Marketplace Fairness Act May Help Clear Muddy Tax Waters

Unless you or your clients are in a state that has no sales tax, you can be assured that just because the e-tailer didn't collect tax on an otherwise taxable item or service, a corresponding use tax is still due. The use tax is designed to be the self-reporting side of the sales tax. It requires a taxpayer to independently evaluate what he or she bought or consumed, determine whether or not it was taxable and if the answer is yes, voluntarily remit the tax.

Use tax compliance has often been lax and states have been aggressive in stepping up enforcement. Many states have inserted a line for use tax on the required personal income tax filings. Taxpayers are expected to put an amount down, even if it is zero, and returns are generally considered incomplete if the line is left blank. Some states, including New York, provide a table where the taxpayer can estimate his or her use tax liability based on adjusted gross income. The taxpayer signs the return under penalties of perjury. As part of a complete sales tax audit, states routinely examine a taxpayer's purchases to determine if the requisite use tax has been remitted.

This sounds much simpler than it really is. As a tax professional, I constantly monitor for new products and services that are and are not subject to the sales tax ' and there are no clear lines that allow for assumptions. For example: installing a fire sprinkler system is not taxable, while changing the sprinkler head is. Couple this with the lightening-paced digital age and the law's inability to keep up and you'll understand why trying to independently determine the taxability of transaction is difficult at best. Add to this complexity the taxing schemes expectations of use tax self-compliance and all of a sudden a complicated piece of federal legislation, the Marketplace Fairness Act (MFA), can actually seem fair.

The MFA Shows Potential

Never in my professional career did I imagine that I would see the federal government make serious efforts to unify (some might not agree with simplify) sales tax collection standards. Nevertheless, the MFA was passed by the Senate on May 6, 2013 and passed on to the House of Representatives on May 20. Its fate in the House is uncertain and it appears that there will be a difficult journey to ratification. Opponents argue that the MFA will create new taxes and make life even more complicated for businesses. Proponents insist that no new taxes be created, the administrative issues have been worked out, and passage will level the playing field for all retailers, large and small, Web-based and not.

While no tax practitioner looks forward to additional rules and regulations, I don't hold with the argument that the MFA creates new taxes. In fact, some believe that passage could result in lower sales tax rates as a large portion of the tax base that is currently not being reported would now be generating additional tax revenue. Granted, it shifts the burden to retailers who may not have otherwise been obligated to collect sales tax, but it attempts to do so in an equitable and administratively efficient way. As the Act is currently written, an exemption is provided for small online retailers with annual sales of less than $1 million. Clearly, it will eliminate the unfair advantage of the perceived online discount provided courtesy of your state taxing authority.

The Case for Getting on Board

Should attorneys get on the MFA bandwagon? I think so. An inordinate amount of time and resources are now expended by attorneys and their clients in determining whether sales tax should be collected and use tax remitted. Whether or not it is good public policy for particular goods and services to be subject to tax is an issue separate and apart from the MFA. The added administrative burdens of the MFA are likely less demanding than the current state of affairs.

It may not be readily apparent why a law firm should be concerned about the MFA for its own operations. In fact, attorneys may find themselves, as well as some of their clients, the subjects of sales and use tax examinations. While an attorney's fee income and other receipts from rendering legal services are almost universally exempt from sales tax, states, in their search for revenue, have continued to target professional service organizations ' especially law firms ' for examinations for potential use tax liability.

The apparent impetus for concentrating on professional service firms stems from an increase in Internet purchases of tangible personal property, software and information from the growing number of vendors throughout the country. A very substantial portion of a law firm's purchases includes legal books and periodicals as well as computer hardware and software from out-of-state vendors.

In many cases, the out-of-state vendors don't have a sufficient presence in the particular state and, consequently, are not required to collect sales tax. However, as previously discussed, many law firm purchases are subject to the use tax, due and payable by the firm making these purchases. Moreover, once a law firm has been selected for audit, all purchases are fodder for examination. This means that many other items not initially considered by the firm as taxable become a potential source of use tax liability, among them:

• Office supplies and other recurring-type purchases;
• Office furniture, fixtures, and equipment; and
• Other expenditures assumed to qualify as capital improvements and thus free of sales tax.

