Sales Tax Bonds: “Tide’s Out, Time to Discover Who’s Swimming Naked”
Author: Suretypedia Team
Posted On: 04-07-2020
As a financial guarantee to businesses with a high rate of failure, Sales & Use Tax Bonds have long been considered riskier than many other small commercial surety requirements even in normal and good economic times. The past few weeks have been far from normal, a state not likely to return for some time. With many retail establishments largely or completely shut down, much of the surety industry is understandably concerned about the potential for elevated loss ratios in this economically sensitive, and generally short claims tail, line of business.
Upon reflection, Suretypedia is not so sure that this category of bonds will be disproportionately impacted by the social distancing policies enacted throughout the country. Many businesses requiring a Sales Tax Bond remain open, even in jurisdictions with some of the strictest social distancing orders such as California and New York, either because they are considered “essential services”, such as gas stations, or because they can be operated by a single employee, such as liquor stores ( ”Stay-at-Home": List of Essential Services Matters Greatly to the Surety Industry). Moreover, a severe drop in business activity means much less underlying risk for the Surety (no sales means no sales tax means no claims) so the concern is really for the unpaid reporting periods prior to the social distancing measures.
While many of these businesses are permitted to remain open in some fashion, it doesn’t mean business as usual. Numerous retail shops are seeing sharp declines in sales due to self quarantining and social distancing. Others have seen a spike in sales as people look to stock up on alcohol and supplies to wait out shelter-in-place orders. There is simply not enough information to determine the impact Covid-19 policies will have on businesses with a Sales Tax Bond.
With all of the uncertainty surrounding the impact on this line of business, the Suretypedia team has decided to focus on a few areas we think are often overlooked by surety carriers:
- Surety concentration of tax bonds by industry
- Sales tax reporting timelines
- Bond form language and requirements that amplify risk
How will this Crisis Affect Sales Tax Bond Principals by Industry?
Sales & Use Tax Bonds are required, primarily by state government authorities, for sellers of numerous products and services including alcohol, tobacco and fuel and providers of services such as dining and construction, and a few pockets of entertainment and other retail establishments. Businesses that collect sales tax on behalf of state and local governments are often required to guarantee payment - typically one month of estimated tax payments for monthly filers and three months for quarterly filers - with some form of deposit, the most popular of which is a Sales & Use Tax Bond. The current downturn is unique as many businesses in these industries are seeing closure, reduction in operations, and a sudden drop off in, or even elimination of revenue. Reduction in sales means less to pay in sales tax, but businesses with one foot out the door are likely to default on these payments.
Sureties should look at off-premise and on-premise alcohol sale establishments differently when assessing risk to alcohol and liquor related tax bonds. Off premise locations such as liquor stores and distributors are seeing a spike in sales. News publications across the nation have cited a study from Nielson showing alcohol sales up 55% in the week ending March 21st. On-premise locations such as bars and restaurants will be drastically affected, unless they are able to successfully transition to take out food for revenue. Alcohol sales from these locations will be reduced substantially even with regulations temporarily lifted for take out drinks. We expect bond principals operating on-premise alcohol establishments to experience elevated claims until some time after social distancing restrictions are lifted.
Motor vehicle fuel sales have already dropped dramatically as commuting and general travel has been substantially diminished, reducing revenue at most gas stations and fuel supply companies. Supply chains are still open so businesses that receive a bulk of business from trucking and delivery services potentially mitigate the risk for bonds related to diesel fuel.
Bond principals that deal in jet fuel will see sharp declines. According to Forbes, air travel has declined by 40% worldwide during the last two weeks of March and is expected to further decline in April. Like the alcohol industry there will be some variation among who will be affected during the Covid-19 pandemic, but the fuel industry will certainly feel the effects of shelter-in-place orders.
Bond customers in the tobacco industry are likely to see the least amount of claims. Unless people are convinced they should take better care of lungs amid a virus that specifically targets the lungs, sales should continue as before. Most cigarette tax bonds are required for distributors who pay their taxes in advance through the purchase of a cigarette tax stamp. Other tobacco related bonds would be more at risk for bond claims due to nonpayment of the sales tax.
Sales Tax Reporting Requirements and Timelines
Sales & Use Tax reporting varies widely from annual, semi-annual, quarterly, to a monthly basis. While there are many sales tax bonds in different industries, most bond principals are required to report their tax liability monthly.
