In June 2018, the U.S. Supreme Court altered five decades of perspective regarding where an entity is “doing business.” Certainly, there are significant implications for tax compliance, but there are also immediate financial reporting issues for companies reporting under generally accepted accounting principles (GAAP).
The tax principle of nexus – the triggering standard that identifies when an entity is doing business in a jurisdiction and is thus subject to that jurisdiction’s tax compliance rules and laws – is not a universal principle. Different tax jurisdictions (principally states) adopt different “triggering” mechanisms for commerce. These mechanisms may be further differentiated for various tax aspects, such as sales and use, income, or franchise taxes. (Payroll-related taxes are their own Pandora’s box.) However, there have been general, underlying principles established by previous Supreme Court decisions that have helped to keep nexus issues from becoming wildly unmanageable.
A 1977 case set nexus via a physical presence with regard to the requirement to collect and remit a jurisdiction’s sales taxes. By 1992, the concept was honed by Quill Corp. v. North Dakota
, whereby companies could generate sales from nearly any jurisdiction and not be responsible to assess, collect, and remit sales taxes.
With this year’s Wayfair
case, physical presence is no longer the triggering mechanism. The implications are dramatic, and possibly even traumatic for many small businesses. Taxes are a significant issue; now add to that what may be needed to reflect accurate financial reporting.
Contingencies (ASC 450)
One tax compliance expectation, particularly for a trust-fund tax,1
is the responsibility to collect and remit legally required taxes. A company that fails to collect the tax is often liable to remit and pay the tax from its own funds. A sales tax is a specified tax rate applicable to a taxable sale. Accordingly, it is quite probable that a company reporting financial statements using GAAP would have to record a liability for sales taxes had that company failed to assess and collect under the new Wayfair
standard of nexus.
Under ASC 450, a contingency liability should be recorded when a cost or loss is probable and an amount can be reasonably estimated. So, going forward, if a business had $120,000 in sales to customers in a state (assuming the South Dakota standard of $100,000 in sales is applicable), where the state rate is 5 percent, then it appears the liability/responsibility is probable, and the amount can be reasonably estimated at $6,000 ($120,000 x 0.05), materiality aside. Further, it may be necessary to disclose the nature of the accrual and the amounts accrued, since disclosures are needed to provide clarity and transparency and to prevent the financial statements from being misleading (without the context provided from the disclosure). Finally, the dominoes related to Wayfair
might not necessarily be limited to sales taxes. A virtual nexus could also be applied to income tax nexus.
Income Tax Accounting (ASC 740)
There is the possibility Wayfair
may trigger an income tax nexus. For a tax-paying entity, the implications for tax accounting include the following:
- The sufficiency of accrued state income tax liabilities
- Whether management concluding the company does not have income tax filing nexus constitutes an aggressive tax position necessitating the assessing and determining of a “more likely than not” tax provision that should be recorded and disclosed in the financial statements
- Whether management concluding the company does not have a sales tax compliance responsibility also constitutes an aggressive tax position necessitating a “more likely than not” provision and disclosure
One beneficial perspective is that the standards established by Wayfair
are expected to be prospective. Therefore, the past should be the past.
Revenue Recognition (ASC 606)
While ASC 605 still applies for private companies in 2018, ASC 606 is relevant here because of required expanded disclosures. However, there is a policy election within both 605 and 606 pertaining to the recognition of reportable gross revenue in financial statements, and that is the decision whether to include sales taxes as gross revenue (and part of the transaction price in ASC 606, step 3). If a company includes sales taxes as a part of gross revenues (and the obliged remittance of sales taxes as, generally, a cost of goods sold), the implications on revenue are recognized. While the implications of performance metrics (analytics and financial relationships between expenses and sales) may be minor, ASC 606 disclosures will need to be updated, including new disclosures regarding the geographic location of revenue.
The revenue recognition aspect may appear to be the least burdensome of the GAAP issues, but there is the consideration of the investments a company has put into revamping its accounting (including software applications) in preparation of adopting and applying ASC 606. Wayfair
may require more systems modifications to properly provide the information necessary to meet all the compliances needed.
Seldom are the tax and financial reporting worlds completely autonomous. However, for small-physical-presence-footprint companies, the lag until they can achieve and maintain compliance with the expanded sales tax (let alone income tax) could result in companies not timely complying, thus triggering ASC 450, 740, and 606 implications.
1 A trust fund tax is a tax that is required to be assessed and withheld from one party and then remitted to the levying jurisdiction.
James J. Newhard, CPA, is a sole practitioner in Paoli, a CPE presenter for the Loscalzo Institute, past president of PICPA’s Greater Philadelphia Chapter, and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org or on Twitter @CatalystJimCPA.
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