Virginia Sales and Use Tax Penalties

Be alert. The Virginia Department of Taxation has taken the position that if at the end of an audit there is a tax owed a penalty will be assessed under Section 58.1-635. There is a problem with the Department’s logic. The statute reads as follows:

“A. When any dealer fails to make any return and pay the full amount of the tax required by this chapter, there shall be imposed, in addition to other penalties provided herein, a specific penalty to be added to the tax in the amount of six percent if the failure is for not more than one month, with an additional six percent for each additional month, or fraction thereof, during which the failure continues, not to exceed thirty percent in the aggregate.”

This has the conjunctive word “and”. That means that a penalty can only be assessed if the dealer fails to file any return and fails to pay the full tax.

Therefore, the penalty should not be assessed under this section in a situation where a return is filed, is audited, and a tax is deficiency is found. However, the Commissioner has viewed it another way.

What if you won the $1.5 Billion Powerball

So, you take the cash option of $930 Million. What do you do now?
Let’s say you want to put some into a business, some into investment (including say buying your own tropic island). After taxes state and federal you will have approximately $490 Million left. So, let’s say you invest $400 Million. Assume an average 5% return on investment. At the end of 20 years you’d have $660 Million to play with after taxes.

If instead you took the money and put 1/2 into a Foundation that you controlled, the other half kept, you’d have about $245,000,000 left to invest, etc. However, if you were planning on giving to charity anyway, this allows you to use the money for charitable purposes and it grows tax free which allows more money to go to charity than using aftertax money to make gifts later. At the end of 20 years assuming a modest 5% growth rate, the charitable funds would be worth approximately $930 Million. The $245 Million which you’ve invested would be worth about $392 Million due to taxes on your investment income.

The moral is that if you are charitably minded do it at the beginning. That way, you have instead of $660,000 to give away over time, you have $1.17 Billion to control and of that $930,000 is available to charity.

Hidden Tax Bomb when Selling Your Business

Let’s say in 2011, your accountant suggested it might be good to elect S Corporation treatment for your business which has been a C corporation for 5 years. You’ve got the hottest bar in town. Its worth $1 Million and you only invested $100,000 which is fully depreciated, but there are good years and bad years and you like the fact that you can deduct losses and avoid double taxation of income by using S. Fast forward to 2015. Porky comes by and wants to buy your name, assets. He’s offering $1.2 Million. You are so excited. Selling these assets would yield a gain at capital gains rates what could be better. Then you talk to your tax lawyer. He says wait. Under Section 1374 of the Internal Revenue Code there is a built in gains tax that looks back 10 years. Thus, if at the time of your S Election in 2011, your business was worth $1 Million, it must recognize that $1 Million at ordinary corporate rates. Thus, instead of the tax being $250,000 on the gain it is $565,000 give or take. A huge difference.

SPIN OFFS

Suppose you own a corporation MYTABLES, Inc. that manufactures tables. Your company has an opportunity to go into the desk market, but wants to limit its exposure. So, it sets up a subsidiary, DESKO, LTD. MYTABLES, INC., owns all of the stock of DESKO. People love the desks. The Company needs capital to hire more people to make desks. The owners go on the Barracuda Tank and Cube Markan offers to give $1 Million for 18% of the Company, but wants DESKO separated from MYTABLES. So, how do you separate out DESKO from MYTABLES. Under Section 355 of the IRS Code you can do what is known as a spin-off and so long as the DESKO has a different line of business from MYTABLES (they do) and so long as the shareholders of MYTABLES still own 80% of the stock of DESKO, then you can spin off, so long as DESKO and MYTABLES continue in business. There are lots of technical rules under Section 355, but that is the gist of it.

Virginia Supreme Court clarifies BPOL allocations for Interstate Businesses

Suppose you are a computer software consulting business with offices in Arlington, Virginia and Prince Georges County, Maryland. You have employees who move back and forth between the offices consulting with clients and making calls on clients. Both Maryland and Virginia have income taxes. How do you allocate the income for purposes of the Arlington County, Virginia Business Professional Occupational License Tax. The Supreme Court adopted a three part test to use to determine how you allocate that burden In Nielsen Company v. Arlington County last month.
First, you must allocate the tax based upon payroll percentages in each jurisdiction. Then you are permitted a deduction for income subject to income taxes in another state. It is this deduction that the Court is concerned with.

The Court went on to say:

“That is, “attributable” does not mandate or prohibit any particular
methodology to determine which receipts captured in the pool of
taxable gross receipts are subject to deduction.”

The means that your company can allocate sales receipts in any acceptable manner.

There is a safe harbor under Section 58.1-3732(B)(2) which the Court rules is to be interpreted in the following manner:

“The Tax Commissioner held that the following analysis
determines whether the Code ยง 58.1-3732(B)(2) deduction may be
taken by a taxpayer, and, if so, how to determine what receipts
are backed out from the pool of taxable gross receipts:
1. Ascertain whether any employees at the Virginia
definite place of business participated in interstate
transactions by, for example, shipping goods to
customers in other states, participating with
employees in other offices in transactions, etc. If
there has been no participation in interstate
transactions, then there is no deduction. If there
has been participation, then;
2. Ascertain whether any of the interstate
participation can be tied to specific receipts. If
so, then those receipts are deducted; however, if
payroll apportionment had to be used to assign
receipts to the definite place of business, then it is
very unlikely that any of those apportioned receipts
can be specifically []linked to interstate
transactions. If not, or if only some of the
participation can be tied to specific receipts, then;
3. The payroll factor used for the Virginia definite
place of business would be applied to the gross
receipts assigned to definite places of business in
states in which the taxpayer filed an income tax
return. Note that payroll apportionment would
probably be needed to assign receipts to definite
places of business in other states.”

So, if for example the employees in the Virginia office don’t deal with any interstate business there is not additional deduction. If however, the Virginia employees handled Maryland sales, then you can trace the specific receipt. If that doesn’t work, then you can allocate those according to payroll percentages for the second deduction.

Remember the business can still allocate receipts according to any reasonable formula for allocating receipts, there is just no safe harbor if challenged as unreasonable.