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Henry A. Hoss, CPA, Kirk H. Low, CPA. Tennessee CPA Journal. October 2003.

 

The Streamlined Sales Tax Law that passed during the closing days of the last session of the Tennessee Legislature and the new sen­ior staff of the Tennessee Department of Revenue (TDOR) were the main topics at the recent TSCPA State Tax Liaison meeting held on Aug. 1, 2003. 

Commissioner Loren Chumley said that since taking office in January, there has been a whirlwind of activity at the TDOR. During the legislative session, the emphasis was in minimizing the effect of the across-the-board budget cuts. After the end of the session, the commissioner embarked on a statewide listening tour. 

The three years of work on the part of 37 states to simplify sales and use tax under the name “Streamlined Sales Tax Project” is, according to Commissioner Chumley, an effort to simplify and make more uniform the sales tax laws that exist in 45 states and the District of Columbia, with a view toward ultimate­ly convincing either the courts or Congress to require remote sellers to collect and remit sales tax to the states. With 57 percent of Tennessee’s revenue coming from sales and use tax, the commissioner said this was most important to Tennessee. When asked about some of the changes that have to be made to Tennessee sales tax laws to achieve uniformity, the commissioner said, “We have to weigh overcoming 60 years of complexity against the loss of the tax base due to electronic commerce.”

There was concern from the commit­tee that Congress may not pass the needed legislation. The commissioner replied, “Congress acting will make it mandatory.” However, under the current voluntary system, national scale retailers are beginning to comply by collecting and remitting taxes on e-commerce sales for business and marketing reasons and to show support for the streamlined initiative.

On a national level, streamlined legis­lation has been adopted by the minimum of 10 states with 20 percent of the population. The next step is for the states that have passed legislation to form a governing board that will certify that states comply with the requirements of the streamlined project. Commissioner Chumley expected this would happen in November.

For example, Texas and Washington have failed to adopt the destination sourcing provi­sions and may not be certified as in compliance. Several business groups are watching the governing board that decides if a state complies with the streamlined provisions. In a volunteer system, sellers who are voluntarily col­lecting sales taxes for a participating state that is found to be no longer in compliance may decide to stop collecting taxes for the expelled state.

For Tennessee, the following had to be reconciled to the streamlined uni­form definitions and concepts: 

• the current 19 tax rates had to be dealt with in some way in order to comply with the agreement’s sim­plified rate structure requirements; 
• the differing tax bases had to be changed so that if a sale is subject to state sales ta x, it must be subject to local sales tax; and 
• destination sourcing. 

Currently, Tennessee uses origin sourcing to calculate sales tax. For example, office supplies from Murfreesboro dealers delivered to Nashville are taxed at the higher Rutherford County rate, and Rutherford County gets the tax revenue. Under the streamlined agreement, clothes shipped from Cool Springs Mall in Franklin to Murfreesboro will use the Murfreesboro city rate, and Murfreesboro gets the tax revenue. The commissioner said 14 notices to industries on sourcing were in the draft stages.

The legislature made the choice to leave common carriers and aviation at lower rates. Common carriers will get a self-pay permit that will allow them to report at a special rate. These are two examples of what will become “privilege taxes” instead of sales and use taxes to protect reduced rates. A practitioner asked about credit for paying tax in another state on tangible personal prop­erty that will become subject to a privi­lege tax. For example, if aviation fuel is purchased in Kentucky and tax is paid to Kentucky, will the Tennessee taxpayer receive credit for the Kentucky taxes paid against the Tennessee tax due if the aviation fuel is brought into Tennessee for use? At this time, it appears this question is unanswered by the streamlined provisions.

Business interests have pushed the National Conference of State Legislators to make the cost of compliance with streamlined provisions minimal. The current streamlined provisions require vendor compensation for non-nexus reporters of sales tax. The commissioner mentioned that this might bring a return of vendor’s compensation to Tennessee’s sales and use tax system.

Also mentioned was that PriceWaterhouseCoopers was retained for a study on the costs of collection. 

A simplified audit process under the Streamlined Sales Tax Law is being developed. Several states may audit the vendor at the same time. 

