Nonprofit organizations often receive loans that are interest free. Because these are not normally obtainable through traditional financing options, the American Institute of Certified Public Accountants (AICPA) believes a restricted contribution element should be recognized to reflect the value of an interest-free loan. In addition, interest expense should be recognized over the life of the loan using an imputed interest rate. How should a nonprofit organization determine an appropriate imputed interest rate to recognize interest expense? In this blog article, we will answer this question and discuss the proper accounting treatment and journal entries for interest-free loans.
Determining an Imputed Interest Rate Determining an imputed-interest rate requires the nonprofit’s management to estimate the organization’s incremental cost of capital. Simply put, this is the estimated market interest rate the organization could obtain if it otherwise obtained a loan. A nonprofit’s weighted average cost of capital on existing financing could be used to estimate this rate. If the nonprofit does not have any existing financing, a risk-adjusted externally published rate, such as the prime rate, could also be used as an estimate.
3 Steps for Accounting for Interest-Free Loans and Imputed Interest Expense
Receipt of loan
Upon receipt of the interest-free loan, the nonprofit should record the loan at face value and the restricted contribution revenue at the fair value of the interest-free element received. Generally, the value of an interest-free element on the loan can be determined by the difference between the face amount of the loan and the present value of the loan’s future required payments at the imputed interest rate.
Note: The interest-free element is recorded as donor-restricted support, due to an implicit time restriction. The organization realizes the benefit of the contributed interest-free element over the life of the loan. See step two for recording releases of restrictions.
Example: ABC Charity receives an interest-free loan in the amount of $100,000 from Stice Corporation on January 1, 20X0. Five equal payments of $20,000 are due on the loan annually on December 31. ABC Charity’s management has determined an imputed interest rate of 5.00% appropriately reflects their organization’s incremental cost of capital. As of January 1, 20X0, the present value of five annual payments of $20,000 first due December 31, 20X0 discounted at 5.00% is $86,590. The journal entries are as follows:
Journal entry to record receipt of loan:
Journal entry to record restricted contribution revenue and discount on loan:
Discount on note payable
Contribution revenue – restricted by donor
Recording interest expense, releases of restrictions, and cash payments
The nonprofit should recognize interest expense using the effective interest method, whether or not required cash payments are made according to loan arrangements. Additionally, the nonprofit should record unrestricted support revenue and the related release of donor restrictions to reflect the value of the interest-free loan used in the current period.
Example: ABC Charity makes its first required cash payment of $20,000 on December 31, 20X0. Using the effective interest rate method (see: Table A), it determines 20X0 interest expense to be $4,329 (5.00% * $86,590 net outstanding note payable).
Table A: Effective Interest Method
Present value of payments at 5.00%:
Reduction of Principal
December 31, 20X0
December 31, 20X1
December 31, 20X2
December 31, 20X3
December 31, 20X4
The journal entries are as follows:
Journal entry to record cash payment on loan:
Journal entry to record 20X0 interest expense using the effective interest method:
Discount on note payable
Journal entry to record 20X0 satisfaction of implicit time restriction:
Net inserts with donor restrictions – release of restrictions
Net inserts without donor restrictions – release of restrictions
Presentation on financial statements – additional consideration for interest-free loans
Note: The requirements listed below are in addition to other U.S. GAAP financial statement requirements for loans and interest expense.
Statement of financial position (SFP) The outstanding loan should be presented as a liability net of any unamortized discount on the statement of financial position (SFP). If a classified SFP is presented, the current portion of principal due (within one year of the SFP date) should be classified as a current liability.
Statement of activities and change in net assets (SOA) Imputed interest expense on the loan should be presented with total expenses as a decrease in net assets without donor restrictions on the SOA. The restricted contribution element should be presented with total revenues as an increase in net assets with donor restrictions. The release of restrictions should be presented with total revenues as both an increase in net assets without donor restrictions and a decrease in net assets with donor restrictions on the SOA.
Statement of functional expenses (SFE) If feasible, imputed interest expense should be directly allocated to programs and supporting services the loan’s proceeds benefited. Otherwise, imputed interest expense may be allocated across programs and supporting services using an appropriate allocation method determined by the nonprofit’s management.
