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Senate tax practices committee holds first hearing

The Senate interim committee appointed to look into the treatment of taxpayers by the Missouri Department of Revenue got an earful Thursday from taxpayers – and no response from the agency or Governor Jay Nixon’s office. The official purpose of the Committee: “To investigate the process and policy used by the Missouri Department of Revenue to interpret, enact and enforce tax statutes and uncover potential conflicts or inconsistencies in the administration of tax law.”

Committee Chairman Senator Will Kraus was joined by fellow Committee members Senator Bob Dixon, Senator Ed Emery and Senator Paul LeVota. Associated Industries of Missouri President Ray McCarty was on hand to monitor the discussion.

Leading off testimony were representatives from Ace ImageWear, a company that provides uniform, linen and other services in the Kansas City area, regarding sales tax exemptions for items used in their business.

Company spokesmen said the company provides linen services, uniform services and other services by providing clean items for customers, collecting soiled items, cleaning and repairing those items and recirculating them through the process. Since enactment of the change in sales tax law that was championed by Associated Industries of Missouri in 2007, section 144.054, the “manufacturing inputs exemption”, the company had purchased chemicals, soap and other items used to process their uniforms and other products exempt from sales and use taxes. The company charges sales tax on the amount they charge for their services. The company pointed out they do not ask for abatements or other tax incentives, and were simply using the exemption that was provided for processing items as it was written in the law.

During an audit by the Missouri Department of Revenue, the DOR notified the company they would be charging them sales and use taxes on some of the chemicals and soap products they used in the process of providing their service for the previous three years. The company appealed that decision. The Administrative Hearing Commission (AHC) agreed with the taxpayer, but the Department of Revenue appealed the decision to the Missouri Supreme Court and won a decision that said that the chemicals and soap were taxable, resulting in a large sales tax liability for the company.

The spokesmen told the Committee officials in Kansas have been very aggressive in offering incentives to lure businesses to that state. He says some of Missouri DOR’s recent actions are putting the victim Missouri companies at a competitive disadvantage with other non-compliant companies in Missouri or companies in other states.

They explained to the Committee that DOR was relying on the Unitog case, an old case that held laundry equipment was not manufacturing equipment under the existing sales tax exemption at the time, section 144.030. They explained that since that time, the new sales tax law had been enacted, section 144.054. That section expanded the exemption so that the exemption should now include the laundry supplies used in this process. DOR rejected the argument and pursued all the way to the Missouri Supreme Court. The Court overruled the AHC saying “processing” and “manufacturing” meant the same, and “manufacturing” did not include laundry services. The court gave no recognition or weight to the new statute enacted in 2007, virtually ignoring the new exemptions granted under that section.

The taxpayers then argued if they were liable for tax, then tax should only apply once, not multiple times. The ruling meant the taxpayers would be taxed on the purchases of goods they used to perform the services and also on the services they provided. DOR rejected that argument, as did the Missouri Supreme Court. As it stands, laundries must pay tax on inputs and collect tax on services. Laundries that are not complying with law or those across state lines are able to enjoy a competitive disadvantage over those that comply with this new double tax reading of the statute.

The taxpayers concluded their remarks by asking the legislators to override the Governor’s veto of SB 612.

Sen. Kraus asked how DOR treated the company during the audit and why it took so long. Witnesses said they were not sure why it took so long. They said the state also added interest and penalties on the taxes, adding additional burden to them. Sen. Kraus asked if they were the first laundry to receive such a decision. One of the witnesses testified they were aware of at least one other industrial laundry that went through an audit and did not receive assessments for the same items in their audit.

Sen. Kraus pointed out SB 662, passed by the legislature and vetoed by Governor Nixon, would require DOR to notify taxpayers of changes in tax policy also before holding taxpayers liable for the policy changes.

Sen. LeVota asked witnesses if there was another industry that was similar to theirs that would have given them notice that they were supposed to collect taxes and the witnesses said they were not aware of any other similar taxpayers that had been charged taxes on the items before their case. They explained the legislature must have had a purpose in enacting the new law in section 144.054. Sen. LeVota said he would like to see the DOR interpreting the statutes going forward rather than assessing taxpayers and collecting back taxes.

