The digital age created a new standard for your operations. Not-for-profit organizations no longer need brick-and-mortar locations to deliver services, and employees do not need to be physically present in your building in order to work for your organization. Online gift shops and bookstores may also necessitate tax filings in multiple states.
Staying compliant with multistate tax requirements can be complicated because income, sales and use and payroll tax rules vary state by state. Some jurisdictions have “trailing nexus,” where entities are required to pay taxes even after their nexus in the state ends. What’s more, there is no statute of limitations on tax compliance. Your tax exposure will date back to the time the nexus in that locality was established if appropriate filings haven’t been completed.
Using the following case study as a guide, we’ll provide a brief reference for how not-for-profits can approach their state and local tax (SALT) compliance in order to minimize their SALT exposure risk.
The Case Study
A Massachusetts-based 501(c)(3) university employs adjunct faculty. It has an online education program that it plans to grow. To help support that growth, the university identified possible employment candidates in Florida and Washington. Before hiring, it wants to know the impact that hiring these candidates would have on its state and local tax obligations. The university also operates an online bookstore.
Unrelated Business Income (UBI) and Unrelated Business Income Tax (UBIT)
Your not-for-profit organization can become subject to a state’s tax requirements if it conducts a certain level of activity in the state, including owning property in that state and employing staff who reside there. It is also possible that you will have filing obligations if your not-for-profit generates unrelated business income in a state. UBI is generally defined as income from any trade or business the conduct of which is not substantially related (apart from the need of such organization from income or funds) to the exercise or performance by the organization of its charitable, educational, or other purpose constituting the basis of the organization’s tax-exempt status. UBI can be derived from a variety of sources including certain bookstore or online store sales.
States follow varying rules to determine what, if any, income is taxable, so it is crucial that your organization understand the rules in place so that it can meet the appropriate filing requirements. Florida exempts from UBI consideration sales that are “related” to a not-for-profit’s core mission but taxes unrelated business income. The university in our case study would have to determine how much of its Federal UBI is subject to tax in Florida based upon payroll, property and sales apportionment considerations.
Keep in mind that not all states have income taxes; some have different tax regimes. Washington is one such state. Its business and occupation tax is not an income tax, so the standards used to determine whether an activity is UBI do not apply. Our university would have to consider whether the activity conducted in Washington would meet the thresholds for the business and occupation tax. Further, given that the tax is not an income tax, its tax base will include items beyond UBI.
Sales and Use Taxes
Entities are generally subject to sales/use taxation if they are physically present in a state. Physical presence includes in-state employees and use of independent contractors. Items or services sold within a state must be analyzed in order to determine whether they are subject to the state’s sales and/or use taxes.
Should your organization determine it meets the requirements to pay sales and use taxes in a particular state, i.e., it has sales and use tax nexus, then the organization becomes subject to the state’s sales and use tax provisions and filing requirements. All items sold to end users in that state would need to be analyzed to determine whether those items would be subject to sales and use tax.
Using our example, if the university has sales and use tax nexus in Washington and Florida, it would have to determine whether to collect sales and use tax from its online bookstore sales to students based in Washington and Florida. It would also need to consider use tax on computers or other equipment the university provided to faculty in those states to assist in their online instruction.
Many states exempt not-for-profit organizations from various aspects of sales/use tax. Part of the consideration of your sales/use tax obligations should be determining if your organization qualifies for available sales/use tax exemptions. The statutes that exempt not-for-profit organizations from sales and use tax can be narrowly written and do not always apply across the board, so a careful evaluation of the particular exemption is imperative. Should your organization be subject to sales and use tax, it must understand its filing deadlines. The deadlines can can be monthly, quarterly or annually, so to meet them, your not-for-profit must have a robust recordkeeping system in place.
In general, payroll withholding is based on the location where employees perform their work. Payroll taxes differ by location. By way of reference, Florida and Washington do not have personal income tax, so the university in our example would have to understand this when running payroll for its faculty members based there.
Reciprocity agreements may also factor into the equation. These agreements involve the state where the employee lives sharing the appropriate amount of payroll withholding with the state where the employee works.
Unemployment insurance withholding is generally determined by the state where the employee works. The withholding for unemployment insurance is based on the applicable rate multiplied by the state wage base. Your organization needs to understand the varying complexities of unemployment insurance withholding in order to stay in compliance.
Tax Exposure and Remediation
Frequent state and local tax risk assessments can help ensure you are meeting the filing requirements of the states in which you operate.
If you evaluate your state and local tax requirements and find that you have an exposure that has not be handled appropriately, you have several options for remediation. You can reach out to the state with the exposure directly and try to reach a settlement. This will require some negotiation and may necessitate the use of a third party.
States also have voluntary disclosure programs. Entities that “turn themselves in” for tax exposures may be able to minimize their penalty and the look-back period for their exposure. This is important because there may be no statute of limitations on state and local tax issues. If you uncover a long-spanning issue, we recommend you use the applicable voluntary disclosure programs.
For More Information
State and local tax professionals can help your not-for-profit organization manage and meet its state and local tax reporting requirements. For more information about state and local tax compliance for not-for-profits, please view our complimentary webinar or contact us here.
.............................................................................................................................................................................Tarra Curran is Managing Director in the Tax Department. She can be reached at firstname.lastname@example.org or 401.626.3240.
Craig Klein is a Managing Director of the Not-for-Profit & Education Tax practice. He can be reached at email@example.com or 617.761.0509.