Statement of cash flows (SCF) The initial recording and amortization of the discount on the loan should be presented as a reconciling increase and decrease, respectively, from change in net assets on the SCF. Cash proceeds and principal payments related the loan should be presented as financing cash flows on the SCF. The portion of payments on the loan attributed to imputed interest should be presented in the SCF supplemental information as cash paid for interest.
Footnotes Management’s accounting policy for determining imputed interest on interest-free loans should be disclosed. The nature and description of the interest-free loan arrangement should also be disclosed.
For more information on interest-free loans or related matters, contact Karl Spanbauer in Aronson’s nonprofit assurance group at firstname.lastname@example.org or 301.231.6200.
Sources: AICPA NFP Guide, paragraphs 5.172 through 5.174
The Small Business Administration (SBA) recently said “no,” overturning a set-aside award to a woman-owned small construction business. The firm in question is 51% owned by two women, who serve as the president and vice president. The women did not have prior construction experience and had not previously held similar positions in other industries. However, their respective husbands, who serve as the firm’s secretary and treasurer, have extensive experience in the construction industry. The company job descriptions and organization chart indicated that the women could control the firm, at least to some extent, but that was not acceptable to the SBA.
To qualify as a woman-owned small business, the management and daily business operations of the concern must be owned and controlled by one or more women. The issue in this particular case was the definition of control. The SBA based its decision on CFR 127.202 (b), which states that in order to show control, a woman “must hold the highest officer position in the concern and must have managerial experience of the extent and complexity needed to run the concern.” The SBA ruled that the women owners of this firm did not have sufficient experience in the construction industry or business in general to realistically control a construction company. The SBA also noted that the women’s husbands did have construction experience or possess the required licenses, and they were heavily involved in managing the day-to-day operations.
The lesson is the use of paperwork (i.e. job titles and descriptions, organization charts, etc.) is insufficient to demonstrate a woman’s control of a concern, when the woman does not have the experience required to manage the firm. This will certainly continue to be a hot-button issue, as in this case, when males who do have sufficient experience have equity in the firm and stand to benefit from set-aside awards designed to help women entrepreneurs
For more information on SBA, women-owned small businesses, or other relevant matters, contact Tom Marcinko at 301.231.7630.
The Tax Cuts and Jobs Act (TCJA) made significant changes to a company’s ability to deduct meal and entertainment expenses. Prior to the TCJA, meals provided by an employer to employees on the business premises, when the employer needed employees to remain on-site, were 100% deductible. Effective under the new tax law, such meals are now only 50% deductible, until January 1, 2026, when an employer’s ability to deduct these meals will be completely eliminated.
Examples of businesses that qualify for the 50% deduction include: companies that give employees very short meal breaks, such that the employee could not reasonably be expected to eat off-site; companies where peak workload happens during normal meal hours; and companies who require employees to remain on-site for emergency calls. Office holiday parties and an annual outing remain 100% deductible under the TCJA.
Perhaps Marie Antoinette was onto something with her famous line: “Let them eat cake.” Interestingly, office-provided snacks are still 100% deductible under the new tax law. Litigation is bound to arise, in order to determine what can be classified as a snack, as affected employers look for ways around this deduction that has been halved, and will soon be cut off — much like Marie Antoinette’s head.
For questions about how the new tax law has affected fringe benefits, please contact Laurence C. Rubin, CPA, Aronson’s tax controversy lead partner, at 301.222.8212.
The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated or impacted many aspects of individual income tax deductions, including the much-cherished charitable contribution deduction. Fortunately for the philanthropic and their chosen charities, Congress did not eliminate the charitable contribution deduction and even expanded the limitation to 60% of adjusted gross income. As the second article in our two-part series examining strategic options for claiming a charitable contribution post-tax reform, this article will focus on the use of trusts.
Non-Grantor Trust A non-grantor trust is considered a separate taxpayer from an individual and files its own income tax return, Form 1041. A trust does not have a standard deduction, so all deductions are itemized, which can create income tax planning opportunities for deductions lost on an individual income tax return.
