PA Extension: Income Tax and Potential Issues
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
We have done a number of episodes about the PA Voluntary Compliance Program, but they have extended it once again, so we thought we could talk about it again today because I believe it's a really important issue, and it ties into our nexus series for both sales and income tax nexus.
Here’s a glimpse of what you’ll learn:
Current PA Extension
Why is PA extending this program?
How can you have nexus if you are under the state’s 100k threshold?
Does this program apply to international sellers?
Connect with Michael
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here is your host, Michael Fleming.
[0:28] Mike: Hello everyone! Mike Fleming here, founder of Sales Tax and More and today's co-host of the Sales Tax and More podcast where we talk about everybody's favorite subject, which is of course sales tax. Now, today we're going to, it seems like we're talking about this every other week, but we're going to revisit the Pennsylvania voluntary compliance program because they've extended it once again. And we want to talk about it. And I think it's a really important issue. And we're going to talk about income tax issues in general, as well as the program in specific. But before we get started, I'd like to introduce you to my cohost, Ellie Moffat.
[1:14] Ellie: Hi everyone! Mike, great to be here, talking with you again about Pennsylvania. I think we are going to tie it in really well to some other great information here, but before we get started before I started quizzing you, I want to do an introduction for Sales Tax and More. Sales Tax and More is a full-service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs.
[1:42] So we do a lot of sales tax returns, sales tax registrations, consultations, research, and like our name states more. So if you have questions about our services, if you'd like to work with us, please reach out to us. We would love to hear from you and we will give you plenty of ways to do so. So, Mike, they previously extended this program 30 days. How long are they extending it this time?
[2:05] Mike: Great question, Ellie. And right now it's open-ended. There's been a lot of great interest in this program. And as much as we talk about it and others have been talking about it, many sellers still don't know anything about it at all, or they have been slow to react. So it's open-ended as of right now, but they can close it with a 24-hour advance notice. So for the foreseeable future, we're going to be able to take advantage of this program.
[2:38] Ellie: So obviously sellers who don't know about this, can't take advantage of the program, but why do you think many who do know about it haven't done anything?
[2:50] Mike: Great question. Couple of answers to that. There has been a lot of sellers who have taken advantage of this program. So much so that one of the reasons I think Pennsylvania extended this is because they're so backed up and they've got to work through everything. For the rest of the people, it calls for a little bit of speculation, but I'm happy to share some of my thoughts. These are just my thoughts. The first reason I believe some sellers are not participating is that many Amazon sellers think that this doesn't apply to them because Amazon's actually collecting the sales tax. So they're thinking this is for everyone else. It's not for me, but while Amazon is collecting the sales tax, on the Amazon sales, they're not collecting the sales tax on any of the non-Amazon sales and they're not paying your income tax. In reality, this program is specifically targeted at Amazon sellers. Yes, it's for anyone who has inventory in the state of Pennsylvania, but specifically, it's for...they're targeting, they're sending letters to the Amazon sellers. So I just don't think that they're, thinking that this applies to them. So that's one reason. The second reason is that many sellers don't believe the states have the right to come after them, or they don't have the power to collect the tax. And unfortunately, states have a lot more power than most people believe out there. And, in talking to the state of Pennsylvania, we've said, how do you plan on enforcing this? Because they're going to be going after foreign sellers too, and they've formed a lot of reciprocity agreements with the states that have ports in them. So they're going to be impounding, shipments, into the country. They're going to be going after inventory in the Amazon warehouses. They're going to go after the accounts receivable that Amazon has. So a lot of people just don't think that the states can get to them or get to their money, but the states have a lot of ways to come after these sellers. So that's a big reason. And the third is that there's a group out there it's called the online merchant scaled and it represents online sellers and, online sellers need someone to be out there representing them. However, they had this lawsuit and, they filed it in federal court and it gives false help to a lot of people that, hey, this is going to get overturned and we don't have to worry about it. But, that case was thrown out of court. Basically, the federal court said, come on, this needs to be filed in state court. Now the online merchants guild may have further filings, but. They were not able to stop this. I don't see how they're going to stop it. I think that Pennsylvania's on fairly firm ground here, unfortunately for online sellers, the facts of it way on the side of Pennsylvania. So I think between those three things. Sellers have just been a lot of them have not been taking this seriously. A lot of them have, which is why the program is so backed up and why they're opening it up for more people to take advantage of.
