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Surrender (But Don’t Give Yourself Away) – Voluntary Disclosure Agreements

Posted by David Harris on Jul 25, 2023 5:11:17 PM

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You’ve just started working with a new accountant because your old one retired.  When you agreed on the engagement, you told him you just had a couple of state returns.  Now it’s time to prepare the return, so you send him your sales by state schedule, and he calls you back immediately.  He says something about “Wayfair” and sales tax and that you ought to be filing in a bunch more states.

He explains that a lot of states passed laws after the Wayfair case in 2018 that required businesses to start collecting sales tax on their sales to customers in the state if those sales exceed $100,000 or 200 transactions in any year.  It turns out that as your business has grown, you’ve exceeded those thresholds in a lot of states, but you never registered or collected tax.  So far you haven’t gotten any notices, but your new CPA assures you that you will.

After some arguing and complaining, you decide you should go ahead and register and start collecting tax in all those states going forward.  Your CPA says it’s not quite that easy.  When you register with the state, one of the items of information you have to provide is the date you started doing business in the state.  He explains that what they’re really looking for is the date you established sufficient connection to the state to allow them to force you to collect tax or file a return.  And if you answer that honestly, and you’ve had that connection for a while, the state is going to want returns and taxes for all the periods from then until now.

You decide that telling your CPA to lie on your behalf is not a good way to start a relationship, so you start working with him to figure out how much you might owe.  You start with Illinois.  It’s close by, so you’ve had a lot of sales there – over a million dollars each year.  Your CPA checks his research and says that Illinois implemented their Wayfair law on 10/1/18, and you should have started collecting sales tax on 1/1/19 based on your activity.  At Illinois’ sales tax rate, that’s over $60,000 per year in tax you’ll have to pay, plus penalties and interest.

When you catch your breath and your heart rate returns to normal, you ask if there’s any way to reduce the liability.  He explains the concept of voluntary disclosure agreements, where a company that hasn’t been contacted by a state yet can voluntarily come forward and admit that they’ve been subject to the tax, but haven’t complied.  In return, the state will limit the number of prior years you have to look at - usually to three or four, and they will waive the penalties (but not the interest).

You think about that for a while.  Your options are to A) register on a going-forward basis, B) enter into the voluntary disclosure agreement, or C) just put your head in the sand and hope they never catch you.  C doesn’t seem like a good idea, because every year you don’t comply, you’re racking up additional tax you should have collected from clients, but will have to pay yourself if you get caught.  If you go with B, you’re admitting fault for four years and paying all that tax.  You don’t want to tell your accountant to lie, but you could fill out the registration yourself and say you just started doing business in the state.  No harm, no foul, right?

Your accountant, while touched at your concern for his ethical boundaries, tells you that your plan might not work.  You see, after Wayfair, when states knew a bunch of new companies would be registering, they realized that some of those newly-registered businesses might have been subject to tax for a long time.  So when companies register, the state often sends them a detailed nexus questionnaire, asking questions about their activities and when they started.  And those questionnaires are usually signed under penalty of perjury, meaning if you lie, you can go to jail.

Now you really start thinking.  If you do the voluntary disclosure, there’s a 100% chance that you’ll have to pay $60,000 per year for four years plus interest.  If you don’t do the disclosure, there’s a chance that the state never sends you a nexus questionnaire, and you never have to pay any more tax.  If they do send the questionnaire, and you do owe the back taxes, your liability only extends back to 2019 anyway, based on your activity and the date the law went into effect.  2019 through 2022 is four years, so you’re paying the same tax and interest.  The only difference is the penalty, and eliminating that might not be enough compensation for giving up the chance that you never have to pay any back taxes.

Your CPA, rather than praising you for your astute risk analysis, starts asking more questions.  Have you ever had any employees working in Illinois?  Do you have employees based outside Illinois that go into the state to work on occasion?  Do you have any property in the state?  That last one makes you wince.  There’s a warehouse in Illinois where you’ve stored materials for a very long time – at least 20 years.

It turns out that before Wayfair, the connection that was needed with a state to allow them to force a company to collect sales tax was physical presence.  That standard has applied since the 1950’s, and it still applies, in addition to the Wayfair thresholds.  Property in a warehouse in the state is textbook physical presence.  So your liability in Illinois does not just extend back to 2019, but to the first day you stored materials in that warehouse.  Since you never filed returns in Illinois, there is no statute of limitations.

After a wave of nausea subsides, you realize the potential cost is too high, and you’ll need to do that voluntary disclosure agreement after all.  You guess $60,000 per year for four years (don’t forget the interest!) is a painful, but not debilitating, price to pay.  As you’re coming to terms with this, your accountant informs you that the same activity that allows the state to force you to collect sales tax also makes you subject to income tax in the state, and you’ll have to file and pay income taxes to Illinois for those four years as well under the same agreement.

You immediately faint when you hear this, and now you’re too embarrassed to go back there, so you’re looking for a new accountant again.

If this is you, or if you’re concerned that you might have some exposure in states that you haven’t seriously considered before, we may be able to help.  Please contact us.


Topics: Tax Planning & Strategies

David Harris

David Harris

David specializes in state and local taxation, helping companies and individuals navigate the various rules for income, sales, withholding, and property taxes across the ever-increasing web of jurisdictions.

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