To illustrate, let’s suppose a taxpayer donates $10,000 to charity during the year and pays $20,000 in property tax for their principal residence and a vacation home. Before the TJCA, this taxpayer would have had itemized deductions of $30,000, far in excess of the standard deduction ($6,350 single or $12,700 MFJ). However, under the TCJA, the taxpayer’s property tax deduction is capped at $10,000, leaving them with only $20,000 of itemized deductions. If single, the taxpayer will still itemize their $20,000 instead of choosing the standard deduction at $12,000. If the taxpayer is married, however, they will choose the higher standard deduction of $24,000 (MFJ) instead of itemizing their $20,000 deductions, effectively losing any charitable contribution tax benefit.
By utilizing a non-grantor trust, the taxpayer can salvage their charitable contribution and potentially remove some income from their individual income tax return. After consulting with competent tax professionals, the taxpayer would set up a non-grantor trust and contribute income-producing assets, which they currently do not rely on for support. The taxpayer then designates beneficiaries for the trust, in accordance with their estate plan, and includes a provision allowing the trust to potentially be toggled to a grantor trust in the future, should they desire. Now, instead of making charitable contributions personally, the taxpayer directs the non-grantor trust to make the contribution every year. The trust, without a standard deduction, is able to take a charitable contribution deduction, which offsets the income generated by the trust’s assets. If done carefully, the trust could break about even every year, with little or no tax liability due. To go a step further, the taxpayer could also contribute the vacation home to the trust, thus, also rescuing the excess property tax deduction by transferring it to the trust.
Although this method or related approaches require sophisticated, granular tax planning by experienced professionals, a carefully-crafted plan can remove income from the individual’s income tax return, while salvaging the charitable deduction that would otherwise be lost.
Charitable Lead Trust (CLT) A charitable lead trust (CLT) is an irrevocable trust that allows a donor to transfer property to a trust in exchange for a charitable deduction equal to the value of an income interest paid to the charity. The CLT provides an income interest to a charitable beneficiary for a specified period of time, after which the property reverts back to the donor or designated beneficiary. Thus, the donor receives a charitable contribution deduction and is still able to control all remaining trust assets after the specified time period.
A CLT is useful to a donor who can afford to lose the income stream generated by the trust assets. The CLT itself is not tax exempt; therefore, any undistributed income is taxed at trust tax rates. Unlike a charitable remainder trust (explained below), a CLT can be structured to distribute higher-taxed income to the charitable beneficiary first, leaving lower-taxed income to be reported by the CLT. Typically, the charitable income beneficiary is tax exempt and will not be affected by the receipt of ordinary income or capital gain. A word of caution: if the income characterization provision is deemed to not have economic effect, the provision will not be recognized for income tax purposes.
Charitable Remainder Trust (CRT) A charitable remainder trust (CRT) is in many ways the reverse of a CLT. Income from trust assets is paid to at least one non-charitable beneficiary – usually the donor or his/her family – for a specified time period or for life. When that time period ends, the trust assets pass irrevocably to the designated charity.
A CRT can be created as an annuity trust (CRAT), which pays a fixed amount each year to the non-charitable beneficiary, or a unitrust (CRUT), which pays a percentage of the annually determined value of trust assets. The donor’s income tax deduction for a CRAT is determined by calculating the present value of the annuity payments and subtracting the result from the amount contributed. For a CRUT, the deduction is calculated by determining the present value of the remainder interest after the term of years or life of the income beneficiary.
Unlike a CLT, a CRT is tax exempt. This makes a CRT an attractive option for a taxpayer owning low-basis assets seeking to retain lifetime income. The taxpayer can contribute the assets to a CRT, and receive the annual distributions without recognizing any gain either individually or in trust. In addition, the taxpayer can utilize the income tax deduction now for assets that will eventually pass to charity.
Summary Although tax reform threw a wrench in machine of charitable giving, opportunities still exist in many situations to harvest a tax benefit from taxpayers’ charitable contributions. Solutions involving trusts must be custom-designed for each taxpayer’s unique situation and created in concert with the estate plan. Trust documents must include specific provisions and be drafted with flexibility in order to adapt with the next change in tax law or taxpayer circumstances. With the assistance of a few experienced tax professionals, an astute taxpayer is able to support her chosen charities and enjoy perennial income tax savings year after year, all while simultaneously customizing her estate plan.