Tennessee taxpayers will have four choices in complying with the stream­ lined tax provisions as follows: 

• Model 1 has a certified service provider, compensated by the states, providing all of the seller’s sales tax functions, and the use tax is reported separately; 
• Model 2 has the seller using a certi­fied automated system to perform only tax calculation function, and the seller reports and remits on its own, 
• Model 3 has the seller using pro­priety software certified by the states collectively to calculate the tax due, and the seller reports and remits on its own; or 
• continue to report without the use of special software. 

The fourth option will be the choice of many smaller Tennessee taxpayers who do not ship to other counties or states on a regular basis. The commis­sioner said that the “mom and pop” vendor would only see a different form. 

Implementation by the TDOR includes the following: 

• A policy team is going through the new law and the streamlined provisions 
• Privilege tax forms are being created 
• Sales tax forms are being changed 
• An education program is being developed 

There will be one return per state. Therefore, Tennessee’s location-based filing system will have to be changed.

The commissioner said the U.S. Senate was marking up the Internet Tax Freedom Bill that deals with Internet access. Tennessee was grandfathered out of the current bill and has been able to tax access charges. The U.S. House has voted to extend the Internet Tax Freedom Act, but remove the grandfathered states. According to the commissioner, this would cause a reduction of about $18,000,000 in revenues from the telecommunications tax.

Reagan Farr, assistant commissioner, announced that the sales and use tax return could now be filed online. By filing using the Internet, the return is automatically loaded into  RITS (the TDOR’s computer system), reducing keypunch errors. Mr. Farr encouraged the use of ACH payments and said a system to use credit cards was being considered. Legislation must be introduced next year to allow the use of credit cards.

Members of the committee suggested a system for filing Hall Income Tax returns electronically, using tax preparation software. Beginning Jan. 1, 2004, taxpayers consistently liable for more than $10,000 per month in sales and use tax who in the past must have paid in readily available funds must file electronically. The penalty is $500 for each instance not paid electronically. The TDOR is sending instructions to the 4,500 enti­ties identified that will need to comply with this change. 

Mr. Farr also discussed the change in the safe harbor for franchise and excise tax estimated payments to the lesser of 25 percent of the prior year per pay­ment or 25 percent of the current year’s tax. A notice discussing this change is on the TDOR’s Web site. 

The headquarters creditor sales tax has ended, according to Mr. Farr. The new statute, effective July 1, 2003, requires expenditures of $50 million in a headquarters facility or an investment of $20 million with the creation of 200 new jobs at an average wage, double the higher of the county or metropolitan statistical area average wage used for a minimum of ten years. The credits effectively lowers the tax to the local option tax on “qualified tangible personal property” used in the headquarters facility.

Mr. Farr said the loophole for banks has been closed, and the TDOR expects banks to report investment subsidiaries on their 2003 returns. The effective date is Jan. 1, 2003. Therefore, subsidiaries in existence any time after Jan. 1, 2003, must be shown on the return. 

The ruling in the Exxon case that the TDOR was in error in deciding that one of the largest businesses in the world was inadequately capitalized was dis­cussed at length. Mr. Farr said the case may be appealed, but a decision has not been made on how to proceed. 

David Gerregano, the new general counsel, reviewed the following cases. 

Except as otherwise noted, each of these cases is subject to appeal. 

AT&T Corp. v. Johnson – the Court of Appeals ruled that sales of telephone central office equipment did not qualify for the industrial machinery exemption, ruled that engineering services were part of the sale of the central office equipment and, thus, subject to sales tax, and decided that the Chancery Court did not have jurisdiction on a claim for refund when the taxpayer did not file a formal claim for each of the years. Permission to appeal was denied by the Supreme Court. 

BellSouth Advertising and Publishing Company v. Johnson – the Tennessee Supreme Court ruled, reversing the lower courts, that the taxpayer could take credit for an Alabama sales tax paid on photocompositions against use tax paid on telephone directories. This is the final decision of the Supreme Court. 

