Even when federal tax laws change, do you know how the states your company has a presence in are responding?
Your company’s state and local tax matters can get complicated fast depending on where your business is located, where your employees are located and where your customers are located. So what should savvy companies know in 2022 about state and local taxes?
In this episode of The Wrap, Colleen Aldridge, CPA and state and local tax expert, joins our hosts to discuss the tax landscape beyond federal tax changes and details the current landscape of state and local taxes for organizations.
After listening to this episode, you’ll know:
- How the most recent tax reform impacted the limitation on state deductions
- How pass-through entity taxes work and which companies are impacted
- What companies contemplating mergers or acquisitions should consider when it comes to state and local taxes
- The story of a real-life example of a company that made state and local tax changes after an acquisition
- What’s coming next in the world of state and local taxes
Resources for additional learning:
- Blog: What You Need to Know about Sales Tax, Nexus and Wayfair [Answers to Real Questions from Real Companies]
- Blog: Do You Know Where Your Remote Employees Are? (and Why It Matters)
- Blog: Georgia and Alabama Adopt Elective Pass-Through Entity Tax
(00:00:00) Commentators: I’m Kim Hartsock and you’re listening to The Wrap, a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it. So, you can listen, learn and then get on with your day. Now let’s get down to business.
(00:00:17) Kim Hartsock: Hi, everyone.
(00:00:23) Paul Perry: Welcome to The Wrap. Today, we’re going to be talking about state and local tax or as we call it, SALT.
(00:00:27) Kim Hartsock: Yeah. Paul, the coronavirus certainly threw wrenches into the 2021 tax season, including giving all of us an extra month to file. 2022 tax season should be back to business as usual and here with us today to talk all things state and local tax is our very own Colleen Aldridge. Welcome back.
(00:00:46) Colleen Aldridge: Thanks, Kim and Paul. very much looking forward to discussing what’s going on in the state and local tax arena today.
(00:00:55) Kim Hartsock: And since you always refer to your practice as SALT, do people make salt and pepper jokes to you?
(00:01:00) Colleen Aldridge: All the time.
(00:01:03) Kim Hartsock: You’ve got to keep things fun and light around here. Can you just take a few minutes and introduce yourself to our listeners?
(00:01:08) Colleen Aldridge: I’m a Principal at Warren Averett, leading our State and Local Tax Group. I’ve been doing tax for over 25 years and particularly have a fondness for state and local tax. Because even when federal laws changed, state and local is a little slower to make the same changes. Plus, we’ve got 50+ jurisdictions to keep up with and it keeps life interesting. That’s for sure.
(00:01:30) Paul Perry: And as everyone knows by now, state tax deductions are limited on the federal returns. State legislators have been actively seeking to remedy this in the form of entity-level state filings.
(00:01:40) Colleen Aldridge: Paul, in terms of what you’re talking about with the state and local tax deductions being limited on the federal returns… As part of the Tax Cuts and Jobs Act a few years ago, there was a limitation put in that a taxpayer cannot deduct more than $10,000 in state and local taxes related to anything.
Property tax, income tax, withholding taxes, all that stuff is limited now on your federal return. So, in response in the last couple of years, over 20 states have enacted what we refer to as pass-through entity taxes. Those are elections that a business can make to have income taxed at the entity level and not be subject to tax at the owner level, thereby becoming a deduction to the entity and not to the individual.
It’s what’s called a workaround. That’s the common terminology we’re using these days, a workaround for that federal income tax limitation on state and local taxes. Who all does that impact? A pass-through entity in the tax world is generally defined as a partnership, an S corporation or an LLC.
This would be mainly for companies that are doing business in multiple states or have a significant presence in one state where they have a tremendous amount of income that’s being taxed, and that income would be limited on the federal income tax return of the owner if the owner were to pay the tax.
So, if you were not to make this election, basically what happens is the pass-through entity files the return, but the tax is not paid by the pass-through entity. It’s paid by the owner. Sometimes the states require the entities to make a payment on behalf of the owners, but it’s still deemed to be a payment by the owners at the end of the day, thereby flowing through to an individual or another type of member or partner return.
Now, under these pass-through entity elections, you can file. And these are all elections that have to be made by the owner. There are various requirements that have to be met in order to make those elections. If the entity makes the election and the tax return is filed by the pass-through entity and may or may not require a filing at the owner level, depending on the state methodology.
