Multi-State Sales and Use Tax Attorneys
Multi-State Sales and Use Tax Attorneys
Multi-State Sales and Use Tax Attorneys
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What is a worker classification issue?  When the Internal Revenue Service (“IRS”) believes that a taxpayer (i.e. employer or service recipient) is improperly treating workers as independent contractors instead of employees it will pursue the taxpayer by initiating an examination, more commonly known as an audit, where the taxpayer will likely receive a Letter 3850 (Rev 3-2006) in the mail providing them notice of the inquiry.  A worker classification issue will usually start with an analysis of whether the worker should have been classified as an independent contractor or an employee.  If it is determined that the workers should have been treated as employees, then a calculation must be prepared to determine how much the taxpayer (employer) owes the IRS.

Often, a taxpayer will resolve the tax liability generated from the worker classification audit through one of the IRS settlement programs (known as CSP or Classification Settlement Program) or through Section 530 of the Revenue Act of 1978.  Also, a taxpayer who fails to withhold the required tax may be entitled to relief, under §§ 3402(d), 3102(f)(3), 1463 or Regulations § 1.1474-4, but they must show that the worker reported the payments and paid the corresponding tax.  More simply stated, an independent contractor does not have any of its taxes withheld from a check it receives.  However, if the independent contractor should have been classified as an employee, then the employer would be entitled to offset some of the tax liability it owes the IRS by proving that the misclassified worker still paid his or her taxes that should have been withheld.

In a recent Tax Court case, the Mescalero Apache Tribe (“Tribe”) won on a motion to compel discovery against the IRS.  The Tribe was in the middle of a worker classification case.  In dispute, was the reclassification of hundreds of workers as employees instead of independent contractor.    The taxpayer, Tribe, has the burden of proof to show its worker paid income tax to reduce the amount it would owe the IRS.  (Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11)

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The rise of internet sales has created a tax problem for states. States are having difficulty getting revenue from these sales because the sellers lack nexus. In the legal community, that nexus is known as a connection with a state which allows for it to exercise jurisdiction over a vendor. Nexus is a growing concern for internet sellers because they are not physically present and states have begun overreaching in their extension of jurisdiction over them. Last year, Oklahoma enacted the Oklahoma Retail Protection Act of 2016. The purpose of the act was to (1) expand nexus to include a presumption of its existence in cases where a vendor has certain relationships or arrangements with people who do have a physical presence in the state, and (2) require out-of-state vendors to provide annual reports to their customers acknowledging the potential use tax liability on their purchases without disclosing which particular items were purchased.

This first part, which expands the jurisdiction of Oklahoma to cover more out-of-state vendors than it did previously, ultimately only applies a presumption to vendors who fall into a particular category. That presumption can be overcome with proof that the person with physical presence who has a relationship with the vendor does not establish or maintain the sales market in Oklahoma for that vendor. But is even a presumption of nexus in those cases crossing a line? In Quill Corp. v. North Dakota, the United States Supreme Court made it very clear that physical presence must be required by a vendor for it to have nexus within a state. To extend that to “physical presence of anyone associated with the business” is, at the very least, stretching the holding in Quill.

Meanwhile, the second requirement of the Oklahoma Retail Protection Act of 2016 requires out-of-state vendors that are not required to collect tax to send records to their customers to whom sales have been made within the state. These records need to identify the total sales made by the vendor to its in-state customer without revealing the particular items purchased. As this requirement appears to be on vendors who have no physical presence whatsoever, even by a third party, it is questionable whether Oklahoma has the authority to enforce such a burden on companies who are located entirely outside of their state.[1]

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Earlier in 2017, Premier Netcomm Solutions LLC (“Premier”) lost on reconsideration in New Jersey tax court.  The case dealt with the taxability of software as a service (“SaaS”) dating back to an audit from 2004 through 2005.  After initially beating for state, the court overturned a prior decision on reconsideration, which ultimately upheld New Jersey’s tax assessment.

Premier seems to be a classic IT provider in that it provides services such as network supports, internet access, consulting and design of IT and telephone projects, trouble shooting, remote training, data back-up, and network monitoring for businesses.  In the original decision, the court sided with Premier that its sales were not subject to sales tax.  The court concluded that prior to 2005, sales of services related to prewritten software were not taxable. In so doing the court invalidated New Jerseys tax assessment against Premier.

