Join Ellen Minnig, Tax Director at PKF Mueller, for an in-depth interview on how the Wayfair decision changed the income tax landscape for businesses. In this episode, Ellen provides insight on state income tax nexus limitations, how to apply constitutional principles, and ways to minimize risk.
[00:00:00] Ashley: Hi, I’m Ashley and you’re listening to the business Owner’s Guide Podcast ‘”Tips, Trends and Talks From a CPA. “Today, we welcome Ellen Minnig from our Tax Department for discussion on how the Wayfair decision changed the income tax landscape for businesses. But before we begin, let’s find out more about our guest.
[00:00:26] Ashley: Ellen is a tax director here at PKF Mueller. She has over 20 years of tax experience in public accounting and industry work, and is also a key member of the Firm’s State and Local Tax Group.
[00:00:36] Ashley: Ellen, thank you so much for joining us today.
[00:00:41] Ellen: Hi Ashley, thanks for having me.
[00:00:45] Ashley: Can you start off by telling us what are some state income tax nexus limitations?
[00:00:49] Ellen: For income tax nexus the main considerations that have been around for quite a while is the state law and the state methods of taxation are those in, in combination constitutional. And the two areas under the constitution that we look at are the commerce clause, and the due process and equal protections clauses. So that’s, that’s the broad overview question.
[00:01:15] Ellen: Another key question is, what kind of contacts does the client have with the state in terms of physical presence, which is the old school, method of looking at nexus. And do they have employees in the state that are actually only soliciting sales, but doing nothing else? That’s its own particular area of nexus and there’s a federal law called P.L. 86-272.
[00:01:45] Ellen: For P.L. 86-272 the basic requirements are that instate employees are simply marketing or soliciting sales, and that these sales are filled from an out-of-state warehouse and shipped into the city. So in other words, the employees are not closing the sales.
[00:02:08] Ellen: They’re not picking up the goods and delivering them. They’re simply soliciting a sale and then forwarding that onto their headquarters in another state. Along with that, it’s important to remember that P.L. 86-272 basically says there’s no nexus and therefore no income tax can be assessed.
[00:02:28] Ellen: However, it only applies to sales of tangible, personal property. Tangible personal property, as we will talk about a little more in terms of digital goods is in fact, inclusive of digital goods. So many states have labeled digital goods or software, even if it’s downloaded on the internet as a, tangible good for purposes of P.L. 86-272.
[00:02:57] Ashley: What does the Wayfair case have to do with this?
[00:03:00] Ellen: So the Wayfair case, address some of the concepts, I just talked about which again, are the state laws and how they’re being enforced constitutional? And that’s under the federal constitution and the state constitution. And basically are the activities in the state so minimal that the only activity is employees that are doing marketing, but are not handling any operations and are not closing sales, writing contracts these employees would be solely marketing. In that case, there is not sufficient contact with the state to allow the state to impose income tax. Those are the broad considerations.
[00:03:44] Ellen: Wayfair specifically, in the opinion, the justices point out it is not determining income tax nexus. But for sales tax nexus, no longer is any kind of physical presence required. The older laws, which the justices tried to enforce in, in a different age where, it really did matter. Were, did you have an office in the state? Were you registered with the secretary of state? Did you have an agent in the state for service of process? Did you have employees in the state? Did you own property in the state? Things that were very much physical, we’re the old considerations and they’re still around for apportionment purposes.
[00:04:30] Ellen: The main consideration there is do those activities and those types of physical presence still matter for income tax after Wayfair, because under Wayfair, we no longer look at those. We simply look at a threshold primarily of sales. And in most states of sales are more than a hundred thousand, sales tax applies.
[00:04:57] Ellen: It’s a very simple economic test and while those other considerations can come into play before you meet thresholds, the thresholds are the key way to, you know, look at in today’s world, look at, at whether you’re subject to sales, tax and state. So that’s a lot more simple. And also , in today’s age, physical presence isn’t as important. Now we have the internet, we have numerous ways of contacting and dealing with the residents of a state and marketing products and making money from them without ever entering the state. So the justices pointed this out, but they did not deal with the income tax nexus question.