[6:29] Ellie: Whew. Okay. So before we address potential issues as to why people may not be responding, could we do a refresher on what Pennsylvania is doing and also, why Mike?
[6:45] Mike: Yeah. And let's reverse that. Let's start with why. And then we can move on to what. Pennsylvania believes that having inventory in their state creates nexus for both sales tax and for income tax. Now, as a matter of fact, most states believe this. And even when you know, inventory is consigned. Most states still believe that you owned inventory in the state and therefore that is nexus creating. So I know a lot of Amazon sellers think that this is, like a consignment sale and, Amazon should be collecting the tax. That's an entirely different argument. Then the inventory creating the nexus. So Pennsylvania's reminding everybody that even though Amazon's collecting the tax if you have inventory in an Amazon warehouse, it creates nexus for all of your other business channels. And it also creates nexus for income tax. Whether the inventory is in an Amazon warehouse or any other type of warehouse. Pennsylvania's reminding people that, Hey, this nexus that is created by the inventory requires you to pay income tax to us. And it also on any of your other sales that are outside of Amazon and they are not a marketplace. So they're sending out these letters and saying, Hey, remember that this is an issue. And this doesn't apply to people who just got the letter, but Pennsylvania is telling people, we know who you are. That's why you got this letter. And we urge you to take advantage of this program because we're not going to be so nice on a going-forward basis. If you don't take advantage of this program.
[8:34] Ellie: Mike before you go any further, let me stop you and shoot some of our, some frequent questions we get on the subjects. The first of which is when is this going to stop all these new taxes or how can they want income tax in the first place? Or when did this start? And as a little side note here, these are. All variations of my first question and I do have more questions.
[8:59] Mike: I'm sure you do, Ellie. Okay. Let's start with your last variation first. When did this start? The answer is 1959. So this is nothing new at all. How the states can ask for income tax sort of relates back to 1959 also. It's the first year that Congress passed the interstate income act of 1959 or public law, 86-272, as it's commonly called a lot of people say, Hey, if it was passed in 1959, was it called 86-272? That 86 stands for the 86th session of Congress, not the year. It's the only law that Congress ever passed concerning nexus. And what it basically says is that a state cannot impose a net income tax. It's restricted to net income taxes. They cannot impose a net income tax on you. If all you do is sell tangible personal property in a state, the orders are sent outside the state for approval, and then they're fulfilled from a point outside the state. So, let's talk about FBA sellers. They generally meet the first two requirements easily. They're selling tangible, personal property and the orders are being sent to outside the state in most instances for approval. So it's the third one. That's the problem because if you have inventory in an Amazon warehouse, at least some of your sales are going to be fulfilled from a point inside this state and the problem with public law 86-272. It's all or nothing. So maybe 30% of your sales are fulfilled from inside the state. You don't just pay the tax on the 30% you pay the tax on all of your sales, into the state, so all or nothing. So let's boil this down. To the most basic impact, what's congress actually saying? Congress is saying that if you have inventory in a state, the state can impose an income tax on you. So we just, switch the words around a little bit there. So this is nothing new. Since 1959, Congress has said, If you have inventory in the state, then yes. The state can impose an income tax. They didn't say who moved the inventory into the state. They didn't say, hey, anything but consignment sales. They said if some of your sales are fulfilled from a point inside the state. Then the state can impose a net income tax on you and that's what's happening here. I don't know how you can make an argument any other way. Some of your sales are being fulfilled from appointing inside the states. So this is one of the reasons why I believe the states are on firm ground because this is not new. This has been around since 1959. If the inventory's in the state, the state can tax you. Now, the reason why this feels new is that sometimes you gotta be careful of what you wish for because everyone wanted Amazon to be collecting and remitting the tax and now they are. However, now the states have all of this information at their fingertips who the big sellers are. Who's you know, who are any of the sellers are, and they can ask, Amazon, hey, who's got inventory in my state and that's what we see happening? That's what happened in California. And that's what happened in, in Pennsylvania here. Marketplace collection is really a double-edged sword. It helps on the one side and it sort of brings you to the attention of the state on the other side, which is one of the reasons why we're saying that income tax is going to be the next big battle. Not only FBA sellers, but all eCommerce sellers, but it's starting with FBA sellers and it starting with California and Pennsylvania, I think it's only going to grow from there.
