?

Franklin Chow on April 5, 2024

Sales & use tax audit notices are never a great letter to receive in the mail. But, by following the steps outlined in this article, they may not be as bad as they seem.

Whether you are running a service or product-based business, it does not take much for sales & use tax laws to become relevant. Sales & use taxes are a complex beast. Businesses need to:

Pay sales tax to vendors when they purchase taxable goods or services
Accrue and pay use taxes when they were not charged sales tax at the point of sale on taxable goods or services
Collect sales taxes from their customers on taxable sales
Remit the collected sales taxes to the state

There can even be the requirement to notify customers of their requirement to accrue use tax in instances where, as a result of specific circumstances, you are not required to charge them sales tax at the point of sale.

To make matters even mirkier, this works on a state by state (often county by county) basis – where rules vary markedly in each jurisdiction. Complicated, right?

Receiving an Assessment Notice

Being that sales & use tax is as complex as it is, it should not come as a surprise when a state comptroller or department of revenue sends a business an assessment notice.

A sales or use tax assessment notice is a communication received from the state or county (generally by mail) that requests documentation pertaining to a company’s purchases and sales activities.

The notice will have a due date for which the documents must be sent to the assessor.

Receiving an Assessment Notice

Being that sales & use tax is as complex as it is, it should not come as a surprise when a state comptroller or department of revenue sends a business an assessment notice.

A sales or use tax assessment notice is a communication received from the state or county (generally by mail) that requests documentation pertaining to a company’s purchases and sales activities.

The notice will have a due date for which the documents must be sent to the assessor.

Upon review of the information, the assessor will likely notify the business that it has been delinquent in its sales & use tax filing or payment requirements, and outline the estimated amount of unpaid taxes, penalties, and interest that the company owes.

This notice will be accompanied by a request for additional information, and another deadline.

All this communication from the state or county can be daunting and difficult to digest – especially when the figures provided are high, and the business owner’s knowledge of the subject is limited.

Here are five steps to follow if you find yourself in this predicament.

1. Don’t Worry, You’re Not Alone

First things first – breathe. The notice may seem dauting, and you may be caught off guard, but it likely seems like a bigger deal than it is.

These notices are quite common, and they are based on assumptions and generic data that is unlikely to align with your business’s exact fact pattern.

The key is not to react or fret. There is a process to follow, and the outcome is almost always going to be less harsh than the assessor may originally make it seem.

2. Request an Extension

In almost all cases, and deadline provided by an assessor is flexible. It is important to be aware that you have the ability to ask for more time.

Be reasonable, though. What you are looking for is some time to digest the information, review your circumstances, and seek advice before responding.

3. Keep Communications Limited

Outside of requesting an extension, communication with the state should be limited. Every document, email, or phone call you have with the state can be interpreted in different ways, which can result in confusion and heartache down the line.

4. Enlist the Help of an Expert

There are people out there with a wealth of experience in navigating these notices – and diligent business owners will take the first opportunity they get to seek out assistance from such practitioners.

A CPA is generally not a sales & use tax expert (unless the CPA firm has a sales & use tax specialty arm. Experts are specialists in this area of tax law and are best placed to work with a CPA in gathering information and providing responses.

Enlisting this assistance comes at a cost. However, the cost is almost guaranteed to be paid back in spades, as experience enables these specialists to negotiate reductions in assessments amounts, penalty abatements, and so on.

5. Consider Your Other Sales & Use Tax Liabilities

Receiving an assessment notice provides the opportunity for business owners to consider their potential exposure in other states that are not under audit.

Getting ahead of the curve is important, as dealing with exposure prior to receiving an assessment notice costs the business far less financially and enables the company to sidestep the disruption that audits typically cause.

Multi-state businesses can use the one assessment notice as cue to review their affairs in other states and put mechanisms in place to avoid the same scenario occurring elsewhere.

Refund of Tax Paid on Software Purchases

Franklin Chow on March 13, 2024

Refund of Tax Paid on Software Purchases by Companies Located Illinois, Massachusetts, New York, Pennsylvania, Washington or Utah

The multiple points of use (“MPU”) exemption is a provision in sales and use tax laws designed to address situations where software is purchased for use in multiple jurisdictions. The MPU exemption allows for allocation of tax based on the proportionate use in each jurisdiction. This results in a refund of sales tax paid on software purchased.

Why do companies overpay sales & use tax on software purchases?

