CFOs Struggle to Manage Complexities of State Tax Filings

Tax season might be over. But then again, there’s always next year.

As Wendy Walker, solution principal at Sovos, told PYMNTS, the complexities of tax reporting will still demand that organizations of all sizes gear up for changes in the tax code and rigorous reporting requirements that will always be fluid and complex.

But one thing is simpler: The IRS’ Combined Federal and State Filing program seeks to simplify some of that complexity by taking things online. As Walker told PYMNTS, direct state reporting takes place — as the name implies — when an enterprise files 1099 tax information directly with a state government.

“Generally speaking, if you are required to issue a 1099 to the IRS, there is going to be a state requirement as well,” she said.

Tax laws require that states use most of the information contained in 1099s, W-2s and other returns that are filed with the IRS to compare income and withholding amounts on state income returns.

Although state tax reporting is nothing new — it’s been around for decades — Walker noted that enforcement has seen some renewed vigor in terms of making sure that all the information matches up. Missteps or failure to file those forms with the states winds up having consequences, chiefly in the form of penalties.

“Sometimes states have a per-failure penalty rate, so they will charge a certain dollar amount for each information return that has not been filed,” she said. “Other states will levy penalties based on the income reported on the returns that were not filed.”

“There can be pretty stiff penalties, depending on the state,” she added.

Amid the stepped-up enforcement, complexity reigns too. This is becoming more apparent as states lower direct-reporting requirements below IRS thresholds. Walker offered the example where some states now require direct reporting of Form 1099-K for transactions done through online apps such as Uber and DoorDash at a $600 threshold, while the IRS only plans to lower the federal threshold to $5,000 for 2024 reporting.

Although the IRS’ combined filing program seeks to allow states to file information with the IRS — and the IRS shares the info with the states — the fact remains that the IRS does not (yet) support all the information that states require. California, in just one instance, requires information returns for cancellation of debt that are not included in the combined program.

“So, if you are in California, you would have to file those returns directly with the state instead of being able to rely on the IRS,” Walker said.

In other cases, some states are listed as participating in the combined program, but their websites say that companies must file directly.

“This can all get a bit confusing,” Walker said.

Add in the fact that the rules change frequently, well into the first months of the year, and some states still accept paper filings (while others have pivoted only to digital channels), and companies must find ways and means to make sense of it all and reduce their tax reporting burdens.

Relying solely on the states’ systems may be a hurdle to easing those pain points, as only two-thirds of states have fully modernized their tax reporting systems, which means a sizable percentage of states have not.

“Some states are in the early stages of testing those new systems, so the impact of the technological changes are not yet known,” Walker said.

Companies should examine the benefits of partnering with providers such as Sovos to streamline connectivity and compliance, while outsourcing the burden of keeping up-to-date on the constantly shifting tax reporting landscape, she said.

“Having a provider that can ingest the data, transform it into various state tax outputs and into the IRS combined federal and state filing formats takes on that burden for your organization instead of you doing it all yourself,” she said.

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