By: Steven D. Hamilton, Principal, Steven D. Hamilton, CPA

May 21, 2015 7:08 pm EDT
Paulie Walnuts
The television character Paulie "Walnuts" Gualtieri in the HBO series 'The Sopranos'

Over the years I have had clients that expanded aggressively into numerous states. I was continually evaluating when they reached the “trigger” to start withholding sales taxes or payroll taxes or filing income taxes with name-the-state.  

This is an area that has radically changed since I started practice three decades ago. There was a time when you practically had to have a storefront in the state before you had to start worrying about taxes. Now you have states that want to tax you should you attend a business convention there. Among the most recent lines of attack is something called “economic nexus,” meaning that - if you target the state’s citizenry as an economic market – the state figures it has enough power to tax you. Think about that for a moment. Say someone is weaving Alpaca sweaters in Miami and decides to sell a few over the internet in Illinois or Massachusetts. ANY sales into a state would trigger nexus under this theory. Many tax professionals, me included, are skeptical whether economic nexus would even survive  a constitutional challenge under the commerce clause of the Constitution.

Unfortunately the Supreme Court has refused to hear cases on tax nexus for about as long as I have been in practice, so there have been few checks-and-balances as the states claim tax superpowers for themselves.  

Let’s segue this discussion to registering a corporation to do business in a state.

A corporation or an LLC is only a corporation or LLC because a state says that they are. That is the way it works. The state wants an annual check for this, and, if asked, they will then say that you are a corporation or LLC. It is a great money tree. Paulie would have approved.
 
Let’s kick it up a notch.

Let’s say that you have an Ohio corporation. An opportunity strikes and you start doing business in Kansas. You know to worry about Kansas income taxes, sales taxes, payroll taxes, et cetera.  What you may not consider is telling Kansas that your corporation is doing business in their state. In addition to possible fines and so forth when you finally surface, there is the possibility of compromising your attorneys’ hands should something happen, such as litigation.

Or responding to an IRS notice.

That one somewhat surprised me, but it appears that California (let’s be honest: California would be among our first guesses for any incident of state tax idiocy) is making things easier for the IRS.

I am looking at Medical Weight Control Specialist v Commissioner.

Medical had its corporate privileges suspended by California, presumably for failing to pay Paulie his annual check. It happens, unfortunately.

Medical got into it with the IRS, which eventually sent them a 90-day letter, also known as a Statutory Notice of Deficiency (or “SNOD”).

NOTE: Appealing the SNOD is what gets you into Tax Court. The Court gives you 90 days to appeal and not a moment over. There a sad stories of people who missed it by minutes, but there is no “close enough” rule here.

The IRS sent the SNOD to Medical in May, 2013. Medical filed its appeal with the Tax Court in June, 2013.

I do not know what Medical’s tax issues were, but I can tell you that the IRS wanted over $1 million-plus from them.

Medical made things right with Paulie in May, 2014.

OBSERVATION: One year later.

Medical obtained a “certificate of reviver” and “certificate of relief from contract voidability” from California.

Someone at the IRS must have read Sun Tzu and the maxim that the battle is won before the armies take the field. The IRS filed a motion to dismiss. Medical did not legally exist when it filed its appeal, and that which does not legally exist cannot file an appeal of a SNOD with the Tax Court.

Medical fought hard, they really did, but California law was against them. The Tax Court agreed with the IRS and dismissed the appeal.

And there went $1 million-plus.

Now, every state is different, so the answer for an Ohio corporation (say) might be different from a California corporation. But I will ask you what I would ask a client: is it worth it to test the issue?

The IRS seems to have caught on to this Oh-you're-a-California-corporation-sorry-about-your-luck thing. I see that another California taxpayer – Leodis C Matthews, APC – got its appeal bounced when the IRS made virtually the same argument.

Please remember to pay Paulie.

The views and opinions expressed herein are those of the author(s). Core Compass’s Terms Of Use applies.

About the author

Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

economic nexustax nexusstate business taxesstate income taxesstate corporate feesStatutory Notice of Deficiency
Editor's Selection

Business Taxes

HRAs Are Back

In 2017, Health Reimbursement Accounts (HRAs) will be available to employers with fewer than 50 full-time-equivalent employees and are tax-free as long as employees also have health insurance.

Intelligent Investing

Become the Landlord of Your Stocks

If you are able to understand the principal concepts of how to become an effective landlord of real estate, then applying the same principles on how to become an effective landlord of your stock portfolio is highly achievable.

Intelligent Investing

The Grand Divorce

How does total domination in a sector of the economy play out for the shareholders of the leading company involved?

Personal Taxes

Caution With S Corporation Losses

The Tax Code allows you to deduct losses to the extent you have money invested in the S. If you try to deduct beyond that threshhold and it isn't your personal money, expect problems with the IRS.

Intelligent Investing

Net Neutrality or Level Playing Field

“Net Neutrality” is a worthy concept in theory, but the loss of its most powerful supporter and bureaucrat will significantly change the landscape of internet access and concentration issues in more traditional media outlets.