The purchase of specific software licenses or many cloud-based products, such as SaaS, PaaS, and DaaS, products are subject to sales tax in various (but not all jurisdictions) across the country. Typically, sales and use tax laws require tax to be charged based on the location where the software is billed to as this is assumed to be location of ALL OF ITS use. Many companies, especially post COVID-19 have employees that are located in jurisdictions across the country either working out of satellite offices and / or working from their homes. In these situations, companies are overpaying sales & use tax on software purchases because they are paying tax for users that are located in jurisdictions outside of where the software purchases were billed to.

How does the company qualify?

There are no industry and / or purpose of use qualifications to meet in order qualify for this exemption. The only qualification for the MPU exemption is that the software should be capable of being used in multiple locations or by multiple users. While there may be other exemptions applicable to software, the MPU exemption is primarily for companies that are based out Illinois, Massachusetts, New York, Pennsylvania, Washington or Utah.

What is the opportunity?

Once identified there are several ways to recover the overpayments of sales & use tax. The taxpayer can get the refund from the vendor and / or from the state the overpayment was made. In instances where the taxpayer has an open audit, it can be used to offset any audit assessment liability.

How can a taxpayer claim the refund?

Analyze your company’s purchases to identify which vendors are charging sales tax on software or any cloud-based products, such as SaaS, PaaS, and DaaS products. Source Advisors has developed proprietary technology to make this task simple. Our platform allows us to analyze, identify and collect all the documents necessary to file refund claims with minimum resources from our clients.

Regardless of how you chose to pursue the refund claim proper documentation is essential to support the application of the exemption. This will definitely include the purchase invoice, it may also include contracts, usage agreements, and other relevant documentation. Source Advisors has developed relationships with many of the larger technology companies to facilitate the recovery process. Source Advisors is extremely well versed with the sales & use tax refund claim process with these states having submitted, substantiated, and secured hundreds of refund claims.

Sales Tax Due Diligence in a Post Wayfair World

Franklin Chow on February 21, 2024

Over the past five years, sales tax awareness has increased amongst the private equity world as states have expanded their ability to tax remote sellers through economic and marketplace nexus rules. However, as a result of the South Dakota v. Wayfair, sales tax has worked its way to the top of the due diligence list.

In fact, the enforcement dates for many states began as early as July 1, 2018, resulting in any deal currently in the pipeline potentially facing major sales tax exposure that may affect your ASC 452 accrual – and as a result, directly impacting EBIDTA.

What is a Remote Seller Under Wayfair?

Many professionals are confused and have assumed that Wayfair only applies to e-commerce transactions. This is not the case. Although many states have not clarified the definition of a remote seller, several have, and the definition is broad as states will cast a wide net.

For example, Nebraska defines remote sellers as “retailers that do not have a physical presence in Nebraska, but sales to purchasers in Nebraska” and Maryland defines a remote seller as anyone who “sells or delivers tangible personal property or a taxable service for use in Maryland”.

What is the Result of South Dakota v. Wayfair?

In 2018, the Supreme Court released its decision on the landmark sales tax case, South Dakota v. Wayfair. The Court overturned the “physical presence” standard that previously governed the determination of when sales tax was due. Wayfair held that the correct standard in determining the constitutionality of a state sales tax law is whether the tax applies to an activity that has “substantial nexus” with the taxing state.

State officials around the country continue to implement a range of possibilities for taxing sales by remote sellers to take advantage of the new economic Wayfair test, and the landscape is changing rapidly.

The Wayfair decision has made it critical for remote sellers to review their current business against existing and quickly evolving state legislation to make determinations as to which states they may now be required to collect and remit sales tax.

Utility Studies for Sales and Use Tax Exemptions

Franklin Chow on February 19, 2024

While specific exemptions vary from state to state most manufacturers are aware that all states offer some type of sales & use tax exemptions for having operations located within their state. Manufacturers always capture all of the savings pertaining to sales tax exemptions on raw materials, machinery and equipment, but often overlook the utilities exemptions. Some jurisdictions exempt manufacturers from paying sales tax on energy sources, such as electricity, natural gas, and water, when used in the manufacturing process.

What Is a Manufacturer?

The definition as to what qualifies as manufacturing varies from jurisdiction to jurisdiction. The key is that manufacturing involves the transformation of raw materials or components into finished goods through a series of processes. Different business activities and operations that can be considered as manufacturing including assembly, fabrication, processing, machining, chemical production, printing, textile production, automative manufacturing, wood working, plastic molding, food and beverage production, pharmaceutical manufacturing, aerospace manducating, and packaging.

What Is a Utility Study?