Unhappy with the decision, New Jersey’s Division of Taxation sought reconsideration, which is very difficult to prevail on.  The Court seemed to grant reconsideration because the original case erred fundamentally on its analysis.  Primarily, the court originally believed the law did not tax such services until its 2005 amendment.  However, the amendment was really based on New Jersey’s membership into the Streamline Sales and Use Tax Agreement (“SSUTA”) in 2005, which required it to adopt a uniform definition.  Therefore, based on a 2004 Bulletin, the court reconsidered the case and ruled that the services were and have been subject to tax since 2004.

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Over the past several years software as a service (“SaaS”) has been a booming industry.  Pioneers in the cloud computing industry, like Salesforce, have developed web based applications that offer a wide range of services to the user.  Driven by competitors such as Microsoft, Adobe, Sap, ADP, Oracle, IBM, Intuit and Google, the SaaS industry has become a $204 billion industry and grown by more than 16% last year.

Traditionally, from a sales tax perspective, states tax the sale of tangible personal property but not services.  While many states adhere to that mantra, several states have moved towards taxing software despite being intangible in nature.  Still, it can be difficult to determine whether SaaS is more like a software, which may be taxable, or if it feels more like a service provided, which is not taxable in many states.

States have been consistently inconsistent across the country in determining whether to tax SaaS.  States often have similar statutes and reach completely different conclusions in their quest to analyze SaaS.  Further, many situations occur in which a state can treat two seemingly similar SaaS companies differently within their own state.  In an attempt to comply, companies often struggle with charging the appropriate sales tax in the correct state and/or their state income tax obligations, with respect to SaaS.

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Effective August 1, 2016, Pennsylvania has joined the ranks of states attempting to expand their sales and use tax jurisdiction over digital downloads. With out-of-state internet sales taking away sales tax revenue from the states in conjunction with the sharp decline in “hard copy” sales of various media, states are scrambling to expand their tax base and capture categories of items that escaped their grasp when they evolved with the internet and technology.

ACT 84 of 2016 specifically extends to items delivered to “a customer electronically or digitally or by streaming unless the transfer is otherwise exempt. This includes music or any other audio, video such as movies and streaming services, e-books and any otherwise taxable printed matter, apps and in-app purchases, ringtones, online games, and canned software, as well as any updates, maintenance or support of these items.” While e-books and videos otherwise would be printed or “hard copy” materials subject to tax, apps and certain in-app purchases have never been available through a tangible medium.

Ultimately, the Act regains a lost tax base while also adding new items to it. The question remains that if a Pennsylvania resident makes a purchase while on vacation in Florida and listens to, for example, a one-time podcast while still in Florida, then does Act 84 of 2016 extend to that purchase? In other words, if the sale and entire use occurs within Florida but the purchaser is a resident of Pennsylvania, is the sale subject to Pennsylvania tax?

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Potential good news for the growing mobile workforce.  Currently, there is a Bill pending in the US Senate to simplify the exposure, withholding, and reporting of state income taxes for both employers and employees traveling across state lines to perform their job functions.  The US House of Representatives already passed the Act in late September 2016, and the Bill is now being reviewed and considered by the Senate Finance Committee.

Essentially, the law is attempting to limit employees subject to state income taxes if they work in a state for 30 days or less.  In addition, this would limit the burden on employers for withholding and reporting requirements for those same employees.  The law allows the employers to rely on its employees for reporting days worked in a state where the employee does not reside, as long as, the employer does not have actual knowledge that the employee is lying or the employer is colluding with the employee to lie about days worked in a state.

One of the interesting aspects of this Bill would be its applicability to professional athletes.   Professional athletes tend to earn their income from performing in states all over the country.  The Bill specifically defines a professional athlete and the wages earned that are applicable to the 30-day threshold.  This potential aspect could revamp the way professional sports operate, scheduling of games, or where a professional athlete chooses to play.

