Tax Return Filings for Multistate Operations

Tax Return Filings for Multistate Operations

By Keith R. Lee

In some corporation and partnership income tax return engagements, it might be unclear whether the client has income tax nexus in a given state. Alternatively, a client might not want to file in a state despite it being clear that the client has income tax nexus in that state. The client might not want to file in given states because, for example, the entity would only report a net operating loss in those states, and administrative filing costs may be high.

When a corporation or partnership client does not file an income tax return where a state requires it to do so, adverse ramifications can arise. For example, the assessment statute of limitations remains open, or the client is unable to claim net operating losses or other tax attributes on any future years’ income tax returns.

While the client initially might view disregarding a state’s income tax filing requirement as beneficial, it is likely the client’s view will change when the adverse ramifications become clear. When the adverse ramifications of nonfiling are revealed, the client might seek to make your firm financially responsible. Therefore, when it is unclear whether your client has nexus in a given state, or when the client deliberately ignores a state’s filing requirement, it is imperative that your firm’s engagement letter address the specific state income tax returns that will be prepared. Sample engagement letter language is shown below.

However, note that disregarding a given state’s filing requirement could potentially affect the apportionment or other amounts, or both, that your firm includes on the state income tax returns it prepares. Such engagements therefore should be accepted only after a careful review of the risks involved and after determining that it is possible for your firm to prepare accurate state income tax returns.

Additionally, if a client repeatedly ignores income tax return filing requirements or ignores a filing requirement where the relevant income tax return would report a material amount of tax, or ignores both, your firm should carefully review the client’s engagement history, ascertain the engagement’s professional liability risk level, and determine whether disengagement is appropriate.

Client’s Multistate Operations: Sample Engagement Letter Language

From information you provide to us, our firm will prepare [INSERT YEAR] federal and state corporation/partnership income tax return(s) for the state(s) of: [INSERT SPECIFIC STATE(S)’ NAMES]. This firm is responsible for preparing only the returns listed in the preceding sentence. Please note that if your corporation/partnership has an income tax filing requirement in a given state but does not file the required income tax return, it is possible that the nonfiling could have adverse ramifications including (i) an unlimited assessment statute of limitations and (ii) inability to claim net operating losses or other tax attributes on any future years’ income tax returns.

If your business has any operations in states other than those specifically listed, you are responsible for providing our firm all information necessary to prepare any additional applicable state(s) income tax returns such as the identity of all states in which XYZ Corporation/Partnership does business and the extent of business operations in each relevant state. Any additional state income tax returns prepared will be done as a separate engagement.

Alternatively, under a separate engagement, using gross sales, payroll and other data provided by you, our firm can perform an investigation to determine each state where the XYZ Corporation/Partnership has an income tax return filing requirement. Please inform our firm if you would like to have such an investigation performed.

Keith R. Lee, J.D., CPA, is staff tax counsel/tax services manager with Camico. He works internally with the Camico claims department to resolve some of Camico’s tax claims, and provides Camico policyholders with information regarding corporate income, gift and estate tax transactions.