[12:57] Ellie: Okay. Thanks for sharing and I know that our listeners may not like it, but I do think this is explained well and pretty useful. And it brings me to my next couple of questions too Mike. So the question is if I'm under the state's $100,000 threshold, how can I have nexus for sales tax? And if I don't have nexus for sales tax, how can I possibly have nexus for income tax? I think that we see this, the variation of this question all the time. And it would be great to address.
[13:35] Mike: Yeah, absolutely. They are great questions, Ellie. We do get them all the time and I knew you were gonna ask me these questions. So let's talk about inventory. Inventory is a type of physical presence and a lot of people think that economic nexus has replaced physical presence. It has not, you no longer need a physical presence to create nexus for sales tax, but a physical presence still does create a nexus for sales tax. In fact, an economic nexus is not going to protect you from any other type of nexus. It's just one more way for the states to get you to do what they want, which is collect or pay their taxes. But it's the opposite. That is actually true. An economic nexus will always be superseded by a physical presence. So if you have inventory in this state, that's a type of physical presence. Nexus means link or connection. So if I own something in a state and you own the inventory. That's creating enough of a link or connection in the state that the state says that you now have to collect and remit sales tax or pay the income tax, even if it's underneath that hundred thousand dollar threshold because that hundred thousand dollars threshold is not protecting you. The physical presence nexus is going to supersede, it's going to override that economic nexus threshold because that physical nexus is almost always going to trump, an economic nexus, at least when we're talking about sales tax. So that's the first part of your question. The second part is how can I have nexus for income tax if I didn't have nexus for sales tax? We're saying that, if you have inventory there, you do have nexus for sales tax, but let's assume that it didn't. Since tax nexus has nothing to do whatsoever. There's no connection between a sales tax nexus and an income tax nexus. It's a big myth. It's a big fallacy. A lot of people say if I don't have sales tax nexus, I don't have income tax nexus. Or if I get registered in a state for sales tax, I'm going to automatically have income tax nexus. No, the two are not connected in any way, shape, or form. They both have separate criteria for what creates nexus. So you could have nexus for sales tax and not for income tax. You can have nexus for income tax and not for sales tax, or you could have nexus for both taxes, but there's no link between the two. So that's why, it puts that fallacy that myth hopefully just to rest of, Hey, if I don't have sales tax nexus, how can I have income tax nexus? And if you have inventory there, you have sales tax nexus anyway, so it's a moot point.
[16:35] Ellie: Okay. Thank you. Thank you so much for sharing Mike. I think this has all been really appreciated, but should we move on and finally talk about what Pennsylvania is doing?
