Doug Houser:
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States are under pressure and looking for businesses to help bridge the gap. Increased expenses, decreased revenue, and minimal support is a few things that they're battling with.
Today, Joe Popp, principle and director of SALT Services is here to give insight on state revenues and departments, tips so that you can help preserve state businesses and what you can do to not be at risk.
Welcome to unsuitable again, Joe. I think you are at the record for guest appearances now. We always have this battle between you and Axene. So, I think you certainly have one-upped him now.
Joe Popp:
Nice.
Doug:
So, congratulations.
Joe:
Well, thanks, Doug. It's glad to be back on the podcast.
Doug:
Great to have you as always. State and local taxes don't always sound so interesting to everybody, but I for one ... In today's environment, state and local governments obviously are under so much pressure because of a decrease in revenues. What have we seen with the impact of COVID over just the last six months in that area?
Joe:
That's a great question. I think everybody hears in the news a lot about the stimulus activity that the states are doing. And so, you think about state and local tax. You'll hear about extended due dates and you can pay later. And different states have some funky programs that they're trying to help businesses with cash flow and things like that. And those are if you like phase one, of this whole thing. And we're going to get to what phase two might look like in a minute. That has definitely been there.
When you look at state revenues, and if you haven't stopped to think about this and if you're not in ... Like you're in the business world but you don't really deal with this. You might not have thought about it a whole lot. Transactional tax is the canary in the coal mine. That hits the state government immediately because those are monthly filings.
And so, what you have is this interesting kind of a mix between big tech is going crazy and they're making lots of money and sales have increased and they've picked up. And then, the bottom has dropped out to nothing on some retail and some hospitality work and in certain places construction. We've gotten put on hold on all of that. And all of that is transactional tax.
So, that's been a major impact on state revenues since the thing began a sort of February/March is a decline in transactional tax revenue.
It's been helped out a little bit with state and mostly the federal stimulus. So, if you think about it if you've heard on the news of, "Hey, the stimulus checks. People get them and they go and they buy stuff. And sometimes people make a little more than maybe what they would have made before and so, they go buy more stuff.
And so, you have these really strong trends that are opposing the downward trend on spending, which is the big tech just go crazy and then people have a little bit more money in their pocket due to the stimulus. It's only recently that some of those things have just petered out and now we're sort of at a more normal space where the floor, the protection, the net has fallen away, now we can fall.
Some of those states become a little bit more impacted on sales and use tax, that's transactional tax. The thing to come is income tax, right? It's an annual thing. It's not coming until April or later most times for businesses.
And so, on the state and local tax side of things, they know that that's going to take a dive. And they're mostly on a couple of year budgets. So, they've already committed to the money that they're spending. And they don't have the revenue that is going to come in next year. They know it's a problem but so far it's been okay.
The main thing that states have been dealing with is the increased spending on COVID response. The revenue hasn't necessarily gone [inaudible 00:05:00] because of those things that we just mentioned. But spending isn't there.
Doug:
And that's a huge challenge obviously because unlike the federal government the state and local governments all have balanced budget amendments by and large, right? So, they don't have a choice. They can't deficit spend in perpetuity like we can at the federal level.
Joe:
No, the feds honestly, we don't have to go into any kind of politics at all. None, zero. But what I'll say is the feds should print money. If we're looking at, "Hey, should we give bailout money to the states to help them out? We'll get to it." But the feds can create the money and give it to them. The states can't. They either have to cut spending or they have to increase revenue through taxpayers.
So, the impact of the feds not coming in to help the states a little bit, we talk about more, is that benefits are going to get cut, spending is going to get cut, projects are going to be put on hold.
Doug:
And unfortunately, it's gotten a bit political even across helping certain states or municipalities and saying, "Well, that's this side or that side so I'm not going to help them," kind of a thing instead of looking at us all as under the same umbrella, which I certainly believe we are.
With that said, each state, Joe, has very different tax revenue sources. I mean, you look at a state like Florida, no personal income tax but they rely very heavily on real estate taxes, sales taxes, other things like that versus say, Ohio. We have a commercial activity tax here. A much different structure.
