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April 30, 2008

20080430-1.jpgMinnesota Senate Candidate Al Franken's corporation taxes made the news again yesterday. From

Democratic U.S. Senate candidate Al Franken, front-runner in the race to challenge Republican U.S. Sen. Norm Coleman, said on Tuesday that he has paid $70,000 in back taxes and penalties owed in 17 states, going back to 2003.

Franken, who has earned income across the country for celebrity appearances and speeches, blamed his accountant of 18 years for failing to pay the appropriate taxes owed in each state.

Mr. Franken graciously throws his accountant under the bus:

The accountant, Allen Chanzis of New York, "just made a basic kind of error that had a lot of ramifications," Franken said.

Franken said that he paid federal and state taxes on all of his income, but that the accountant had failed to properly distribute the tax payment

How this happens

State tax compliance is a bane of small business life. It can take surprisingly little activity in a state to trigger "nexus," making you subject to that state's income taxes. If you are in a business that can take you briefly to other states irregularly, like public speaking or consulting, you can end up needing to file taxes in many states. As Mr. Franken learned with California, once you get into a state, they will keep wanting returns until you find a way to formally withdraw from the state.

Mr. Franken's problem is not uncommon. Undoubtedly many little corporations hop in and out of states without bothering to file in every state where they show up briefly. That can be a dangerous habit, as Mr. Franken is learning. If you never file in a state, the statute of limitations never stops running, and you can theoretically be assessed taxes going back forever.

The federal tax law that governs taxation in other states provides that once you cross a relatively low threshold for presence in a state, you can only avoid income taxes if your only activity in a state is sales for delivery from out of state. Some states - notably Michigan, Texas and Ohio - have enacted gross receipts taxes, which have an even lower nexus threshold, so the stakes for state tax compliance are rising. Given that every state has its own laws and its own nexus standards, it's a tough problem for a small business.

Taking your chances

I have no insight into Mr. Franken's business, but I can see how this sort of thing could play out with a similar business. A taxpayer might provide income and expense information to the accountant without mentioning that it was earned in 17 states. Or maybe the accountant doesn't find out about all of these states until he gets client information in February or March. Given that the taxpayer was only briefly in a state, without any payroll in the state or other information that could identify the taxpayer to revenue department data miners, the accountant might decide to just take a chance and not file in some of the states. Or the accountant might point out the exposure in the different states, but the client could decide to take his chances rather than pay thousands of dollars to prepare an extra 17 state returns.

Such decisions may be shortsighted, but they are understandable in cost-benefit terms. Mr. Franken might never have had problems if he hadn't decided to run for office, exposing his tax life to scrutiny.

States are getting more sophisticated at identifying taxpayers who do business in a state, and this is becoming an issue to more taxpayers as interstate business becomes more common even for small businesses in the information age. Of course, states love to tax out-of-state taxpayers because they can't vote. Perhaps personal experience will make Mr. Franken sympathetic to legislation that would prevent states from taxing businesses that only are in a state a few days in a tax year.

If your business has exposure in multiple states, it might be time to sit down with your tax advisor. A typical approach is for a tax advisor to contact the state and work out a deal to limit exposure to, say, three years back taxes in exchange for the taxpayer coming forward voluntarily. But, as the mutual funds say, actual results may differ.

Links to other Franken tax coverage:

Taxable Talk
Prior Tax Update Coverage


Megan McCardle and James Joyner weigh in.

UPDATE II: The TaxProf rounds up coverage.

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I've had the pleasure today of setting up our sales tax rates for Iowa. Sales tax rates are insane, but it's not limited to Iowa. I do like Des Moines/West Des Moines take on sales tax though. Should there be an extra part of sales tax to be kept by the collector to cover the costs of collecting it? Some states do this, one in the NE I think.

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