UHY – Employing Consultants in Multiple States – A Practical Approach to Balance Tax Compliance Costs and Risks
By: Ibby Michalik, Senior Tax Manager, UHY
The IT and engineering staffing industry has historically worked with consultants from various states. Many firms operate without complying with state and local tax obligations subjecting themselves to unnecessary risk. Balancing the costs and the risks for staffing in multiple states can be done by taking a pragmatic and thorough approach.
State and Local Tax Basics
Navigating state and local tax law is a process that requires firms to be aware of definitions and facts outlined by individual states. The staffing industry is especially complicated because states approach different services we provide in unique ways.
Staffing firms need to be cautious when filing taxes with consultants in other states and not be too broad. Doing the research and understanding how each service is defined is imperative in avoiding tax penalties.
Taxability of Services
In preparation for filing taxes, staffing firms need to be aware of how each state defines services. Services are subject to sales tax in some states, making attention to detail even more important.
The goal of apportionment is to compute the percentage of total profits that would be attributable to a particular state to pay income tax for that state. States have used a three-factor formula that includes payroll, property, and sales. More states are moving away from a three-factor formula to a sales factor in order to collect additional taxes. States use a cost of performance approach or a market approach in apportioning sales.
Staffing firms should track relevant data and manage state tax risk. Working with multiple tax jurisdictions can be complicated, but if your tax department is clear on the state laws and is sourcing receipts, there shouldn’t be any surprises come tax season.
Voluntary Disclosure Agreements
A Voluntary Disclosure Agreement (VDA) is a binding legal contract between an entity and the state to provide full transparency and pay its tax obligations in exchange for reduced penalties. During an audit, states can collect over a decade of unpaid back taxes; if a VDA is agreed upon, the state can limit the look back period to 3-4 years. Another advantage of a VDA is that negotiation is often done anonymously.
Coming clean with your taxes also has disadvantages, especially if unpaid taxes are owed. It is essential to be prepared before applying for a VDA. Any missing details can void the agreement, and states have varying requirements. Do not voluntarily expose yourself or your organization if you haven’t thoroughly examined your financials.
Facts and Definitions Matter
The tax professionals at UHY stress that staffing firms should thoroughly examine where their consultants are working, especially as we have experienced more remote work. Understanding the source of services and individual state tax laws is crucial in avoiding penalties.