McLane Company, Inc. v. State of Tennessee – the Court of Appeals ruled that the list of licensed tobacco whole­ sale distributors was controlled by the taxpayer confidentiality provisions of the revenue statutes. By law, the names of tobacco manufacturers, but not tobacco wholesalers, are listed on the TDOR’s Web site. Permission to appeal was denied by the Supreme Court. 

T&T Corp. v. Johnson – the Chancery Court upheld the separate entity con­cept in a franchise and excise tax case, and the taxpayer was not entitled to industrial machinery credit. 

Willard Dixon d/b/a Belle Acres v. Johnson 

• the Chancery Court ruled that pro­ceeds from playing illegal video poker machines were subject to sales tax. 

There is no exemption from sales tax because the machines are not coin-oper­ated amusement devices. 

Norandal v. Johnson – in an industrial machinery exemption case, the Chancery Court ruled that a machine used to regrind rollers in an aluminum foil manufacturing plant was used for maintenance and is not exempt as industrial machinery. 

 Eastman Chemical v. Johnson – the Chancery Court agreed in another industrial machinery case, the court agreed with the taxpayer that a catalyst was exempt. 

 Land of Sun Dairies v. Johnson – the Chancery Court ruled that cleaning solu­tions were not exempt as industrial machinery because they were not part of the actual production and that milk crates were not exempt as packaging. This case was not appealed . 

Prodigy Services Corporation, In c. v. Johnson – the Court of Appeals affirmed the lower court’s ruling that Prodigy’s service, which allows the subscriber to access information and perform certain functions through the Internet is not a taxable telecommunication service. This ruling may be appealed by the TDOR. 

Garris v. Johnson – the Chancery Court ruled that interest was due on a state tax refund where the claim was filed, there was a dispute with the IRS and the TDOR waited to issue the refund until the dispute with the IRS was resolved and the proper amount of the claim could, therefore, be established. This ruling is being appealed. 

Patsy Clark, director of Taxpayer Services, commented that the predictive dialer program in the last six months has corrected 85 percent of the new balance cases before they became an enforce­ ment case. The predictive dialer pro­ gram is very cost effective and allows the collection of delinquent taxes in the service area. 

During the fiscal year ended June 30, 2003, the TDOR generated and mailed 244,716 notices. This was a larger number than usual because of the 2002 tax reform.

Ms. Clark stated that the TDOR was currently working on an online state portal registration for business taxes. Hopefully, this program will be opera­tional on or after Jan. 1, 2004. 

On Aug. 1, 2003, the TDOR imple­mented new image scanning equipment for registration application and changes. This should expedite the processing of registration application and changes on RITS. 

Informal conference requests allow the TDOR to file a lien on the taxpayer, but not a levy. The commissioner said keep­ing the informal conferences within the TDOR improves the consistency in the TDOR’s actions. 

Amy Green, the manager for inheri­tance and gift taxes, said a new program from the IRS is matching data from the payers of interest and dividends to Hall Income Tax returns. Of the first batch of 500 letters sent to non-filers from 1999 processed on July 11, 2000, 250 have responded in some way. They are trying to refine the process and also eliminate letters on bank interest. Ms. Green noted that the return of capital rules for Hall Income taxes do not follow the federal rules. 

Commissioner Chumley announced that Bill Trout would be the new assis­tant director of taxpayers services. In addition, Christine Lapps will work part-time in legal to assist in litigation, and Costin Shamble, a new attorney who started on Sept. 16, 2003, will assist in getting the letter rulings processed quicker. The commissioner closed by saying she was excited about the management team for the TDOR.

Jim Matheny, of the Department of Labor and Workforce Development, discussed the questions about the differences between the quarterly filings required for household employees for unemployment taxes and the annual filing required on Schedule H of the Form 1040. There were approximately 1,200 unemployment claims per year for household employees. Because the “goal is to get the claimant paid timely,” Mr. Matheny said quarterly filing was needed to determine the benefit level.

Employers could see a change in tax rates because the balance in the fund will drop. There will be no change in the rate for new employers. Mr. Matheny noted that new manufacturers now have a rate higher than for other new employ­ers at 7.5 percent, effective July 1, 2003. 