So, talk about what maybe COVID might be doing to affect different states in a desperate fashion like that. And how does Ohio fit in?
Joe:
So, just as Ohio's example. We're sitting in Ohio, so we know a little bit and we keep more on top of Ohio may be inactive memory, short term memory.
So, in Ohio, between 50% and 60% of state revenue, gross revenue is a transactional tax, sales and use tax. And so, personal income tax is like this much. And CAT really is maybe that much. They all are blown away by transactional taxes.
And so, what that means is that Ohio is very dependent on online retailers doing what they need to do in terms of collecting tax and it's a big deal in the state of Ohio. So, just as an example that's one.
Or in a lot of states, we're thinking about doing prior to this whole thing just as part of their normal process was adding gross receipts taxes. And so, to preview a little bit of phase two, this is something that a lot of people in the community are a little worried about because a lot of states ... I think it was seven or so the last time that I checked ... were thinking about implementing a gross receipts tax like Ohio's commercial activity tax.
Sort of let me put my tax nerd hat on for a moment. A gross receipts tax is generally not as a good tax because the same item can be taxed multiple times throughout the whole process. So, someone makes a mask, they sell the mask to a reseller, the reseller sells it to another reseller, the reseller sells it to you. At every level there's CAT. Sales tax is just once. It's at the very end of it.
So, it's not really a tax because it has that business on business kind of component to it. It's not like a good tax. But it is very easy to implement. You just need sales by the state to sort of know if you got somebody. The tax rate is for the most part, just straight up what's your sales and then no deductions, here's your tax.
So, you got Ohio's CAT, Washington's you know, Texas' margins tax or franchise tax that is all sort of big examples. Oregon, I think, just created one as well. Delaware has one. And there's a bunch of other ones that are considering.
So, that's sort of an interesting picture to your point of a mix of state taxes. I think what states are kind of recognizing is to pay income taxes is kind of bad because if there's no income, they won't get any of this money. Sales tax is better because it's based on transactions. But we have better, so many different exemptions.
Gross receipts tax is just sort of a pure ... If there's this amount of economic activity we're going to get this tax period. Doesn't matter if they're profitable. All of these other things. And so, it's kind of a backstop. It's seen [inaudible 00:09:52] sort of next level.
Doug:
Yeah, very interesting. So, you talked about transactional tax and that being kind of the bulk of certainly the revenue source in Ohio. Are we seeing, I know at least in construction in my space we have, are we seeing across all industries more enforcement and audits on that side of things over the past few years?
Joe:
Yeah. I mean, we're in this spot now where everyone went home. All the state tax workers, unfortunately, tax workers not essential. They all went home in most states, at the government level anyway. So, they all went home, a lot of things go put on hold.
The ones to kind of watch for is the discovery departments. The ones that go out and find the taxpayers that haven't been paying. That's where most of your audit activity happens. And then, you've got people that are currently filing and paying and you get selected for an audit.
What I'll say just in terms of what we see, we just have a small slice. We have seen an increase in audit activity from Ohio. But more than that I think we have seen a lot more aggression from some of our neighboring states. Illinois is particularly aggressive in going after things.
I just got a first New York City audit for one of our taxpayers. I don't have a whole lot of people with activity in New York City but we do have some. And so, to see that is sort of like, "Wow, okay. So, they're getting started. They're ramping stuff up."
The other impact I'd say is to the extent that people are a little more flexible and forgiving on penalty abatements and other things that taxpayers may have screwed something up or they paid late or whatever in the past that [inaudible 00:11:44] more leniency and flexibility, we've seen that get a lot more brittle and rigid, and sorry.
It's a, "Do we pay a portion of a teacher's salary or a fireman's salary? Or do we give you a penalty abatement?" So, it's kind of hard and it gets [crosstalk 00:12:01]
Doug:
Yeah, absolutely. I know the Wayfair case which was a big deal a few years ago about establishing economic nexus in various locals. Any updates there or particular areas of emphasis from your perspective that businesses should be focused on?
Joe:
Yeah. I mean, one of the things that have happened I will say in that space is we've had a lot of people who are selling to exempt people. Manufacturers are selling to retailers and things of that nature.
