Many companies struggle to determine if they have sufficient activity in a state, or nexus, to force them to file state tax returns. This can be especially difficult for transportation companies and is based largely on the question of whether driving more than a de minimis amount of miles through a state creates a tax filing obligation. Further complicating matters is that, for income tax especially, transportation companies must use special formulas to determine their share – or apportionment – of tax owed. The complications of determining when nexus exists and cost of compliance outweighing the perceived risk are often cited as reasons why many companies choose not to file in a particular state.
But how do you approach filing initial tax returns in a state where miles have increased and or a terminal or land has been purchased or leased?
Merely filing in states when the risk becomes great enough may trigger further inquiry of the prior year in-state activity, resulting in tax, interest and penalty owed for prior years. In these situations, a Voluntary Disclosure Agreement (VDA) might be a good option. There are generally two benefits of entering into a VDA with a state: limited lookback and abatement of penalty, interest, and or fees associated with noncompliance.
While each state has its own application process, a VDA typically begins with an anonymous letter to state officials describing the company’s activity within that state. A detailed information gathering and negotiation process follows. The company’s identity is only disclosed after the terms have been agreed upon. Assuming the company has provided accurate information to the state and an agreement is executed by both parties, the company then submits the outstanding returns with payment for the lookback period.
When evaluating whether pursuing a VDA is appropriate, the company should compare the potential tax due under an agreement with what is at risk if they choose not to participate and the state identifies them first.
The company should analyze the years preceding the typical lookback period to determine if they had nexus in those years and the amount of potential liability. The cost of compliance under both scenarios should also be taken into consideration. A VDA is generally recommended in situations in which the company is unsure of the liability for periods before the typical VDA lookback period, or if it is known to be a large potential liability, with compounding interest and penalties, and paying that liability would cause financial hardship.
From time to time, states have been known to offer amnesty programs, which are similar to VDAs. However, amnesty programs are only offered for a certain period of time and generally require a company to pay all or most of the prior year taxes in exchange for penalty and or interest abatement associated with the filings. Companies should be careful to note if a state just completed an amnesty program before requesting a VDA, as those states may not respond favorably to taxpayers who could have participated in amnesty but chose not to.
Pennsylvania currently has an amnesty program running through June 19, 2017. This program covers all taxes owed to Pennsylvania that are administered by the Pennsylvania Department of Revenue. Eligible periods are those where there is a known or unknown delinquency that exists as of Dec. 31, 2015. The benefits of participating in this amnesty program include the waiver of all penalties, collection fees, lien fees, and 50 percent of the late-payment interest. Note that for taxpayers who are eligible to participate in this amnesty program but choose not to participate and are later found to be delinquent, an additional five percent penalty may apply. Additionally, taxpayers who participated in the 2010 amnesty program are not eligible to participate this year. Lastly, a taxpayer that has signed a VDA covering any periods eligible for amnesty would not be able to participate in the current amnesty program.
Voluntary disclosure programs offer companies the opportunity to come forward and decrease the amount of tax, penalty, and interest they would otherwise owe. For transportation companies that have previously underreported tax, or not filed at all, these programs could provide substantial benefits. If you believe your company has been playing the game of audit lottery too long, state voluntary disclosure programs may be worth considering.
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