United States

State and local tax controversy challenges in the COVID-19 era

INSIGHT ARTICLE  | 

The COVID-19 pandemic has wreaked havoc on both private and public finances. Businesses across the country are reeling financially as a result of the near total shutdown of the economy. The economic crisis has affected both large and small companies in every industry. Nationwide shelter in place orders, the closure of non-essential businesses and widespread health concerns have grounded much of the economy. The business community has sustained significant losses and have laid off or furloughed millions of employees.

At the same time, state and local governments are losing billions of dollars in tax revenue as a result of the crisis. Virtually, all types of tax revenue have fallen significantly. All states are expecting large budget deficits in 2020 and 2021. The state and local jurisdictions most dependent on retail sales and tourism have suffered massive reductions in sales tax collections. With large scale layoffs and a down stock market, states more heavily dependent on personal income taxes are, and will be, experiencing similar financial hardships.

Despite the perilous economic times, many businesses have ongoing or anticipated controversies with state and local tax authorities across the country. These controversies often involve either significant tax deficiencies or substantial pending refund claims. Moreover, there are thousands of ongoing audits in every state and hundreds of localities. While many of these examinations are on hold because of shelter-in-place orders, they will resume. The economic crisis creates both risks and opportunities for taxpayers and revenue departments with respect to ongoing or expected tax controversies.

State and local governments will need to raise additional revenue to cover the existing budget shortfall as well as increased spending on health and welfare. State governments have balanced budget requirements that will force them to raise additional revenue or reduce services. During past economic downturns, some state and local governments have turned to more aggressive tax administration to close real and perceived tax gaps. More aggressive administration is often politically preferable to tax rate increases. There are strong indications that state and local governments will begin more aggressive audit activity both to continue pre-COVID-19 activity, such as economic sales tax nexus enforcement post South Dakota v. Wayfair, and because of the current and projected lost tax revenue due to COVID-19. Businesses should be prepared for potentially prolonged audits causing increased expense and time to handle. There are ways to minimize the costs and burdens of new tax audits.

However, the state and local fiscal crisis creates opportunities as well. Governments desperate for revenue have an unusual incentive to settle cases as this time. Businesses faced with assessments may be able to negotiate a favorable settlement to the underlying tax and penalty labilities. Such settlements could save companies substantial amounts of money. The state and local governments would benefit from expedited resolution of the dispute as well. Similarly, many companies have ongoing controversies over refund claims. Businesses facing cash flow issues may find it advantageous to settle such claims. The business would receive a badly needed influx of cash. The state or local government would reduce its potential refund liabilities.

Takeaways

Businesses across the country should be aware of the tax controversy risks and opportunities presented by the current financial crisis. The main risk involves more aggressive auditing. That risk can be managed. The potential benefits involve securing favorable administrative settlements in both deficiency and refund disputes. Success will depend on the strength of the underlying position. The RSM U.S. State and Local Tax group can assist businesses in developing strategies to minimize audit burdens and secure favorable negotiated settlements.

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