Locals Exert Pressure on Taxpayers: Compliant No More

by | Jul 25, 2024 | State and Local, Tax News

In this installment of Spreading SALTovation, Tram Le and Connie Zoerink at TaxOps examine business taxpayer challenges in complying with local tax authorities.

By Tram Le and Connie Zoerink, originally published in Tax Notes State, May 27, 2024, p. 637

Local taxing jurisdictions that can impose local sales and use tax — and administer and enforce their own rules and regulations — are commonly referred to as home rule jurisdictions. These local jurisdictions have certain powers of self-governance, including the authority to set tax rates and rules without explicit authorization from the state government. These taxes are established to benefit the members of the local communities in which the taxes are imposed.

While this structure creates autonomy for local taxing jurisdictions, it presents challenges to business taxpayers that may not be aware such tax jurisdictions exist or that lack the resources to properly comply because of the complications with understanding, monitoring, and having the knowledge or systems to track, source, and report sales to the proper local taxing jurisdictions.

Home rule jurisdictions and state tax laws and procedures generally differ in the same state, leading to differences in the tax base, definitions, exemptions, licensing, and reporting requirements. These differences have triggered statewide efforts in several states to streamline state and local filings, which further complicates compliance efforts with local sales and use tax.

As such, local-level taxes are generally overlooked — either unintentionally or intentionally — by taxpayers. In some cases, business taxpayers without the resources to deal with local sales and use tax may choose to ignore local tax duties because the cost to comply may exceed the amount of local tax due. However, business taxpayers that avoid the burden of local tax compliance should reevaluate the risk as local tax enforcement ramps up. Taxpayers who do monitor and manage their local tax duties appropriately are best positioned to handle the increase in locally initiated enforcement of jurisdictional rates and rules.

The administration, compliance, and enforcement issues related to local taxes in home rule jurisdictions vary among the states. Understanding the various home rule states’ nuances will help taxpayers and their preparers to properly comply and protect themselves against enforcement at the local level, particularly in the post-Wayfair environment.

How Local Taxes Are Administered

Local taxes can be imposed by various jurisdictions for various purposes. Some common types of local taxes include those for:

  • cities, towns, and villages;
  • counties;
  • parishes;
  • special districts (that is, school, transit, police, stadium, hospital, shopping,
  • cultural, neighborhood, or amusement);
  • tribal lands;
  • resort areas; and
  • special purposes.

Local sales taxes are generally administered and imposed in one of three ways: they may be composed of state-administered local sales tax; local taxes that are administered independently but follow state laws; and/or local taxes with administration, laws, and ordinances independent from the state.

Because of the varying rules and imposition of local taxes, a taxpayer with nexus at the state level may not necessarily have nexus at the local level. Further, a taxpayer with nexus at the state level may be required to pay the state for certain local taxes based on local nexus from property, people, and nexus activities within the state. Taxpayers generally report and file a single state and local sales and use tax return with only one tax authority at the state level, except in four states that have home rule jurisdictions: Alabama, Alaska, Colorado, and Louisiana. Alabama has several municipalities. Alaska does not have a state sales tax but does have local city sales taxes.

Colorado has over 70 home rule taxing jurisdictions. Louisiana has parishes that administer local taxes, analogous to counties in other states. For each of these states, taxpayers are required to report and remit local taxes directly to the local taxing jurisdictions separate from the state.

Local Nexus and Registration Issues

Taxpayers that have exceeded the economic nexus threshold in a state are generally required to register with the state and collect and remit the applicable state and local sales tax. However, taxpayers with nexus in a state with home rule jurisdictions may not necessarily have nexus with  a local jurisdiction and therefore may not be required to register and collect local sales and use tax. Home rule jurisdictions typically require separate registration if a taxpayer has nexus with the local jurisdiction. Therefore, taxpayers would need to make a nexus determination in a home rule jurisdiction before determining whether they would need to collect and remit local sales and use tax.

Activities that could create nexus at the local level may include hiring remote employees; owning or leasing real or personal property in the jurisdiction, and/or visits into a local jurisdiction; registering to do business with the secretary of state or registering with a state to collect sales tax. With the enactment of economic nexus, exceeding a sales threshold could also trigger nexus at the local level in states with home rule jurisdictions. However, it is not clear whether the state economic nexus rules also apply at the local level in home rule jurisdictions.

In Alabama, taxpayers that exceed economic nexus thresholds have nexus at the state level and are allowed to collect, report, and remit a flat 8 percent sellers use tax on all sales made into Alabama.[1] A taxpayer would not be eligible to collect and remit the flat tax if a taxpayer has physical presence in the state and would also be required to separately register and collect tax in a home rule jurisdiction where physical presence is established. As such, home rule jurisdictions in Alabama require physical presence to establish nexus.