Tax payments are typically due at least three weeks after the reporting period. In jurisdictions requiring monthly reporting, many bond principals either recently paid, or failed to pay, their February taxes. While many states and cities were implying people should shelter in place after March 11th, the first state directive didn’t come until March 19th, which means most businesses were still operating up until the last day before their payments were due, typically the 20th of the month, in March. While we will see the impact of this epidemic truly hit sales tax bond customers in late April, it’s possible certain businesses delayed their March payments for the February reporting period as the news was heating up prompting a ripple before the wave of bond claims.
The biggest concern we have is bonds guaranteeing quarterly tax obligations. The next payment for most quarterly filers comes due in late April. The tax liability is relatively high for these principals as they include activity in January, February, and early March when the economy was still peaking. These tax obligations are in serious peril as revenue from late March and early April drop dramatically with limited visibility into when operations will return to normal.
Almost half of state jurisdictions are providing some form of sales tax relief for businesses. Every state has a different relief strategy, but there are some commonalities such as: allowing an extension just for payments on the February reporting period, waiving interest and fees for missed payments, or providing 60 to 90 day extensions. States are trying to assess the impact between collecting taxes to maintain tax revenue, and offering support to affected businesses struggling to pay the tax.
Much like with utility deposit bonds (see Utility Deposit Bonds: As Restaurants Go Dark, Claims Will Light Up), grace periods are unlikely to protect Sureties. In fact, we see more risk with February payments getting rolled into the balance as small retail operations face more acute cash shortages heading into April. There could even be a greater political incentive by the states, who desperately need the tax revenue as their coffers are depleted, to quickly and aggressively file claims on surety bonds while providing leniency to businesses. When has anyone shed a tear for the insurance company?
With so many variations to sales tax bonds, we highlight states that could significantly impact the Surety industry: Texas, Florida, Nevada, Georgia, California, New York, and Ohio.
The Texas Comptroller is responsible for sales tax reporting and collection for the cities and counties in Texas while the Texas Alcohol Beverage Commission (TABC) handles alcohol related tax and licensing. Most sales tax payers report and pay sales tax on a monthly basis. The vast majority of Sales & Use Tax Bond premium in Texas is derived from principals engaged in fuel and alcohol sales and dining.
Taxpayers who had difficulty remitting their February sales tax due March 20th have been granted the option to make short-term payments and waive fees and interest on the overdue amount. Texas is one of seven (7) states that do not impose a state income tax so the collection of sales tax is paramount for the budget, especially during a recession.
Texas is one of the riskiest states for these bonds and claims could increase significantly within the coming months. Section 151.257 of the Texas Tax Code allows the state Comptroller to demand payment from the surety 10 days after the principal fails to make the tax payment. Moreover, some bonds such as the Continuous Bond of Seller (Sales Tax) , contain a large adverse selection component as existing businesses with a spotty history of tax payments are also required to file the bond.
Any business collecting more than $1,000 in sales taxes on behalf of the state of Florida is required by the Florida Department of Revenue to report and remit tax payments on a monthly basis.
The Florida Department of Revenue issued a press release on March 26th that pushes back tax filing dates from the 20th to the end of the month. Taxpayers who were unable to meet the March 20th deadline will also have penalties and fees waived if their taxes were paid by March 31st. The press release noted that sales tax revenue accounts for more than “78% of Florida’s General Revenue programs.” We expect that Florida will still look to collect this tax by any means necessary, which could be harmful for sureties in April.
Most industries in Nevada that collect sales tax such as fuel distributors, liquor stores, and tobacco retailers, pay monthly, with some variation on the due dates. Fuel distributors pay on the last day of the month, and alcohol related businesses on the 20th of each month.
The Nevada Department of Taxation has not provided any relief for tax payments. While Nevada has some unique calculations that tend to lower the limit on sales tax bonds versus other states, the 6 year liability tail and the Surety’s inability to mount a defense to the statute of limitations, greatly increases the Surety’s payout probability in the state.
Nevada is another state that relies heavily on sales tax revenue as it accounts for approximately 70% of total revenue. Nevada Governor Steve Sisolak officially declared Stay-at-home orders as of April 1st. Considering the state’s revenue exposure to the entertainment industry, Nevada will likely aggressively file claims in April.
Sales Tax Bond principals in Georgia are required to file tax reports and pay amounts due on a monthly basis. Businesses with tax liabilities under $200 can apply to file quarterly or annually.
The Georgia Department of Revenue has provided tax extensions to June for income tax in line with the federal government guidelines; however, this did not extend to sales tax requirements. Tax payments are due on the 20th so principals have already paid or defaulted on their February sales taxes. Stay-at-home orders didn’t hit Georgia until the 21st. We can expect problems for these bonds on tax payments this coming April 20th.