(00:04:15) Paul Perry: So, I guess when we’re talking to our listener base, you know, talk about maybe Georgia and Alabama and how that it plays out differently in those two states.
(00:04:25) Colleen Aldridge: Yes, definitely. Paul, this is especially relevant in Alabama and Georgia because both states have passive entity elections and they are going into effect very shortly.
Alabama is actually effective for the tax years beginning on or after 1/1/21. So returns that are getting ready to be filed for a pass-through entity, generally, they already needed to make that consideration last year because estimated payments were required. But actually, the mechanics of the election have to be done this year.
The first return is being filed this year in Alabama. For Georgia, the election won’t be effective until tax year 2022. What that means, however, is that again, Georgia is going to require estimated payments to be made in advance of the actual filing of the return. Most entities will have to evaluate in the coming six months or so to make sure that payments are being made accordingly in terms of that.
When we talk about making the election, there’s a tremendous number of considerations that have to be taken into account as to whether or not it’s the right answer for a given pass-through entity.
(00:05:46) Kim Hartsock: Now, can you explain a little about what those are?
(00:05:48) Colleen Aldridge: In general, there are two separate methodologies a state can use.
The first methodology is that a state would tax the pass-through entity and then the owners can subtract or exclude that pass-through entity income from their individual income tax return in that state. If you don’t have any income to pass through any other income in that state, you may not be required to file a return because the entity already took care of that filing.
In the other scenario, it’s a little more complicated because in the past, the entity that files the return pays the tax. The owners would still need to include their share of the distributed income from the partnership in that state. But then, they would be allowed a whole or a partial credit for the amount paid by the entity on their behalf.
That can get very complicated when we’ve got a scenario like this where an entity is making a pass-through election in say the state of Alabama, but one of the owners of the entity is in the state of North Carolina. Would North Carolina allow them a credit for the tax paid on the Alabama return on their North Carolina return?
Even though there are over 20 states that have these elections, there’s still a tremendous amount of unknowns out there. States are still trying to figure out the mechanics of this, how it’s going to work, who it’s negatively impacting and who it’s positively impacting. It’s super important for companies that think this might be something they want to look into to contact their tax professional as soon as possible to evaluate their individual situation, what other activity they have in terms of other investments, other residences, things like that, and make sure that it’s the right election.
Some elections are going to be irrelevant. Once you make the election, you’re stuck until you elect out of it. Other elections are going to be on a year-by-year basis, but I anticipate most of those elections will have to be made with the originally filed return.
(00:08:02) Kim Hartsock: So, all that’s really good information and certainly helpful as some of this is coming into effect right now. As people are preparing their tax returns, the past couple of years have been really hot markets for mergers and acquisitions and each year seems to be growing and it doesn’t seem like that’s going to let up at any time soon, but what are you seeing with M&A activity as it relates to your SALT practice?
(00:08:26) Colleen Aldridge: Great question, Kim. I’ve had several large projects that I’m working on with companies where they’ve had sales and use tax obligations over $500,000 in liability because they didn’t keep up with their filings prior to the acquisition and there was time-sensitivity to getting that acquisition done.
But I think most of my advice at this point would be focused on the post-acquisition scenario and the things to be thinking about pre-acquisition, as it pertains to post-acquisition activity. Most companies call it a hundred-day plan or some type of post-integration plan that they use to say who’s going to be responsible for what, who’s going to do what, when is it going to be done and how are we going to get through these first 100 days as a combined entity?
The one thing regarding transaction taxes is those never stop. There are deadlines generally every month. There are sales tax deadlines. Every month, there are withholding filings that need to be done.
There are property tax filings that need to be done and it’s very important to figure out who is going to file those immediately after the transaction. How is it going to be handled? How are checks going to be processed? How has our EFT been done? Have we combined the bank accounts? Have we changed mailing addresses?
Things like that are super important to make sure that there’s a continuity there. Things like putting a general email address that says AP invoices or something instead. A person being designated to receive notices are creating a PO box for all the notices to be sent to, to make sure that things aren’t getting missed, because it’s so much harder to deal with after garnishments and assessments and things like that fall into place because something’s slipped through the cracks because somebody is no longer there or responsibilities have changed.
