If you're like most entrepreneurs, state and local taxes are probably taking a sizable bite out of your company's bottom line. But there's no reason to roll over and pay the tax collector. It's time to put some useful tax-saving strategies to work.
At the state and local levels, the tax landscape has undergone some major changes. "As the U.S. has moved from a manufacturing to a service economy, state and local governments have had to change the way they tax business activity to preserve their tax base," says Joe W. Neff, partner in charge of state tax consulting at PriceWaterhouseCoopers in Los Angeles.
In recent years, states have made more services subject to sales and use taxes. "A lot of states are being more aggressive than ever in this regard," Neff says.
States have also beefed up compliance efforts to boost revenue collection. "While many states find they don't need to raise tax rates, they are determined to collect all the taxes they feel they're owed," says Neff. As a result, a large number of states have established special compliance programs designed to locate businesses operating in their states that are not paying sufficient taxes.
To find out about company operations, states are sending out questionnaires, calling toll-free 800 numbers and attending trade shows to glean as much data as possible about taxable business activity, he explains. Some states have even opened audit offices in other states, established information-exchange agreements among themselves and with the federal government, and have refined strategies for tracking down companies they believe aren't paying their fair share of taxes.
Some state and local governments have even gone so far as to use private tax collectors to track down business taxpayers in their efforts to assess unpaid taxes on unreported business activity, says Elizabeth Burton, state tax specialist with accounting firm Grant Thornton in Chicago. Once tax hunters successfully locate taxpayers and collect the taxes owed, they share a portion of the levies collected.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.
What You're Up Against
In their search for business taxes, states are attempting to prove what is known as "nexus." This means declaring a specific business activity (such as having a sales office located within a state) subject to state taxes. Nexus can also be established if an out-of-state company maintains tangible personal property in that state. Owning or leasing a warehouse in the state or owning land also creates nexus. Once a state proves nexus, it can subject a company to income, sales and use, and other business taxes.
Following the example of many state governments, municipalities are also taking steps to prove nexus. As a result, more business activity is becoming subject to local sales taxes.
As a business owner, if you find your company has tax-collection liabilities in a large number of states and localities, it's a good idea to determine exactly what activity is causing that liability, says John Logan, senior state tax analyst with CCH Inc., a provider of tax and business law information in Riverwoods, Illinois. After consulting with your tax advisor, you may find it advantageous from a tax standpoint to move a part of your business into a state with a lower tax rate.
In determining where you have a taxable presence, be sure to take both income, and sales and use taxes into consideration. Remember that when it comes to assessing income taxes on your business, your company must have some property and payroll in the state.
This type of review will help you determine in which states you have tax filing requirements and exactly what steps you need to take to be in compliance. If for some reason you have neglected to comply with the tax laws in a particular state, it's a good idea for you to try to reach an agreement with the tax collector there, says Neff.
One option is to take advantage of state amnesty programs to settle your outstanding liability. Under such programs, explains Neff, "states may be willing to reduce a company's tax bill for prior years and in some cases waive interest or penalties or both."
For Your Protection
There are a number of strategies you can follow to keep state and local governments from overtaxing your business. Here are some of the more important ones:
- Win business tax breaks. One of the best ways to reduce
taxes is to take advantage of tax-incentive programs being offered
to businesses by many state and local governments. With one hand,
states and localities are taking money from businesses in the form
of taxes. But with the other, they are often willing to give it
back as a part of tax-incentive or credit programs. Therefore, it
pays to thoroughly investigate whether your business qualifies for
any of these special tax-incentive programs.
This strategy works really well if you're relocating or planning to expand your business, says Neff. Logan agrees and adds that "states have been in a contest to see which ones can provide businesses locating within their boundaries with the most attractive incentives.'
For example, Pennsylvania recently established what it calls Keystone Opportunity Zones, in 12 economically depressed areas. If companies locate within these zones, state and local taxes are eliminated for up to 12 years. At the state level, this involves corporate net income, capital stock and franchise taxes. Local governments in these 12 zones have agreed to waive local real estate, earned income/net profits and business gross receipts taxes for businesses in the zones. The program's aim is to stimulate job creation and community renewal. To participate in the program, business owners must be up-to-date with all their state and local tax payments.
To find out about similar programs in other states, you can check out individual states' Web sites. State Web addresses follow a standard format: Simply key in www.state. [name of the state using postal abbreviations] .us (for example, http://www.state.pa.us). Once you reach one, click on economic development. It's also possible to check with states' economic development offices to find out more about tax incentives that apply to your business.
- Use state tracking services to uncover the latest
incentives. CCH publishes a resource guide, available in most
public libraries, known as "CCH State Tax Reporters."
Also, major accounting firms usually have state and local tax
departments, which offer advice on special tax incentive programs
for a fee.
Once you've identified a program for which your business qualifies, contact a state or local government's economic development department to make your bid for a specific tax break. "There's a lot of negotiation going on by which businesses are securing advantages for themselves by working out an understanding with state and local government bodies,' says Logan.
- Regularly check your company's personal-property records. It's important to make sure the personal property you list and report to your local government each year is actually something your company owns and uses. If you've sold or donated any pieces of equipment, be sure to remove these items from your personal-property total. This way you won't end up paying personal-property tax for things you no longer own. (For more details on strategies for reducing your personal-property tax, see January's "Tax Talk".)
- Use state apportionment policies to your advantage. It
may be possible to reduce your state tax bill by establishing a
business presence in more than one state. Being a multistate
business has one advantage, says Burton. If your business operates
and only pays taxes in one state, you have to report 100 percent of
your income to that state. But if your business is taxable in more
than one state, you can divide up the company's income and the
taxes owed among a number of states by using a specific
apportionment formula set up by the individual states. When used
effectively, apportionment may result in some business income not
being taxed in any state.
Becoming a multistate business can be relatively easy. In some cases, all you really have to do is keep inventory in another state or just hire one salesperson who uses a small rented office there. Again, to determine whether a tax strategy based on state apportionment policies will work for your company, check with a tax expert who specializes in state and local tax policies, says Logan.
While there's no way to completely eliminate the bite from state and local levies, taking advantage of sound tax-planning strategies can minimize their sting and help produce healthy tax savings for your business.
CCH Inc., 2700 Lake Cook Rd., Riverwoods, IL 60015, http://www.cch.com
Grant Thorton, (312) 602-8977, firstname.lastname@example.org
PriceWaterhouseCoopers, (213) 356-6191, email@example.com