With 48 separate state-tax codes, you could have tax liabilities you've never dreamed of

Taxes are bad enough. But taxes you never knew you owed are truly nightmarish. Consider this story from Elizabeth Burton, the Chicago-based national coordinator of state and local taxes for the accounting firm Grant Thornton:

"I got a call recently from a company being audited by tax authorities who claimed it had done business in their state. The company was convinced it hadn't done business there and didn't owe any taxes. But once its owner described the nature of its operations to me, it became clear that there really was a state-tax liability. And it was a huge liability because the company had never filed a tax return in that particular state--which meant there wasn't any statute of limitations that had ever started ticking."

Burton pauses, then adds, "The auditor was going after taxes, interest charges, and penalties going back to 1979!"

There was a good reason the company owner was confused by the audit. The company's original sales had all taken place within his home state, but the out-of-state tax liabilities had been triggered by follow-up and service calls at a customer's offices. "To say that this is a gray area is putting it mildly," says Burton. "It's been litigated in some states, while others are setting up different standards about how many days' worth of service calls can generate a tax liability."

Welcome to today's topsy-turvy tax world. These days state taxes--and state-tax audits--pose far greater problems for many business owners than federal ones do. State-tax systems are complicated and aren't consistent from state to state. Worst of all, enforcement is growing increasingly aggressive.

If you're looking for easy rules of thumb, there aren't any. But the kinds of things that cause a corporate tax liability outside your home state fall into three categories: revenues, property, and payroll. "States with business taxes calculate them based on a formula that analyzes the ratio of property, sales, and payroll a company has within the state, compared with those same factors worldwide," explains Jeffrey Unger, a lawyer with the San Diego firm Post, Kirby, Noonan & Sweat.

In a simple universe, all states would rely on the same formula--so a business owner doing equal levels of business in two states could just pay half his or her state-tax liabilities to each one. But the state-tax universe is neither simple nor particularly rational. "State formulas can differ, depending on both their tax rates and the weight they give to each factor in the formula," says Unger.

Typically, a company won't incur a tax liability within a state if a local resident just orders one of its products by mail. But that might change if the company delivers its product in one of its own trucks or sends its employees into the state on service or sales calls. The rules vary so much that the best way to analyze your tax exposure is with an accountant's aid. Be especially careful if your business involves any type of electronic commerce. "There are tremendous discrepancies right now in the ways that states tax electronic sales of goods and services, whether those take the form of software transfers, banking transactions, consulting work, information databases, or more," explains Karl Frieden, senior manager of state- and local-tax services at Arthur Andersen in Boston.

Amid all the state-tax chaos, there is one glimmer of hope. Because tax rules differ so much from state to state, the discrepancies can create opportunities for savvy business owners. If you do business in multiple states, ask your accountant if there are ways you might juggle the location of your sales, property, and payroll to your company's advantage. One of Unger's business clients, for example, saved a bundle by moving some heavy equipment to a warehouse in a neighboring state with less onerous taxes on business property.

Did you know that...the war between the states is alive and well on the tax front? Although 48 states impose some type of corporate-income or franchise tax, the rates vary widely, from 2.3% to 11.25%. When it comes to sales and use taxes, only Oregon abstains entirely. State rates elsewhere range from 3% to 7.25%.

Jill Andresky Fraser ( is Inc.'s finance editor.


Tax issues seldom make for a good read if you're not an accountant. But the state-tax issues roiling the Internet are nothing short of fascinating, in part because of their enormous potential impact on the way electronic commerce will continue to develop. If your company could be affected, spend some time with "The Taxation of Cyberspace," a report by Karl A. Frieden and Michael E. Porter, both tax lawyers at Arthur Andersen. Copies can be obtained at no charge by writing to Arthur Andersen, 225 Franklin St., Boston, MA 02110. Meanwhile, for tips on handling state-tax audits, see " Taxing Endurance," in the December 1996 issue of Inc..

ELIZABETH BURTON, Grant Thornton, 1 Prudential Plaza, Suite 700, Chicago, IL 60601; 312-616-7183 115

KARL FRIEDEN, Arthur Andersen, 225 Franklin St., Boston, MA 02110; 617-330-4727 115

POST KIRBY NOONAN & SWEAT, Jeffrey Unger, America Plaza, Suite 1100, 600 W. Broadway, San Diego, CA 92101-3302; 619-231-8666 115