The witnesses said they really hope the legislature overrides the veto, but if not, they will attempt to restructure so they will pay tax on inputs and try to avoid taxes on markup and services. Sen. Bob Dixon asked more details about the burden the DOR has placed on them with this effort and the taxpayers explained the state would get less tax money if they changed to only paying tax on their purchases because of the difference in markup and the prices charged for their services.

Sen. Emery asked about the back taxes. Taxpayers responded they will have to pay about $100,000 that will not be used for employee training, hiring, or growing their business.

The next witness was Charles Jensen with the law firm of Stinson Leonard Street addressed the Committee regarding the DOR’s practice of pursuing individual members of an LLC for tax liabilities of the LLC.

Mr. Jensen explained personal officer liability statutes can be used to pierce the corporate veil for income taxes and sales taxes and result in personal assessments against corporate officers that are responsible for filing and paying taxes. But he explained DOR treats LLC shareholders differently: all shareholders of the LLC can be held personally liable for the LLC tax liability, not just a “responsible party” and the DOR is assessing multiple participants in LLC’s. He has discussed it with the DOR and they are treating LLC’s as a general partnership, where all partners are liable, regardless of their level of involvement.

Sen. LeVota asked if Mr. Jensen is asking for legislation to change this tax procedure and if Mr. Jenson knew what DOR’s response would be to this type of legislation. Mr. Jenson said the fair way to handle this is the way it is handled for other types of entities – responsible parties within companies should be held liable, not all participants. Sen. LeVota said he suspects they will hear from DOR, as legislators regularly do on legislative issues, that the bill will cost a large amount of money to implement.

The next witness was Dianna Pfaff, owner of Miss Dianna’s School of Dance in Kansas City. Ms. Pfaff testified she has never collected sales tax on instructional fees because she is providing dance lessons with lesson plans like any other school. She told the Committee her school holds programs for mentally handicapped children and fills out a census as a school, just like any other school. Says she was audited by DOR and they billed her $73,000 in sales tax on her instructional fees that has now grown to more than $87,000. She appealed to the AHC immediately and has received continuances, hoping the veto of SB 584 is enacted over Governor Nixon’s veto.

She said they are facing some of the same issues as the first taxpayer: direct competitors are not collecting sales taxes. She sent a letter to DOR showing her services are purely instructional.   She said President Obama is asking to get kids up and moving and that is what she does, and now she is paying the price. Going forward, this will really cause problems in her business.

To date, the DOR has issued liens against her building for the tax liability. She told the Committee she has no problem collecting and remitting sales taxes on shoes and other sales, but believes this tax is just incorrect. She said the audit took a year to complete. Sen. Kraus asked if anyone else in their industry had been audited. Taxpayer put out an email to fellow dance instructors and found nobody else in her industry that was collecting tax – even in other states.

Sen. Dixon asked about the location of her business. She responded the business was located in Kansas City. He asked if the city had talked about any loss of revenue because of this issue and she had not heard from any local officials. Sen. Dixon asked about whether she was concerned about the fiber of the local officials if they put revenue ahead of doing what was right regarding treating taxpayers fairly and she agreed.

Sen. LeVota again reiterated his contention that his preference would be that the DOR should enforce policy changes going forward, rather than penalizing taxpayers by hitting them with tax bills. He said DOR says if they override veto, it will cost $21 million per year, but it is his position that the revenue is not collected now. He believes in making changes prospectively and treating taxpayers fairly – not in assessing back tax liability on new tax policies. Sen. Emery said there are lots of rumors floating around through local officials regarding impact and he believes, like Sen. LeVota, that the impact discussed includes taxes that are not being collected or remitted now.

Ms. Pfaff says everything she does is about children and making their lives better, but with the tax collector standing at her door and liens filed against her business, she doubts whether she will be able to pass the business on to her children

Bill Gamble, registered lobbyist for the City of Kansas City, told the Committee the City of Kansas City has been following the issues just like the Senators and has not taken a position in favor or against overturning vetoes. The committee discussed the large estimates of impact being espoused by the Nixon administration and Gamble said KC officials are looking at the impact from a KC perspective only based on the facts.