For more information regarding charitable giving or estate planning, please contact John Ure or one of our experienced tax advisors at 301.231.6200. To read Part 1 of this blog series, click here.
On April 17, 2019, the Comptroller of Maryland issued a Tax Alert to provide guidance to taxpayers on the state’s taxation of global intangible low-taxed income (GILTI), a new category of foreign earnings subject to federal income tax as a result of provision enacted by The Tax Cuts and Jobs Act (TCJA). The Tax Alert outlines Maryland’s treatment of GILTI, as well as the different reporting requirements for C corporations, pass-through entities, and individuals.
The TCJA enacted the GILTI provisions (IRC section 951A) to target businesses with offshore intangibles that have significant value outside the country. U.S. shareholders that own 10% of a controlled foreign corporation (CFC) are required to report and pay U.S. federal income tax on a new category of undistributed income from the CFC. The GILTI rule taxes the U.S. shareholders of CFCs on income that is considered to be excessive, as compared to the CFC’s tangible assets.
States have taken different approaches to their treatment of GILTI, so multistate taxpayers need to be aware the specific rules in each jurisdiction. The state treatment of GILTI, as is the case in Maryland, also can be different depending on the type of taxpayer. Some states have existing provisions that may address whether GILTI is ultimately excluded, in whole or in part, from the state income tax base. Still, the applicability of these provisions may depend on whether the particular state characterizes GILTI as a deemed dividend.
The Tax Alert generally outlines the reporting requirements on the income returns for each type of taxpayer. Maryland’s Tax Alert clearly states that the Comptroller considers GILTI to not be a dividend or deemed dividend. Thus, a subtraction under Maryland’s dividend received deduction will not be allowed for GILTI. For C corporations, GILTI and the corresponding IRC § 250 deduction are included in Maryland taxable income for corporations. However, there is no foreign tax credit for GILTI, as may be the case for federal income tax purposes. For pass-through entities and individuals, GILTI is similarly included in Maryland taxable income. However, due to the IRC § 250 deduction specifically provided, under federal rules, for C corporations, the Tax Alert indicates that the deduction is not allowed on Maryland pass-through entity or individual income tax returns.
The Tax Alert also addresses how GILTI is reflected in the Maryland apportionment factor. Specifically, the Maryland sales factor should include the entire amount of GILTI in the denominator of the factor. The numerator should include a percentage of GILTI equal to the average of the payroll and property factor percentages. This rule is based on the treatment of GILTI as income attributable to intangibles, the sales factor treatment of which is addressed in an existing Maryland regulation.
As indicated above, other states are treating GILTI differently. Massachusetts, for example, has amended its definition of “net income” for corporate excise tax purposes to include GILTI, but the law provides that GILTI will be treated as a dividend received. Thus, eligible corporate excise taxpayers can subtract 95% of GILTI through Massachusetts dividends received deduction. Virginia has similarly amended its corporate income tax law to allow a full subtraction of GILTI. Taxpayers that have GILTI need to be aware of the varying state income tax treatment, as well as the specific reporting requirements.
If you have questions regarding Maryland’s Tax Alert, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.
The General Services Administration (GSA) recently made an important announcement about its schedules program and provided a progress update on Phase II of the commercial platform initiative. GSA and the Office of Management and Budget (OMB) hosted a Federal Marketplace Industry Day to lay out the agencies’ vision for the future of the schedules program and the commercial platform initiative. GSA Administrator Emily Murphy summed up GSA’s actions as part of the agency’s effort to “modernize, simplify, and make it . . . just easier to do business with the federal government.”
In the first of a two-part series, we will discuss GSA’s plan to consolidate the 24 GSA Multiple Award Schedules (MAS) into a single, comprehensive schedule. One of GSA’s goals of the consolidation of GSA schedules is to simplify processes for contractors and customers who purchase from the schedules. Background information on this initiative can be found here.
During Industry Day, some key updates were announced:
As part of Phase 1, GSA will be releasing a new single schedule solicitation and closing off all existing schedules to new offers by the end of this fiscal year (FY19).
In January 2020, GSA will commence Phase 2 and start issuing mandatory modifications to convert existing single-schedule contract holders to the new contract and conform to the new terms and conditions.
