Risks of Apportionment
While apportionment issues present challenges they also present opportunities. Proper planning can help to manage your overall tax liabilities, and knowledge of these issues can help mitigate potential exposures and combat aggressive taxing authorities on audit.
So under a lot of these traditional cost to performance methods, there was a lot of record keeping that was required. You had to keep very detailed record of where your costs are, where your people were, where your property was you had to keep records possibly on a job by job basis, customer by customer basis, project by project or contract by contract, and it got very difficult to often keep those records, especially with states having different rules and regulations because some states would include third party costs, some states would include indirect costs like overhead and SG&A and how do you include those in specific contracts and such. So there was a lot of record keeping with that. The problem with the market sourcing, unfortunately is that while there's less record keeping, you also just may have less information available to you. Specifically, if you're selling things like software or some other sort of intangible, you may be told to deliver it via the Internet to a file transfer protocol site.
Well you don't know where that servers located. You're just delivering it to an Internet address. You could be in India, could be in Europe, could be in California. You don't know where to actually getting delivered to, nor do you know where your customer's going to be using that. And a lot of these rules for market sourcing are actually written such a way that you're supposed to know where your customer is utilizing these items and utilizing your sales. You may not have access to that at all. And, very often, these rules for market sourcing are written in a hierarchy, which although they tried to take into account as much as many of the situations as possible, they never address all of them and very often they default to something as simple as billing address or your customers' major address where the contract came out of, which is very easy to manipulate from a revenue standpoint.
So, some of the major risks are basically that you're either overpaying your taxes now or that you're significantly underpaying it or paying it to the wrong locations, which could lead to big assessments. You might be thinking, well, I'm already paying 100 percent or close to 100 percent of my income, and you think you're okay. When, in reality, maybe you're sourcing it to a different state than it should be sourced to. Now, depending upon the timeframe involved, you may get audited by one state and you end up paying a big assessment there and you may be thinking, well, I can just go back to the other states and get a refund. Well, some of those states may be barred by the statute of limitations where maybe you got assessed going back 7 or 10 years. Meanwhile, you can only get a refund in the other state going back three or four years, so that would be one of the pitfalls there, and then you've lost that opportunity to get those refunds back.
Some of the other pitfalls could just be you're paying to the wrong jurisdictions and maybe you're paying too much to a high paying high tax jurisdiction where the tax rate is nine percent. Versus to a jurisdiction with a tax rate might be five percent. So again, you could be overpaying those taxes. Some of the other issues may just be you're not keeping proper records and whenever that happens, the auditor's may have a field day because when they come in and turn to you to try and prove your revenue was because the auditor's assessment is generally deemed to be correct, unless you can prove otherwise.
In this Apportionment overview, Gary Bingel discusses challenges and opportunities and how planning can help manage overall tax liabilities, and knowledge can help mitigate potential exposures and combat aggressive taxing authorities on audit.
Apportionment is the manner in which income is divided between various taxing jurisdictions. A number of states have moved to receipts receiving more emphasis. Our video overview sets the stage for our pitfalls, risks and opportunities discussions.
Defensively, your tax team wants to avoid pitfalls associated with nexus. On the other hand, understanding nexus can open the door for opportunities such as Voluntary Disclosure Agreements or amnesty.
A major nexus pitfall includes unpaid taxes, uncollected sales tax and flow-through entity issues are sometimes missed. Avoiding sticky situations requires an understanding of what creates nexus for different taxes, and in different jurisdictions.
In this Nexus overview, Gary Bingel discusses how Nexus varies state by state, the contacts required to generate taxes, "physical presence" and other key focus areas including remote employees, and new sourcing rules among others.