Dave Cain: Welcome to unsuitable on Rea Radio, the award-winning financial services in business advisory podcast that challenges your old-school business practices and their traditional business suit culture. Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie while offering you meaningful modern solutions to help enhance your company’s growth. I’m your host Dave Cain and welcome to the Halloween edition of unsuitable on Rea Radio.
Your business is growing and that’s a great thing. Well it is as long as you prepare to confront the things that go bump in the night. Consider for example finding yourself in unknown territory. Just think about the dangers you could face or what it would had to endure for the sudden disappearance of a key member of your staff due to seemingly supernatural reasons. Worse still, what if you find yourself in the company of a vampire of a hungry state tax auditor with an aversion to garlic. The truth is there are a lot of unknowns that come along with business growth which is why it’s so important to have someone on your side who can help eliminate those demons, ghosts, and goblins.
Joining us on today’s special Halloween edition of unsuitable is Scott Zielaskiewicz and Joe Popp from Rea & Associates consulting team and they’re expert monster slayers and business growth consultants and we’re about to have a scary good time.
Welcome to unsuitable Scott and Joe.
Scott Zielaskiewicz: Thank you.
Joe Popp: Thank you, Dave, nice to see you again.
Dave: Good to hear you. One of the things we want to talk about that we talk about frequently on unsuitable is business risk and trying to eliminate risk for our clients and multiple business owners. What’s coming into the environment in the last several years are these state and local tax liabilities. I think you guys are here to help us navigate through that.
Joe: Sure, absolutely.
Dave: It’s interesting to point out as we start, I’m a general practitioner C.P.A. and there’s a lot of general practitioner C.P.A. firms around the country. You know a little bit about SALT, state and local tax, federal tax, but that’s all you guys do is state and local taxation. Is that what you guys spend, Scott, 100%?
Scott Z.: Yes, that’s correct.
Dave: 100% of your time. Joe, 100% of your time?
Joe: Yes, pretty much. It’s a fascinating topic. If there are such things as tax nerds, I’m definitely one of those so there you go.
Dave: All right, we like to have nerds on the show. In our interview we’re going to tackle a few areas that have come to our attention from feedback from our business owners. And again, like I mentioned earlier on the risk and that’s what we’re trying to identify here and again as your business keeping with the Halloween theme, as your business begins to walk through new spooky foreign woods like Michigan or other places, you need a plan and that’s what we refer to as nexus, as a business goes into various states and localities.
Both Joe and Scott are going to handle the nexus but let’s talk about the definition of nexus if you will. Scott, you want to tackle that definition?
Scott Z.: Yeah, I’ll take that. Nexus is basically just that connection between a vendor or a seller and that state in that state. So it’s basically just engaging in enough business activities within that state to create a connection within hat state.
Dave: What would be a sample of a connection? Is it if I have a state in that state? If I’m from Ohio and I have a sale in another state, is that a connection?
Scott Z.: When it comes to sales use taxes there’s a lot of different things that could create nexus. Having a sale in that state could potentially create nexus. The biggest are having a salesman in that state and an employee in that state. A physical location in that state or regularly shipping products into that state, it’s going to create nexus.
Dave: Joe, you want to expand on that, on the Nexus comment.
Joe: Sure. So nexus is actually one of these really deep interesting intellectual kind of topics. It grew out of the legal system and the original question was which state is it appropriate for an individual to be sued in. So for example, if I’m driving through Ohio and I’m a Michigan resident and I smack into someone, can that person sue me in Florida because let’s say that person’s a Florida resident who happened to be in Ohio too. And so, that’s where these rules came from is basically a where can someone sue another person. It’s evolved into when can a state tax you. When can a state impose its will on you and make you do something with regards to collecting a tax or paying a tax.
And so, the original cases in this area in the sales tax area came from mail order catalogs, remember those things? If you send in a mail order catalog into a state and someone were to take that catalog and then make an order, is that enough nexus for a state to be able to tax you. And that’s kind of where this has grown out from. As Scott mentioned at the beginning of his answer, right now we’ve kind of come full circle to man, if you just make a sale in a state, sometimes that’s enough. And it used to be back in the day, we were getting further and further away from that. You really needed to have a sales person there and the states are now coming back full circle to man, if you just make a sale that’s enough many times.
Dave: This nexus issue, this sounds like that’s a big company term that only large manufactures and contractors have to deal with that but I think you’re going to prove me wrong that this nexus issue applies to anybody and everybody. Scott, you want to chime in on that?
