State & Local Tax Blog

A New Way States Are Using to Find You

So you use 3rd party contractors to perform work on your behalf in another state. Does that mean you have sales tax nexus in that state? The answer to that is “yes, probably”.

We have many clients in this situation. They will usually concede that they should get registered in these states, but they want to make a benefits vs. cost analysis. Sometimes they ask us to assess the risk of being found by a taxing jurisdiction, when their only contact with a state is through nonrelated 3rd parties.

Obviously, it’s difficult to put a percentage on the amount of risk they have in that situation. But we can tell them the experience of others in a similar situation.

Here are some of the more common ways states can find companies doing business in their state. And rest assured of this, states are most anxious to find companies, especially out of state (read nonvoting) companies with nexus in their state.

One of the ways, perhaps the most common method states use to find nonregistered companies who should get registered is through audits of other companies. In other words, let’s say you use a 3rd party contractor to do maintenance services for a customer in a state where you have no employees or property and in which you are not registered. You don’t charge tax. Your customer is audited and naturally the state reviews purchases of maintenance services. Maintenance almost by definition involves people working on site at your customer. When the auditor finds your invoice with no tax on it, she will usually check to see if your company is registered in the state. Then, it’s an easy audit lead and the auditor gets a pat on the back.

Another method states use works in the situation where you have employees in a state but are not registered in that state. To find you, they simply do a comparison of payroll tax returns and sales tax returns. Companies almost always register to pay payroll tax as soon as they have employees in a state. They register for payroll tax purposes, but not for sales tax purposes. The tax return comparison approach easily finds companies with nexus by having employees in the state.

There are other methods that states use, like posting agents at truck stops on freeways in their states taking note of trucks that come into the state representing companies who are not registered.

But I want to highlight the recent experience of one of our clients as proof of another popular method states are using to find companies using 3rd party contractors. Think about how you pay these contractors and the filings you are required to make with the IRS by January 31st of each year. That’s right 1099’s.

States have sharing agreements with the IRS and can get 1099 data for contractors/businesses in their states. This information includes the name of the payor, of course. So what the state does is get a list of payors who made payments to contractors in their state. Then they compare that list of payors to a list of registered companies. The resulting list is a list of companies who use 3rd party contractors in the state.

So, the state has numerous means at its disposal to find companies in their state. If your exposure is relatively high, you should consider how best to limit your exposure, including using the voluntary disclosure process.

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