[16:48] Mike: Yeah, absolutely. It's not fair to elude that. I talk a lot when you're actually asking me the questions. Okay. If you say so, but let's get on to what Pennsylvania is doing. So they're offering a voluntary compliance program for sellers that have inventory in Pennsylvania, it's really just a, I'd say a special VDA but let's call it a very special VDA. VDA stands for voluntary disclosure agreement. And, they're usually offered...A state wants to reward you. If you step forward voluntarily, this way, they don't have to track you down. They don't have to spend their time, their money, their treasure tracking you down, and they're going to reward you for that stepping forward voluntarily. So usually, if a state finds you and you're not in a program like this. They can go back seven, eight, or ten years. They actually can go back to the first date that your nexus began. Whether it was 12, 15, 20 years ago. But in reality, they only go back seven, eight, or ten years. They can go back further. We've seen them go back further, but yeah, generally each state has their own rules and in general and they go back seven years, like a Texas, they go back eight years, like a California. I don't know of anyone who goes back nine years and then they could go back ten years, like a Hawaii. So seven, eight, or ten years. So as a reward for stepping back, stepping forward voluntarily, the state's going to say, all right, rather than go back, seven, eight or ten years, we're going to go back three or four years. So right away, you're saving years’ worth of back tax penalties and interest for that period outside the VDA lookback period. Also for the period that they are looking at most states just about all states, you're going to waive the penalty. A handful of states will also waive interest like a Texas waives, a hundred percent of the penalty, and a hundred percent of the interest, but most states don't do anything at all with the interest. So you still have to pay the interest. You still have to pay the back taxes within that lookback period. The reason why this program is so very special is that it's just like a VDA, but a couple of differences. Number one, in a normal VDA if the state contacts you, you're not eligible for the VDA in most states and Pennsylvania is like that. And this special voluntary compliance program, even though you get a letter from the state saying, Hey, we think you have inventory in our state. You can still participate in this. So that's a big difference. That's a huge difference. Number two is the lookback period. They say that you only have to go back to January 1st, 2019 Now, why is that so good? A normal sales tax VDA goes back to January 1st, 2018. And if we're talking about income tax, it goes back to January 1st, 2016. So you can see the difference here. If I wanted to take advantage of a VDA, I'd be paying a whole extra year of back tax for sales tax and a whole extra three years of income tax. So this truly is a very special VDA and it's going to waive the penalty inside of that look back, period. You still have to pay the interest and the tax is going back to 2019. Now, one other thing Ellie I want to say here, Pennsylvania is a notorious state. They use like the carrot and the stick. So this is the carrot, they're telling people look at this great program, take advantage of it. If you don't take advantage of it they usually come down. If they know who you are, they find you, then they're going to come down and you're in it like a ton of bricks. So even for people who didn't get letters, we suggest that they take advantage of this. But if you got a letter, then I think it's absolutely ludicrous that you're not taking advantage of this program because the state already told you, they know who you are and they're telling you, we believe that you have nexus and we believe you will all these back taxes. So if the state's telling you that, why in the world will we not pay attention? Why in the world, will we not do something to limit some of our past exposure?
[21:31] Ellie: Mike, does this program apply to international sellers?
[21:35] Mike: Yeah. As I alluded to earlier, states are sovereign, which means that they're not a party to any of the federal tax treaties. A tax treaty to prevent double taxation is between the United States and another country. So states can choose to honor that treaty or choose not to honor the treaty. So there are 13 states that do not honor the treaty and Pennsylvania is one of those states. Even foreign sellers are subject to income tax in Pennsylvania. They're also subject to the sales tax and a lot of foreign sellers say great come and get me, how are you going to get my money? Well, if you're an Amazon seller, if you have inventory in the United States, this is what we said earlier. Pennsylvania's coming after that inventory, Pennsylvania will come after, everyone gets paid every two weeks or so from Amazon, you have money at Amazon. They're going to go after that money at Amazon and other states, the state of Washington has said, not only are they going to do these things, but they're going to pressure Amazon, not to do business with you. So that's usually the straw that breaks the camel's back. That's where we've seen compliance with foreign sellers before. But there's one thing this time that I haven't seen states do. And that's these reciprocity agreements. So as you're, if you're a foreign seller, you're shipping things into the United States, there's only a couple of ports that you can generally come through and, Pennsylvania has flat out, told us they have these reciprocity agreements. And they are going to work with those states, with the ports to impound goods on your shipments, coming into the United States. Whether they carry out with all of that, Hey, time will tell, but this is what they're telling us they're going to do. I generally don't believe that it's a good strategy to play chicken with the states. Generally, you're going to lose that game.
