The owners and executives of many tactical businesses complain about federal taxes. However, more often, the state and local tax burden is far greater for those who operate in one jurisdiction or more than one. What’s worse, many of those state and local laws change from year to year.

Plunging revenues have prompted many state and local governments to step up their pursuit of taxes. State and local budgets that seemingly flirt with disaster even in good times are, in many cases, in dire straits, something with big implications for every tactical retailer. Coping with and easing the state and local tax burden means planning beginning with the state income tax.

The Complexities of Taxing Income

Today, state income taxes can cost a business between 2.5 and almost 10% — or more — of its pretax income. That is not an insignificant amount, regardless of the state of the economy.

Every tactical retailer should also be aware of whether those deductions they’re planning to claim on their federal tax returns will receive the same treatment at the state level. While many states follow federal tax rules, some states decouple from certain tax provisions.

Although 44 states levy a corporate income tax, many retailers are not subject to it because they are taxed as pass-through businesses where income is reported as the owner/shareholder’s personal income. 

Beware, however; multistate taxation is tricky. Every business faces an interesting challenge: What happens if you do business in more than one state? The state that the business calls home generally wants to tax every dollar of income. Every other state where it does business wants to tax income earned in their state. Does that mean paying taxes on the same income twice?

Fortunately, good records and planning can ensure there are no overlooked or duplicate payments for taxable income earned in another jurisdiction and, no tax bill for a tactical business operating as a pass-through entity, such as an S corporation or partnership.

Across State Lines

Battles over the cross-border reach of state tax authorities are as old as the country. In 2018, the U.S. Supreme Court, in South Dakota v. Wayfair, overturned the rule that a physical presence was necessary to require remote sellers to collect sales taxes. That decision allowed states to impose sale tax collection obligations on remote sellers.

Although some businesses may not be required to collect tax on their sales of products or services, they usually must pay them on some of their own purchases. It’s all too easy today to get caught ignoring the sales tax due on purchases made in another taxing jurisdiction, via the internet or where sales taxes should have been collected but weren’t — don’t forget the “use” tax.

Labor Laws and Taxes

Federal, state and even local laws dealing with employees change from year-to-year, and all usually effect the tax bill of a business that cates to the tactical market. While these laws are designed to be beneficial for employees, businesses find it increasingly difficult to remain profitable.

Many states have created programs to compensate businesses for expenses related to minimum wage law changes, worker incentive programs, such as paid family leave, and other laws dealing with employees. However, this is only a temporary solution and rarely addresses higher payroll costs and increased payroll tax bills.

Property Taxes

One tax that is often overlooked and frequently over-paid is the tax assessed on the property and, in many places, the equipment and other business assets. Surprisingly, few tactical retailers challenge their property tax bill. While the tax rate can’t be questioned, the assessment of the business’s property, the value placed on it by the local assessor, can be challenged and could result in property tax savings year after year.

State Tax Credits and Incentives

State and local governments often incentivize businesses through tax breaks, grant programs or business-friendly policies. But is the business taking advantage of all of the programs they qualify for? 

Credit and incentive packages are usually offered by economic development agencies and based on the economic benefits, such as job creation, job retention and/or capital investment an applying business will bring to the area.

Obviously, awareness of the tax credit or incentive programs is necessary before any retailer can negotiate the best possible credit and incentive package with a state economic development agency.

Potential Pitfalls

The road to tax savings on the state and local levels contains a number of potential pitfalls such as:

• Independent Contractors. Retailers have long appreciated the absence of payroll taxes and the withholding burden associated with employees but non-existent with independent contractors. Many individuals favor the flexibilty, freedom and perceived tax benefits as independent contractors. 

Unfortunately, it is not only the IRS and the U.S. Department of Labor that are changing the definition of who is and who isn’t an independent contractor. A growing number of states are adopting the controversial — and far stricter — definition of independent contractors originating in California but driving up payroll costs elsewhere. 

• Conforming to Federal Tax Reform. Although slated to soon expire, the Tax Cuts and Jobs Act (TCJA) lowered the federal corporate tax rate and made significant changes to the cost recovery possibilities and deductions available to businesses. The states have largely settled on TCJA conformity, but each year, a number of taxing jurisdictions institute changes or adapt specific provisions.
• Cryptocurrency. A major consideration with state taxes is how should purchases of tangible personal property or services made with cryptocurrency be treated? Whether the purchase of virtual currency or cryptocurrency is a taxable sale under the state’s sales and use tax rules is another consideration.

Many states have yet to issue guidance on the tax treatment of virtual currency or cryptocurrency making. Where the issue has been addressed, do they conform with the latest federal tax rules? Delving into the treatment of these new currency options in both those states that haven’t addressed the issue and those where rules are already on the books can mean avoiding expensive penalties.

Separately Accounting

While most businesses take a general approach to apportion income, many states allow the use of “separate accounting.” Separate accounting is pretty much what it sounds like: a second set of books. The tactical business computes its net income based on the income and expenses within the state. Unless the operation in the state is almost a separate entity, this generally is not easy. It can also be expensive.

Overhead, salaries of employees who work both in and out of the state, expenses, overhead, etc., must be allocated to those locations. However, despite the problems, the use of separate accounting can result in significant tax savings, especially if the operations within the state produce little or no income, and the state has a high tax rate.

Those businesses that don’t operate in more than one state or tax jurisdiction can also benefit from separate accounting. While a business must compute their income using the same method used in keeping their books, they are not required to use the same method when preparing their financial statements.

Many small businesses find it easier to use the cash method of accounting for tax purposes, while others use the accrual method. The accrual method is preferred for both tax purposes and financial reporting because it gives a clearer picture of the financial status of the business.

Filing

When is a retailer required to file a tax return in another state? Even that becomes a complicated question, one that depends on the rules in that particular state. Generally, if a business simply sends goods into a state and does not have employees working in that state, the business probably will not have to file income or sales tax returns in that state. Until Washington State began sending its questionnaires and eventually tax bills to out-of-state businesses, a business sending independent sales reps into another state was usually able to avoid filing income tax returns.

In the past, even a business with a sales office in a state, one which takes orders that have to be approved at another office out of state, have been exempted from filing income taxes in that state. Of course, once a retailer has property located in a state or has employees in a state (or some other similar connection) the operation must generally file tax returns and pay taxes. Not filing could result in penalties, interest and a host of other tax problems.

Keeping Abreast of State and Local Taxes

State and local tax codes are varied and in constant flux. However, keeping abreast of the business’s state and local tax obligations can, while complex, could be worth the effort. Failing to keep abreast can significantly affect the operation’s cash flow.

A thorough review of the tactical retailer’s federal tax situation and its potential liability for state taxes can mean a lower tax bill. It may also uncover opportunities for automation, advantageous filing and apportioning methods, or valuable credits and incentives. As always, professional guidance is recommended.