Why Is Multi-State Tax Compliance So Hard?

This post was originally published on Forbes Jun 12, 2015

SALT is an acronym that stands for State and Local Tax.  Reilly's Fifth Law of Tax Planning states "A tax plan that ignores AMT or SALT is not much of a tax plan."   It is tough being a SALT specialist in a national or large regional CPA firm.  On a big job they will often be the last ones in after auditors finish the financial statements and the federal tax return is almost done. In a last minute compliance crunch, they are usually the bringers of bad news and are asking questions that should have been asked at the outset.

At The Pinnacle Of SALT Practice

Of course national and large regional firms tend to scorn compliance work.  That is something that should happen as if by magic with the work done by brilliant accountants in south Asia, who work for a pittance, but can be billed at the same rates as Americans.  Accountants on the same continent as their clients need to be consultative, because - Well - because properly educated clients will write bigger checks for that.  SALT people shine more in the consultative arena.  For a complex organization to be in compliance with the laws of many states in the areas of income tax and sales and use tax and not be overpaying its local property taxes can be mind-numbingly complex.  Studies, studies, studies - Kaching!

Then there is the dance of the seven veils known as the "voluntary disclosure agreement" that my friend Inez Mello can take you through.  The study shows your company should have been filing in Mississippi for the last fifty years?  She helps you work out a deal anonymously that will limit the lookback to maybe three years before you step forward and identify yourself.  It is the classic case of CPAs charging you a lot of money for solving a problem you didn't know you had, but it actually does make sense.

In The Trenches

For ordinary CPAs and other tax service providers serving businesses with revenues in the $100,000 - $20,000,000 (More or less) range SALT is mainly a source of aggravation.  Frankly if you have good software throwing another state into the income tax package is not that big a deal, but there are often nuances that can be missed, particularly in the northeast where some of the states a are a little peculiar.  Those nice rectangular states tend to be easier with state taxable being much more closely related to federal adjusted gross income or federal taxable income.

When a client calls with sales and use tax problems, you can really be at sea.  Then there is the nexus question.  "So I was wondering - elaborate story about sales reps or warehouse or whatever - do I really have to file a return in - "Some other state's name here" ?

Now I know some real sharp SALT consultants with boutique practices like Inez and Sylvia Dion, whom I featured in women in accounting series, but there are only so many favors you want to ask, so I have developed my own easy rule of thumb.  If you ask if you should be filing in a particular state, the answer is probably yes.

And here's the killer.  Most preparers don't have that much trouble working another state income tax return in, but when it comes to your sales and use tax requirements.  Forget about it.  You are lucky if they have a clue about their home state.

I had somebody ask me the question last week out of the blue.  I'm going to make up a fact pattern that illustrates their problem but is entirely fabricated.  As far as I know there is no business like the imaginary one I am about to describe.

So You Want Your Own Museum

It was Mary Museum that gave me a call.  She has an S Corporation based in Manhattan called "Enough is Never Enough" (ENF).  ENF caters to the 0.01%.  Here's the thing.  You've got your $40 million dollar house and your $100 million art collection.  But do the two really mesh all that well?  For the really special art work you need the right display space not to mention all the environmental preservation considerations.

That's where ENF comes in.  Mary, a former museum director, designs the space - either an addition to the house or perhaps a conversion.  I mean, really, you don't use the indoor basketball court that much anymore.  Most of the work will be done by local contractors, but Mary will be there overseeing it along with her two employees Hans, an HVAC engineer, and Luigi, a craftsmen who makes sure all the fine detail is perfect.  The local guys really like Mary who does little things to boost their morale like bring them chocolate chip cookies and get them tickets to the Knicks games when they visit New York.  The guys respect Luigi who does not mix with what he calls the "journeymen" very much.  They are afraid of Hans.  There are certain key components that have to be bought through ENF, but I've pretty much exhausted my imagination so you will have to make them up.

From a state income tax viewpoint, Mary has chosen one of the worse possible places to live, but of course it fits her business well.  Her customers are drawn from the same ranks as the women that  Wednesday Martin describes in her controversial Primates of Park Avenue: A Memoir.   Of course those people own houses in other states and not all her potential customers live in New York.