Mr. Matheny noted that the access numbers were the biggest problem with the Tennessee Premium and Wage Reporting System (TNPAWS), and the TDOR is working on possible solutions. He also said that paper returns do not update the TNPAWS system, so the year-to-date information must be updat­ed by the user. 

Kirk Low. Tennessee CPA Journal. January 2002.

The Tennessee Department of Revenue (TDOR) has removed the penalty from franchise and excise tax returns that receive an assessment because of estimated payments that did not meet the one-time require­ments for the tax years beginning on or after July 1, 1999, and before July 1, 2000, that the amount of each estimated payment be the greater of 25 percent of the combined franchise and excise tax liability for the preceding tax year, annualized if the preceding tax year was for less than twelve months or 25 percent of 50 percent of the franchise and excise tax liability for  the current tax year. The interest due will continue to be assessed. This change should allow practitioners to advise clients to pay the interest due and request abate­ment of the penalty by telephone. 

At the TSCPA State Tax Committee Meeting on Nov. 16th 2001, Commissioner Ruth Joluson said the Tennessee Department of Revenue’s budget requests for the upcoming legislative session will be similar to last year’s requests. Key items in the improvements requested include the following.

• Adding 16 part-time clerks in pro­cessing to cover the peak periods 
• Overtime for processing personnel 
• Six additional positions to set up an electronic commerce system 
• A computer operations manager 
• An image processing system and support positions to isolate the mailroom from the rest of the TDO R 
• Additional Tax Enforcement Division positions for the “Predictive Dialer” program 
• Attorney positions to increase the number of hearing officers and provide staffing to speed respons­es to requests for revenue rulings 
• Additional positions in Special Investigations 
• Increases in the Audit Division including setting up technical positions and increasing travel allowances 
• Equity funds to upgrade positions in the Audit Division. 

During the last year, 45,000 new tax­ payers were added and personnel had to be pulled from other divisions to meet the processing deadines. 

Commissioner Johnson noted the TDOR was losing middle management staff and several of the improvements are targeted at retaining experienced employees. 

The commissioner also reported that since July 1, 1999, 132 lawsuits have been filed against the Department of Revenue. Of those, 53 (40 percent) went through the informal conference process. The 53 informal conference decisions that went to the courts were 10.5 percent of the 505 conference deci­sions since July 1, 1999. With approxi­mately half of the informal conferences resulting in no change in favor of the taxpayer the low number of court deci­sions shows that many cases were set­tled. Commissioner Johnson also report­ed the Department of Revenue was hav­ing difficulty getting cases to the Tennessee Supreme Court level. 

Responding to the committee’s ques­tion, “If an individual income tax is adopted, what state’s laws and  rules will be used as a pattern?” Deputy Commissioner Mike Cole said that no particular state had been identified. The TDOR has looked at Connecticut, North Carolina, and Ohio as examples but rules have not been developed.

Additionally, the best practices identi­fied by the Federation of Tax Administrators will be used in developing the, rules if the tax is adopted. Cole stated that the TDOR expected two million additional returns if an individual income tax was adopted, plus withholding returns from 150,000 employers and estimated payments from 350,000 self-employed individuals. The TDOR will request 375 to 400 new employees, approximately a 50 percent increase in staffing, to handle the tax, adding to the processing and taxpayer services areas if the legislation is passed. TDOR staff estimated that a lead-time of six months would be needed as a “bare minimum” for implementation of the new tax with the hiring of new staff being critical. 

The franchise and excise collections were negative in October 2001 as enti­ties requested refunds of estimated pay­ments in excess of the actual tax due. A comparison of the franchise and excise tax returns from Sept. 15 through Nov. 14 for the last two years is found in Table 1 above. The increase in the num­ber of returns filed was due to the first time filings of the limited liability enti­ties. 

A tour of the processing of tax returns saw automation in many areas, but the processing remains a very labor-inten­sive operation. Processing starts with the sorting of mail. Use of the envelopes supplied by the TDOR or using the complete nine digit zip code directs the return and payment to be opened as part of a batch of similar returns, thereby reducing mistakes. Example 1 on page 30 lists the zip codes that practitioners ­should use. 