(00:10:28) Commentators: If you want to receive a monthly newsletter with The Wrap, then head on over to warrenaverett.com/the-wrap and subscribe to our email list to have it delivered right to you. Now, back to the show.
(00:10:41) Paul Perry: What if you are undergoing an asset sale and you have sales tax exemptions from your customers that apply to the items they’re purchasing?
(00:10:47) Colleen Aldridge: You’re going to have to obtain all the sales tax exemption certificates from your customers in the name of the new entity that’s making the sale. How are you going to handle that in your system until you get those new certificates? The last thing in the world anybody wants is to upset the flow of their customers any more than it’s already being upset.
And if a company starts charging sales tax on something that historically has been exempt, that’s just one more aggravation that your customers don’t want to have to deal with. So, making a plan as to how you’re going to get those sales tax exemption certificates updated is super important. And what’s your transition plan?
Are you going to just go ahead and allow that exemption and allow 60 days for your customers to provide you with a new exemption certificate? Or are you going to try to get those before the transaction, which is even harder because many times it’s confidential.
Just having a plan as to how that’s going to take place: do you need outside help to accomplish that and do you have a system for storing these exemptions certificates? It’s a good time to think through all of your exemptions certificate procedures in-house and tighten up any internal controls that need to be tightened in that account.
The last thing that I’m seeing is that when you have an acquisition, sometimes there’s just economies that are afforded by offering similar products or similar services.
Maybe you’re reducing your sales force or you’re increasing your sales force and product offerings and making sure that from a sales tax perspective, you’ve looked at how those product offerings have changed. What’s taxable and what’s not, and from a nexus standpoint, re-evaluating your nexus and how that has changed.
(00:12:38) Kim Hartsock: Do you have any examples or any clients that you’ve helped that might be in a similar position?
(00:12:41) Colleen Aldridge: In one case and a company I’m helping right now, they have made a substantial number of changes after their acquisition. They’ve consolidated payroll, and now they’re breaking payroll back out and so they are just trying to figure out where they have a taxable presence and where they need to be filing and then closing the accounts for the entities.
There are things that don’t need to be filed anymore to reduce the amount of notices coming in and the confusion at the state level. I think those are probably the three things that I’m seeing most often that are creating the most headaches and frustration for taxpayers and clients that could be remedied with a little bit more forethought and attention paid on the front end in anticipation. Your team that’s in place now may not be the team that’s in place two months from now to help through the transition and determining what sort of temporary resources you might need to accomplish that.
(00:13:39) Paul Perry: It’s interesting that you mentioned the hundred-day plan. I believe in some of our past podcasts, when we’ve talked to our friends, David Legrand and Hanny Akl on the M&A space, they always talk about setting that plan in place. We’ve heard it a couple times and that really seems to be an important thing that maybe people miss when they’re getting into a transaction is that all they’re thinking about is the transaction itself and not everything that comes before and after.
I think that’s really good advice on creating a hundred-day plan as it relates to this, the state and local tax and trying to prepare for what is to come and maybe what falls through the cracks during that. So good advice there.
(00:14:19) Kim Hartsock: What should we be on the lookout for when it comes to state and local tax? What’s coming up next?
(00:14:22) Colleen Aldridge: The winter and spring season is packed with legislative sessions going on. As we know, the economy has taken a hit related to COVID and the prior few years. Many states are looking for ways to increase revenue from everyday transactions.
One of those ways is looking at transaction taxes, like sales and use tax, which historically are based on the sales of tangible personal property. Not necessarily taxation of services or electronic transactions, but what I’m hearing from colleagues in this space is that we’re expecting to see an expansion of the sales tax base.
What sales tax is imposed on, we’re starting to see expansions in that base. And that started a little bit last year with Maryland attempting to tax digital goods and it’s generally considered to be in limbo at this point. There are several large companies that have already started filing legal filings to stop the imposition of this law.
It’s generally anticipated that these are going to be very broad based taxes, in terms of what’s included in the taxable base. And my personal client base involves a tremendous amount of technology companies and our client base is affirming clues. I think this is going to be particularly relevant for a lot of our clients to stay on top of: where are they doing business; what’s the state definition of digital goods; does it include more the songs, the videos?
Are we talking about software as a service infrastructure, as a service platform, as a service, and then our non-fungible stuff and transactions like that?
