Back taxes: How to know if you owe them, what can you do if you’re obligated to pay them
If worrying about all of the states where you might be obligated to file and remit sales tax wasn’t bad enough, you might be faced with the possibility of owing back taxes. It’s a stressful reality that many businesses grapple with, especially after the U.S. Supreme Court cleared the way for states to enforce economic nexus with their ruling in South Dakota v. Wayfair, Inc. Before you do anything, it’s important to know your options and make a plan.
Before you do anything, know where you’re on the hook to register
Economic nexus gets all the attention because it transformed the way businesses trigger tax obligations throughout the United States, but it’s not the only reason you might need to register in new states. Remember physical nexus? Having a physical presence in a state is still one of the primary reasons why a company should register and remit sales tax. Have a satellite office or employees who work remotely? Do you have marketplace inventory stored in various locations or conduct business at trade shows? These are just a few of the ways you can trigger a tax obligation and potentially owe years’ worth of back taxes.
Your first step in the process is to understand the various nexus laws and determine if they apply to your business. You can learn all about them in our state-by-state guide.
You have prior tax exposure in a state, now what
Here are five potential options to consider:
- Option 1: File back taxes
- Option 2: Enter into a voluntary disclosure agreement (VDA) with the state
- Option 3: Seek out a tax amnesty program
- Option 4: Register with the state (but ignore past liability)
- Option 5: Ignore everything and carry on
Option 1: File back taxes
Just rip the bandage off and pay up. If you owe a state for a prior tax period and haven’t paid them, your eventual returns and payment will be delinquent, which can incur penalties and interest charges. If your prior exposure is minimal, you might be able to simply back file those returns and pay the associated penalties, fines, and fees. You can also request relief from delinquency fees and penalties in some situations (for example, the California Request for Relief form). With a good excuse, some state tax authorities may provide leniency.
Again, we recommend consulting with a tax expert before filing back taxes. You might end up overpaying or neglecting to pay in full. And don’t forget that you must first register with the state before you remit any tax.
Option 2: Enter into a VDA with the state
A voluntary disclosure agreement, otherwise known as a VDA, is the big mea culpa in sales tax compliance. When you discover that you owe back taxes in a state, you have the option of declaring your delinquency and working out an arrangement to get compliant. States often view VDAs as a good faith gesture and are willing to work with you because you’re being transparent.
One of the benefits of a VDA is that tax authorities might limit the look-back period (the amount of time a state can assess overdue taxes) and reduce or waive late filing or late payment penalties. Because of this, VDAs are typically a good option when your tax exposure is high. In the end, you might end up paying less than you would if you had simply paid all of the taxes and penalties you assessed on your own.
If you’re considering a VDA, you might be able to avoid exposure and reach out to a state anonymously at first. According to the California Department of Tax and Fee Administration (CDTFA), “Applicants may obtain a written opinion as to whether the CDTFA would approve a voluntary disclosure request based on circumstances presented anonymously.” But not all states allow this. The Washington State Department of Revenue blocks businesses from disclosing their identity upfront and states, “Your application for voluntary disclosure cannot be approved until the identity of the business is disclosed.”
Before you participate in a VDA, consult with a tax professional. They’ll tell you if a VDA makes sense and guide you through the process.
Option 3: Seek out a tax amnesty program
It might sound too good to be true, but some states offer temporary tax amnesty programs as a way to encourage businesses with prior liability to come forward and make things right.
Tax amnesty programs are usually created by lawmakers and can vary greatly depending on the states that offer them: Some apply to businesses that aren’t registered, while others may apply only to those that are currently registered. Some may provide temporary relief for certain tax periods, but not all. For example, in early 2021, Pennsylvania offered limited amnesty for unregistered remote sellers with inventory in the commonwealth.
The differences between programs vary widely, so it’s important to do your research and decide if a program is right for you. And, talk to a tax professional.
Option 4: Register with the state (but ignore past liability)
What if you register with the state but not disclose any past liability? It’s an option, but there are no guarantees that what you owe from prior years won’t eventually surface to the tax authorities. You’re taking the right step by registering your business, but you may end up putting yourself at risk if you simply register without first acknowledging that you’ve been doing business in the state for quite some time.
Most states ask businesses to provide details on when they created a tax obligation in their application forms. It’s best to be honest. Worst case scenario, concealing or lying about past nexus can lead to civil and criminal penalties.
At the risk of sounding like a broken record, consult with a tax professional if you suspect you have past liability in a state. You might find out that you don’t owe the state anything. But it’s best to know your liability before you register.
Option 5: Ignore everything and carry on
You can ignore a leaky faucet or the pile of laundry for a long time without consequence, but the same doesn’t apply to sales tax compliance.
Turning a blind eye to your tax obligations is risky and not a good long-range business strategy. While many people have avoided addressing their tax obligations, don’t assume that states aren’t taking notice. Economic nexus, which is now in effect in every state with sales tax, has granted states far greater authority to impose tax obligations on businesses than ever before. Some states are going to great lengths to seek out noncompliant businesses. For example, Connecticut, Illinois, Indiana, New York, Ohio, Oklahoma, and Pennsylvania are using data mining “to find out-of-state sellers that either aren’t aware they owe tax or are shirking collection and remittance.”
Some states might leave you alone, or it might take a long time for them to find you. But if they do, you could end up owing a lot of money if your prior exposure is severe. In that case, you’ll likely have to pay a lot more than the sales tax that you could have been charging your customers. That would not be the worst outcome in that scenario.
Before you decide that doing nothing is the preferred option, please talk with a tax professional.
Nobody likes to deal with the possibility of owing back taxes. But often enough, the reality isn’t as bad as you imagine. Being proactive is far better than worrying about any what-if scenario. Get educated about the tax laws that might affect you, seek professional advice, consider your options, and remember to breathe.
Cover photo by Canva
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