Key takeaways
- Wayfair expanded nexus rules: The 2018 ruling replaced the old “physical presence” standard with economic nexus, requiring remote sellers to collect and remit sales tax in more states.
- VDAs reduce exposure: Voluntary disclosure agreements help businesses resolve past noncompliance, limit lookback periods, and secure penalty waivers.
- Proactive review is key: CPAs should assess clients’ physical and economic nexus activities early to identify risks, calculate exposure, and guide them toward timely compliance.
In short: A voluntary disclosure agreement (VDA) lets a business settle past sales tax liabilities with a state. Penalties are usually waived, and the lookback period is usually three to four years. Since the 2018 Wayfair ruling added economic nexus, CPAs can use VDAs to bring exposed clients into compliance.
In 2018, the Supreme Court overturned the physical nexus rule, a holdover from the 1992 Quill case ruling. It called that rule “unfit and unsound” for today's economy. SCOTUS found South Dakota's concept of “economic nexus” a better fit for modern commerce. This revolutionary change opened the floodgates, and states rushed to revise their nexus laws to raise sales tax revenue.
Economic nexus does not replace physical nexus - it works as an addition to physical nexus. In fact, businesses with healthy revenues from remote sales will likely meet the criteria for both types of nexus. States will keep pursuing remote sellers that triggered other nexus-creating activities in their jurisdiction before Wayfair. So it’s more important than ever to consider whether a voluntary disclosure agreement is the right path to registration for your exposed clients.
CPA firms have long used voluntary disclosures to help their clients. Many states are now seeking to increase revenues. A primary way to do that is to enforce the taxation of out-of-state businesses, as the Wayfair decision allows. This raises exposure risk for many businesses. As a result, CPAs must be ready to offer nexus advisory services. These include preparing voluntary disclosure applications, when applicable.
How Do You Bring Clients Into Sales Tax Compliance?
You bring clients into sales tax compliance by reviewing their sales activities for current and prior periods before states come to them. The current environment gives you a window to do this proactively. Being proactive is likely to reduce exposure or tax liability assessments. Here are some critical points when you assess the business activities of your installed client base:
- A thorough evaluation must consider both economic and physical presence nexus. Physical presence activities did, and still do, create nexus for unsuspecting sellers.
- Review sales amounts and transaction thresholds back to 2017. This makes sure your client doesn’t have any “prior-period” economic nexus exposure under Wayfair.
- Check whether your client has/had any physical presence activities sufficient to constitute nexus, and the date(s) of first occurrence.
- Depending on the scenario, decide on remediation for your client. Options include registration, voluntary disclosure agreements, or participation in amnesty programs.
Years after the Wayfair ruling, most businesses are painfully aware of the resulting changes and are scrambling to become compliant. More than ever, they need their CPA to be a trusted advisor on this topic. Businesses need help to identify states where they may have exposure. They need help to calculate that exposure in dollars. Finally, they need help getting compliant.
What Types of Sales Tax Exposure Can a Client Have?
A client's sales tax exposure falls into two broad categories: 1) Pre-Wayfair exposure; and 2) Post-Wayfair exposure. Pre-Wayfair exposure is probably the most common and also the most complex. Post-Wayfair exposure breaks down further into timely compliance versus untimely compliance.
What Is Pre-Wayfair Exposure?
Pre-Wayfair exposure arises when a business had physical presence nexus for sales tax in a state before Wayfair but did not register and collect tax. This is the most common, complex, and concerning situation. The pre-Wayfair physical presence might have been limited or minor. Even so, these businesses chose not to register and collect tax.
Due to the recently enacted economic nexus laws, the business will have no choice but to comply going forward. State sales tax registration applications require an attestation. So your client will have to disclose the unresolved physical presence nexus. This creates exposure dating back to when physical presence nexus first occurred.
This is a classic case for a voluntary disclosure agreement (VDA). A VDA addresses the historical exposure and brings your client into current compliance. Expect your client to owe back taxes and interest for the applicable lookback period (usually 3-4 years). As part of the VDA, years before the lookback period are generally waived. Penalties are generally waived in the VDA process too. Still, your client is likely to face a steep bill for the prior-period tax liability.
What Is Post-Wayfair Exposure?
Post-Wayfair exposure affects businesses that had no physical presence in a state before Wayfair but may still have economic nexus issues. This is a smaller group of businesses. Their issues will more likely relate to timely versus untimely compliance with the Wayfair decision. Either way, you need a thorough understanding of the applicable rules to advise your client well.
What Is Untimely Compliance?