After the mandatory modifications are put in place, Phase 3 will begin. Phase 3 will be more complex, as it involves contractors with multiple schedule contracts and could require consolidation of disparate terms and conditions. GSA plans to seek industry input on the best way to accomplish this phase.
Industry professionals voiced two primary concerns about the consolidation during the industry day. A contractor with four schedule contracts asked how the varying regulations in different schedules will be incorporated into the new terms and conditions. Administrator Murphy acknowledged that thorough studies and work are in progress to map the variances among terms and conditions, discover why the variations exist, and figure out the best combination that will continue to work for all contractors. This concern is the reason that the consolidation of contractors with multiple schedules will be tackled in Phase 3.
Another common concern is whether contracting officers who currently specialize in specific schedules will have the necessary experience and knowledge to manage a universal schedule. GSA promised that contracting officers will have access to training and resources to effectively administer contracts. It is GSA’s hope that the consolidation will also bring more consistency across all GSA Schedule centers and among contracting officers. Considering the inconsistency that currently exists, even within Acquisition Centers, the industry will warmly welcome these efforts to improve unity among GSA’s contracting professionals.
Stephanie Shutt, Director of the MAS Program Management Office, also commented on the consolidation phases. She noted that the Phase 1 process includes using an implementation team from GSA to review terms, conditions, and Special Item Numbers (SINs) across all schedules to determine their applicability in a unified solicitation. GSA anticipates that the mandatory modifications issued during Phase 1 will begin to simplify GSA terms and conditions. We’ll have to wait and see the full effect of this change.
Shutt added that she receives a great deal of questions regarding Cooperative Purchasing, which allows state and local governments to purchase from certain schedules, and whether it will be extended across the entire consolidated schedule. Shutt confirmed that Cooperative Purchasing will not change with the consolidation, due to specific “regulatory and legislative restrictions.”
A panel of industry experts who spoke at the industry day were in favor of the move to a consolidated Schedule, but expressed concern that the Price Reductions Clause (PRC) still needs to be addressed. Larry Allen of Allen Federal Business Partners described the PRC as “an anachronism,” adding that the clause “has no place in a 21st century [MAS] Program.” Panel members agreed that the PRC limits the market by discouraging companies from selling new and innovative products to the federal government.
As GSA moves forward with consolidation plans, GSA contractors and all industry stakeholders should follow the process closely in order to adjust to this major change in the GSA Schedule program.
In March 2019, the Social Security Administration (SSA) announced that it will begin to notify employers if a wage and tax statement (Form W-2) contains a name and Social Security number (SSN) that does not match the SSA’s official records.
The issuance of “no match” letters is not a new practice. The SSA began sending these letters in 1993 until they were suspended by the Obama administration in 2012. There is speculation that the revival of the “no match” letters is part of the Trump’s administration efforts to crack down on illegal immigration, an issue that has historically plagued industries such as restaurants, hotels, and food distributors.
Employers that receive a “no match” letter about one of their employees should not panic or assume that the letter is regarding an unauthorized or undocumented worker, for which their business is liable. The employer can resolve the matter by taking the following actions:
Confirm that the employee’s information matches to what is on file.
If there is still a discrepancy, inform the employee and ask them to confirm his or her name and/or SSN.
If the discrepancy still exists, advise the employee to reach out to the SSA to have his or her records updated.
FOLLOW UP with the employee regarding their progress towards resolving the “no match” issue.
Employers should contact immigration counsel if the employee does not respond or resolve the issue.
The reappearance of “no match” letters should serve as a reminder to employers of all industries — particularly restaurant, hotel, and food distribution owners — to verify both the identity and employment authorization of prospective employees before hiring. Failure to properly complete and maintain I-9 forms could put a company in legal jeopardy and force the business to pay expensive fines.
Our tax specialists are available for consultation on this issue and other business management matters for restaurants, hotels, or food distributors. Please contact our hospitality tax advisors or Aaron Boker at 301.231.6200 for more information.
