What Are the State & Local Tax Implications of Tariffs?

Tariffs are the issue of the day and seem to be impacting our economy in unforeseen ways (at least to some). As people look at tariffs' various impacts, I am reminded of one of my Partners whose favorite catchphrase is “don’t forget about the states.” With that in mind, let’s look at what impacts tariffs may have on various State and Local Taxes (SALT). 

Sales Tax Implications of Tariffs  

The number one question people are asking is whether tariffs are subject to sales tax. In general, the tax base of an item subject to sales tax is the total compensation paid. Implicit in this concept is that “compensation paid” refers to the amount paid to the actual vendor of the item in question. Thus, it would seem that to the extent an importer is buying a taxable item for $1000 and is then forced to pay a $500 tariff to the government, that the amount subject to sales tax is the $1000 that was paid to the vendor, and the $500 tariff is excluded from the tax base.  

However, assume that the same importer buys that same $1000 item for resale (such that it is exempt from sales tax), they still must pay that $500 tariff to the government, bringing the total cost of the item to $1500. When that importer goes to sell that item, he will need to recoup that tariff somehow. Assuming the importer normally sells that item at retail for $1400, they will now have to sell it for $1900 (the $1400 normal retail price, plus the $500 tariff). In this instance, the tax base is the entire amount paid to the importer of $1900, since this is the total amount of compensation actually paid to the importer. 

The tariff cost is just like any other cost incurred by the vendor, such as payroll or rent. This would be the case regardless of whether the vendor separately stated the cost of the tariff on the invoice. This reasoning follows the guidance put out by California, Illinois, and Washington. Note that the importer/retailer in the above example has had its gross sales inflated from $1400 to $1900. This could cause them to breach bright-line economic nexus thresholds in additional states, creating an additional sales tax compliance burden. 

Tariffs and Income/Gross Receipts Taxes 

Just as the tariffs can create additional sales tax filing responsibilities, they can also create additional income tax and/or gross receipts tax filing responsibilities when they are passed through to the consumer.  

Assume a company previously had $400,000 of sales into Texas, which has a bright line nexus threshold of $500,000. If this company imports $250,000 of goods with a 50% tariff, that’s $125,000 of increased costs. If this company passes these increased costs through to its customers (as most if not all will), it will now have $525,000 in Texas sales, which is over the bright-line threshold. Also, the Texas Margins Tax is not a “net income tax” and, thus, is not subject to the protections of P.L. 86-272. This company now has a Texas filing requirement where none existed prior to the tariffs. 

Further, assume that, instead of Texas, the above entity was selling into Washington State, where it was subject not only to its sales tax but also its Business & Occupation Tax (B&O). Previously, the entity’s B&O tax base was $400,000. Now, due to passing through the tariff costs to its customers, it now has a tax base of $525,000, resulting in a tax increase of over 30%. This is a tax borne directly by the business as it cannot pass through the B&O to its customers. 

This increase in gross sales will also impact a company’s apportionment. Assuming the burden is born proportionally across all states, the net impact is likely minimal (other than the potential for increased compliance costs as noted above); however, what if imported items are specific to certain geographies, and, thus, the sales increase is not proportional across all states? For example, assume a sporting goods entity sells both hockey equipment and surfboards and swimwear. Further assume that only materials related to the hockey equipment are imported. Assuming that hockey is more popular in the northern states and surfing/swimming is more popular in the southern states, the tariffs will have a greater impact on the apportionment percentages in the northern states that buy the hockey equipment and have the tariffs passed through as an increased cost. 

Consider the Full Impact of Tariffs on SALT  

Tariffs could impact many other areas, including property taxes, like the effect COVID-19 had on retailers and the real estate industry. As can be seen, tariffs – or, more accurately, the recoupment of the increased costs associated with tariffs – can impact state and local taxes in many ways. Take these taxes into account when considering the full impact of tariffs on a business. 

Contact us below if you have questions and need help assessing how tariffs may impact your organization.