By Samantha Stone
What’s a NAICS Code? Before July 1, you’d have been forgiven for not knowing the arcane acronym for North American Industry Classification System, a set of codes describing categories of business activity. Each registered Nevada business has a NAICS Code assigned by the state agency that tallies labor statistics. Business operators have been largely heedless of their code.
But now, under Nevada’s new commerce tax law, NAICS identification will be linked to business tax liability. For the first time, business entities must self-select one of twenty-six NAICS Codes encompassing everything from food service to telecom. Each code comes with a tax rate. Choosing correctly will be critical, and getting it wrong could be costly.
Some businesses are chafing at the prospect of using a single code to characterize their activities. Consider a company with multiple divisions producing several unrelated revenue streams that ebb and flow according to market demand, or a seasonal business with calendar-driven business activities that vary. A single NAICS Code forces them to apply the wrong tax rate to part of their business.
If Nevada’s traditionally simple approach to business taxes has been a game of tic-tac-toe, it’s about to become a Rubik’s Cube. Business lobbyists pummeled the Department of Taxation last month at a regulation workshop, presenting a long and vexing list of situations not contemplated in the commerce tax law. Their message – even the simplest business has complexities. The unanswered questions look like land mines to the businesses, which fear that any wrong move could trigger an audit.
The Department says the complications have been overstated.
“There’s a lot of specificity in the bill, and that’s why it looks like it’s so complex,” said Deputy Director Pauline Oliver. “Once you get down to preparing a tax return… you find out that it’s not as complicated as it seems.”
Assemblyman Derek Armstrong, a tax attorney who chaired the 2015 Assembly Taxation Committee, says most of the questions arising from the workshop were considered while the law was being crafted. But many of the people asking the questions disagree on both counts. They contend the law fails to address some fundamental business practices, and they claim their concerns were brushed aside during the legislative session.
Some of the angst is straightforward, like the requirement to file returns according the state’s fiscal year, which runs from July through June. Most businesses operate on the calendar year, as does the Internal Revenue Service (IRS). It looks as though two sets of books will be necessary – one to satisfy the state and one for the IRS.
CPA Doug Winters calls the filing date more of a nuisance than a serious problem, but it will be an expensive nuisance for the construction firms he represents. Construction companies arrive at their taxable income in December by calculating their progress on each project, using a method called percent-complete accounting, Winters told Department officials. The percent-complete report takes stock of the work that’s been paid for, and can cost several thousand dollars to compile. Twice-annual tax filings would effectively double the tab.
Compliance costs will add up to more than a nuisance for some sectors. Paul Enos, CEO of the Nevada Trucking Association, has met with each of his members to review their records and assess the effect of the commerce tax.
“What I have found in almost every case is, it will cost more for my guys to comply than it will to pay the tax,” Enos said.
For really big-ticket turmoil, consider “affiliated entities,” two or more companies with the same owner. If you have ten affiliated companies, can each one claim the allowable exemption on its first $4 million of gross revenue? It’s a $40 million dollar question.
Another conundrum applies to businesses maintaining a separate entity for personnel management, a protective practice that’s developed in response to employment litigation. The human resources entity owns the employees, but generates no revenue. The operations entity earns the money, but has no employees. How do you apply the payroll tax credit allowed in the law?
Deputy Director Oliver says the personnel entity gets the tax credit. But lawyers and CPAs maintain it isn’t clear.
A legal language problem may top the distress list. “Pass-through entity” is defined differently in the new law than in the federal tax code, said Robert Armstrong from law firm McDonald Carano Wilson. It’s a term of art with important implications in the movement of assets from one party to another. Nevada is now at odds with the IRS. (Armstrong is not related to Assemblyman Derek Armstrong.)
Armstrong also wants to limit unnecessary disclosure of private information, a concern shared by others.
Retail merchandising wizardry enhances efficiency, and it takes us into the realm of the abstract. At Walmart, tubes of toothpaste arrive without any records, as Procter & Gamble responds to daily point-of-sale data from the stores, and automatically restocks the shelves. No money changes hands until the store’s customer buys the product. Legally speaking, P&G owns the product until the consumer pays for it. At the same time, Walmart takes possession of the product, but never assumes ownership. Which company is responsible for the taxes on the transaction between the two?
Accounting for goods that move into or out of the state will require a new level of government scrutiny, raising the specter of a Nevada IRS. Merchandise produced elsewhere moves through a multi-layered distribution chain, with a Nevada retailer as its final destination. Ray Bacon of the Nevada Manufacturers Association suggests tracking these transactions requires an IRS-style enforcement agency.
Moreover, does Nevada have jurisdiction to tax out-of-state companies? The state covets revenue from multi-national manufacturers like General Motors, says former Nevada Tax Commissioner David Turner. This is an interstate commerce question, he told the Territorial Enterprise.
Outbound goods may be even trickier. A Nevada food company sells to grocery distribution centers, which send the product to stores inside and outside of Nevada. The commerce tax applies to the product intended for Nevada grocers, but not to the outbound product. The separate paths taken by bottles of salad dressing will have to be tracked.
Further complicating the picture, some of the product is sold to producers who will use it as an ingredient in other food products. This hints at a Nevada court decision declaring that goods purchased by a manufacturer for use as an ingredient in another product are exempt from the sales tax.
Outside the workshop, there’s skepticism about the Department’s experience in the arena of business taxation. Many believe the questions will have to be bumped up the ladder to the tax commission. And history suggests that some of these matters will be settled in court.
Turner, who served 12 years on the tax commission, recalls the work sessions necessary in 2003 to implement Governor Kenny Guinn’s tax package, which included a badly flawed banking tax bill. Commissioners met weekly from July until November, filling in blanks left by the lawmakers. A significant departure from their ordinary role vetting and approving the finished regulations, he says.
Turner and former commissioner Barbara Smith Campbell, who led the 2003 effort, have suggested to the Department a similarly intensive schedule of workshops with commission oversight from now until the commerce tax job is done. The Department would accept such a proposal only from current commissioners, Oliver says.
Meanwhile, the clock is ticking. The published timeline pegs November 15 as the Department’s tentative date for a regulation adoption hearing, with one additional workshop in September “if necessary.”
With the first commerce tax payments due in August of 2016, it’s an ambitious timeline by all accounts.