Many companies struggle to determine if they have sufficient activity in a state, or nexus, to force them to file state tax returns. This can be especially difficult for transportation companies. One of the issues is whether driving more than a de minimis amount of miles through a state creates a tax filing obligation. Further complicating matters is the fact that, for income tax especially, transportation companies must use special formulas to determine their share, or apportionment, of tax owed. The complications of determining when nexus exists and cost of compliance outweighing the perceived risk are often cited as reasons why many companies choose not to file in a particular state.
But how do trucking companies approach filing initial tax returns in a state where miles have increased and/or a terminal or land has been purchased or leased? Merely filing in states when the risk becomes great enough may trigger further inquiry of the prior year in-state activity, resulting in tax, interest and penalty owed for the prior years. In these situations, a Voluntary Disclosure Agreement (VDA) might be an option worth pursuing.
There are generally two main benefits of entering into a VDA with a state: limited lookback and abatement of penalty, interest and/or fees associated with noncompliance. While each state has its own application process, it typically begins with an anonymous letter to the state detailing the company’s activity within that state. A detailed information-gathering and negotiation process follows. Only after the terms have been agreed upon is the company’s identity disclosed. Assuming the company has provided accurate information to the state and an agreement is executed by both parties, the company then submits the outstanding returns with payment for the lookback period.
When evaluating whether pursuing a VDA is appropriate, the company needs to compare the potential tax due under an agreement with what is at risk, if they choose not to participate and the state identifies them first. The company should analyze the years preceding the typical lookback period and determine if they had nexus in those years and the amount of potential liability at issue. The cost of compliance under both scenarios should also be factored into the equation. A VDA is generally recommended in situations where the company is unsure of the liability for periods before the typical VDA lookback period, or if it is known to be a large potential liability, with compounding interest and penalties, and paying that liability would cause financial hardship.
Amnesty Program Offerings
From time to time, states have been known to offer amnesty programs, which are similar to VDAs. The key differences are amnesty programs are only offered for a certain period of time and generally require a company to pay all or most prior-year taxes in exchange for penalty and/or interest abatement associated with the filings. Companies should be careful to note whether a state just completed an amnesty program before requesting a VDA, as those states may not respond favorably to taxpayers who could have participated in amnesty, but choose not to.
Indiana recently announced its plans to offer an amnesty program before the end of 2016. Similar to the amnesty offered by Indiana in 2005, the program provides an opportunity for individuals and businesses to disclose and pay unreported taxes that were due and payable for a tax period ending before Jan. 1, 2013, in exchange for abatement of penalties, interest, and collection fees or costs that would have otherwise been imposed. Taxpayers who are eligible to participate in the amnesty program and choose not to will be subject to an additional penalty — effectively doubling the penalty that would ordinarily be imposed on a delinquent liability. Taxpayers who participated in the 2005 amnesty program are not eligible to participate.
Voluntary disclosure programs offer companies the opportunity to come forward and decrease the amount of tax, penalty and interest they would otherwise owe. For transportation companies that have underreported tax in the past, or not even filed at all, these programs could provide substantial benefits. For companies who have been playing the game of audit lottery too long, state voluntary disclosure programs may be worth a look.