Associations and membership organizations: Preventing nexus from becoming your nemesis

True or false? Nonprofit associations are exempt from sales tax.
Answer: It depends.

Nonprofit nexusLike most not-for-profit organizations, a nonprofit association that falls under IRC 501(c)(4), (c)(5), (c)(6) or (c)(7) may think it is exempt from taxes, but in most states, as a non-IRC 501(c)(3) entity, its association status will actually give rise to many tax issues. Certain activities create an obligation for an association to file and pay sales, property or employment taxes. For some association activities, there’s no avoiding the nexus issues that create a taxable obligation, so it’s best to learn about growing regulatory demands and the associated tax risks, and be prepared to file returns and pay applicable taxes.

States have become serious about collecting taxes Tax laws are changing as state and local governments seek ways to make up for revenue shortfalls that began with the recession and have accelerated through the advancement of the online marketplace. Where previously nonprofit associations were permitted to conduct business away from their home states without the complication of out-of-state taxes, in some states, associations are now required to register, file and pay state taxes for certain regularly occurring activities.

There is no uniform set of state taxation laws. Each state may impose taxes on products or services sold in that state, and each state, county and city may set its own tax rate and taxation parameters. Besides the variations in taxation, some states have no statute of limitation on collection for nonregistered entities. This, together with their tendency to be unforgiving and disinterested in negotiating, constitutes an association’s biggest risk.

Understand your nexus footprint
Each jurisdiction has its own rules about the level of activity that triggers nexus. There are a number of factors associations should consider in determining whether they have nexus within a state. For sales tax purposes, nexus is triggered when an entity has “substantial nexus,” which has traditionally been interpreted to mean a physical presence in a state. A physical presence can be achieved in a number of ways, including but not limited to having employees, independent contractors and property (real or personal) in the state. However, the organization does not need all of these items to have nexus; just one can create potential issues. Additionally, nexus does not automatically mean that the entity is making taxable sales; it simply means the entity has a potential obligation to register. For associations, two of the largest potential sources of nexus taxable activity are sales and use, and income.

Determine what is taxable
Sales tax can be imposed on numerous sales transactions that are part of a tax-exempt association’s day-to-day operations, including:
  • Merchandise sold online
  • Digital content (e.g., training or conference videos)
  • Software applications
  • Database access
  • Training materials
  • Journal subscriptions — printed or downloadable
  • Membership dues
  • Advertising

Participation in a trade show, seminar or conference can trigger sales tax; when the cost of materials is not broken out from the attendance fee, the cost of the entire event can be taxed. Sales tax can also apply to publications sold at an event, online or via mail order. One of the greatest risks in establishing nexus in a state is that your sales tax liability can be extended to all sales or gross receipts, not just those limited to the initial event or activity, such as a one-time conference. Your association may be required to collect and remit sales tax on all taxable sales in that state.  

The commonly held belief that tax-exempt organizations are not subject to sales taxes is false in more than 45 states, as well as in numerous county and city jurisdictions, and Washington, D.C. There are a variety of sales tax laws that include both online and physical sales. Payroll taxes can additionally be imposed when employees, independent contractors or third parties work in the jurisdiction, or the association regularly and systematically solicits sales, even if no property is owned. The association must then pay taxes for each home-based employee in a jurisdiction and must generally withhold taxes for every jurisdiction to which employees travel.   

A nexus study is the core of your plan The key to managing your state and local taxes is getting a handle on activities and understanding the related taxes.  

First, take an inventory of activities and jurisdictions where activities take place.

Then, work with nonprofit state and local tax specialists on an initial nexus study, which is a custom analysis of the inventory and pertinent regulations. The nexus study will reveal your association’s risk exposure and potential tax liability and filing requirements, providing your organization with tools for planning and management decisions. If the nexus study discovers a history of noncompliance, your association can contact those noncompliant jurisdictions and — under a voluntary disclosure agreement (VDA) — offer back payment for a span that falls short of the period when taxes went unpaid. This option limits the tax to a few years versus all open tax years if the state has no limitation. The VDA program varies by state as far as the length of time an organization will need to go back, but it is typically three to five years. The program is widely accepted by states because organizations remediate past issues, become compliant with state laws, and provide tax revenues going forward. If you wait until a jurisdiction contacts you, it’s too late to negotiate.

Final steps begin with establishing a framework for internal dialogue among departments to keep tabs on activities (e.g., between program or conference departments and finance, or HR and finance). Create a business plan for tax filings to help manage risk or to move activities between states to diminish tax exposure or reduce taxation. In creating your business plan, determine if your association has nexus. Then answer the following questions: Does it plan to file in states where it has a presence, or wait for a state taxing authority to send a notice? Will it use resources internally or externally for any required filings? Does it have the right software to handle the filings internally?

Lastly, continually monitor regulatory activities and evolution in legislation, and work either internally or with external tax advisers to conduct periodic nexus studies.

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