Two Opinions

Mary called me to be a tie breaker because she had two opinions on a question.  She had been commissioned to work on a house in Aspen, which means she and Luigi and Hans would be spending a lot of time there.  It will be worth her while to rent a condo to save on the hotels.  One person told her to not worry about it just file like everything is being done in New York.  The other told her that she has to register to do business in Colorado.  She and Luigi and Hans will be filing Colorado income tax returns.  And then there is the sales and use tax.  It struck her as a lot of trouble to go to for a single project.  Well a single $800,000 project that will have her and her guys in Colorado for months.  Still.  She might not have another job there for years, if ever.

 Who Is Right?

Keep in mind.  This is a mythical company and you are not my client.  There is a sense in which both advisers are right, although the second one is clearly righter.  If you are blowing in and out of a state, taking a calculated risk on being less than meticulous in your compliance can be a reasonable business judgment.  Mary is not really avoiding any state income tax.  She would probably get a credit against her New York income tax for whatever she paid Colorado.  Of course if Colorado catches up with her after the statute has expired on her New York return, she is out of luck.  As far as the sales and use tax exposure goes, it will not make or break whether she gets the job, it is just the hassle she wants to avoid.

My Great Idea

What I tell Mary is that she should do is add some number to her project cost for state tax compliance.  What's the number? I figured that would be easy.  I would just call around and find somebody who offered a seamless state compliance solution like the way ADP or Paychex take care of payroll.  In my mind the hard part is the sales and use tax. So I start making calls and the kind of answers I get go something like"Well we just completed a year and a half project for a major retailer and we created a matrix ........."  What I wanted was - Colorado $4,000 - California $6,000 - New Hampshire ? Ahh.  Nobody can figure out New Hampshire.  (Just kidding).

Of course I can't say the solution isn't out there, but if it is their marketing is terrible.

I spoke with Jim Frazier who runs Take Charge Seminars which does seminars on sales and use tax.  His business, which is pretty much just him, has a similar problem to Mary as he bops around the country putting on his seminars.  He really needs to be meticulous about compliance though and we're not talking about big projects.  So he won't do seminars in Connecticut.  It is no so much the hassle of registration.  It is his interpretation that they would then be able to tax his webinars. He is philosophical about it noting that Connecticut is a small state, so if you want him to do a seminar for people who are in Hartford, they can always just drive to Sturbridge, Mass.

If there is some sort of seamless solution, he doesn't know about it or at least he is not saying.  He said that maybe I needed to start a business.

Well.  I'm 63 years old and have worked in public accounting for 37 years - mostly local and large regional.  That has giving me some sort of insight into the character of a person who would create the company that I am thinking should exist.  It is certainly not me and probably not a SALT expert, who tend to be kind of like artisans.  On the other hand, I know people like that.

Why The Seamless Solution Might Not Be There

I really lucked out as the second former client (Call him Joe) I talked to had actually built a business around a compliance issue that companies were having trouble with.  It was not so much that they wanted to be scofflaws.  It was just very challenging to be compliant, which is really what is going on in the SALT area as it relates to smaller companies.  (At the more ethereal levels, there is complicated planning on how to avoid state corporate income tax by shuffling around a lot of subsidiaries, but that's not what I am worried about here).  He actually ended up having regulators, in effect, doing his marketing for him.

Companies that were out of compliance would be told that there was, in fact a solution - Joe's company.  Then things began to slip.  He had built this seamless compliance platform.  Companies were motivated to adopt it, because the consequences of being out of compliance were severe and the regulators were aggressive.  Then the regulators slacked off.

We live in a world in which there are a lot of rules - many of them quite complicated. It takes effort to be in compliance.  Somebody can build a business around making it easy, but only if there are enough motivated customers. In my first years in public accounting, I used to go out to clients and manually prepare their payroll tax returns.  Clearly payroll tax services are more efficient.  One of the things that makes them work though is the market.

The penalties for non-compliance, even just being a bit late with deposits, are pretty severe.  There is personal liability on the part of responsible parties.  There is a general sense that payroll is something that it is a bad idea to screw around with which makes it easy to sell a seamless solution.  Multi-state sales and use and income tax for people who are sporadically in and out of states is just not as compelling.  You will hear that revenue hungry states are getting more and more aggressive.  But I have been hearing that for decades.

Don't get me wrong.  I believe that the prudent thing is to try to be in pretty good, if not perfect, compliance.  Just don't expect anybody to make it really easy any time soon.