[00:05:44] Ellen: So at this point, many states have tried to say, well, we have a sales tax method here and the income tax is exactly like it. So we’re just going to say economic nexus if you’re over a threshold, we’re gonna apply income tax. Well, technically that’s not constitutional, that’s not what the federal law says. It’s states attempt to try to simplify and take advantage of the recent Wayfair sales tax case.
[00:06:13] Ashley: How do we apply constitutional principles?
[00:06:16] Ellen: So in this area, I think a, a lot of people find it sort of daunting to think about the U.S. Constitution and various principles. And I think to simplify it, the main considerations are does it seem equal compared to other states or is one state, really drastically collecting, tax in a way that seems completely inconsistent with other states. In other words, if Washington is charging, what seems like the same tax on five different goods and another state is only charging that type of tax on one good, that doesn’t look right. That looks like there might be an issue with equal projection. Are they subject to the same limitations in every state or are they so widely different that they’re unfair in certain states?
[00:07:10] Ellen: So the reason that’s important is the commerce clause says that states basically need to be consistent. States need to be limited in their ability to tax and that limitation should include some consistency so that, you know, if you’re, if you’re planning to do business in a new state, you think twice, Do I like the laws? Do I like the way they’re applying them? And you should be able to get at least a similar scenario of taxation to other states.
[00:07:42] Ellen: And I think we all know that a lot of states are different now and they tend to, capitalize on certain areas and not others. So it’s a matter of just making it more simple for your average vendors doing business and your consumers, so they know what to expect. It’s important that some states aren’t able to tax more and, thereby become a lot more powerful than other states. Again, just because, in the U.S. that’s not a concept that we would encourage.
[00:08:14] Ellen: Basically the, the situation then becomes, you know, just look at these considerations, do they appear to be taxing me on more than they should? Do they appear to be taxing the same thing multiple times? Because one of these concepts, the most basic constitutional concept is that the tax is a sales or use tax. This is basically a one time transactional tax and it shouldn’t be imposed over and over on the same goods.
[00:08:44] Ellen: So all the states are to be constrained in their application and shouldn’t continue taxing the same good over and over. It’s either they apply a sales tax at some point during the life of the product, when it’s sold usually, or at times it’s over time, like for instance, with a car registration. And if that tax isn’t being paid, the sales tax on the value, then use tax applies and it needs to be paid, but it’s one or the other. And states shouldn’t be taxing multiple times. So that’s an important consideration. I think that’s the gist of the constitutional issues that come up with income tax.
[00:09:25] Ashley: What are best practices to ascertain whether income tax filing is required?
[00:09:29] Ellen: So, to ascertain whether income tax is required, as I’ve mentioned, one of the main considerations is there nexus and the current concept under the existing Supreme Court cases is, do I have substantial nexus with the state? Of course, the question is what does that mean? And substantial nexus is generally nexus in terms of having the economic presence.
[00:09:56] Ellen: So for instance, perhaps this company is subject to sales tax. They sell more than a hundred thousand, dollars in value of goods into the state, but also substantial nexus means, do I have physical presence? Am I doing business? And a big consideration here is, it’s still important that it basically a company is doing business in the state and that matters for substantial nexus while it may be possible to sell a lot of goods into the state and do a lot of individual transactions, the income tax inquiry is more am I not just selling into the state, but am I doing business in the state? Do I have an office in the state? Am I registered? Am I licensed in the state? Am I banking there? Have I gotten loans from the state?
[00:10:45] Ellen: And I think that’s important in that it does show there’s a harder burden to me in terms of income tax. Doing business is more than just selling into the state. And it’s more than economic, benefits. So that’s the main thing to look at along with the constitutional questions along with, am I just marketing in the state and I’m not doing anything else there.
