Conference Speakers: Cash-Starved States Increasingly Aggressive on Taxes

By:
Chris Gaetano
Published Date:
Dec 9, 2020
mark klein_small
Mark Klein


Companies that moved their business online because of the pandemic, with activities increasingly cross state lines, are finding new tax liabilities, leveled by increasingly cash-strapped state governments; these states have eroded some of the protections that the companies had enjoyed for years, according to a pair of speakers at the Foundation for Accounting Education's New York and Tri-State Taxation Conference on Wednesday.

One of the speakers, attorney Mark Klein, a Hodgson Russ partner, brought up Public Law 86-272, also known as the Interstate Income Act I(IIA) of 1959, as an example. The law had been set up, he said, on recognition that having to navigate the patchwork of varying state tax laws severely inhibits interstate commerce, as few want to "set up an entire accounting department to track 40, 50 states and all their income tax rules."

The law basically says that a state cannot tax out-of-state corporations on income derived from business activities within the state if their activities are limited to "mere solicitation of orders" for the sale of tangible personal property and the orders are approved and filled from outside the state.

Klein said, however, that the law was written at a time when the economy was very different, and was drafted mostly with "your old-school walking around to different locations with samples and demonstrating stuff" in mind, and so the list of protected activities includes activities such as carrying samples and promotional materials for display purposes, maintaining a sample showroom or recruiting sales personnel. Many aspects of commerce have changed since then, making these protections far less useful than before, including one big development. 

"If you're one of those companies that uses this thing called the web, then it doesn't apply, which means it no longer applies to anyone, and that's kinda crazy," he said.

Beyond economic changes are also tax law changes that have taken place in the meantime, said the other speaker, Jason Rosenberg, a Withum Smith + Brown partner. He noted that the act protects businesses from income taxes, meaning that they're still liable for sales tax, minimum taxes, franchise taxes, "or all along those lines."

Further, Rosenberg noted, the act provides that qualifying for the protection means that the order has to be accepted from outside the state, that the product is shipped and sold from outside the state, and that the order can be only for the sale of tangible personal property. And so if a business has mixed revenue streams, say money from both tangible property and service on that property, "just that fact alone [may mean] potentially that protection might be impaired, as the state might suggest the business is soliciting service revenues in the state, which would tarnish 86-272."

"So, you need to be thinking of the entire product life cycle and understanding each activity the business conducts when we think of 86-272," he said.

Klein noted that Amazon sellers in particular might be vulnerable, as the physical presence of inventory in a state can trigger nexus in that state. Complicating matters further is the fact that sellers don't always know the exact physical location of that inventory.

"Amazon will say it's in Tennessee, but Amazon can move it to another warehouse and not notify our client, and it later pops up on audit, so there's potential risk with that," he said. "We've noticed that a lot of these marketplace facilitators try to be as transparent as possible to provide that information, but there is the risk you have inventory out there and not aware of it."

Klein added that businesses should also be aware of "throwback rules" that certain states have. Essentially, with the application of 86-272, states with a throwback rule require taxpayers that ship goods to states without the rule to "throw back" the sale to their home state if the protections kick in, meaning that these states can impose their net income tax upon the income derived from those sales. Klein said it's mostly states in the Midwest and West that have these rules.

Rosenberg added that New York in particular is proposing to further erode 86-272 protections by making it so that businesses can lose their protection for activities that include close sales assistance using electronic or email communications through the company webpage; soliciting online applications for branded credit cards; having a career page on a website that accepts applicants for non-sales positions, "which would seem to be, like, everyone"; remote product patches; updates or upgrades; the sale of extended warranty plans; or the sale of streaming video or music services. He added, though, that there is a lot of opposition to the proposal, and so "we'll see where it goes."

Klein said that moves like this are "a revenue grab, not really in the intention" of the original law, but he noted that states are hungry for cash and are becoming more aggressive.

WIthholding

Payroll tax withholding is another area where Klein has seen states get more aggressive, saying that he has been seeing greater numbers of withholding tax audits across the country.

"Most companies think, 'Well, I use ADP, I don't have anything to worry about,'" he said. "But what the auditors say is, 'We don't want that; we want to look at your [travel and expense] reports to see if the company is sending people into the state.' And a lot of companies say, 'We've got thousands of people, we've got to keep track of all that for withholding?' And the auditors say, 'You sent them as an employer, you know what flight they took, what hotel they stayed in, even what they watched on pay-per-view; how can you say you don't know where they're going?' And that's the kind of thing auditors are focused on these days." 

Klein said that this means that it is especially important for employers to keep track of where employees are, adding that he has seen some companies using IP addresses, and to have an action plan that helps minimize risks down the road. He said his firm is advising clients to make sure all departments are involved in creating this plan, including human resources, finance and legal.

Klein also mentioned the "convenience of employer rule," which in the COVID-19 era has become darkly paradoxical. Six states, including New York, have this rule, which essentially says that if a worker is telecommuting from another state, if this is done for convenience purposes, then the income is considered to be sourced from the home state. Under this rule, workers telecommuting because they have to travel to look at real estate investments is acceptable and does not trigger this rule; those same people telecommuting because traffic is generally very bad is not, and will trigger the rule.

While some states have offered some form of relief from this rule, New York seems to have chosen to double down instead. Klein said that the state recently issued an FAQ that has actually taken the word "convenience" out of the rule, meaning that "what New York now says is that if your primary work location was in New York, and now you're working from home, that is a New York day for the purposes of this rule."

"I must say, I respectfully disagree," he said. "I'm working from home in New Jersey or Connecticut. My governor has told me to shelter in place. New York's governor said, 'I will close your office.' Help me understand that when my office in Manhattan is physically closed, how is it possible my work at home is [for] my convenience? It sure sounds like necessity because I can't use my office, it's closed. So it's going to be very interesting seeing what kind of litigation applies here, but the department has taken a position that the convenience rule doesn't seem to be a convenience rule."

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