The processing of Hall Income Tax returns is one of the more manual operations. Only one percent of the Hall returns are filed on the TDOR’s forms. The TDOR mailed the Hall forms for 2001 in November, but likely will not mail the forms in the future. 

Patsy Clark, director of Taxpayer Services, stated the account number was not necessary for the Hall returns. Because the Hall returns must be completely keyed to get the data into the system, the account number is not required. 

Additionally, the TDOR demonstrat­ed an “e-filing” Internet application for the Hall returns . The application is intended to allow taxpayers to enter and submit the Hall return over the Internet. A coupon would be printed to accompany the remittance. The State Tax Committee formed an ad hoc com­mittee to meet with the TDOR and state Web site developer to assist in the development of this application. The TDOR is looking at “e-filing” applications for the professional fees, franchise and excise tax extensions, and franchise and excise tax estimated payments. Loren Chumley, director of the Audit Division, would not discuss the audit selection process, but did say that all assignments where made out of Nashville. She said that recent audits found problems in the following areas:  

• Making exempt purchases without an industrial machinery exemp­tion 
• Differences between Schedule C on the franchise and excise tax return and sales tax filings 
• Confusion on bundled transactions 
• Software. 

The TDOR has collaborated with Tennessee’s print fs on an industry guide and is currently working on a guide for the security systems industry. 

The “predictive dialer” has been successful. The TDOR has decided to keep this program that replaced the second notice with a telephone call from Taxpayer Services. Between the start of thjs program on Oct. 26 and Nov. 16, a total of 19,980 cases had been closed. 

The 14 employees are concentrating on low balance, new balance and out of state issues where there has been no response to the first notice. It is expect­ed that 20,000 calls per month will be made in the future. Telephone calls to Taxpayer Assistance have decreased because the second notices are not being mailed at the same rate as before this program was initiated. 

During the year ending Dec. 31, 2000, the Department of Revenue processed the returns and payments in Table 2 on page 30. In a discussion of the notices present­ ed by the committee as problems, Patsy Clark stated the following: 

• The penalty on the Hall Income tax and the franchise and excise tax is calculated at 5 percent per 30-day period 
• All “heads down “data entry is now being verified to reduce the number of notices 
• Additional edits have been added to the system to reduce the num­ber of notices 
• Processing equipment has been upgraded 
• The TDOR will review the Inheritance returns lack of a provi­sion for a refund 
• Envelopes are retained for all fran­chise and excise tax returns and late filings of sales tax returns 
• The “mathematical discrepan­cy… ” description on the notices will be removed as of Dec. 1 
• The change in account numbers of franchise and excise tax accounts that caused overpayments from the prior year not to be applied to the next year in all cases was a one-time occurrence and should not happen again. 

Responding to questions about the lim­ited liability entities that are exempt from the franchise and excise taxes because of family ownership and pas­sive investments, Arnold Clapp, direc­tor of Legal Services for the TDOR, said that a son-in-law would only qualify  as a family member if the daughter  also had an ownership interest in the entity. The first year that a limited liability entity is exempt from the franchise and excise tax, a letter detailing the percent­ age of income from passive investments and the ownership should be sent to the following address: 

Tax payer Services 

Tennessee Department of Revenue Andrew Jackson State Office Building 500 Deaderick Street 

Nashville, Tennessee 37243 

Beth Chapman of the Unclaimed Property Division of the Treasury Department explained the amnesty pro­gram that eliminates the penalty for filers that come into compliance by May 1, 2002. Chapman said 29 percent of the unclaimed property collected was returned to Tennesseans and $17 mil­lion was reverted to the General Fund. 

Linda Bell of the Department of Labor and Workforce Development said that 99 percent of the employment security audits were random to meet the requirement that two percent of the accounts be audited each year. If an account has “an abundance of wage protests,” that employer may also be audited. The auditors are looking for excess wages not reported, misclassified workers and sole proprietorships reporting relatives. 