Tax criminals beware: like the hosts in Westworld, the Internal Revenue Service (IRS) is becoming sentient! The IRS is now using artificial intelligence (AI) technology to more efficiently detect tax fraud, hidden assets, money laundering, identity theft, and other noncompliance. In the past, instances of tax-related criminal activity had to be manually discovered by revenue agents, which could take days or weeks – a losing strategy for an agency that has seen nearly $1 billion in budget cuts since 2010. Now, thanks to AI, the pace at which the IRS can process data and conduct criminal investigations has advanced in line with 21st century necessity.
The IRS launched a new chapter of its AI program with the signing of a seven-year, $99 million deal with Palantir Technologies in late 2018. With an ever-shrinking budget and a loss of about 150 agents per year due to attrition, the IRS is deploying machine learning, natural language processing, and graph analytics to successfully identify instances of fraud and illegality before financial loss occurs.
The IRS plans to mine data from tax returns, property returns, bank reports, and even social media accounts. The project will then employ algorithms and AI to identify patterns where taxpayer noncompliance might be present. In addition, the IRS will use natural language processing – technology that enables a computer to read and translate filings, as well as contemplate their meaning, which, will help predict IRS success in its appeals process. Through language processing, machine learning is able to provide indicators of why appeals were either won or lost, and thereby, provide the probability of future success for cases with similar facts. In a cost-conscious environment, the IRS is under pressure to be smarter about how it selects cases that are most likely to conclude well.
In a webcast hosted by the American Bar Association, the IRS revealed comparative data for the use of this technology and fraud detection. As an illustration, AI technology is able to spot 296 suspected fraudulent returns claiming nearly $1.3 million, according to Benjamin Herndon, IRS Chief Analytics Officer. Previously, 84 percent of these returns had not been flagged during manual review by agents. The application of this technology means that the IRS can better uncover blind spots. As Todd Egaas, IRS Director of Technology, Operations and Investigative Services, reminded during the webcast, “We are a small agency tasked with enforcing tax law across 250 million Americans.”
If you believe you have been a victim of tax fraud or identity theft, contact Patrick Deane or one of our tax controversy specialists, at 301.231.6200 to investigate and resolve your matter.
Restaurants that donate food inventory to charitable organizations could have the opportunity to claim tax deductions for charitable contributions, which are given special and advantageous treatment by the Internal Revenue Service (IRC).
According to IRC Section 170(e)(3), a taxpayer is eligible for a charitable deduction for donated “apparently wholesome food,” if the food given to the charitable organization is for the care of the ill, needy, or infants. “Apparently wholesome food” is defined as food that meets all the quality and labeling standards imposed by federal, state, and local laws and regulations.
The charitable contribution for donated food inventory is the lesser of:
The cost of the donated food, plus half of the appreciation (gain if the donated food were sold at fair market value); or
Twice the cost of the donated food.
Taxpayers that take a deduction for food contribution must reduce their cost of goods sold by the original purchase price of the food that’s being donated.
Example: A restaurant donates 1,000 pounds of chicken to a nonprofit organization. Assume the chicken costs the restaurant $3 per pound ($3,000 total) and the chicken has an appraised market value of $10 per pound ($10,000 total).
Calculation #1: The restaurant reduces their cost of goods sold deduction by the total cost of the chicken, which is $3,000. Under this computation, the tentative tax deduction for the donated inventory equal to the basis of the donated food, plus half of the appreciation, is $6,500 ($3,000 for the cost, plus $3,500 for half one of the appreciation).
Calculation #2: The restaurant reduces their cost of goods sold deduction by $3,000. The tentative tax deduction for the donated inventory would equal twice the cost of the donated food, which would be $6,000 in this example ($3,000 x 2).
The tax deduction the restaurant would claim is the lesser of the two computations, which would be $6,000 from calculation#2.
While the value of the charitable contribution can prove to be advantageous, there are special limitations that taxpayers have to be aware of. For a taxpayer other than a C corporation, the tax deduction is limited to 15% of each owner’s aggregate net income for the year from the trade or businesses from which the contributions were made. If there are any contributions that exceed the imposed limitation, the owner is allowed to carry over the excess contributions up to five succeeding tax years.
Restaurant owners with food inventory that may spoil and end up getting trashed should consider donating this inventory to charitable organizations, as it can provide not only great tax benefits, but excellent publicity for the restaurant. Before pursuing these tax deductions, it is recommended that restaurant owners discuss this topic with a tax advisor to ensure that all of the criteria to claim the deduction are met, which include overcoming the income limitation hurdles to claim the deductions on their individual income tax returns.
