The Coming Sales Tax Amnesty and What It Will Cost You
On November 12, 2002, representatives of 34 states and the District of Columbia approved a final version of a multi-state Streamlined Sales and Use Tax Agreement (the "Agreement") designed to simplify and modernize sales and use tax collection and administration. The final Agreement is the result of more than two years of collaboration among the states. This collaboration, which has been several years in the making, was prompted by judicial decisions determining that retailers without physical presence in a given state do not have to collect sales and use tax on sales made into that state. The explosive growth of e-commerce during the late 1990s (which has continued today, although with less public attention) has increased the number of transactions that have escaped sales tax. States claim to be losing revenue and so called "bricks and mortar" retailers claim that they are at a competitive disadvantage to the electronic retailers because they do have to charge and collect sales tax.
The Agreement does not go into effect immediately because many of the states that are parties to it will have to amend their sales and use tax laws to conform to the Agreement. At least ten states whose aggregate populations constitute more than 20% of the population of states with sales taxes, must bring their laws into substantial compliance with the Agreement before the Agreement becomes effective. The official deadline for the agreement however, has not been finalized.
When and if the Agreement goes into effect, it will have a dramatic impact on many businesses. To comply with the final Agreement, almost every state will have to change the definitions and exemptions in their sales tax laws, with the result that some previously untaxed articles may be subject to tax in the state and vice versa. In addition, most businesses doing business in one or more of the states that are parties to the Agreement (the "Implementing States") will have to decide whether to voluntarily register under the Agreement. Voluntary registration offers a number of benefits, including the ability to claim the benefits of a tax amnesty in many cases but imposes significant burdens. Accordingly, businesses will have to weigh these benefits and burdens carefully when deciding whether or not to register voluntarily.
In addition, although the Agreement and the state implementing legislation does nothing to change the current rule that provides that a retailer who has no physical presence in a state cannot be required to collect and remit sales tax, the Implementing States are likely to petition Congress for authority to require such retailers to collect and remit sales tax.
Finally, even before the Agreement goes into effect many of the states that anticipate implementing the Agreement will need to enact legislation to bring their sales and use tax laws into compliance with the Agreement, with the result that there could be immediate changes in sales and use tax law.
The Implementing States that approved the Agreement are:
District of Columbia
Retailers who make sales into these states are therefore the most directly impacted if the Agreement becomes effective. Many of these states have already begun conforming their laws.
OVERVIEW OF THE FINAL AGREEMENT
The purpose of the final Agreement is to simplify and modernize sales and use tax collection and administration. At the present time, there are over 1,600 state and local taxing jurisdictions, each with their own set of inclusions, exclusions, collection procedures, remittance procedures, returns and administrative guidelines - in short, a businessman's nightmare. For example, most states either exempt medicine from sales tax or provide a lower tax rate on medicine. However, the definition of "medicine" is by no means universal. For example, prescription medicine is usually clear, but what about candy flavored cough drops? Also, food is usually taxed at a lower rate, but candy and prepared meals are taxed at the full rate. This causes confusion at the edges, where, in some states, miniature marshmallows are considered an ingredient in baking and thus food, but large marshmallows are considered candy and taxed. All of these differences place an enormous compliance burden on retailers who are required to learn the law in each jurisdiction, and possibly withhold and remit sales tax to multiple states. And woe to the retailer who guesses wrong, since there frequently is personal liability for the corporate officers who are responsible for failing to remit sales tax.
The Agreement is designed to address many of these concerns by:
1. Providing for State Level Administration of Sales and Use Tax Collection. Under the Agreement, a retailer would remit sales tax to the state in which the sale occurs. The state is responsible for redistributing the local sales taxes to local governments. All audits are conducted by the state. Thus, the 1,600 taxing jurisdictions are cut down to 47 (3 states have no sales tax). Not the best result, but a good start.
2. Uniformity in the State and Local Tax Bases and Uniformity of Major Tax Base. This is designed to address the definitional problem mentioned above, and has two parts. First, all state and local sales taxing jurisdictions within that single state must utilize the same tax base. Thus, the state and all its local taxing jurisdictions must decide, for example, that "food" will be exempt or eligible for a reduced rate of tax. No more having to search for exemptions at the state and every single local jurisdiction level.
The second part is that all Implementing States must adopt a uniform set of definitions for key items in the tax base. For example, the states will be free to tax or exempt medicine, food, clothing, etc., but will have to use standard definitions of those categories. Thus, a clothing retailer will be able to determine whether a given state taxes clothes sales without having to struggle with each different states' definition of clothes, which is an enormous administrative relief.