Untimely compliance means a business registered for sales tax later than the state's economic nexus rules required. This is a less than ideal, yet common, scenario. Every state with a statewide sales tax, including Florida and Missouri, has now enacted economic nexus laws. So you likely have many clients with untimely compliance exposure. As their trusted advisor, it is your job to get them compliant as soon as possible.
Unfortunately, this scenario creates a dilemma. The company must decide to either ignore the interim period of non-compliance, or file the late returns and incur penalty and interest. As their trusted advisor, you must tell your client that the registration document is generally signed under penalty of perjury.
The registration asks a representative of the client to declare the business start date in the taxing jurisdiction. If the start date is before the timely registration date, it is likely to trigger an inquiry for the missed filing periods. If your client enters the present date as the start date, the attestation on the registration becomes a problem.
How Does a Voluntary Disclosure Agreement Work?
A voluntary disclosure agreement works by letting you approach a state on your client's behalf to settle past tax liabilities and secure penalty waivers. CPA firms have a chance to get ahead of the enforcement initiatives that are bound to follow. Voluntary disclosure is the main solution for clients with pre-Wayfair or untimely post-Wayfair exposure.
The advantage of this process is that you can approach the state anonymously on behalf of your client. You can then negotiate a settlement of past tax liabilities and secure penalty waivers. However, look before you leap. Each state has different requirements and nuances in its VDA program. Get to know the specific states where you plan to file a VDA for your client. Protect your client's anonymity until the state(s) and your taxpayer reach an agreement.
A typical voluntary disclosure agreement requires the company to register and pay its current and future taxes. Most states also require the company to pay back taxes and interest for the stated lookback period. Each state has its own lookback period, but most range from three to four years.
In most cases, states waive penalties on the back taxes. Most importantly, states usually agree to waive audits of the tax years before the lookback period. Make sure to negotiate an agreement that covers your client’s prior period obligations.
The taxpayer is responsible for submitting the voluntary disclosure agreement. As their trusted advisor, you should know the sales activities for the lookback periods in each state. You should also understand the “good faith” estimate of liability. The more thorough your analysis, the fewer surprises your client will face.
Be ready to file back tax returns for the lookback period and support the tax liabilities. This is essential. Sales audit worksheets should form the basis of the agreement and show your client the financial impact.
What Details Does a Typical VDA Application Require?
Most states follow the Multistate Tax Commission model for the data they require in a VDA application.
- Name and contact of CPA or taxpayer’s representative
- Last digit of taxpayer’s FEIN
- Entity type (C-corp, S-corp, LLC, etc.)
- Fiscal year
- Nature of the business
- Does the taxpayer have any property in the state?
- Employees, independent contractors, or representatives activities in the state
- What activities does the taxpayer have that constitute nexus (i.e. remote sales, employees, inventory, etc)?
- Date on which nexus first occurred
- Did the taxpayer collect sales taxes and not remit them?
- What gives rise to the voluntary disclosure application?
- Has the applicant been previously contacted by the state?
Conclusion
Voluntary disclosure agreements are an important tool for CPAs to reduce clients’ exposure to prior tax liabilities, when applicable. As their trusted advisor, you must apply a wide range of rules and tests. These include economic nexus rules, physical presence tests, lookback periods, transaction audits, and registration timelines. They also include marketplace facilitator implications and calculated exposure amounts. Together, they help you protect your taxpayer client and minimize their overall risk.
Using the LumaTax solution, you never have to worry about tracking all of these varying parameters to deliver this advisory service efficiently and effectively.
How Taxually handles this
Taxually’s LumaTax runs a nexus analysis on your sales, helps you register in the states where you must collect, and prepares and files multi-state sales tax returns, including Canadian GST/HST. LumaTax is currently available to enterprises and accounting firms. For the full workflow, read how to automate US sales tax filing in every state.
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Frequently asked questions
What changed with the 2018 Wayfair decision?
The Supreme Court replaced the old “physical presence” rule with economic nexus, allowing states to require out-of-state sellers to collect and remit sales tax based on sales volume or transaction count, even without a physical location.
Does economic nexus replace physical nexus?
No — it adds to it. Businesses can have both physical and economic nexus in multiple states, which increases compliance complexity and potential exposure if they haven’t registered properly.
How can voluntary disclosure agreements (VDAs) help?
VDAs allow businesses to come forward voluntarily, settle past sales tax liabilities, and typically avoid penalties. They’re especially useful for addressing pre-Wayfair or late post-Wayfair compliance issues.