Looking ahead, the statute of limitations may not run on an assessment of use tax. Generally, there is a three-year statute for assessing unpaid use tax from the date a sales and use tax return is filed. However, if no return has been filed (which may be the case where a law firm has no taxable receipts), no assessment limitation period applies. In this instance, the taxing authority may assess unpaid use tax for an unlimited time period ' even dating back to the firm's inception ' which could add up to hundreds of thousands of dollars. Despite having this right, taxing authorities generally agree to limit their sales and use tax examinations and any related assessments to a “reasonable” period, usually from seven to 10 years.

To lessen the potential impact of a tax examination of future periods, it is prudent for a firm to register with the state taxing authorities for sales and use tax purposes. By registering, the firm will be required to file sales and use tax returns and pay any use tax due. While this may result in additional tax compliance responsibilities, it will certainly eliminate any surprise costs and likely reduce the time-frame within which the state may seek to examine the firm for use tax liability.

The MFA may even help alleviate the current use tax headache. By applying the sales tax on a more consistent basis, all professional service firms should have a much lower exposure for any use tax liability since the appropriate sales tax amount would have already been collected.

Attorneys and their clients have too long charted an uncertain sales and use tax path, with the possibility of stumbling into a tax examination always hanging in the air. The MFA, for all its debatable points, is a lumbering but positive step in the right direction. And in the world of taxation, any step forward is something to be welcomed with open arms.

Wayne Berkowitz, CPA, J.D., LL.M. , is a partner and head of the State and Local Tax Group of CPA and Advisory firm Berdon LLP with offices in New York City and Jericho, Long Island. He advises law firms and other businesses across a spectrum of industries and professions on the unique tax regulations of states and municipalities throughout the nation. He can be reached at 212-331-7465 or [email protected]. ' 2013 Berdon LLP.

With my mom probably one of only a handful of people who haven't made an Internet purchase, I think it is fair to say that we have all seen certain online retailers almost bragging that there is no sales tax on merchandise ordered from their e-store. As I write, I observe the following on a national electronics retailer's website: “No Sales Tax & Free Shipping on Qualifying Orders.” The first question this raises is whether the “qualifying order” language refers to the shipping, the sales tax or both. The second is: Can these e-tailers work this magic to make an otherwise taxable event, nontaxable. If the answer was yes, we would all be fighting for their talents to be applied to other areas of the tax law. In reality, they are simply muddying the waters, but clarity may be on the way in the unlikely form of federal legislation.

Understanding the Sales and Use Tax Picture

While, I can't answer the free shipping issue, as a tax professional I can confirm that many, including some who may be your clients, are being misled if they believe that Web purchases are tax free. Whether or not the e-tailer is obligated to collect the sales tax does not relieve the purchaser from owing his or her state's corresponding use tax. The notion that Internet purchases are “tax free” is one that practitioners have had to dissuade their clients of ever since the 1998 passage of the Internet Tax Freedom Act. While the Act played an important role in largely prohibiting the states from taxing Internet access, it in no way restricted a state's ability to require an e-tailer to collect sales tax under certain circumstances and correspondingly apply the use tax where no sales tax collection effort was made ' whether or not collection was required by the e-tailer.

Unless you or your clients are in a state that has no sales tax, you can be assured that just because the e-tailer didn't collect tax on an otherwise taxable item or service, a corresponding use tax is still due. The use tax is designed to be the self-reporting side of the sales tax. It requires a taxpayer to independently evaluate what he or she bought or consumed, determine whether or not it was taxable and if the answer is yes, voluntarily remit the tax.

Use tax compliance has often been lax and states have been aggressive in stepping up enforcement. Many states have inserted a line for use tax on the required personal income tax filings. Taxpayers are expected to put an amount down, even if it is zero, and returns are generally considered incomplete if the line is left blank. Some states, including New York, provide a table where the taxpayer can estimate his or her use tax liability based on adjusted gross income. The taxpayer signs the return under penalties of perjury. As part of a complete sales tax audit, states routinely examine a taxpayer's purchases to determine if the requisite use tax has been remitted.

This sounds much simpler than it really is. As a tax professional, I constantly monitor for new products and services that are and are not subject to the sales tax ' and there are no clear lines that allow for assumptions. For example: installing a fire sprinkler system is not taxable, while changing the sprinkler head is. Couple this with the lightening-paced digital age and the law's inability to keep up and you'll understand why trying to independently determine the taxability of transaction is difficult at best. Add to this complexity the taxing schemes expectations of use tax self-compliance and all of a sudden a complicated piece of federal legislation, the Marketplace Fairness Act (MFA), can actually seem fair.