A utility study, in the context of sales and use tax, refers to an examination and analysis of utility usage within a business to determine the portion of utility expenses that may qualify for tax exemptions. The goal of a utility study is to identify and document the usage of utilities—such as electricity, natural gas, water, and other energy sources—that are related to qualifying activities, typically those associated with manufacturing or other specified processes.

The sales and use tax regulations in most jurisdictions provide exemptions for certain types of utility usage, particularly when those utilities are consumed in specific activities that contribute to the production process. By conducting a utility study, businesses aim to segregate and document the utility consumption that qualifies for these exemptions, with the ultimate objective of reducing or recovering sales and use taxes paid on non-exempt utility usage.

What Are the Steps to Doing a Utility Study?

Performing a utility study to obtain a refund of sales and use tax for utilities used in the manufacturing process involves a systematic approach to document and analyze utility consumption. The process may vary based on jurisdiction, but here is a general guide:

Understand local regulations and identify eligible utilities
Document utility usage, determine exempt usage, and quantify qualifying and non-qualifying usage
Prepare legally required documentation including exemption forms
Submit refund, communicate and negotiate refund claim withing taxing authorities
Adjust policies and procedures to minimize liabilities move forward

The utility study process requires careful documentation and adherence to tax regulations to support any claims for exemptions or refunds. It is advisable for businesses to work with tax professionals or consultants who specialize in sales and use tax matters to ensure that the study is conducted accurately and in compliance with applicable laws.

Different Types of Sales Tax Nexus for E-Commerce

Franklin Chow on February 16, 2024

For online businesses, navigating the ever-shifting sands of sales tax can feel like wandering through a labyrinth. One wrong turn, and you could face unexpected tax liabilities and penalties. Understanding sales tax nexus – the connection that triggers your obligation to collect and remit sales tax in a state – is crucial for ensuring compliance and avoiding costly missteps.

The Big Four of Sales Tax Nexus:

While the definitions can vary state-by-state, there are four main types of nexus you need to be aware of:

Physical Nexus:
The classic brick-and-mortar scenario. Having a physical presence, like a store, office, or warehouse, in a state automatically creates nexus. This is the most traditional form of nexus and occurs when a business is physically in a state. Some examples include:
- Having a store, office, warehouse, or other physical location in the state.
- Hiring employees or contractors who work in the state, even if remotely.
- Storing inventory or other property in the state.
Economic Nexus:
This type of nexus is based on a business’s economic activity within a state, regardless of whether it has a physical presence there. Since the landmark ruling of Wayfair vs South Dakota in 2018, states have adopted economic nexus laws, which often trigger a sales tax obligation if a business meets certain thresholds for sales, transactions, or revenue generated within the state. These thresholds vary by state and can be based on factors like gross receipts, taxable revenue, number of transactions, or a combination of both.
Affiliate Nexus:
This type of nexus arises when a business has a relationship with another entity (an affiliate) that has physical nexus in a state. If the affiliate refers customers to the business or assists with sales in any way, the business itself may be found to have nexus and be responsible for collecting sales tax. However, the specifics of affiliate nexus vary by state, so careful analysis is important.
Click-Through Nexus:
This type of nexus is relatively new and less common, but it’s worth mentioning. It generally applies when a business operates solely online and uses an affiliate in a state to link to its website and generate sales. Some states have laws establishing click-through nexus, but the legal landscape is still evolving and varies widely.

Navigating the Labyrinth:

Staying compliant with sales tax nexus can feel daunting, but here are some helpful tips:

Stay informed: Regularly update yourself on changes in nexus laws, especially for states you have business in.
Seek professional guidance: Consulting a tax professional with a specialization in SALT, experienced in e-commerce can save you time, money, and headaches.
Leverage technology: Many software solutions can help you track sales activity and manage nexus compliance across various states.
Register and remit responsibly: Once you establish nexus in a state, promptly register and start collecting and remitting sales tax.

Failing to comply with sales tax nexus can result in significant penalties, interest charges, and even potential audits. By understanding the different types of nexus and taking proactive steps, you can navigate the sales tax labyrinth with confidence and ensure your business stays on the right side of the law.

Sales Tax Nexus with Source Advisors

When it comes to sales tax nexus studies, it’s crucial to explore your options and find the right solution for your business. Source Advisors is well-versed in the complexities of sales tax nexus and offers expert assistance to businesses in need. Our team of seasoned professionals can guide you through the process and provide accurate and comprehensive sales tax nexus studies.

Our tailored approach means we consider the unique aspects of your business. Whether you operate as an e-commerce business, a brick-and-mortar store, or a combination of both, we provide a sales tax nexus study that meets your specific needs.