Our tax specialists are available for consultation on this and other business management matters for restaurants, hotels, and food distributors. Please contact our hospitality tax advisors or Aaron Boker at 301.231.6200 for more information.
Virginia became the latest jurisdiction to implement an economic nexus standard for sales and use tax, which will require many out-of-state retailers to collect Virginia sales tax. The legislation, SB 1083, which became law on March 26, 2019, will take effect on July 1, 2019. This gives Virginia retailers a few months to determine the impact on their businesses, unlike some states that have afforded sellers little time to prepare for possible sales tax collection requirements..
Virginia’s legislation, which is a result of economic nexus rules being deemed constitutional by the U.S. Supreme Court’s decision in South Dakota v. Wayfair, has come relatively slow compared to many others jurisdictions. Soon after the Wayfair decision was issued in June 2018, a number of states rushed to pass legislation in time for the holiday shopping season. An initial review of the Wayfair law suggests that Virginia wanted to avoid some of the lack of clarity many other states’ laws contained.
At the outset, Virginia’s rule is consistent with a large number of other states with respect to the thresholds that it sets for determining when a sales tax obligation is triggered. An out-of-state retailer, or “remote seller,” which is essentially a seller with no physical presence in Virginia, will be required to collect Virginia sales tax on in-state sales if it either:
Receives more than $100,000 in gross revenue from retail sales in Virginia in the previous or current calendar year; or
Engages in 200 or more separate retail sales transactions in Virginia in the previous or current calendar year
Although the thresholds in Virginia’s law are the same as many other states, due to the scope of the sales that it includes, the thresholds end up applying to less sales. Some states have drafted their legislation in a way that requires registration by as many sellers as possible. This has been done by having the thresholds above apply to total gross sales, regardless of whether the sales were retail sales, wholesale sales, taxable, or non-taxable.
Virginia has limited the sales that count towards the threshold. Specifically, only “retail sales” apply when determining if a seller has to register for sales tax collection. “Retail sale” is specifically defined in Virginia law. First, the sale needs to not be a wholesale sale (i.e. a sale for resale). Second, the sale needs to be a sale of tangible personal property or of a service that is subject to tax in Virginia. In short, the sale needs to be one for which the seller would need to collect tax. For example, a remote seller that only makes wholesale sales would not be required to register for Virginia sales tax regardless of whether its sales to Virginia customers exceed $100,000 because the sales are not sales at retail. Similarly, a seller of a Software as a service (SaaS) product to Virginia customers would not be impacted by the Virginia law because the Commonwealth does not, unlike a number of other jurisdictions, currently impose its sales tax on SaaS.
As with many other states, Virginia’s Wayfair bill also expands the sales tax collection obligations of marketplace facilitators. This aspect of the law will capture sales tax revenue from online marketplaces through which small retailers sell their products. Many of those retailers may not meet the economic nexus thresholds discussed above. However, the marketplace facilitator collection obligation will result in businesses such as Amazon.com and Walmart being required to collect Virginia sales tax on sales of products sold by third-parties through their websites.
The presumption under Virginia’s legislation is that the marketplace facilitator is the party required to collect the sales tax for sales made through its platform even if the seller individually meets one of the thresholds above. When a seller that sells products through a marketplace facilitator’s platform also makes direct sales (e.g. on its own website), Virginia’s law provides that only the direct sales are considered in determining whether the seller meets one of the thresholds above. The legislation does allow for a marketplace facilitator to apply for a waiver if certain circumstances are met, but the legislation calls for the Department of Taxation to establish regulations regarding the particular of the waive process.
The Virginia legislation was certainly something that was anticipated. Although Virginia may have missed out on months of additional revenue by taking a bit longer to pass its Wayfair law, it appear that the additional time has resulted in legislation that contain more clarity for sellers as well as marketplace facilitators. For Virginia consumers, the law means that online shopping will get a little more expense on July 1, 2019. The legislature has estimated that bill will generate up to an additional $155 million in fiscal year 2020.
If you have any questions regarding your companies sales tax collection obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.