I received a call this week from a potential client which perfectly illustrates the key topics I want to cover in this new SERVICES TAXATION blog. So I decided it might be helpful to create a post to help service companies (large and small) to better understand how sales/use tax rules are changing specific to SERVICES - and to clearly illustrate the growing risks they (or their customers) face. BTW - I have changed the states, the services provided (and some of the facts), in order to protect those involved.
In this "sample" scenario, we have a family-run commercial janitorial services company. It's a successful local business which has been operating for years in the state of Georgia (GA). One of the owner’s sons approaches his father about leveraging their business reputation in order to grow their business exponentially. The plan is to launch a nation-wide Internet marketing campaign - and then subcontract new business from across the country to local service companies. The idea becomes an impressive success and suddenly the company is growing leaps and bounds. Everybody's happy! That is until one of their customers is audited by the state of Texas (TX).
Texas is a state (along with at least 17 other states) which taxes all or some commercial janitorial services. When a company gets audited the auditor not only looks at sales, but also purchases. If a seller does not charge you tax on a taxable transaction, you are supposed to self-assess and remit the tax directly to the state yourself. It does not become a tax free transaction. During the audit, the customer is told by the Texas auditor that the service provider should have charged and collected tax because they had nexus.
The customer is furious with his accountant who did not know about use tax, let alone janitorial services being taxable - but that is for another post. The customer was also furious with the Georgia company because they had to pay back tax, penalty and interest, when his vendor should have been collecting the tax all along. The customer calls the Georgia company and reads them the riot act. The customer also tells the Georgia company that the Texas auditor now has their information.
The father goes to their long time accountant who tells him not to worry as you would have to have nexus with Texas before they could require you to collect taxes, and besides janitorial services are not taxable. The father was feeling better and told the son who wanted a second opinion just to be safe. He was referred to me.
Unfortunately I had to break the bad news that they not only had an irate customer, but they had a whole lot of exposure all across the country, and at least the state of Texas was likely to come looking for them. Both father and son almost had heart attacks. They had almost $135,000 spread among the states in back taxes, penalty and interest they owed and could not pay.
They wanted to know how this could be - after all - they were located in Georgia! How could they have nexus in Texas? I let them know that there is a U.S. Supreme Court Case (Tyler Pipe v. Wash. Dept. of Rev., 483 U.S. 232 (1987)), that says third-parties, even if those parties represent multiple companies can create nexus if they are helping to establish or maintain a market place. The subcontractors were creating nexus for the Georgia company, who then had a responsibility to collect sales tax where their services were taxable. They were surprised any states taxed their service and now they were unhappy with their long term accountant who did not understand current nexus requirements - nor that janitorial services could be taxable.
I let them know that multi-state taxation is difficult and that while many accountants understand their home state or region, they don't always have the tools and/or resources to stay abreast of multi-state tax issues. And quite frankly - historically there wasn't always a need - but the Internet is changing all of that.
For our new Georgia client we suggested they immediately request a voluntary disclosure agreement (VDA) in Texas, because once a state contacts you a VDA is not an option. A VDA is a program that helps reduce the amount of money owed. In Texas it waives 100% of penalty and interest. Once we have the Texas VDA filed, we will work through the exposure in the rest of the states. We have a plan where we will use a combination of VDAs and registrations and will work with some customers to see if they have already paid the tax. We will also work out some payment plans.
This company will be OK, thank goodness to their customer who called to complain. If the customer had not called this could have been a lot worse. Don’t get me wrong - it is still a costly mess, just one that can be handled. I hope their unfortunate experience proves the point that we cannot rely on old assumptions. When it comes to sales tax the rules are always changing and we need to test our beliefs from time to time.
Are you (or your clients) providing services - and concerned about changing sales/use tax rules? If so - please feel free to contact me to discuss, using the various options listed below.