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Tennessee is the latest of states to jump on the economic nexus bandwagon.  In an effort to sidestep the physical presence the proposed rule would require out-of-state dealers that engage in the regular or systematic solicitation of consumers in Tennessee through any means and make sales exceeding $500,000 to Tennessee consumers during the calendar year would be considered to have substantial nexus with the state. One substantial nexus is established, the dealers would be required to register with the state and collect and remit sales and use tax.

Similar to recent rulemaking in Alabama, Tennessee does not believe its position offends the Commerce Clause. The proposed rule, may go into effect on or about November 8, 2016. It is worthy to note the rule is subject to committee review in both house of the Tennessee legislature and legislative approval is needed before a rule can become permanent.

Tennessee is not the only state attempting to combat Quill. Similarly, Alabama and South Dakota are litigating whether their economic nexus standards are sufficient to satisfy the Commerce Clause substantial nexus requirement. Earlier this year, South Dakota adopted the economic nexus for sales and use tax purposes. South Dakota is currently a plaintiff and defendant in two separate cases addressing the constitutionality of the substantial nexus law.

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If states could impose tax on every company that makes a sale within its borders, they would. Luckily, the Commerce Clause of the Constitution requires something known as “nexus,” or a connection, between a company and state in order for that company to be subject to state and local taxes. The standards for nexus can be ambiguous, particularly in recent years as a result of the radical changes to traditional business models that have occurred with the internet.

While nexus may seem easy to determine using the physical presence test, the definition of physical presence has in fact been something that courts across the country have struggled with since the beginning. That struggle has only become increasingly complicated with the internet and virtual marketplaces that no longer require a company to open a brick and mortar shop everywhere it wants to sell its products.

Recently, Washington state has found nexus with a company that made wholesale sales through infomercials. This particular company sent employees to Washington to participate in trade shows and other promotional events. However, they did not have a physical business location within the state.

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Hawaii was the most recent in a line of states to take a stance in the long tax battle between online travel companies, such as Priceline, Expedia and Orbitz, and states over what is commonly referred to as “tourist development taxes,” or “bed taxes.”  Over the last couple of years, states have fallen on both sides of the issue of whether hotel rooms are taxable at the price a hotel receives for a room or the price that an online travel company sells a room.  The Hawaii case, Travelocity.com, L.P. v. Hawaii Director of Taxation, involves two taxes, the first of which is called a “GET” or “general excise tax,” and the second of which is called a “TAT” or “transient accommodations tax.”

The 2015 court decision has been clarified this month in an announcement by the state that online travel companies were in fact liable for the “GET,” along with any penalties for late payment, on their portion of the sale price for hotel rooms located in Hawaii. However, online travel companies are not liable for the “TAT.” This is similar to states like Florida, in which the amount the online travel company receives for the rental of a room within Florida is not subject to local tourist taxes.

The state reasoned that the portion of the sale that online travel companies receive is in fact for “occupancy rights” that are used in their entirety within the state of Hawaii when the sale is for a room within the state. Under that reasoning, the state determined that the revenue made by the online travel companies is subject to Hawaii state tax.

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Florida’s hotel reservation industry recently received an important victory relating to Tourist Development Tax (“TDT”).  TDT is a tax imposed on the privilege of renting, leasing or letting “for consideration any living quarters or accommodations in any hotel . . ., or condominium for a term of six months or less.”  § 125.0104(3)(a)1., Fla. Stat.  Notably, the TDT is due on the consideration paid for occupancy in the county. § 125.0104(3)(a)1., Fla. Stat.

In 2015, the Florida Supreme Court held that the “consideration paid for occupancy” is limited to the actual rental amount paid for occupancy of the room and not to mark-up charges and service charges associated with the reservations.  See Alachua County v. Expedia, Inc., 175 So. 3d 370 (Fla. 2015).

The issue in Sarasota Surf & Racquet Club Condominium Assn., Inc. v. Sarasota County, et al., Case No. 2015 CA 002612 NC (Fla. 12th Cir, July 11, 2016) was whether reservation and cleaning fees charged by a condominium association to guests during the reservation process were subject to TDT.  The County argued that the fees were part of the total consideration paid for occupancy and therefore subject to TDT.  The association argued that, pursuant to Expedia, only the rental amount was subject to TDT, not the reservation and cleaning fees charged in connection with the reservation.