How far is this going to go? And even to that extent, one of the things that becomes a real issue with digital transactions is how much information do I have about my customer? One of the clients that I’m helping right now, we didn’t have anything more than an IP address to work with in terms of where these things were being sold.
So, we worked backwards from the IP address to obtain a city, state and ZIP Code related to that IP address. But even then, there are some real limitations regarding the taxation of this, how that would even be affected and what our clients have to do to obtain the proper information for state sourcing, taxability and things like that.
I think this is really going to turn technology companies on their heads and they’re already struggling to grapple with things like the Wayfair rules that came into place three years ago with regard to nexus for economic threshold transactions.
(00:17:16) Paul Perry: Those vague laws are really hard sometimes to wrap your head around and you really got to make a spreadsheet and say here’s where I’m doing business and here’s what it is for this state, because you can’t rely on state per state. We see that on the cybersecurity side a lot with breach notification laws, right? There are never two that are alike. And some just say you have to have security measures in place and they don’t tell you what that is.
It really becomes an effort to get down and actually write on paper. Okay: here’s the nine states I work in, where I sell in and here’s what their law says from a digital goods perspective. One thing may be taxed here, but it may not be taxed there. So that is a piece that people need to prepare for when they start getting into that.
I’ve seen some companies out there just say, “Hey, we’re not going to sell to anybody in this state. It’s too stringent for us, and we don’t want to spend all the time preparing for that.” So, I’m sure that there are some of those states that are out there that people just go, “Oh, I don’t really like working there.”
You talk about IP addresses. I may be using an IP address for Spectrum in my home state, but it may get routed somewhere else. And so, does that IP address cross another state? That really becomes an issue for me so I can definitely see the issues there.
(00:18:33) Colleen Aldridge: Yes. I expect that as legislative sessions end in April, May and June, we’ll have a lot more clarity on what direction these types of efforts are going to go and which taxpayers are going to be most affected by that.
But it is something that we’re keeping an eye on and we’ll be back with more updates if we anticipate that this is going to be the year. But I think that it’s just being aware that this is out there. Because many times, you may be able to impact where you do business, but a lot of cases, if you’re dealing with individuals and digital download songs, I can’t pick and choose what state that person lives in.
It gets really complicated and really difficult, especially for growing companies where it’s very hard to be a hundred percent compliant and making money at the same time.
(00:19:28) Kim Hartsock: So, Colleen, here on The Wrap, we always ask our guests to wrap it up in 60 seconds or less. What would you like to leave listeners with today in regard to state and local tax?
(00:19:36) Colleen Aldridge: There’s not really anything specific to state and local tax that doesn’t apply to any tax and that’s planning. The best you can do is to plan ahead with these pass-through entity elections. It’s being aware of where you’re doing business, where you have other business activities as an owner and talking to your tax professionals to figure out how it impacts you as these elections come into play.
Then again, in terms of M&A, it’s the same thing. It’s planning, it’s being aware of the fact that there are rapidly approaching deadlines all the time when it comes to transaction taxes and it’s something that you can’t ignore. Otherwise, it turns into a storm of unwanted activity in terms of notices and garnishments and payments and things like that.
So being prepared and just being aware that deadlines and resources are never the same post-transaction as they are pre-transaction with respect to the digital taxes. I think that’s going to be a thing to look for if this is of particular interest to your business or you think it would, you’re curious as to how it would impact your business.
We’re happy to have a conversation on whether it may happen. And then again, look for future publications from the firm on how this might impact the tax basis of each and how we’re seeing digital goods be defined in these emerging laws.
(00:21:01) Paul Perry: I’m sure that those laws will constantly change and so there’s a constant need to update what they consider. And I guess once they see, you know, everybody makes a law and then people find a way around it. And that’s why there are updates to the laws, right? Because somebody forgot about NFTs or they forgot about something else that people say, “Oh, I need to tax that and we need to make money.”
Colleen, always a pleasure. Thank you for being back with us to talk about state and local tax.
(00:21:28) Kim Hartsock: Colleen, thanks so much for being with us today.
(00:21:29) Colleen Aldridge: Thank you. I appreciate everybody’s time and happy to help any way I can.
(00:21:36) Commentators: And that’s a wrap. If you’re enjoying the podcast, please leave a review on your streaming platform. To check out more episodes, subscribe to the podcast or make a suggestion of other topics you want to hear. Visit us at warreaverett.com/the-wrap.