In the movie Field of Dreams, starring Kevin Costner, the central theme is “Build it and they will come”. The main character, an affable dreamer driven to build a ballfield in the middle of a farm, is believed in and supported by his wife and young son. Yet other characters – and the audience – question the endeavor. The man continues to build as the drama unfolds, and ultimately his project is successful: scores of people – more than ever imagined — flock in to take part in the action.
Field of Dreams is a classic entrepreneurial tale in which inspiration, good planning, a great team, hard work, evangelical zeal and a bit of magic make the dream a reality. The same qualities are present in the offices, manufacturing plants, design studios, restaurants, and showrooms of America’s entrepreneurs who are setting up new businesses. It’s an exciting time as the company grows, new hires embrace the vision, and the company catches the attention of the buying public. In turn, customers clamoring to buy products and services challenge the entrepreneur’s capacity to grow, open up markets, fulfill orders, develop new product lines and maintain high customer service as the company lifts off.
Sadly, these businesses also capture the attention of tax authorities. Entrepreneurs and management teams are frequently unaware of tax compliance issues facing their growing companies. For example, the owner of our fictional ballfield is responsible for business personal property tax and sales tax on transactions at the field, and may also owe amusement, stadium district sales surcharges, parking, transit district, business occupation, water or additional food and beverage taxes depending on the jurisdiction in which the park is located. And we can’t forget liquor and beer taxes on sales at the field.
In fact, multiple jurisdictions may have tax collection rights if the facility crosses the boundary of a county, city, or special tax jurisdiction.
Multi-jurisdictional tax compliance is a growing issue for entrepreneurs. Small businesses are expanding geographically at historically fast rates because of the new Internet technology, inexpensive communication, fast travel, wireless access, and reliable worldwide shipping that is fueling expansion into new markets. Indeed, competitive pressure makes it almost imperative ti expand – geographically and functionally – relatively early in a business’ development, and entrepreneurs may quickly suffer the headaches usually reserved for big businesses.
In addition, new industries are creating multi-jurisdictional tax exposure for relatively small companies. For example, an early stage communications company would create tax exposure with the nationwide build-out of communication gear needed to offer service in America’s major markets. A web-hosted business-to-business company that installs proprietary hardware such as handheld devices in client facilities might have sales and business occupation tax depending on the structure of the lease agreements or how the service revenue is recognized on the books. A biotech company is likely responsible for use taxes on special chemicals and supplies they bring into the state as well as personal property taxes on assets spread across multiple facilities.
Taxes are big business for governments, and complicated for businesses. The United States collected $500 billion dollars in property and sales taxes in 1999, and US businesses file 500 million local, state, and federal tax returns and responded to over 600 sales tax rate changes. It is difficult to develop a tax exposure profile because of conflicting methods of determining nexus, the legal presence necessary for tax purposes. Some Washington communities aggressively target companies (including florists and contractors) from neighboring towns delivering goods or services in their community. The argument is being advanced by several Western Washington cities that a small business making a delivery in an adjacent community is subject to that city’s business occupation tax and licensing requirements.
A national debate is shaping up in the state courts and legislatures about what constitutes nexus in the various states. Certain parties champion the traditional view that physical presence of staff, offices, or property constitutes the threshold that must be met in order to assess taxes. Other parties are challenging the traditional view by suggesting that economic presence created by delivering direct mail pieces such as catalogs or goods generated by remote sales (catalog or web-based sales) is enough to create a taxable situation. Already, the US has launched the nationwide Streamlined Sales Tax Project in order to tax remote sales such as eCommerce and catalog sales. Critical focus areas under discussion include developing common tax base definitions, exemptions and implementation guidelines. Ultimately, the project wants to implement a technology-based solution to enable easy collection of sales taxes.
Numerous tax pitfalls exist for entrepreneurs that faithfully execute their business plans without planning for future tax exposure based on where a facility is located. On the West Coast, Washington has over 300 separate location codes that must be tracked, California has 619 location codes, Utah has 264, and Idaho has 5 location codes. In all, there are more than 7,500 sales tax and 36,000 property tax jurisdictions in the United States, a complexity that leads to costly errors. Twenty percent of manually prepared tax returns have errors resulting in underpayments, overpayments, legal costs, and audit costs and Washington retailers pay on average $3,062 in legal fees and wages appealing audit decisions. This figure is on top of audit-related wages, record retrieval, and assessment penalties.
The stakes are very high, for tax authorities have nearly unlimited resources to support audit and legal activity. Thus, small and medium size enterprises must incorporate tax planning into their overall business plan. Little steps such as moving the office one block (which happens to be in a different city) could be the difference between being in a business occupation tax jurisdiction or not. On the other hand, being in a special jurisdiction such as an Empowerment Zone may bring valuable tax credits to enhance the value of the business.
Taxes can be daunting but, with the right help, the tax compliance challenge can be managed with sound planning and execution. Specifically, a management team should:
Seek tax advice from a qualified CPA (who knows your industry) while you are developing your business plan and pro forma financial statements.
Review market penetration plans with a CPA who knows the peculiarities of doing business in the target market.
Maintain meticulous records and ensure tax returns are completed monthly. Many states require a business to file even if no sales were posted during the period. Failure to do so may result in penalties.
Assign internal resources or hire outside professionals to manage your tax compliance activity.
Oliver Wendell Holmes, former Justice of the United States Supreme Court, said, “Taxes are what we pay for a civilized society.” Regardless of how one feels about taxes, it is incumbent upon every individual and business to pay the correct amount at the right time to avoid headaches. Timely planning and good advice can keep an entrepreneur focused on growing a business and increasing revenue; headaches caused by too much revenue are much more manageable.