And where we've seen a lot of impacts recently in that space is people that traditionally ... Like you have online retailers that have been doing business not collecting tax ever. Okay, those people got some issues to work through.
But so the next wave of this is those folks that are selling to what they think is the completely exempt client. And what we've seen when we get in there is whenever you're doing one of these exemption certification collection campaigns ... you call a bunch of people, email them, et cetera ... you never get the 100%. It's somewhere we've found in the 85% to 95% you get back. And that's in a situation where you have a 100% of our people are tax-exempt when we sell stuff to.
And when you go in you say, "Well, is that material for you 5% to 15% of top-line sales with no exemption?" And most people would say, "Well, kind of, yes." That's sort of the space that we're in right now to try and really rev that up. "Can you get 85% to 95%? Can you get 95% to 99%?"
And then, what do you do about the other exposure? Because, again, the states are hungry for money. This is an easy one for them to come after. And if you can't produce the documentation, then, even though it might be exempt, they're going to ding you for the whole thing anyway.
We've been playing a lot in that space right now trying to get people protected sort of ahead of time. We haven't gone through all of them but a lot of the people that are just online salespeople to end-users. They sort of know the jig is up and they're either accepting the risk and moving on. Or they're trying to go through the process, we've got to get the software, get your system ready. You've got to register in all these places. You've got to start the filing. It's an undertaking.
Doug:
So, in the space that I'm familiar with, certainly construction and we see this certainly with other segments too, manufacturing. We've talked about the exemption certificates and all that. So, what are some of the things that you and your group advise to protect yourself from that whatever it is, 5% to 15% that you really can't document?
Joe:
So, on that, one of the things is to have at really strong control on your transactional tax. If you don't have it set up go backward. Okay. But like on the front end, any time you get a new client, say, "Listen, I need this document from you or I've got to charge you tax." It's pretty easy. If they're a new client, you're just sending them stuff, that's a real easy one to start getting in the habit of.
Which state is it sometimes is difficult? If different shipment terms and people are picking stuff up in different places and dropships, then those get a little complex. But in general, you need a form if you don't want to charge someone tax around sales, for the most part.
So, that is something we're doing. The other thing we're doing is it's not all doom and gloom on transactional tax. Some of this is you have a competitive advantage that you can gain if you're paying attention to this vis-a-vis like in the construction world. If you have someone who's doing an exempt billing for somebody or partially exempt like a manufacturer ... it's not the whole building but [inaudible 00:15:54] is exempt ... what we've found is that a lot of times construction contractors are bidding on the whole building as if it was just a building and not a manufacturing facility.
As a competitive advantage if you know those pieces, you can go to your sub, your material vendor, whoever and say, "Listen, this is for an exempt project and on this portion of concrete, whatever, I don't have to pay you tax, they don't have to pay you tax, no one pays tax because we have an exemption that we can hide behind, that we can utilize."
But it's only going to be there if you've done that review and really understand if you're doing a manufacturing facility or you're doing an agriculture structure. Things that have partial exemptions, not a full exemption but partial exemption, what can we do to help you when you're doing your bid and we can go down your list and say, "Okay, this one, yeah, you've got to pay tax. This one, you've got to charge them tax or they have to give you a certificate. And this one, hey, this one doesn't pay tax. This [inaudible 00:16:55] either."
And if you haven't done that kind of process then you're either way overcharging somebody or you're not paying the appropriate tax and you're creating risk. There's a lot of different things that we're trying to do to help people out.
Doug:
And, again, it goes to right there just being in touch with you and your group. And understanding where there's potential for you to either reduce risk, mitigate risk, or take advantage of your situation as you said.
The worst thing we always see people do is to try to go it alone and you miss out. The best businesses always have these processes and procedures in place, or constantly look at their process or procedures to improve.
We can talk about the next thing that always comes to mind, Joe, when we sit down is if you don't have these things in place or haven't assessed this risk, what about business transferability? We see this a lot with a lot of successions and stuff like that. Where have you seen this come into play in terms of risk assessment at that time?
Joe:
So, it's a great time to look at this kind of thing. When we often get involved is when there's trouble. Something has happened and they're like, "Oh my goodness. What other controls don't we have?" We come in and we talk to them and we look at stuff.