In Colorado, some home rule jurisdictions have adopted economic nexus and required out of-state taxpayers to register where sales have exceeded the state’s sales threshold. However, instate taxpayers (those located in Colorado) may not have the same requirements to register with a home rule jurisdiction where sales exceeded the state’s threshold. As such, adopting economic nexus at the local level has not been enforceable because of the undue burdens on out-of-state taxpayers.[2]

Complexities With Compliance

Home rule jurisdictions often have varying tax bases, rules, and requirements, creating complexities for businesses that are required to comply with local sales and use tax laws and rules. In some instances, local laws and rules do not sufficiently address or lack sufficient guidance to help taxpayers determine the taxability of goods and services.

Taxpayers often assume that the local taxing jurisdiction follows the state rules, but this is not necessarily the case. For example, while Colorado does not impose sales and use tax on software that is electronically delivered, the same taxability treatment does not apply for most home rule cities. In this case, the disconnect between the state and home rule city puts unwary taxpayers at risk. Understanding the unique sales and use tax laws, regulations, and rules in the home rule jurisdictions that administer and impose tax is key to reducing exposure under audit.

Audit Issues

In recent years, local jurisdictions have increased audit activities and used various methods to audit and enforce local rules and ordinances. One common method used by smaller localities is the use of contract auditors. These same contract auditors may have contracts with other instate local jurisdictions, which by nature can open the taxpayer up to broader scrutiny and additional audits. In the past, contract auditors were allowed to charge local jurisdictions for their audit services on a commission-fee basis, which encouraged the contract auditors to be more aggressive in their assessments of taxpayer errors. While this practice may not be widespread, taxpayers need to be aware of the risk.

Auditors will assume tax is owed, and taxpayers have the burden of proof that tax is not owed (or that tax was properly imposed and timely paid). Without sales and use tax expertise in these jurisdictions, it will be difficult for a taxpayer to determine the proper sales and use tax liability. Local jurisdictions may also have different audit processes from the state. Those may include differing audit appeals and procedures, statute of limitation periods, and positions on imposing penalties and interest.

Simplification Efforts

States recognize the need to simplify reporting and streamline administration for local tax collections. Making tax collection easier for remote sellers is on Alabama’s agenda. Alabama’s simplified sellers use tax program allows eligible sellers to participate in a program to collect, report, and remit a flat 8 percent sellers use tax on all sales made into Alabama. An “eligible seller” sells tangible personal property or services into the state from a location outside the state and has no requirements to collect the Alabama tax.

Simplification initiatives are underway to simplify local tax collection and reporting in Colorado and Louisiana, and Alaska’s independent jurisdictions have adopted joint rules under the Alaska remote Seller Sales Tax Commission.

In Colorado, efforts to simplify local filings for online sellers have resulted in the Sales and Use Tax System (SUTS), in which all but a couple of cities currently participate. (See Colorado Department of Revenue for a current list of participants.) Included in SUTS is a geographic information system tax rate lookup tool, taxability and exemption matrices, and a single portal to handle compliance for all participating home rule jurisdictions.

While SUTS helps address some of the complications of tax compliance, the administrative burden still exists. The use of SUTS is voluntary for business taxpayers today, but the Colorado DOR encourages all sellers to file sales tax returns for the state, state-administered local jurisdictions, and participating home rule cities using SUTS. Before using SUTS, be aware that registering without remediating existing exposure can be costly.

Louisiana has side-by-side initiatives to help remote sellers as well as streamline taxpayer administration. The state created the Louisiana Sales and Use Tax Commission for Remote Sellers to administer and collect sales and use taxes imposed by the state and political subdivisions.

Effective January 1 of this year, Louisiana oversight of the state’s uniform local sales and use tax return and remittance system shifted from the Louisiana DOR to the Louisiana Uniform Local Sales Tax Board, which is expected to design and oversee a single remittance system for all taxpayers.

Although there are no state-level sales or use taxes, Alaska also established its own taxing authority, the Remote Seller Sales Tax Commission, for remote sellers to administer the state’s local taxes. Sellers are only required to collect tax for localities that have elected to participate and have passed the appropriate legislation. As of this writing, there are 49 locals with a general sales tax participating and three additional pending jurisdictions that have joined the commission; the three pending have yet to adopt the commission rules.

Conclusion

Local taxing jurisdictions add a layer of compliance — and complexity — to a seller’s business. Not only do local taxing jurisdictions create additional filing obligations for the taxpayer, but they also require more involved research to determine what is taxable and where. To aggravate matters, local taxing jurisdictions have become stricter about enforcement in recent years. This is largely because of the home rule jurisdictions’ efforts toward simplification and improvements in reporting.

Local jurisdictions want their fair share of tax and as such are finding new and creative ways to push taxpayers to get it right. A taxpayer without sufficient internal resources — or a taxpayer who is working with providers who do not understand the implications of local jurisdictions — should seek out a qualified tax professional to put a framework for compliance in place.

[1] See Alabama’s Simplified Sellers Use Tax Program.

[2] 2Wayfair LLC v. City of Lakewood, Case No. 2022CV30710 (2022).

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