Extreme Gymnastics owner, T.J. Rehak, says he was audited and DOR said everything he did would be taxed – then gave him a back tax bill of $225,000. He said he has started to collect tax on everything from the time he was informed of this requirement and even paid one month’s worth of tax out of his pocket. He said the DOR told him he was the test case so they would not settle with him. He told the DOR none of the other similar industries (dance, etc.) were collecting sales taxes, but DOR said they were going after all of them. He told the Committee he had to raise his rates to include the sales taxes and most of the gyms with which he competes are not charging tax, except those that have been audited. He has 47 employees. They had expansion plans that are now off the table. He thinks SB 662 and SB 584 are very important bills for the community.

He said he has also noticed DOR appears to be focusing their increased audit activity in the KC area. He said another business in St. Louis proved somehow they were educational and were not assessed tax. Sen. Kraus asked if DOR auditors in Kansas City were different than the auditors in St. Louis and TJ said they were in different audit districts. Sen. Dixon asked how long he has been dealing with this: TJ said he received letter in May 2012. Sen. Dixon asked Mr. Rehak about his confidence level in state of Missouri personnel and he said not very high since DOR auditor could not answer any questions. He also did not think the auditor was comfortable with the audit findings.

Sen. Kraus pointed out to the Committee the City of Lee’s Summit has remained neutral on bills and vetoes.

The next witness was from Rebound Gymnastics has not been audited, but started charging and remitting sales taxes at the beginning of the year when she found out about the problems experienced by the previous witness. She explained some gyms have proven they were more like babysitting or more instructional in nature and the auditors have said there is no sales tax liability; yet auditors from other regions, like KC, hold just the opposite. She said her business is struggling and if DOR shows up to audit her, she would likely not be able to pay back taxes and it would probably put her out of business. She asked Committee members, “How productive is that for the state?” She pointed out that would lead to a real loss of revenue for the state and local governments, not the imaginary loss of revenue that has never been collected to begin with. When she heard about what happened with Mr. Rehak, she called her accountant. Her accountant called DOR and were told gym fees were not taxable, then were told they may be taxable, but it was subject to interpretation. She says there is a difference between physical fitness activities and recreational activities. When she increased the rates to start collecting sales taxes, she lost customers. She says for Missouri DOR to be unfair to taxpayers is not good for the state. She just wants them to be fair.

Richard Sheets, Deputy Director of the Missouri Municipal League, said cities are really concerned about the expansion of sales tax exemptions in some of the bills that were vetoed. He asked the Committee members not to focus on the Governor’s numbers. He said the fiscal notes say there are hundreds of millions of dollars at stake and he said has talked with local officials and knows there are concerns. They are having a meeting next Friday to discuss the numbers. He is asking cities to give them time to generate better numbers. He said expansion of sales tax exemptions really cuts into the services cities provide. He asked for time for cities to give them numbers. Sen. Kraus asked if they were going to do their analysis bill by bill. Sheets said he wants to clarify misinformation that he said now exists.

Sen. Dixon asked Mr. Sheets if he knew how many cities respond to fiscal note requests for information when they are sent to them by the Oversight Division of the Committee on Legislative Research that prepares the fiscal notes. Sheets said he’s not sure, but he thinks some ignore them. Sen. Dixon said in the press, it has been said the exemption bills were a “Friday free-for-all” and there were claims that they had not been filed as individual bills. He said, with one exception, that is not true. Sen. Dixon said the City of Springfield did not respond to the requests that were sent to them, yet now the city officials in Springfield claim the “sky is falling”. Dixon asked where the numbers the cities have received originated. Sheets acknowledged the only numbers so far have come from the Governor’s office. Sheets said they are still working through the local impact to determine what the real impact is to local governments. Dixon asked if MML is encouraging cities to talk about the impact if they don’t know what it is. Sheets said he is encouraging members to talk about impact without focusing on numbers. Sheets said the data center exemption is causing some concern. Sen. Dixon asked if it was wise for local leaders to “parrot” the Governor’s numbers before they verify the accuracy of the numbers. Sheets said MML is trying to provide some talking points and more credible information.