New CFO, new financial people, it's a good time to do that. And the other time is the one you just mentioned, which is the succession and transfer of the business to the new generation, or you're selling it, or the like. And a few super quick issues. We'll need a whole podcast on that.
But most of the time, these taxes at the state and local level transfer with the business. Even if you're doing an asset sale. Structurally if you're trying to do this for a federal purpose to maybe get around some things. At the state level, most of those liabilities, they transfer right on over. So, there's no structural way of getting rid of them.
And so, one of the things that we do in this sort of space is to figure out, "Hey, 5, 10 years ago it would have been cool if you got these controls in place. Hey, what can we do right now you're a year out, six months out, a month out from doing these transactions. What could we do right now?" And the gain typically is, "Can we take a reserve account and move it way down so you get access to the cash? Can we take a liability instead of it being like seven years, can we move it to three years that you're paying?"
And the other thing I think that people don't realize sometimes is EBITDA, which is the evaluation on [inaudible 00:19:46], I'm not going to go into in any great detail, but generally, you've got a multiple of that and that's something about the value of the business.
Income taxes are not counted in that but sales taxes are. And so, if you have problems, not only are you out that money but on that valuation, you might be out on. Bad place to be.
So, there's a lot to do in that sort of space. And it's never too late. Even if it's your past sale or about to be a past sale, we or some other accounting firm can come in and try and contain the risk. That's a great time because you see an immediate cash benefit to that. Where if it's proactive that's a great thing for the future and you're setting yourself in a good spot. But it's not like you see an immediate, "There's a cash money return, I can see it."
Doug:
No, that's very important and certainly will be going forward to as we continue to see M&A activity. And there are so many businesses that are going to transition as boomers age out. We've seen that trend now doubt.
Well, lots to keep up on, Joe. That's why we have you on frequently. And some of this really, to be honest, scares the hell out of me. So, we should have you on right, I know these episodes going to air close to Halloween. That's probably appropriate.
Joe:
Hey, there you go. Spooky. I like it. Well, and we've done this in the past. Going into another state to do business is sometimes like walking through spooky woods and auditors are the ones that are in the woods to jump out at you, not the werewolves. But you don't have to go this alone. A lot of this stuff isn't rocket science. There's just a lot to it.
And in terms of the controls, like if you don't have controls set up ... And when I say controls I mean written documents, plans or how you're going to deal with this. The role this person is going to do in terms of making sure when an invoice comes in does it have tax on it? Should it? If it does have tax on it, should it? Do we get a refund? Should we get a refund? There's good and bad, refund and exposure through this whole thing. And if you don't have the control in place, you're just kind of walking through the woods. It's kind of scary.
But with a flashlight it's cool. Cool werewolf over there, cool vampire. It's nice. Sparkly vampires are …
Doug:
As long as you stay on the path, right? That's why you and your team, they do great work and great research. I know you and several of the folks have been just wonderful help to our clients and specifically several client situations that I've been involved with.
Always check with Joe. He is an attorney, so that's just good general advice.
Joe:
Keeping up the …
Doug:
Yes, I do, yeah. Well, thanks, Joe. Appreciate you being on as always. And look forward to having you on again as this topic always continues to be and should be top of mind and continues to evolve obviously.
Now, legislatively who knows what we're in for, right?
Joe:
Well, right. You know, I'll leave you with that sort of phase two teaser, I suppose. Phase one is all the stimulus stuff. Phase two is how the heck do we pay for it? And that's where we get the CAT. Maybe we get sales tax exemptions that can be done.
These are things that are the horizon to think about at the time that you're listening to this podcast. Who knows what will have happened since we've recorded it. Just pay attention to that stuff. Like it will come up probably not before the election because people are busy with all those things. But after the election, there's going to be some changes and who knows what they're going to be. But some revenue raisers are likely in the future.
Doug:
For sure, yep. I agree completely. Well, that's certainly sage advice. And thanks again, Joe. And if you want more business tips and insight, or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. And while you're there, sign up for exclusive content and show notes.
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I'm Doug Houser. Join us next week for another unsuitable interview from an industry professional
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