The state tax landscape has changed once again. Nevada, once viewed as a “tax-friendly” state, implemented a $1.5 billion tax plan to fund its education system. As part of the plan, the state created a business entity tax called the “commerce tax.” As the year end has just passed for calendar-year taxpayers, many questions about the commerce tax remain unanswered. When is it due? Is it an income tax for ASC Topic 740 purposes? How are the business categories determined? Are any credits available? This guide will assist companies on some important aspects of the commerce tax.
Effective July 1, 2015, Nevada S.B. 483 imposes an annual commerce tax on business entities engaged in business in Nevada, including partnerships, limited liability companies, limited liability partnerships, C corporations, S corporations, trusts, and individual taxpayers engaged in business and therefore required to file Schedule C, Profit or Loss From Business, Schedule E, Supplemental Income and Loss, or Schedule F, Profit or Loss From Farming, of Form 1040, U.S. Individual Income Tax Return, with the IRS.
The tax base is gross revenue minus certain exclusions and deductions. The tax is imposed on every business whose Nevada gross revenue exceeds $4 million, but no deduction is permitted for cost of goods sold or other expenses. The tax is imposed on a separate entity basis. No exceptions exist for affiliated groups to file on a combined, consolidated, or unitary basis. The commerce tax has 26 business categories that determine an entity’s tax rate. The tax rate varies by category and ranges from 0.051% to 0.331%.
Business entity’s tax year end is irrelevant
The tax year for the commerce tax is July 1–June 30. Calendar-year and fiscal-year taxpayers, other than those with June 30 fiscal year ends, must adjust their reporting to conform with commerce tax requirements. Entities that produce information on an interim basis should be able to configure their process fairly quickly. The fiscal-year requirement for the Nevada tax is burdensome, however, for entities that do not report on interim bases and may not have the resources to comply.
No automatic extensions
The initial tax reports are due on the 45th day following the end of the tax year. Business entities may request a 30-day extension to file and pay for good cause. For the initial reports, a grace period is permitted through Feb. 15, 2017. The initial reports will not accrue penalties or interest unless the failure to file and pay was intentional or due to willful neglect. Subsequent reports may be paid at the extended deadline without incurring a penalty. However, interest will begin to accrue on the due date and continues to accrue until the tax is paid.
Carefully examine the NAICS code
The tax rate varies by industry depending on the business entity’s North American Industry Classification System (NAICS) code. The NAICS code submitted on the initial return cements the business entity’s tax rate. The NAICS code may be changed in the future if the taxpayer presents evidence, which is submitted on a form prescribed by the Nevada Department of Taxation.
Since the NAICS code determines the company’s tax rate, any change from the initial report must be substantiated.
Example 1: A laundromat business (NAICS code 812310, taxed at 0.142%) starts selling pizzas. If the pizza sales become a majority of the laundromat’s revenue, an argument could be made that the laundromat’s primary business is a pizza parlor (NAICS code 722511, taxed at 0.194%). Under these circumstances, the Department of Taxation may consider changing the entity’s business classification.
Consider three-year averaging
Section 3 of the proposed regulations (Nev. Tax Comm’n Prop. Reg. R123-15) governing the tax provides that if a business entity is engaged in more than one type of business category, the initial NAICS code selection “may be made by averaging Nevada gross revenue generated over the prior three years.” This means if an entity has multiple businesses, the industry with the most Nevada gross revenue can be selected for NAICS purposes, which may permit choosing a category with a lower tax rate.
Example 2: A CPA firm typically falls under NAICS code 54, which pays the commerce tax at a 0.181% rate. Many CPA firms do substantial business with annuities and other insurance products. Finance and insurance products fall within NAICS code 52 and pay the commerce tax at a 0.111% rate. A CPA firm that generates more revenues from insurance products over the preceding three years is primarily engaged in insurance and should pay the commerce tax at the 0.111% rate.
Exclusions and deductions
The Nevada Legislature carefully considered other Nevada taxes when implementing exclusions and deductions from the commerce tax. For example, gross proceeds from minerals extraction, which are subject to a separate tax, are excluded from the commerce tax. Specific exclusions and deductions are listed in S.B. 483. Business entities should carefully review the list of exclusions and deductions to determine whether a reduction of the commerce tax is available.
Topic 740 considerations
ASC Topic 740, Income Taxes, requires businesses to calculate and recognize the effects of taxes based on income, but it does not define “taxes based on income.” Generally, an income tax exists when the tax is based on income less allowable expenses incurred to generate earned income. The commerce tax does permit exclusions and deductions, but it does not permit exclusion of items such as cost of goods sold and other business expenses incurred to generate earned income.