Scott Z.: Sure. A lot of companies, a lot of smaller companies love to expand out of state. They don’t realize that all the activities or determinations that they’re going to have to make outside the state. They just think they’re physically located within that state, that’s the only state they file in. A lot of experience I’ve dealt with is online retailers and I think that’s a big issue that nexus has come along way again is online retailers such as Amazon, they weren’t charging customers sales tax but they had presence in all 50 states.
So, anything online retailer or smaller retailers that want to sell online, they think they’re just physically located in one state and they want to sell in all states across the country, you’re going to have more sales use tax implications than just that one state.
Dave: So when we talk about taxation in multiple states, we’re talking about a number of taxes I believe. Is it sales and used tax, could it also be income tax?
Scott Z.: Yes, it can.
Dave: So many different levels. So again, if I’m doing, I’m located in Ohio and I have sales in West Virginia, Indiana, Illinois, New York, Pennsylvania, Oregon, Washington D.C, I guess that’s the start of nexus.
Joe: It is the start Dave and that’s a really great question. With nexus, there’s different kinds of nexus, so there’s different species of nexus if you like. Tying to our Halloween theme, there’s the fast zombies and the slow zombies. So you’ve got, yes they’re all zombies but they’re different stripes if you like to each one. There is a nexus as I kind of mentioned to be sued in the state. So if you sell a product into a state, it’s defective, it hurts somebody, probably are going to be able to be sued in that particular state even if you don’t have anything else going on.
Now is that state going to be able to sue you? The state itself, can they sue you to collect tax if you decide not to do that? Maybe not. So you might have nexus for legal purposes but not for tax collection purposes. And then you also have different layers of nexus so you may have a sales tax nexus but you may be protected from income tax nexus. Just because you have something that starts you down the path of having something, having that connection that will make you follow that state’s laws, pay that state’s taxes, there’s a lot yet to be worked through in terms of which one of those triggers that you actually have triggered. Which level of nexus you have and therefore which kind of tax you have to pay.
Dave: So I do business in Ohio, I work in Ohio, I’m engaged in Ohio, practice accounting and taxation and consulting in Ohio. I don’t know the rules in Michigan, Pennsylvania, New York. Is that where you guys come in and your day to day activities that you’re consulting?
Joe: Asking for a friend, Dave?
Dave: I need some help. Need a lifeline. Call a friend.
Joe: It’s interesting. On the services side of the house, it’s a little different than the tangible property side of the house so when you have a vendor that is primarily providing services, the rules are a little different than if you’re selling widgets or iPhones. Services are just a little bit more difficult to deal with because as you said, you could be sitting in Ohio, never leave Ohio and you have clients that you’re helping all across the country, all across the world.
Aside from nexus, you also have a concept that is common in state and local taxation, apportionment. Where are all those sales going to get taxed? Assuming you have nexus in all of those places, how in the world are you sitting in Ohio going to figure out which state gets to tax which pieces. And the rules are actually polar opposites in some places. Some use a wherever the client is kind of controls and one uses a wherever the service provider is sitting controls. So it’s interesting. You’ve got quite a wide variety of different terrors lurking in the woods of different place.
Dave: Sounds like I run the risk or likelihood of paying way too much tax or not enough.
Joe: That’s right, that’s right.
Dave: I want to switch directions just briefly about processes and I want to refer to maybe a story that Scott shared and shares on our website about a client that had a very small accounting department and apparently that individual left or the process wasn’t in place and there was a tremendous overpayment of sales and use tax because the process wasn’t correct within that company. Now Scott, let’s talk more about that example or the process that you would look at to make sure a company is in compliance.
Scott Z.: Actually, you talked about was my experience and my previous walking into a billion dollars manufacturer that had three people in their tax department and two of them specialized in property tax and nobody knew about sales use tax. I came in, it was one of my clients from a previous job, I came in, they offered me to take over the tax, clean it up and it definitely was a toll to do it but when I walked in there, there was no process, there was just papers everywhere, you couldn’t find any past returns or any past document stating why they did this. They were just taken percentages and full accounts or full assets.
So, we ended up when I first started within a month, we were under 34% separate sales and use tax audits and this is because nobody, wasn’t a centralized person handling it all, it was different processes and different plants across the country. I think we have 30 different states that we were actually operating in. We only filed probably in 10 when I was starting. When I left, we were filing in 50 fifty so the problem I walked into is process documentation and what I came up with is a step by step process to help determine if somebody suddenly left or as our example, somebody got lost in the woods that somebody could come in and follow step by step process and get to the same result as the person that got lost in the woods.
