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The State of New Jersey has a certain, shall we say, reputation with tax folks. Not only are they one of the most taxpayer-unfriendly states, but the bureaucracy to fix one of their many mistakes makes you want to jump out the window.

New Jersey is one of the states (along with West Virginia) leading the charge to change (read: expand) the kinds of companies that the state can legally tax. I won’t bore you with the details, but the US Supreme Court ruled twenty years ago that a business had to have a physical presence in a state (employees, buildings, etc…) before a state could make the business remit sales taxes. This is why you don’t pay sales taxes when you make purchases at Amazon.com, though you should be paying what’s called a use tax to the state. This case was generally seen as mandating a physical presence standard for all state taxes until about five years ago when several states decided that they didn’t really like the ruling and were going to begin ignoring it for everything but sales taxes.

Part of the pushback was due to companies setting up various tax structures to generate deductions in states and shift income to states like Delaware and Nevada, which either don’t tax corporate income or make it easy to avoid corporate income taxes. This idea that states can tax companies that are “exploiting local markets” without a physical presence started out attacking these structures, but some states have gotten a lot more aggressive.

In this case, under sworn testimony in Congress, the State of New Jersey threatened to impound a truck from a company that it claimed owed taxes under this economic nexus theory. The company was delivering boats into the state both via common carrier and via its own fleet of trucks. The company thought that it was protected under Federal law (ed: they probably aren’t due to the deliveries from their own trucks) from having to file returns in states other than South Carolina, where all manufacturing and back office functions are performed. The State of New Jersey believed otherwise and seized the vehicle and driver. I’ll let Mr. Godwin pick up the story from there (warning: pdf link).

On July 23rd, 2007 I received a call transferred over from our truck fleet dispatcher at 10:15 am. The person on the other end was Ms. Kostak, a revenue agent for the State of New Jersey. I was immediately told that our truck had been pulled over at the weigh station on the interstate highway and could not move until we paid New Jersey for jeopardy assessment taxes. I asked Ms. Kostak why they were doing this. I was told that we had a dealer in the state of New Jersey. This incident was becoming unbelievable, so I asked her to fax me proof that she was who she said she was. I asked what I could do to let the driver go and I was told to pay the New Jersey Division of Revenue money. I asked how much and I was told it depended upon our sales into New Jersey. I looked up the sales for the past seven years as requested and Ms. Kostak quoted me a price of $46,200 to release the truck. I then told her I would need to discuss the issue with our company president. Ms. Kostak told me I had until 1pm that day to get them the money or the truck would be impounded and we would need to make arrangements to retrieve the driver. I asked her, “Can I not send you a check or work something out to let the truck pass through New Jersey?” and I was told to wire them the money.

I first talked to our truck driver and asked him what had happened. Our driver was passing through the State of New Jersey carrying a load of boats for delivery into Massachusetts. Our driver told me that the agent pulled his rig over at the weigh station and asked him if we had a boat dealer in New Jersey. The driver had
never delivered into New Jersey and told the agent, Ms. Kostak, that he did not know. (Our driver told me that there were ten other trucks stopped at the weigh station for the same interrogation.) Because he did not know whether we have a New Jersey dealer, he gave Ms. Kostak our home office number and the dispatcher’s name. Ms. Kostak called our dispatcher and found out that we have a dealer in New Jersey, asked more probing questions and then was passed over to me.

After talking to Ms. Kostak, I discussed the situation with our company president. We decided to call another boat manufacturer who also had been stopped by a New Jersey revenue agent while transporting boats through New Jersey. Their company president of told us that his boat company had spent over $140,000 in legal fees and the issue was not yet resolved after two years. We were also given contact information for the company’s attorney. I contacted the attorney to find out our options. The attorney was not encouraging and did not feel we could win against the State of New Jersey. The attorney told me that it was very likely that unless we paid the amount requested, our trucks would be stopped each time thereafter in New Jersey. The attorney suggested that we pay the amount demanded and then appeal in the tax courts of New Jersey. After consultation with our company’s president, we decided to pay what Ms. Kostak demanded so that we could free our load of boats to be delivered and let our driver go.

…

When our truck crossed the New Jersey state line, Stingray did not have an outstanding issue, warrant or any other legal matter or business activity with New Jersey. If fact, the State of New Jersey did not know we had an independent dealer in the state. Ms. Kostak gathered “evidence” along the way to invoke a jeopardy assessment against Stingray. The manner in which the State of New Jersey acted is commonly defined as extortion. Fortunately, I have never been the victim of a crime in my life. But, that day in July, I believe I was strong-armed by a state of the United States of America.

I know it’s long, but the story really is unbelievable. Instead of simply getting the information from the driver and sending an audit notification, the State believed that it could impound the truck without determining guilt or innocence first. While I don’t believe that the company was protected from filing in New Jersey, it doesn’t excuse the fact that the State of New Jersey threatened to break the company’s legs take the company’s property unless it paid a certain amount of money within several hours. It really does boil down to extortion and the State should be ashamed of itself (though I’d imagine the agent was probably promoted).

Aggressive tactics such as these is really the reason that the relationship between company tax departments and state auditors have gotten so strained.  Yes, there are companies that bend the rules beyond recognition, but auditors are making no distinction between them and the companies that believe they are doing right and assuming that all companies are cheaters. Pressure from politicians to find more money (especially from out of state companies) is only aggravating the problem.

Now, Congress wants to get involved in the whole mess after the US Supreme Court denied cert. to two tax cases that would have solved this whole mess. Unfortunately for Stingray, the fix from Congress wouldn’t help them (even though this testimony came out of a hearing for the bill).

I believe that requiring a physical presence is a nice bright line, but it ignores reality. In a digital world there is no reason that companies that have sales in states without physical presence shouldn’t be taxed on those sales. Is Amazon.com using the Missouri market to make money? Yes, so they should be paying taxes here. The physical presence requirement worked well in a manufacturing economy, but like so many things in the tax and law realms it has become a golden rule that simply no longer makes sense. Strongarm tactics from the states aren’t the answer either, we still have to follow Constitutional procedures. This wasn’t a coke dealer taking a shipment, it was a well known boat manufacturer trying to deliver something to Massachusetts.

I’m not sure of the answer. Maybe economic nexus is the way to go. Maybe we still need the physical presence standard to avoid situations where states resort to measures such as these to get money it thinks it is owed. Maybe we need to scrap Federalism in the tax concept and go the way of many foreign countries where the Federal government administers the tax programs for the states and allocates the money appropriately. Who knows, but there has to be a better way than this.