[00:11:10] Ellen: For income tax nexus it’s important to look at is there actual kind of give and take with the state and that’s what constitutes income tax nexus. And that’s in today’s world in spite of the fact that, you know, we do a lot of business online, and it’s possible to do a lot of business online, but that, that give and take doesn’t, doesn’t always exist with the simple online relationship.
[00:11:36] Ellen: So it’s important to see is there more substance to the business relationship with the state?
[00:11:43] Ashley: What types of positions are sufficient to minimize risk?
[00:11:47] Ellen: This is a tough area, again, because as I mentioned, the Supreme Court hasn’t addressed income tax nexus in today’s world. They’ve hinted at it under Wayfair, but didn’t address it. They’ve hinted at it, in other cases, but at this point, the only really viable cases are quite a bit older Supreme Court cases because they are not taking the new cases.
[00:12:10] Ellen: It’s an indication that the Supreme Court and, federal law is not being modified to either guide or to scrutinize what the states are doing. And that’s important to note because if that’s the current tact, these states may get away with more and it’s important to be very aware of how they approach nexus within reason.
[00:12:36] Ellen: I’ve been doing this a long time, and it’s interesting how many laws are unconstitutional that exist on the books or that don’t follow state statutes under their legislatures. And they do this because they can , you know, they want to make money and so this is their way of, we want it to be this way and until challenged it is that way. So in order to bolster your case, you know, if, if for instance, the state regulations are, are contrary to what you think they should be and are probably, you know, if you went to court over it, you could get rid of ’em they’re they’re not correct. They don’t follow the current law, but they may well not be constitutional, but they still exist. They’ve been passed. So in order to deal with that one of the best methods I find is to look at the simple question of when I file a return, I need to know what kind of position I’m taking. And in order to take a viable position, I need to have a more likely than not chance of succeeding.
[00:13:42] Ellen: So that means, look at cases, look at what the law says in the state, but also look at all the laws in the state, not just laws coming out of the agencies, which tend to be interpretive code sections. But look at the state statutes, look at, anything case law, every type of law that’s enacted in the state and then make a determination. Am I more likely than not to succeed. And if that’s true, most states will work with you. They, they rarely go out on a limb when they know you have a, a solid position.
[00:14:15] Ellen: So I think it’s important to document that. And that doesn’t require that you necessarily go out and try to nullify the law in court, but just that you have a reasonable documented position, that’s more likely than not to succeed. And with that kind of position, you don’t have to disclose anything to a state or the IRS in terms of I’m going out on a limb or I’m taking a position that’s somewhat different than, than a state regulation. You don’t have to do that if you have that kind of authority.
[00:14:45] Ellen: And then the other consideration would be, you know, am I in a situation where the authority’s very thin and I know I have a good position, but it’s not a substantial. And in that case, usually disclosure is required before you file a return.
[00:15:02] Ellen: For instance, you’re, you’re not paying income tax in a certain state because you’re taking a certain position, technically disclosures required. And the hard thing there is, if I don’t file a return, how am I going to disclose? And that’s, that’s a point that generally, you know, we hear on the side of not filing and not disclosing, but, that’s more of an issue where either a dialogue could be established with the, state, which I’ve seen a lot of companies do to determine, will you accept this position? We think it’s reasonable and you can put that in writing with the state and that way you have documentation and have minimized risks.
[00:15:44] Ellen: And another way to do that is to ask for a letter ruling, a private letter ruling or something that will cost a bit of money, but will document your position. And the state will agree not to impose tax in that case. So those are ways to minimize risk. And there’s always the consideration of, if you don’t feel like your authority is, is substantial enough file in the state, and disclose the position.
[00:16:12] Ashley: Are certain client industries more susceptible to audit?