Dave: Right, or the AP clerk and as we all know the AP clerk is always the first one to go in a horror movie. Always the one to go. Again, a big part of what you guys consult on is the process, the recognition and the process. Now I want to talk about, okay, let’s talk a little bit about audit defense. It used to be, again, I’ll refer to the good old days, it used to be, one of the business strategies was let these states catch me and then I’ll pay the tax and I think we all found out the hard way, that’s not a good business strategy.
Joe, I think this is in your specialty. Let’s talk about audit defense. If for some reason I am under audit, what’s going on? They’re not going to audit one year, it’s going to be multiple years. Is that your experience?
Joe: Yes, that’s right. Fairly often the lookback period is something like six or seven tax years. There’s a number of problems with that. The first one is, when you start to look at a business over a longer period of time like six or seven years, it’s very likely that someone who is in a key position has turned over at that point and so your record keeping may be different within that six or seven years. The documentation may be different during that six and seven years. How things were recorded are different.
And so, oftentimes on audit, what you end up doing is taking a sample year, looking at that one sample year, projecting the result over the entire audit period which may be six or seven years and that’s under the assumption that things have been pretty much the same throughout those whole six and seven years. Things got booked to the same account, same kind of vendors in the same account. You may have a difference when you start going back that far just due to another person at the helm. You may end up paying a lot more tax for the simple reason of you didn’t come forward and do something proactive and have a shortened period of time people were looking at this, rather than having an auditor come in do something for one sample year and then you may get a great deal or you may get a really horrible deal just because of the way that typically works.
The best thing for audit preparedness is having a process in place. So kind of as Scott mentioned, thinking about these things before they happen, trying to get your house in order before an auditor shows up. That’s really the best thing. There are some techniques that we can use to help us out once we are audited but the tool kit is cut in half by the time that you’re actually audited. So, thinking about these things and taking some actions that frankly don’t have to cost you a lot of money, they just have to take a little bit of time and a little bit of thought on the front side and a willingness to spend that time oftentimes can give you great results that you just can’t get any other way.
Dave: Okay, so we touched on nexus processes and on a defense, maybe want to throw a question to you that maybe it’s unscientific but let’s give it a go. Let’s say that you guys consult or walk into 10 different businesses. Based on your experience, how many of those businesses have state and local taxation problems? Scott, any idea?
Scott Z.: I would say 90% to 100%.
Dave: 90% to 100%.
Joe: For me I would also say 10. There is a, unscientific again, zero percent chance that a business is doing it 100% correct. I will tell you that accounting firms that have sales and use tax experts in them are not at 100%, right? Not naming any names but I’m just saying that there are issues that will come up and that even under the absolute best conditions possible you will not get to 100% but you can get close. And so, if you were to ask us, you know, of those 10 businesses, which ones are 50% plus in the good, I’d say you have a running shot at maybe four or five of those but there’s still a large percentage of businesses that have substantial issues that once you start shaking the trees, the issues just kind of pop out at you.
Dave: As states revenue budgets continue to shrink, our audit of state and local taxes, use taxes, are they on the rise?
Joe: Absolutely. In fact, a lot of people were kind of surprised about sales and use tax. A lot of people who are not in business, no idea what use tax is. If you were to look at sales and use tax in the state of Ohio, over 50% of the state’s budget is generated by sales and use tax. All of the other tax types if you were to put them together from oil and gas to tobacco to personal income tax to CAT, all of those things but together are not the same revenue number as sales and use tax. It is the biggest source of revenue in Ohio.
And a lot of other states are going that way too. Whenever you hear of a state slashing income tax rates to be more competitive, oftentimes that’s accompanied with an increase in the transactional tax.
Dave: Joe, you used the term CAT. Can you explain what CAT means in the taxation form?
Joe: Yes. In taxation form, CAT means Commercial Activity Tax. It’s Ohio’s gross receipts tax. This is actually an interesting one maybe for Scott to mention on the nexus issue because this is one of the tax types that is kind of off the reservation to this old physical presence standard if you had to have someone they are physically in order to pay the tax but CAT is very different.
Scott Z.: Yeah, it is. CAT does a lot of out of state companies that deal with Ohio, don’t realize that they will have CAT issues. CAT is basically a commercial activity of doing business in Ohio. So a lot of the times, out of state companies doing business in Ohio, they don’t realize and then they get a CAT audit and they’re like …
Dave: What’s going on.
