Capital Goods - August 2008

Muzzling the tax bite
By Scott Mooneyham

Seven years ago, North Carolina lawmakers were starved for cash. A slowing economy put the state budget temporarily in the red, leaving a shortfall exceeding $1 billion. Legislators responded by turning the dogs loose on tax scofflaws.

The dogs seem to be out of control. Small-business owners have come to legislators with horror stories of being billed for uncollected sales taxes based on what they say are changing interpretations of law. Audits of 20 interior-design firms — based on an interpretation that purchase of tangible goods, such as lamps or couches, meant that subsequent design services should be taxed as well — led to assessments between $8,000 and $200,000. Bakeries were told they should have been charging retail customers the 6.75% sales tax for prepared food on loaves of bread that, sold in a grocery store, were taxed at the 2% rate for unprepared food. One Wake County baker was sent a bill for $130,000.

Legislation to leash the tax man, and potentially forgive large portions of those back taxes, will be one of the hallmarks of the 2008 session. It’s a rare occasion when you see a large group of legislators receive more than polite applause. But when a Senate committee recently made clear its overwhelming support for one of these bills, a crowd of bakers and interior designers whooped and cheered like fans at a football game.

Still, it’s worth noting how we got here in the first place. Those heroes in the committee meeting room that day, to some degree, bear responsibility for the small-business owners’ tax woes. David Hoyle, a Gaston County Democrat who co-chairs the powerful Senate Finance Committee, oversaw a lot of those stepped-up collection efforts. Now he’s sponsoring the legislation to clarify sales-tax laws for bakers and forgive back taxes for several classes of small-business owners. Another bill ensuring that interior-design services aren’t taxed also moved through his committee. “I certainly don’t think I voted for any of the types of taxes being assessed on these people. If I did that, it wasn’t my intent,” Hoyle says. Few legislators expressed reservations when Project Tax Collect was born in 2001. They gave then-Secretary of Revenue Norris Tolson the ability to assess 20% late fees — in addition to the existing 10% penalty — on delinquent taxpayers. The fees went to hire 52 more tax collectors. People who owed more than $5,000 saw their names published. In 18 months, the department collected $187 million in back taxes.

Two years later, legislative budget writers had so much confidence in Tolson and the Department of Revenue that they spent $112 million they anticipated would be collected as part of a new initiative focusing on multistate corporations. Project Compliance went after companies improperly claiming tax credits or using avoidance schemes to shift revenue earned in North Carolina to states without corporate-income taxes. The effort included action against mall retailer The Limited, which had been shifting revenue to Delaware by making royalty payments to an affiliated holding company. After the state won a lawsuit, other companies using the same scheme settled up, bringing in more than $50 million to state coffers.

In 2005, after three years of planning, North Carolina and 12 other states launched the Streamlined Sales Tax Project to pressure Congress into passing legislation that would allow states to collect from Internet vendors (something that still hasn’t happened). States had to make their sales-tax laws more uniform so that Internet merchants wouldn’t have to sort through 50 sets of laws to determine when to tax what. One result: more stringent sales-tax definitions that left bakers and interior designers with fat bills for uncollected taxes.

Revenue officials say they applied the law correctly to bakers and interior designers. “My personal view is that we don’t have a ‘gotcha’ mentality,” Revenue Secretary Reggie Hinton recently told legislators. Hoyle, though, says small businesses trying to follow the law as they understand it shouldn’t be left with tax bills that could put them out of business. “[Revenue officials] are looking for the low-hanging fruit. It is wrong what we’ve done.”

The fruit is really hanging about midtree. Those additional tax collectors got the low-hanging stuff a while ago. And plucking the delicious morsels on the upper branches, with tax lawyers and accountants working to make sure they remain untouched, looks like too daunting a task. Legislators, though, never figured out that this army of new tax collectors they had formed would keep turning an eye to different parts of the tree.

Scott Mooneyham is the editor of The Insider,

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