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Blake Christian
Blake Christian
State and Local Tax Woes Will Likely Increase Audit Activities

Here’s why.

September 24, 2009
by Blake Christian, CPA/MBT

A recent in-depth study* of state tax revenue trends by the Nelson A. Rockefeller Institute of Government (Rockefeller Study) concluded the recent drop in state tax collections is the largest decrease in 50 years.

While this news may be music to the ears of business owners and individuals who feel over-taxed, a closer look at the statistics and consideration of the longer term impact of this trend, both corporate and individual taxpayers will likely be facing more state-level audits and higher fees and taxes in the coming years in order to bridge these widening state budget deficits.

Based on the Rockefeller Study, 35 states experienced drops in tax collections during the fourth calendar quarter of 2008. After factoring in inflation, legislative changes and other adjustments, 42 states actually experienced decreases in 2008 tax collections. Only the Plain State region did not experience a downturn. The four percent decrease (6.1% after adjusting for inflation, legislative changes and other adjustments) in year-to-year tax receipts is broken down as follows: 1.1 percent fall-off in individual income tax receipts, 6.1 percent less sales tax collections and a whopping 15.5 percent reduction in corporate income tax receipts.

None of these tax collection reductions should come as a great surprise based on the economic chaos over the past two years. The fall-off in estimated tax payments accelerated at a rapid pace. For the 2008 calendar year, estimated income tax payments made between April and January decreased on average in all states by 3.5 percent, but fell even more precipitously in the fourth quarter to an average of 13.8 percent — apparently as taxpayers realized that their financial results were even worse than expected in prior quarters. California, Hawaii and Massachusetts all saw fourth quarter reductions of nearly 30 percent or more. Iowa, Louisiana and Wyoming and West Virginia were the only states with fourth quarter increases — likely attributable to strong sector results for the year such as natural resources.

The start of 2009 continued the negative trend with an overall decline of state tax revenue collections of more than 12 percent. Even with some minor signs of recovery, the year-to-date drop in auto sales, home construction and property values, coupled with skyrocketing unemployment and business closures does not bode well for calendar 2009 tax receipts.

This state landscape is compounded by claw-backs from the federal government as a result of the federal deficit problems. Therefore, this perfect economic storm of lower consumer spending (reduced sales tax receipts), reduced real estate values (reduced property tax receipts) and contracting businesses and high unemployment (reduced corporate and individual, respectively, income tax receipts) compounded by reduced federal allocations, are producing unprecedented pressure on state government cash flows.

The reaction of state officials to counteract the severe drop off in tax receipts includes the following:

  1. Increasing personal and business state tax audit activities,
  2. Evaluating amnesty programs to incentivize taxpayers to “come clean” and pay delinquent taxes with reduced or no penalties and/or interest (the “carrot”),
  3. Considering escalation of penalties and compounded interest (“the stick”) to encourage taxpayers to report their full past and future taxable income and tax liabilities and timely pay such amounts,
  4. Evaluating new state tax structures (including value added taxes, gross receipts or flat tax systems) that will reduce the wide swings in tax collections from year-to year,
  5. Increasing tax rates and/or accelerate tax collections through passage of new tax legislation,
  6. Increasing pressure to raise state and local fees, permits, etc.

Since state and local taxes are often based on a base other than federal taxable income, they can comprise a significant portion of total taxes and a relatively large percentage of the operating costs for any business. Due to the trickle-down effect of the federal and state budget process, these trends are occurring at not just the state level, but also at the county and local levels. Therefore, CFOs, tax directors and controllers need to be focusing their attention on state and local tax matters to ensure that they are legitimately minimizing their state and local taxes by making sure that they are:

  • In compliance with the complex tax rules applicable to income tax, sales/use tax, property tax and other taxes and fees.
  • They are taking full advantage of the abundant income tax, sales tax, property tax and other exemptions, credits, grants and incentives.

Since many state and local tax jurisdictions provide tax exemptions, tax holidays, tax credits, grants and other incentives, it is critically important for taxpayers and their CPAs to spend time evaluating the state-by-state and local tax incentives.

These significant tax benefits fall into a number of categories which should be fully explored:

  1. Sales and use tax exemptions or credits for purchasing (including capital leases) certain equipment used in specific industries or with special characteristics, particularly manufacturing, pollution control or energy conservation equipment,
  2. State and local training grants for job training/re-tooling employee skills,
  3. Research-and-Development credits and other incentives associated with developing new technologies, products and processes,
  4. Evaluation of state nexus, intercompany income and expense allocations and apportionment formulas to maximize multistate strategies, including choosing tax jurisdictions that offer the lowest overall tax burden for your specific industry and operations. In addition to “statutory” credits and other incentives, many states, counties and cities are offering a variety of “negotiated” incentives to locate or expand in their jurisdiction,
  5. Real and personal property tax exemptions and reduction for certain industries or redevelopment areas and/or other tax incentive zones,
  6. Hiring tax credits for hiring economically or physically challenged individuals in certain states (42 states) or federal tax zones (thousands of Empowerment, Renewal, Indian Tribal Lands, Rural Renewal County and other zones throughout the country) that can entitle employers to annual credits ranging from $2,400 to $15,000 per “qualified employee,” which generally include employees who were unemployed prior to being hired, many veterans, public assistance recipients, Native Americans and/or a variety of other employee candidates. Please see Steering Tax Life on ‘EZ’ Street
  7. Grants and other federal and state programs (including a variety of 2009 American Recovery Act “Stimulus” funds) to defray costs of projects ranging from building improvements to pollution clean-up, to technology enhancements, etc.

A variety of detailed information on these subjects is available by performing keyword searches with your tax research software and/or Google searches.

As discussed in a State Tax Burden, the state and local tax burden can be very significant — even for unprofitable companies. Therefore, time invested in ensuring that state and local taxes are not overpaid can produce significant refunds and long term benefits to companies and their equity holders.

Conclusion

In light of these challenging economic times and the significant impact of state and local burdens and benefits, tax advisors can add significant value to the bottom line by fully evaluating the aforementioned SALT strategies for their employers or clients. Favorable results, including refunds, can enhance your reputation and job security with your employer or clients.

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Blake Christian, CPA/MBT, is a tax partner in the Long Beach, California office of HCVT, LLP. Christian is also co-founder of National Tax Credit Group, LLC.

* The report issued by the Rockefeller Institute is for the first quarter of 2009.