3. Central Electronic Registration System for all Member States. Retailers will be able to register as a retailer on-line in all states. States cannot impose a registration fee in a state in which the retailer is not legally obligated to register. States in which a retailer is legally required to register without regard to the Agreement can, however, impose additional registration requirements and fees.
4. Simplified State and Local Tax Rates. A state may not have more than one sales and use tax rate, and all local jurisdictions in that state may not have more than one sales and use tax rate.
5. Uniform Sourcing Rules. The Implementing States must adopt uniform rules for sourcing sales to a particular state, so that it will be clear where a taxable sale occurs.
6. Simplified Administration of Exemptions. State exemptions need not be uniform, but standard forms will allow retailers to claim exemptions electronically. Retailers who follow specified procedures have no liability if the transaction turns out not to have been exempt.
7. Uniform and Simplified Tax Returns. A retailer will only have to file one tax return for each period for an Implementing State and all local jurisdictions within that state. Simplified reporting is also provided for in some cases, such as cases in which a retailer is not legally obligated to file in a particular state.
Retailers will have alternative methods of complying with their obligations depending on which "Models" they use. A Model 1 seller will select a Certified Service Provider (CSP) who will perform all sales and use tax functions, other than the retailer's obligation to remit taxes on its own purchases. A Model 2 seller will select a Certified Automated System (CAS) to perform part of its sales and use tax functions, but retains responsibility for remitting the tax. CAS software will be certified under the Agreement to calculate the tax imposed and maintain records on all taxable sales into the Implementing States. A Model 3 seller will develop its own proprietary CAS. In order for a retailer to be a Model 3 seller, the retailer will have to have sales in at least five Implementing States and total annual sales revenue of at least $500 million.
NO IMMEDIATE EFFECT
The Agreement does not change any of the laws currently applicable to retailers. Rather, changes occur as the Implementing States bring their own state statutes into compliance. No one is intended to have standing to challenge the Agreement itself.
Under current law, a retailer cannot be required to collect and remit sales tax on behalf of a state if the retailer has no physical presence in the state. The final Agreement does not change this rule. However, once the Agreement is in effect the Implementing States are likely to petition Congress for authority to require remote sellers without physical presence to collect and remit sales tax.
In addition, the final Agreement provides a number of incentives intended to encourage retailers to voluntarily register under the act. As noted above, the Agreement provides for on-line electronic registration and prohibits the imposition of registration fees by states in which the retailer has no physical presence. Additionally, the Agreement offers incentives for voluntary compliance which should be considered. A retailer may revoke its registration at any time. The final Agreement provides retailers with alternatives for automated compliance and some protection from liability for errors based upon reliance on the automated compliance system. The final Agreement also provides for financial incentives to defray a part of the costs of compliance.
The final Agreement also requires member states to provide a tax amnesty for previously uncollected or unpaid sales and use tax if a retailer registers within 12 months of the date the state becomes a party to the Agreement. This last benefit may be attractive to many taxpayers. In many cases, businesses that have operated in a state for years without registering are reluctant to correct the error or begin filing currently because of the fear that they will be assessed taxes, penalties, and interest for all prior years of noncompliance. The amnesty provides such businesses with a way of getting into compliance while avoiding this potential liability. The amnesty requires the business to remain registered for at least 3 years and does not apply to amounts covered by a current audit or previously assessed or paid.
However, the Agreement imposes a number of burdens on businesses that register as well. The businesses must collect sales tax on behalf of all member states, even those states in which they have no physical presence. In addition, to the extent that the business also operates in states that are not parties to the final Agreement, the business will have to maintain a separate sales tax compliance systems for those states. The final Agreement does not provide protection against multiple audits by states that are parties to the final Agreement. Finally, it is not entirely clear whether voluntary registration creates nexus for income tax purposes. Similarly, it is not clear that voluntary registration would not provide a basis for asserting that nexus exists for sales and use tax purposes if the retailer withdraws the registration.
Accordingly, businesses will have to carefully weigh the benefits and burdens of voluntary registration.
Please contact Michael T. Donovan ((312) 201-2603) or Joseph E. Bender ((312) 201-2234) if you have any questions about this development. Mr. Donovan and Mr. Bender are members of the Corporate, Securities & Tax Practice Group at Wildman Harrold and practice primarily in the areas of federal, state, local and international taxation.
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