For businesses operating across state lines, historical sales and use tax exposure is a common and unavoidable risk. Since the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., states have been redefining the way they can tax out of state businesses. These evolving nexus standards, and rapid growth of online businesses, can create a perfect storm for companies to have unpaid liabilities in jurisdictions where they were not previously registered. Multistate voluntary disclosure agreements (VDAs) provide a structured pathway to resolve these liabilities. However, the process is nuanced and requires careful planning.
A voluntary disclosure agreement is a formal arrangement between a business and a state department of revenue. It allows the business to come forward and voluntarily report past tax liabilities. The VDA process has a few benefits, namely, waiver of penalty and limiting the lookback period to the relevant state statute of limitations. In the absence of a VDA, the state can assess tax going back to the first day a business established nexus, and penalties can be up to 50% of the tax due. Because of this, the savings from a VDA can be substantial. In exchange, the business agrees to register, file returns, and pay the tax due for the agreed period.
This process starts with a high-level review. A business must evaluate whether it has established nexus outside the states where it is currently registered to do business. Nexus generally arises in multiple ways, the two most common being physical presence and economic nexus. Physical presence nexus is triggered when a business has employees, inventory, or offices in a jurisdiction. Economic nexus arises from sales in excess of a certain dollar value, generally $100,000, or a transaction threshold such as 200 sales.
Once the business has established they have triggered nexus, and the date nexus was established, they will review the taxability of the products sold to start drilling down on the tax exposure. Taxability varies state to state. By way of example, the sale of software is not subject to sales tax in Florida, however that same product sold in Washington would be taxable at the retailer’s B&O tax rate, and a sale in Texas may be taxable at 80% of the retail price. Because sales tax is complicated, and varied, hiring a tax professional with multi-state experience can help eliminate the unknown, and make this process run more smoothly.
Not all taxpayers qualify for voluntary disclosure. Most states will not allow a business the enter the VDA program if they were previously contacted by the state about the same tax type. Some states do not allow a business to enter the VDA program if the business was previously registered and filing in the state. There is a common assumption that an unregistered business is unlikely to be contacted by a state. This is becoming increasingly outdated guidance. States are getting more savvy at using technology to find unregistered businesses by tracking online presence, and coordinating with other state agencies to track shipments and state and local licenses. If a nexus and taxability review finds liability, swift action can help ensure the business does not risk losing eligibility for the VDA program.
When filing the VDA, there are two ways to proceed. Some businesses will disclose their names, provide all documentation upfront, and get fast-tracked through the program. Certain states have expedited processes that can be completed in 30 days. Other businesses may need more time, but want to get accepted into the program while they gather the appropriate books and records. In these instances, states allow VDAs to be initiated anonymously, typically through legal counsel or a representative. This approach allows the business to determine eligibility, negotiate key terms, and establish liability without disclosing the business name. Only after terms are agreed upon does the taxpayer disclose its identity and execute the agreement. Anonymous filings are a great tool in multistate projects because they add some flexibility to the timing of each step of the process.
When disclosing in multiple jurisdictions, coordination becomes critical. In addition to the flexibility of anonymous disclosures, businesses often sequence the filings or group them into tranches. This allows the business to manage the documentation burden and any cashflow concerns. Additionally, once the VDA has been completed the business will have an obligation to collect and remit tax on a prospective basis. Staggering the disclosures allows the business to slowly add those additional monthly filings.
Multistate voluntary disclosure is a powerful tool for managing historical sales tax exposure, particularly in the post-Wayfair environment. By limiting lookback periods and eliminating penalties, VDAs provide a pathway to compliance that is far more favorable than audit-based assessments.
However, the process requires careful legal and strategic analysis. Each state presents unique rules, and multistate coordination adds layers of complexity. With thoughtful planning and execution, businesses can resolve past liabilities efficiently while positioning themselves for compliant growth going forward.
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