Bell also said there was a chance that unemployment rates would increase next year. An Internet reporting applica­tion for employers with 25 or less employees is scheduled to be in the pilot phase during the first  quarter of 2002. In a discussion of industry stan­dards, Bell said that if the industry stan­dard did not fit the law, the industry standard was not used. 

Audits are normally completed with­in 90 days, but could take up to a year because the auditors have several other responsibilities. If there is a difference that cannot be resolved with the auditor, an informal conference may be request­ed before going to the more structured appeal procedures. An exit conference should be held by the auditor at the end of each audit. 

Kelsie Jones, the Executive Secretary for the State Board of Equalization, said the lawsuits by several counties contest­ing the board’s 15 percent reduction in the assessments of utilities, railroads, and airlines are continuing to the Tennessee Supreme Court. The audits of tangible personal property continue and all counties now have an approved plan. 

In a discussion of the legislation from the last session and issues he sees being addressed in the near future, Jones said the following: 

• He hopes the defining of when materials leave inventory and become work-in-process can be clarified by a rule 
• Consistency in the appeals process is needed · 
• A manual on tangible personal property is in the early stages 
• The assessor in each county has the final call on an assessment 
• Legislation passed in the last ses­sion made the tangible personal property in vacation homes tax­ able if three or more are owned in the same country 
• There may be an effort in the next session to offset the under valuations of some groups of the tangible personal property 

Jones also said that a rule might be pro­ posed to make the assessment of software as tangible personal property conform to the TDOR’s definition of soft­ware. Currently, only operating soft­ ware (for example, DOS and Windows for PCs) is taxed and application soft­ware (for example bookkeeping soft­ware) is exempt. 

At the close of the meeting, the committee reviewed the progress made since the last meeting noting the delay of the implementation of the “predictive dialer” pilot so that practitioners could be informed of the change. Also, the end of the “mathematical discrepancy” on the notices will remove the inference that practitioners have made a computation error. The request for an ad hoc group to aid in the “e-filling” effort for the Hall Income tax returns is an additional step to better communication between the TDOR and CPAs.

 

Kirk H. Low. Tennessee CPA Journal. April 1999.

A tax bill arising from the TSCPA State Tax Committee is now on the governor’s desk for signature. Cooperation on  tangible personal property issues between Tennessee’s count tax assessors, the auditors under contract with the assessors, the practitioners, and taxpayers will be enhanced by recent amendments to Tennessee Code Annotated, Title 67, Chapter 5, Part 4, entitled “Providing Confidentiality for Property Tax and Taxpayer Information.” Effective July 1, 1999 information supplied by taxpayers to assessors will become confidential except for the tan­gible personal property return.

In Tennessee, real property records are open to the public.  Confidentiality of tangible personal property records was not a significant issue until the set­tlement between the public utilities and airlines against the Tennessee State Board of Equalization. This settlement required the State Board of Equalization to increase the number of tangible prop­erty audits conducted. County assessors began requiring property schedules to be attached to returns. As a result, key financial information is now being requested by the auditors including copies of Tennessee franchise and excise tax returns, working trial balances, charts of accounts, depreciation sched­ules and lists of leased equipment.

The new law will limit access to the tangible personal property records to the following:

1. the taxpayer or the taxpayer’s designee,
2. individuals with a court order allowing access,
3. the assessors and their employees
4. the auditors employed by the asses­sors, and
5. child support enforcement staff. 

The Tennessee State Board of Equalization will develop rules on the disclosure of tangible personal property information.

This legislation brings the confiden­tiality of tangible personal property records in line with the requirements imposed upon the Tennessee Department of Revenue except that the tangible personal property return remains public. In keeping the return as a public record, the Tennessee Legislature allowed the public to see the amount and relative age of property reported, but not the details of what the company actually owns. However, because leases are listed on the back of returns, the details on leased property would be available to the public.

Communication between the asses­sors and practitioners will improve by these changes in the law. Practitioners will be able to provide information to assessors that, in the past, had to be lim­ited to protect the client’s records.