Scott Z.: I’m not even in Ohio, how I’m I there? The CAT issue is a big deal. Another thing is what Joe mentioned earlier is sourcing the sales, that’s a big deal. Where your sales are sourced are going to be where CAT and a lot of companies either under-report CAT or over-report CAT based on that.
Dave: After talking to you guys, I think I want to take my business off the grid. Any thought there, Joe? Go camping or something.
Joe: It’s interesting. One of the things that is brought up with CAT is let’s say that you moved your operation to China, because, you know, China, if you did that and you made over five hundred thousand dollars of sales into Ohio, your Chinese company CAT nexus and is a filing requirement in Ohio. Even if it may not have an issue with U.S. federal tax, which probably does but even in that case, CAT would reach that that business even if you go all the way off the reservation to or in locale, Transylvania or the like. Or even Michigan.
In any case, you’re wanting to be mindful of not just Ohio’s CAT, Texas has a margins tax that is very similar and it’s a gross receipts tax. The city of Philadelphia I believe has a gross receipts tax. If you make x number of sales into the city, you have to pay that tax. They could audit you.
So, these are just traps for the unwary that as you’re trying to walk through these spooky new woods, you just have to be mindful of those things, have someone watching out for them.
Dave: You guys have mentioned again using your unofficial stats that if you looked at 10 businesses there would be, all of those 10 businesses would have one issue or some issues in all that we talked about in the state and local taxation so again that tells me as a business owner my risk is off the charts as far as potential tax liabilities, penalties and interest now. How about some preventative maintenance in the few minutes we have left, what can I do, what can you do to help me out with my business not to have this risk? Scott? Scotty Z., I’m going to call you Scotty Z.
Scott Z.: That’s fine.
Dave: That’s good?
Scott Z.: Yeah.
Dave: So our clients when you call, I want to talk to Scotty, just say I want talk to Scotty Z., they’ll find you.
Scott Z.: Yeah, absolutely. To answer your question, what you can do all goes back to process documentation, making sure that you know what your business activities are because a lot of times I talk to companies or controllers that are in charge of their companies and you’ll get a different answer every time you talked to them of what services they provide.
Knowing your business is going to help you tremendously. Knowing where you have employees, knowing where you have employees, knowing when you have a new employee come on board. If it’s in a different state then you’re already registered. If you’re expanding you’re coming up with more buildings or more plant operations in other states, you’ve got to be aware at every business activity that you do might create nexus nowadays.
Dave: You know, we’re talking about underpaying tax in a lot of these cases but there are situations where you probably could be overpaying especially when you talked about the commercial activity tax or the CAT tax, a lot of opportunities there. So again, I think that preventative maintenance is, I got to sit down and talk to you guys. We got to go through some interview process, might be a little bit challenging on my part but we need to dissect the business a little bit, see where we’re doing business, see where the employees are. We go into trade shows, what’s going on.
Joe: It doesn’t have to be super complex. The power of simple questions is very apparent in this area. So, a business owner coming to whoever’s in charge of AP or the C.F.O. and asking a simple question like, where are we registered for sales tax? How do we figure out which of our sales should have tax on them? When we buy stuff, do we know if we’re overpaying tax? How do we know? What’s our process?
These aren’t difficult questions for the business owner to ask but you’d be surprised when you start asking these questions, when we ask these questions of a business owner, how quickly things become apparent that maybe there’s an opportunity a risk or a refund here. The questions are really simple but if you think about your business in kind of that way and kind of approach it as a I just want to know how we do these things. We don’t have a process, well that seems like not a good thing, right. It is something that you can find out relatively quickly and easily.
Dave: Great, great insight. Thanks again for joining us on unsuitable today Scott and Joe.
Scott Z.: Thanks for having us.
Joe: Yeah, thanks Dave.
Dave: Our guests today have been Joe Popp and Scotty Z. from Rea & Associates, state and local consulting group, also known as the SALT group and these guys are very active and very willing to help our clients out with risk and maybe some reward, with some refunds.
Again, thanks for shoot scaring the pants off us today. Listeners, check out unsuitable on our YouTube channel to see what goes on behind the scenes and don’t forget to join the conversation on Facebook and Twitter using the hashtag #ReaRadio. Finally, don’t forget to subscribe to unsuitable on iTunes. Until next time, I’m Dave Cain encouraging you to loosen up your tie and think outside the box, trick or treat.