[23:36] Ellie: And I love the analogy there, Mike, and this is so much great information. Is there anything else that you want to add in?
[23:45] Mike: Yeah. I just want to reiterate, even if you didn't get a letter, if you have inventory in Pennsylvania, maybe you're not an Amazon seller. If you have inventory in Pennsylvania for any reason, or even if you are an Amazon seller and still didn't get the letter, that doesn't mean they don't know who you are. It just means you didn't get a letter and that's not a defense you can win. If the state comes after you, later on, you can't say you never sent me a letter. So again, playing a game of chicken or Russian roulette, is it going to click on that full chamber? Is the state going to come after you? Are they going to make an example of you? I think that everybody who has inventory in Pennsylvania needs to take advantage of this program. Pretty darn good program. If you're selling through Amazon, Amazon started collecting before the look-back period. So you're not going to owe any taxes on any of your Amazon sales. It's your sales outside of Amazon that are not marketplaces. So E-bay, you don't have to worry about Etsy, Walmart.com you don't have to worry about it, but if you sell it through Shopify or big commerce, WooCommerce, that's when you have to worry about this. And if you got the letter, to me, it's just insanity. If you're thinking the state's going to forget about you. If you've got the letter, I can't say it's strong enough that you really have to pay attention to it.
[25:17] Ellie: Thank you so much, Mike, and yeah, if you have any questions about any of this again, we encourage you to reach out. We'd love to tell you about our services. We'd love to work with you.
[25:29] Mike: Hey Ellie, before you go further, I just want to say one more thing. Cause we've been talking about FBA sellers and the bigger picture is FBA sellers right now, are low-hanging fruit because of how we talked about public law 86-272, but the states are gearing up for an all-out assault on eCommerce sellers. There are three things going on right now. ECommerce sellers have to be aware of number one the state of Massachusetts in light of Wayfair thinks that this public law, this federal law, this public law 86-272, they think it's unconstitutional. So they're going to be looking to it, to find a case, to try to get, the public law overturned. So that's number one, but what we have to worry about more than that and keep an eye on is the multi-state tax commission or the MTC. And they're the ones who provide guidance to the states on what's a protected activity and what's not protected when it comes to this public law, this federal law. And the last time they changed, it was back in 2002 and they just adopted...everything was based upon a physical presence back then. And in light of Wayfair, they've adopted new guidance. None of the states have implemented it yet, but, the MTC itself adopted it back in November of 2020 and it's out to the states right now. So over the next 6 to 24 months, I think we're going to see a lot of the states adopt this new guidance, which, we eviscerate the protections of public law 86-272, and then we'll have states like Oregon because remember public law only covers net income taxes. So Oregon they have a net income tax, but they said that, oh public law 86-272 is going to prevent us from collecting. So we are going to impose gross receipts tax in addition to the net income tax. So three different ways that, public law 86-272 is under pressure. And, while, unfortunately, FBA sellers are the target right now. They won't be alone for long. I think this is going to spread and this truly is going to be the next big battle. Not only for us Amazon sellers, these FBA sellers, but all eCommerce sellers in general. Sorry to interrupt you, but I thought it was important that we really bring this home in case you're not an FBA seller. You still have to be paying attention to this. You gotta, stay up on the current event. You got to check back with us from time to time because we will be talking about this. We think it's, it's just the next big battle.
[28:26] Ellie: Yeah and thank you, Mike. I think that was an important emphasis there. And again, I'll just repeat it one more time. If you have need of any services, if you have questions about this, please reach out and ask us. We offer a lot of services. We'd love to work with you. We have consultations starting at $495 and happy to answer any questions about our other services. So you can reach out to me directly at emoffat@salestaxandmore.com. Or visit our website salestaxandmore.com. We have a lot of free resources on our website as well, that we'd love for you to access. Thank you so much.
[29:12] Mike: Thank you, everyone. And we look forward to seeing you on the next episode of the sales tax and more podcasts.
[29:20] Outro: Thanks for listening. Be sure to click, subscribe, and check out all of the resources we have out on the web.