[00:16:16] Ellen: I think, there are a few that are, standing out a little more, often industries with a lot of research and development costs and credits are audited more heavily. Another area that I’ve seen a lot of about it with is construction companies. Because of their accounting methods, their revenue recognition tends to vary from other companies. And because of that, they are sometimes audited more to make sure that, the authorities think they’re reporting the revenue properly.
[00:16:49] Ellen: Another area I think is really the up and coming area is the digital and software as a service area, cloud computing, anything to deal with, basically what the Supreme Court has mentioned, you don’t have to go into a state as much anymore for sales tax. We’re not gonna require you to go there. You just sell into the state. All these methods are starting to be challenged more and more.
[00:17:14] Ellen: And states are particularly focusing on missed sales tax opportunities with those areas and scrutinizing what their residents are doing in terms of, are residents buying these goods on the internet? For instance, non tokens are they buying these tokens from foreign companies? And it’s amazing how much data can be gathered by states about these issues from their residents and what they’re doing online.
[00:17:42] Ellen: So this is an important area to look at in terms of, what are states going to be. How are they going to mine the data that they can access, based on where, what their residents are doing on the internet. And I think everyone needs to be more careful and understand the ramifications of selling these more intangible kinds of goods because many states are basically defining them as sales taxable. So they’re defining them as tangible, even though you wouldn’t normally think of them that way in today’s world, they’re saying this is tangible, a digital good is tangible and we’re gonna tax it. Most of the cases involving evolving taxation of digital goods have been upheld.
[00:18:30] Ellen: However, there was a challenge in Maryland, on their tax, on digital advertising services. The advertising services included for instance, services on a digital interface, advertisements in the form of banner advertising, search engine advertising.
[00:18:52] Ellen: The Chamber of commerce of the U.S. versus Francho case was filed challenging the Maryland tax on digital advertising services, and it was not successful in that the court simply held that they did not have standing to hear the claims. Now it may be in the future that this will be raised with the U.S. Supreme Court, but at this point, the particular case that was filed, was not, a case that resulted in a ruling that will help us out with this area.
[00:19:28] Ellen: So at this point, Maryland is still trying to tax digital advertising in all it in many of its forms anyway. And the other issue with the Maryland tax is it only applies if there are digital advertising services revenue in Maryland, and it’s at least 1 million. However, it also only applies if there’s global and annual gross revenues of at least a hundred million.
[00:19:59] Ellen: Maryland’s trying to at least say, this only applies to taxpayers, making a certain amount of money from the digital advertising. Another challenge has arisen with the, particular method of calculating the tax because the tax rates are determined by global numbers. So in other words, they look at basically a rate that becomes larger.
[00:20:25] Ellen: The global revenue is larger, and there’s a challenge again, to this tax that maybe ruling on through the U.S. Supreme Court that looks at can Maryland only tax taxpayers with a certain amount of global revenue. And can they base the tax on that global revenue, which obviously in state based.
[00:20:51] Ellen: So there’s a constitutional challenge based on that as well. Again, it hasn’t been resolved, but it may be resolved in the future. Maryland’s tax is very innovative and it’s one of the cases one of the only cases right now where there’s been some very deliberate challenges to taxes on digital advertising.
[00:21:14] Ellen: So I think it’s important, you know, to, to keep, keep a good, just awareness of that industry in particular, clients in that industry, I would, I would, spend a little extra time, you know, making sure that their transactions and their sales are analyzed for these kind of issues.
[00:21:32] Ashley: Well, I think this was a really great overview and thank you for your time today to explain how the Wayfair decision changed the income tax landscape for businesses. If any of our listeners have any questions or would like to learn more, could you please share how they might be able to reach you.
[00:21:45] Ellen: Sure, they can either call me at ( 312) 975-1646. Or they can email me at eminnig@pkfmueller. com.
[00:21:59] Ashley: And thank you to our listeners. Don’t forget to visit us at pkfmueller.com to learn more about our firm services. You can also follow us on social media for more updates, insights, and upcoming events.