United States: Tax Savings Through Voluntary Disclosure Agreement

Last Updated: August 5 2016
Article by Pam Huelsman

Recently, a Missouri-based company with all property and employees in Missouri became concerned that other states could have a valid claim for imposing tax on the company. Based on a review of employee travel records, the company's adviser suggested the business might indeed have an income tax filing obligation in states other than Missouri. Providing services to an out-of-state customer along with employee travel may be sufficient to establish nexus and allow a state to impose an income tax filing requirement on a business. Fortunately, this company was able to participate in a Voluntary Disclosure Program with the non-filing state and apportion its income in Missouri, resulting in a net tax benefit overall. (While this series of events occurred in Missouri, it's important to note that most states do offer Voluntary Disclosure Agreements.)

Activities That Establish Nexus

Nexus is the necessary connection with a state that allows the state to impose an income tax on an out-of-state business. Taxpayers should be cautious when dealing with nexus issues because while a business clearly has nexus in its home state and in each state where it has an office or employees, other nexus-triggering activities might not be as apparent.

Any of the following non-exclusive in-state activities can establish nexus and lead to an income tax filing obligation:

  • Installation, making repairs or providing maintenance or service to property sold
  • Providing technical assistance, including engineering or design services
  • Solicitation for services
  • Licensing intangibles that are used in-state
  • Revenue from in-state customers that exceeds certain thresholds, with no in-state presence

Voluntary Disclosure Agreement (VDA) an Option for Eliminating Tax Risk

The Voluntary Disclosure Program allows eligible taxpayers the opportunity to come forward and enter into a voluntary disclosure agreement (VDA) in exchange for certain benefits.

The benefits of a VDA generally include a limited look back period (generally 3-4 years), and most penalties are waived. In exchange for such benefits, the company's obligations typically include proper registration and tax return filing for the agreed upon look back period and going forward.

Following is an example of how a VDA benefit works:

  • Company X has determined that it may have an Illinois filing obligation that could go back 6+ years with a projected income tax liability of $10,000 annually.
  • If Illinois were to discover Company X's non-filing status, a likely assessment could be $60,000 (at least) in tax, plus a minimum of $23,000 in interest and penalties, for a total of $83,000.
  • However, if Company X were to enter into a VDA with Illinois, the state would typically agree to a 4-year look-back period and accept $40,000 in tax, $3,000 in interest and waive penalties, for a total of $43,000.
  • The VDA benefit would be $40,000

If you suspect you may have tax exposure for prior years, you should investigate the possibility of the VDA process to protect your business and prevent unpleasant surprises. Often times a VDA can be an important first step in effectively managing state taxes.

Why It Matters to File Taxes in the Appropriate States

Some companies that suspect a tax filing obligation in another state might take the shortcut of allocating all income to their home state. Taking this shortcut approach could be a mistake under variations of three general circumstances:

  1. Corporations not taking advantage of any of the options their state has to apportion income, which can result in drastically overpaying their total state tax liability
  2. Flow-through entities, and their owners, often assume that any tax paid outside their statewill be substantially offset by their home statetax credits, forgetting that the other states have no statute of limitations and can assess back taxes for many years, well after their state statute of limitations has expired
  3. Some trigger — a requirement to certify that the company is tax compliant with a state, a pending sale of the business, or an out of state audit or nexus questionnaire — can produce an unexpected income tax exposure, with large penalties, that far exceeds management's suspected worst case scenario.

Asking for forgiveness is often a good step in general, and particularly when you discover that you are in violation of nexus rules in other states.

To find out if your company has activities that establish nexus and if you should consider a VDA, visit bswllc.com.

For more information about establishing nexus, contact Pam Huelsman, Principal, Tax Services, at phuelsman@bswllc.com or 314.983.1392.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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