Consider the Texas margin tax. The Texas margin tax (still called the franchise tax even though it has been changed) is an income tax because the “revenue less cost of goods sold” or “revenue less compensation” generally produces a smaller “taxable margin.” The characteristics of the Texas margin tax exemplify a tax structure where the deductions are allowed to reduce earned income. Many professionals argue that the Nevada commerce tax is similar to the Texas margin tax and should be accounted for as an income tax for Topic 740 purposes. These professionals further argue that the standard deduction and exclusions produce a modified gross receipts tax, thus resulting in a tax based on income.
This practitioner disagrees because the commerce tax standard deduction and exclusions are not deductions related to earned income. An example of deductions that produce a modified gross receipts tax would be inventory, materials, supplies, depreciation, and wages. Since the deductions permitted under the commerce tax do not generate earned income, it is not similar to the Texas margin tax. Furthermore, compare these taxes to the Ohio commercial activity tax (CAT), which is described as a gross receipts tax imposed for the privilege of doing business in Ohio. The Ohio CAT allows an annual deduction of $1 million and excludes certain receipts. The Ohio CAT is not considered a tax based on income and is governed by ASC Topic 450, Contingencies.
The Nevada commerce tax resembles the Ohio CAT more than it does the Texas margin tax. The Ohio CAT is a non-income-based tax and is governed by Topic 450 instead of Topic 740. This is good news for calendar-year taxpayers who would have otherwise accounted for the tax effects by year end (see the discussion of year-end relevancy above).
The commerce tax requires that business entities with out-of-state records pay for audit examinations. Under S.B 483, section 18, part 2, any business entity that keeps books and records outside of Nevada shall pay an “amount equal to the allowance provided for state officers and employees generally while traveling outside of the State for each day or fraction thereof” during an examination. Furthermore, taxpayers will also be responsible for the auditors’ actual expenses.
In a case where the state auditor travels out-of-state to examine the taxpayer’s records only to discover that the commerce tax was paid correctly, the legislation is silent as to whether such an occurrence would mitigate the “employee audit fees.” The Legislature did not foresee a scenario where if there are no corrections, the employee audit fees could be abated. The obligation for out-of-state businesses to pay audit expense is an important aspect of the new legislation that could be very expensive. This practitioner encourages his clients to attach a statement to the report explaining Nevada gross revenue in order to lessen the possibility of an examination.
Consider the commerce tax recovery charge
If one specific item in the proposed regulations suggests that the tax is a “sales tax,” it is the commerce tax recovery charge. While the commerce tax is imposed on the business entity, an entity may charge the cost to its customers if certain conditions are met. Section 4, parts 1–3, of the proposed regulations state that the commerce tax may be itemized on a customer’s invoice. The entity must write a statement informing the customer that the charge is the cost of compliance with the tax imposed, and the invoice must clearly show that the commerce tax recovery charge is part of the total price collected from the customer and is not an additional charged assessed on the customer’s total. Implementing itemized charges to customers could be challenging, but for companies with smaller profit margins it maybe their only relief.
The proposed regulations permit a business entity’s “payroll provider” to offset the modified business tax (MBT) credit by 50% of its affiliated members’ commerce tax paid. The payroll provider is the business entity within an affiliated group that provides payroll services for one or more members of the group. Many business entities are unaware that an affiliated members’ tax paid can offset another member’s MBT liability.
Example 3: Company A, Company B, and Company C are affiliated group members. Company A has an employee who is paid by Company C but generates revenue for companies A, B, and C. In this example, Company C is the payroll provider and may offset its MBT liability by the commerce tax paid by companies A, B, and C.
The challenge arises for corporations that outsource their MBT returns but file the commerce tax returns “in-house.” How would the payroll provider know how much tax was paid in order to take the credit? This practitioner is encouraging clients to begin the dialogue immediately and facilitate the necessary steps to ensure proper filing.
Benjamin Franklin was right when he wrote that nothing in this world is certain except death and taxes. The once “tax-friendly” state of Nevada now imposes a non-income-based gross receipts tax with initial reports due in 2016. The initial report cements a company’s NAICS industry, which determines the entity’s tax rate. Three-year averaging, the MBT credit, and the recovery charge are techniques to lessen the tax impact. Attaching a statement to the report could reduce the possibility of an examination and paying employee audit fees. The initial report sets the foundation for future years.
Prentice D. Barbee, CPA, MST, president of Barbee Tax Consulting LLC, is a former Big Four and Fortune 500 tax leader. He provides astute state and local tax services to businesses. Additional information can be found at barbeetax.com.