Unexpected state tax obligations can wreak havoc on a business’s bottom-line. It is crucial for CFOs to monitor their companies’ physical footprints (employees and property) to ensure compliance as businesses expand and new customers are found.
In the case of sales taxes, it also means that the company has missed the chance to collect the tax from its customers. A company’s profits from customers in the state can be more than wiped out. Even if the state tax administrator does not catch the business, the problem can come to light during the due diligence process for a sale of the company, hurting the valuation of the business and potentially killing the deal.
With a recent raft of new state tax laws, it is no longer enough to consider a company’s own physical footprint; a business must also worry about state tax nexus risks from outside marketing and sales fulfillment providers. These “affiliate” or “attributional” nexus state laws take the in-state presence of a business partner and treat it as establishing nexus for the out-of-state company. The classic example is an independent contractor salesman, but these proliferating laws extend to everything from online advertising to warranty repairs. While these laws vary from state to state, potentially affected activities include the following:
Catching these issues in the ordinary course of contract review is critical so that a business can weigh the benefits of proceeding against the potential tax risks. Further, sometimes the terms of a contract can be adjusted to reduce state tax risks. This type of monitoring requires a companywide commitment, because a tax or finance department rarely has visibility into day-to-day marketing or operational relationships. Other business units must be educated about the issue so that they can identify risks and consult with tax or legal where appropriate.
Unless or until Congress enacts legislation dictating the extent to which a state may impose its tax jurisdiction over out-of-state businesses, states are likely to continue asserting attributional nexus to catch unwary businesses for sales taxes, income taxes, and other state impositions. While managing these risks upfront is burdensome, the alternative of just “kicking the can” down the road leaves businesses exposed to significant risks if audited. CFOs need to ensure that their organizations are aware of these risks and are actively managing them.
Arthur R. Rosen and Matthew C. Boch are partners in the law firm of McDermott Will & Emery LLP.