The MFA Shows Potential

Never in my professional career did I imagine that I would see the federal government make serious efforts to unify (some might not agree with simplify) sales tax collection standards. Nevertheless, the MFA was passed by the Senate on May 6, 2013 and passed on to the House of Representatives on May 20. Its fate in the House is uncertain and it appears that there will be a difficult journey to ratification. Opponents argue that the MFA will create new taxes and make life even more complicated for businesses. Proponents insist that no new taxes be created, the administrative issues have been worked out, and passage will level the playing field for all retailers, large and small, Web-based and not.

While no tax practitioner looks forward to additional rules and regulations, I don't hold with the argument that the MFA creates new taxes. In fact, some believe that passage could result in lower sales tax rates as a large portion of the tax base that is currently not being reported would now be generating additional tax revenue. Granted, it shifts the burden to retailers who may not have otherwise been obligated to collect sales tax, but it attempts to do so in an equitable and administratively efficient way. As the Act is currently written, an exemption is provided for small online retailers with annual sales of less than $1 million. Clearly, it will eliminate the unfair advantage of the perceived online discount provided courtesy of your state taxing authority.

The Case for Getting on Board

Should attorneys get on the MFA bandwagon? I think so. An inordinate amount of time and resources are now expended by attorneys and their clients in determining whether sales tax should be collected and use tax remitted. Whether or not it is good public policy for particular goods and services to be subject to tax is an issue separate and apart from the MFA. The added administrative burdens of the MFA are likely less demanding than the current state of affairs.

It may not be readily apparent why a law firm should be concerned about the MFA for its own operations. In fact, attorneys may find themselves, as well as some of their clients, the subjects of sales and use tax examinations. While an attorney's fee income and other receipts from rendering legal services are almost universally exempt from sales tax, states, in their search for revenue, have continued to target professional service organizations ' especially law firms ' for examinations for potential use tax liability.

The apparent impetus for concentrating on professional service firms stems from an increase in Internet purchases of tangible personal property, software and information from the growing number of vendors throughout the country. A very substantial portion of a law firm's purchases includes legal books and periodicals as well as computer hardware and software from out-of-state vendors.

In many cases, the out-of-state vendors don't have a sufficient presence in the particular state and, consequently, are not required to collect sales tax. However, as previously discussed, many law firm purchases are subject to the use tax, due and payable by the firm making these purchases. Moreover, once a law firm has been selected for audit, all purchases are fodder for examination. This means that many other items not initially considered by the firm as taxable become a potential source of use tax liability, among them:

• Office supplies and other recurring-type purchases;
• Office furniture, fixtures, and equipment; and
• Other expenditures assumed to qualify as capital improvements and thus free of sales tax.

Looking ahead, the statute of limitations may not run on an assessment of use tax. Generally, there is a three-year statute for assessing unpaid use tax from the date a sales and use tax return is filed. However, if no return has been filed (which may be the case where a law firm has no taxable receipts), no assessment limitation period applies. In this instance, the taxing authority may assess unpaid use tax for an unlimited time period ' even dating back to the firm's inception ' which could add up to hundreds of thousands of dollars. Despite having this right, taxing authorities generally agree to limit their sales and use tax examinations and any related assessments to a “reasonable” period, usually from seven to 10 years.

To lessen the potential impact of a tax examination of future periods, it is prudent for a firm to register with the state taxing authorities for sales and use tax purposes. By registering, the firm will be required to file sales and use tax returns and pay any use tax due. While this may result in additional tax compliance responsibilities, it will certainly eliminate any surprise costs and likely reduce the time-frame within which the state may seek to examine the firm for use tax liability.

The MFA may even help alleviate the current use tax headache. By applying the sales tax on a more consistent basis, all professional service firms should have a much lower exposure for any use tax liability since the appropriate sales tax amount would have already been collected.

Attorneys and their clients have too long charted an uncertain sales and use tax path, with the possibility of stumbling into a tax examination always hanging in the air. The MFA, for all its debatable points, is a lumbering but positive step in the right direction. And in the world of taxation, any step forward is something to be welcomed with open arms.

Wayne Berkowitz, CPA, J.D., LL.M. , is a partner and head of the State and Local Tax Group of CPA and Advisory firm Berdon LLP with offices in New York City and Jericho, Long Island. He advises law firms and other businesses across a spectrum of industries and professions on the unique tax regulations of states and municipalities throughout the nation. He can be reached at 212-331-7465 or [email protected]. ' 2013 Berdon LLP.