Dixon said he and other senators are trying to work with local officials because they all serve the same people. “If we can work together on this, the citizens will be better off so we don’t have to put them through the types of experiences we have heard about today,” said Sen. Dixon.

Sen. Emery pointed out most of the exemptions the Missouri Municipal League is concerned about would not even be in legislation without the aggressive efforts of the DOR. Sheets acknowledged that point. Emery said it is “our job as Senators to side with the individual taxpayers.” Sheets said MML did not create the problem either. Emery does not think the impact on municipal budgets is anywhere near the level claimed by the Governor’s office. Sheets said they are concerned about loss of local tax revenues. Sheets said piggybacking on bills at the end of session was not a good idea. He said it was necessary to veto entire bills because parts of the bills could not be vetoed and they would work with members of the business community and the legislature next year.

Sen. Kraus told Sheets on a number of bills, the intent of the legislature is to make sure the DOR did not enforce future collection of sales taxes that had not been collected before.

The final witness for the day was Chuck Pierce, representing the Missouri Society of Certified Public Accountants, who thanked the members for taking on the subject. He said the MSCPA wants to have input into the Committee’s hearing process. He has reached out to his nearly 10,000 members and offered to relay comments to the Committee.

He said the three year audit process that was mentioned earlier is not atypical at all and that is frustrating for taxpayers. He said the strategy that was mentioned earlier of applying tax to purchases and avoiding tax on services will likely not work and DOR will probably hit them with double taxes anyway. Pierce noted Sen. LeVota’s position asking the DOR to apply policies prospectively – a position echoed by the new language in SB 662- is already law for “unexpected decisions” but courts rarely designate new decisions as “unexpected decisions,” so the new notification law would have an impact. He said the new bill is very beneficial to taxpayers and their representatives by allowing taxpayers to know when the tax policies have changed.

Pierce mentioned differences between regional audit offices of the DOR and the differences in policies that can occur between them. Sen. Kraus asked when changes are made as they were with the dance studios and gymnastics classes, does DOR send a notice to other regions? Pierce said anecdotally, there is a tremendous amount of auditor judgment that goes into an audit, but once they write up the audit, it can “snowball” against a taxpayer quickly. Sen. Emery said, “Surely there is some chain of command that reviews changes in audit positions.” Pierce said sometimes different auditors have different views of the policies.

Pierce said many issues that the legislature dealt with in the bills that were passed this session followed the same process: the legislature considered an exemption, DOR puts a large price tag on it, the bill passed, the DOR tightened interpretation of the law after passage, the issue goes to court, everyone that was involved remembers original impact and we try to clarify the original intent with new legislation and DOR assigns a second amount of revenue loss to the new bill that clarifies the law to establish the original intent (double counting the fiscal impact).

Pierce stressed the importance of the shift in the burden of proof to the Department of Revenue.   Thinks the change will go far in leveling the playing field for taxpayers. The current law only benefits attorneys because there is zero incentive to settle cases and the DOR has the advantage to simply litigate every issue. That would change if the DOR had to make their case.

The other thing that he thinks could be done in the legislative process is that he thinks it would be better to not have omnibus tax bills. Pierce also thinks the DOR should be better about engaging during the legislative process, rather than waiting until after legislation passes, then issuing strained interpretations.

Sen. Dixon asked out of his membership, what is the interest in comprehensive sales tax reform? Pierce said there would probably be high interest, but sales tax is complicated because the legislature passes a law, the courts rule, and the legislature must clarify, etc. He pointed out the difficulties with tax credit reform and potential problems with eliminating precedents that exist under current sales tax law.

Sen. LeVota asked how they could get the DOR to get more involved in the hearing process (presumably for these Committee hearings). Sen. Kraus said he is hopeful the committee can collect comments from all over the state and then have the DOR present at the hearing in Jefferson City.

Sen. Kraus concluded by saying to the crowd the hearings help legislators because they don’t know taxpayers’ problems unless they hear from them, and he appreciated the taxpayers that testified today. He invited further testimony “off line” following the hearing. Hearing was adjourned.

If you have a story you would like to relay to the Committee, please send it to rmccarty@aimo.com.

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