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August 18, 2010

Start preparing your company for the inevitable: increasing state and local sales tax burdens. We are not really going out on a limb in predicting that the sales tax burden for business in 2011 and coming years will grow, but what you may not realize is that the burden will grow substantially more than it has in previous years.

Over the past few years, we have speculated in this newsletter that the day would come when state and local taxing jurisdictions would become more aggressive toward businesses with respect to sales taxes. We believe that day is here and that it will likely include a combination of tactics by state and local governments — raising tax rates, passing laws to limit current exemptions on goods and services, and taking a tougher stance on taxpayer controversies.

With the economy in such dire straits, most state and local government coffers are in negative territory what with demand for public services and unemployment payouts severely straining finances. The situation is likely to get worse in the near term as consumer confidence remains low and demands on state and local government assistance grow. Although the federal government is giving states some additional funding, it is also handing state and local governments more of the burden of caring for citizens.

Most taxing jurisdictions will be considering a variety of revenue-raising strategies; however, most people are only concerned about the most obvious one — a rise in the sales tax rate. But this is not what will have the greatest impact on business. The elimination of various sales tax exemptions on goods and services will cost businesses far more and will have a greater impact on their business operations.

The first sales tax was enacted in 1921 and since then, rates have steadily increased to what many would consider regressive levels. Sales tax became much more relevant for businesses when the combined state and local tax rate crossed the four percent mark. Today, combined rates range from five percent to a high of 12 percent. Most state sales tax rates are around seven or eight percent. Considering that many of those states have limited exemptions from taxation, the burden is actually higher than the average tax rate.

An increase in the tax rate is a substantial cost to a business. But when exemptions are eliminated or statutes revised to subject more goods and services to sales tax, the cost increase can be dramatic. In addition, the cost to retrain staff or reprogram an automated tax system to deal with these changes in the tax code is a further burden for a business.

Most state legislatures consider sales tax to be the safest area politically in which to raise taxes. Many states are already sending signals that taxes will be increased by stating that “everything is on the table” as they consider revenue-raising measures. And we believe that lawmakers consider tampering with exemptions to be even safer when considering how tax increases will play in voters’ minds. Taking away exemptions, such as manufacturing equipment exemptions or exemptions on services, will impact business more directly. Now is the time for businesses to use the tools at their disposal to attempt to impact how legislation is drafted and to ensure that their business interests are properly addressed.

We don’t bring up this subject just to point out the obvious — that taxing jurisdictions will likely raise rates and reduce exemptions — but to say that it is time for those companies without a comprehensive sales tax strategy to act, and act decisively. Typically companies are focused on complying with federal and state income tax laws and regulations, which is to be expected given that those tax dollars can go up very quickly if a company makes a mistake in this area.

But the real issue here is that all companies must pay sales tax, whether they operate at a profit or at a loss. Much like property tax (and any other indirect tax), which is considered “above the line,” sales tax is typically considered a nuisance for companies to comply with. This may be so, but the nuisance taxes are the ones that harm a company when and where they least expect it. In addition, the cost to comply is high and could get higher if you are not addressing this area appropriately.

If your company is not completely on top of what the state legislature is considering in the area of sales tax, you may be missing the boat. Forty-five states and the District of Columbia impose some sort of tax on the sale of goods and services. Within those states are thousands of local jurisdictions that also impose a tax on sales. After property tax, businesses spend significantly more on state and local sales taxes than they do on corporate state income and unemployment tax combined. Yet we frequently encounter companies that don’t spend much time or money on making sure they get it right.

So while sales tax is considered by many companies to be a nuisance tax, it’s a huge cost for businesses. Yet it’s a cost that can be kept in check by making sure that your industry is fairly represented as many states consider legislative changes that would result in substantial sales tax increases.

Alvarez & Marsal Taxand Says...

The state legislatures have a tricky balancing act to perform. Whether they raise taxes or not, they face the public ire. But adjusting sales tax rates or exemptions is typically the easiest way for state and local governments to deal with looming deficits. A company that is not prepared or is not paying proper attention to its sales tax position will end up paying substantially more sales taxes in the future. Now is the time to evaluate what your company is doing to comply with sales tax laws and to be on the forefront of the state legislative process so you know how your company can shape future legislation.

Author

Craig Beaty
Managing Director, Houston
713-221-3933
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Lisa Barnick, Senior Director, contributed to this article

For More Information on this Topic, Contact:

Benjamin Diaz
Managing Director, Miami
305-704-6650
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Brian Pedersen
Managing Director, Seattle
206-664-8911
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Matthew Polli
Managing Director, Atlanta
404-260-4078
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Carolyn Campbell Shantz
Managing Director, Houston
713-221-3919
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As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

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