The financial landscape is looking worse than lawmakers expected, sending states to ferret out every opportunity to expand, demand, and open new and broader tax pipelines. No business will be spared.
$3 billion – that is the magic number in economic stimulus money passed by the House in the latest volley of federal funding. This bill, which at the time of this writing is still live but unlikely to gain further traction, would give cash-strapped states and local governments more than $1 trillion.
And it’s not enough. Lawmakers know that $1 billion spread across the United States would hardly make a dent. Colorado alone posted preliminary estimates of an immediate budget shortfall of as much as $3.1 billion in the next few years as tax revenues decline and needs rise.
Struggling states across the nation are looking at similarly staggering shortfalls. As states grapple with declining revenues and delayed tax collections, policymakers are thinking hard about how to balance their budgets. According to the Tax Foundation, every state but Vermont has varying balanced budget requirements. To find money that has simply vanished during the coronavirus outbreak, lawmakers are reviewing laundry lists of budget cuts and new ways to expand the tax base.
Where will the money come from? And how will the pursuit of state and local tax revenue impact businesses? Forecasting where states will focus their attention is anyone’s guess. But we can look at the past for a good idea of where government pay dirt may be the greatest and businesses can expect to see tax regimes move.
1 Broadening the tax base
The Tax Foundation states that the current crisis affects almost every meaningful source of state revenue, with varying intensity. Sales tax revenue may be the hardest hit by social distancing, shelter-in-place, and mandatory closure orders. Consumption, however, is expected to return to pre-COVID levels, allowing sales tax to climb more quickly than changes in income tax revenue, making sales tax a flashpoint of government interest.
A state priority through recovery will be expanding the sales tax base. Although under consideration prior to the coronavirus outbreak, states are likely to accelerate a move to capture revenue from services, digital marketing, the gig economy and other sources that were previously outside the tax net. Expect sales tax increases, and if you are not automated, get automated to help absorb the burden of changes in taxability, rates, and rules coming in recovery. Even so, sales tax is not a set it and forget it process; it’s important to understand your business nuances, nexus, and customer uses to get sales tax right.
2 Tax exemptions, a political talking point
With S.B. S8394, New York is working to exempt tax on personal protective equipment. A Pennsylvania lawmaker has said he will introduce a state grocer income tax relief bill mirroring similar legislation (H.R. 6567) introduced at the federal level. These types of moves make tax exemptions a political flashpoint that attracts attention.
No matter the intent, tax exemptions have become a political ploy. In the best of times, tax exemptions are hard to manage and measure in a state. Expect more changes as states manipulate tax policy to protect political gains while creating additional tax complexity in managing the on-again, off-again nature of tax exemptions.
3 Aggressive enforcement
Tax enforcement goes through cycles driven by money and the lack of money and the pursuit of money. Pre-COVID-19, governments had set a course with Wayfair and were beginning to increase the rate of information requests and examinations on taxpayers, using activities such as inventory at Amazon warehouses and late registrations to find non-compliant taxpayers.
COVID-19 has dramatically changed the who, what and when of state collection procedures, leaving governments in a budgetary crisis. Although on pause during the worst of the outbreak, taxpayers can expect a tougher enforcement environment as states work to increase collections and work their way out of deficits. Based on our experience in the recession of 2008-2009, we can expect to see a rapid increase in nexus questionnaires and audits as states seek out sources of money. Violations of Wayfair thresholds and missing or late registrations will trigger notices and audits as authorities question why a business failed to register by the Wayfair enactment date prior to and during the COVID-19 crisis. Think about why you are filing in some states and not others, and where you may have fallen behind. Clients should work with their tax practitioners to firm up a tax plan to reduce their chances of getting caught in the crosshairs of heightened post-coronavirus enforcement.
4 One sale de minimis
Lawmakers in Kansas contravened and contradicted the Wayfair case by enacting legislation to apply sales tax to every transaction in the state in 2019. In essence, Kansas has said the second a sale is made into the state, economic nexus is triggered, and a tax is owed, thereby ignoring any small business threshold. Can this rule continue to stand up in a lack of deference to the Wayfair case? Did Kansas overstep its authority, and is its Wayfair rule enforceable?
This controversial issue may have to be settled in court. With fires to put out elsewhere, we’re unlikely to know which way the wind blows on this issue in 2020. If Kansas is successful in gaining more taxpayers with this “one sale” approach, expect other states to follow suit.
5 Remote signatures
It is tough to do “wet” signatures in the era of social distancing, but they are still specifically required in New Jersey and New York. Wet signature requirements can slow down government collections. Remote signatures are eliminating the need to have original and unscanned documents notarized, clearing the way to faster signature capture and a “non-wet” signature future.
Requiring a wet signature is antiquated. States are expected to change their ways, allowing a non-wet signature to be used to routinely transact official business between government and taxpayers over computer networks, transforming how and when government demands are met. In the interim, know the requirements of each state and stay on the right side of the law.
6 Flow-through state audits
Partnership audits are coming on the federal level, with the IRS expected to begin conducting audits using a new partnership audit regime in 2020.
States will follow. State governments are losing out on revenues from flow-throughs, which typically have not been audited. The impact of COVID-19 might accelerate state governments’ move to capture revenue from flow-throughs.
States are in budgetary crisis, with most states eating into rainy day funds or expecting to experience budget shortfalls. As governments find ways to close the gap, businesses should expect state and local taxes to be a significant part of the solution. Governments want businesses back up and running but they need cash to meet their obligations to the citizens of their states, which typically means broadening the tax base.
Flash points will rise and fall as lawmakers debate the best ways to fill state coffers. Business leaders and tax providers must track the fast-moving developments in state and local tax and modify tax plans accordingly to see businesses through a trying 2020.
Judy Vorndran, J.D., CPA, and lead state and local tax partner, and Stacey Roberts, CPA and SALT director, at TaxOps, have been at the table – and in the weeds – guiding dynamic businesses through the morass that is state and local tax for roughly 25 years each. Visit SALTovation.com to contact the authors.
Readers should not act on information presented without individual professional consultation. Any tax advice in this content is for your use only and should not be relied upon to avoid penalties.