The California Department of Tax and Fee Administration (CDTFA) administers sales tax payments and reporting while the California Board of Equalization (BOE) hears all appeals for claims for refund or petition for redetermination denials. Sales Tax Bond principals typically report payments monthly. Some taxes reported quarterly are due this April; such as use fuel tax, sales and use tax, use tax, and some alcoholic beverage taxes.
California is offering the most sales tax relief to small businesses in the country. Small businesses with less than $5 million in taxable annual sales have been granted an extension up to July to pay their March or April sales tax payments, see CDTFA Covid-19 Extensions for details. They can also apply for an interest free payment plan up to $50,000 of the sales and use tax liability. Businesses with more than $5 million in sales are, “encouraged to reach out to CDTFA” if they believe they are also in need of relief and the CDTFA will try to work something out.
While these measures may help some businesses survive until social distancing measures are lifted, we believe that for many the measures could simply delay, and possibly increase, any ultimate bond payout.
The New York State Department of Taxation and Finance requires alcohol distributors to report and pay taxes monthly, while fuel distributors are required to file quarterly. Sales tax returns for all filers are due on the 20th of the month after the tax period. The most recent quarterly and annual tax payments were due on March 20th. Stay-at-home orders for New York went into effect on March 22nd, which spells significant trouble for Fuel Tax Bonds.
While New York does not rely on sales tax revenue to the extent of states like Texas that do not levy income taxes, the state’s budget is in a very precarious position. Thus far, New York has not offered relief for Sales Tax Bond principals. The New York State Department of Taxation and Finance is only waiving penalties and interest for quarterly or annual tax payers. All monthly reporters had to make their March payment and will be expected to do the same for April amid the height of the Covid-19 crisis in New York City.
The New York State Liquor Authority governs retail licenses for alcohol sales, where a large bulk of Sales Tax Bond premium lies, is suspending collection of civil penalties for at least 60 days and relaxing regulations that normally restrict retailers from selling back their liquor supply to wholesalers, hopefully alleviating some pressure on bond principals. However, the Liquor Authority is not providing any direct relief on sales tax obligations.
The Ohio Department of Taxation collects sales taxes from general retailers, cigarettes, and motor vehicle fuel dealers. The most notable bonds in Ohio are the Delinquents Sales Tax Bond and Dealer In Motor Vehicle Fuel Bond. Both bonds are quite adverse and can cause claims and further problems for sureties on claim payments, as we will discuss in detail later.
Sales tax related payments are monthly, and semi-annual for a few businesses. Tax payments are to be made by the 23rd of the month following the tax period. Note, while Ohio did not issue its statewide Stay-at-Home Order until March 23rd, Governor Dewine was early in restricting activities and gatherings, so businesses felt the effects of quarantine practices prior to March payments.
Aside from the general income tax filing extended from April to June, Ohio is not taking any other efforts for business tax relief. Sales taxes account for half of Ohio total revenue.
What Bond Form Language Could Amplify the Surety’s Risk?
Sales Tax Bonds have a few unique bonds required for license holders that are delinquent on tax payments or improperly file returns. The bonds are generally required for a few years, assuming the license holder continues to properly report and pay taxes. We previously discussed implications for adverse clauses in Suretypedia’s Guide to Bond Forms; however, we scoured through our database of tax bond obligations to reference adverse language we found appeared most frequently and posed the most significant risk to the Surety. Adverse selection, forfeiture, extended liability tails and demand clauses were seen throughout our review
Adverse Selection occurs when the Obligee requires the bond of a principal who does not meet a certain standard (credit, net worth, experience, etc). One example of these is the Alabama Sales Tax Surety Bond, which is required of principals when the Obligee has deemed them non-compliant for a specific tax reporting period:
Forfeiture clauses allow for bonds to be claimed for the full penal sum of the bond even when the delinquent tax payment is lower than the bond amount.
Georgia has multiple tax bond requirements that contain forfeiture provisions and, with the heightened risk of the market, these should be reviewed more carefully by Surety Underwriters.
Below is a full list of Sales & Use Tax Bonds in Georgia that contain forfeiture clauses:
Longer Tail Periods
Some sales tax bonds contain verbiage that extends the statute of limitations, known as a “liability tail,” allowing obligees to file a claim well after the bond is cancelled, increasing the risk to the Surety. Any bond form that does not have this verbiage defers to the states general statute of limitations. The most egregious example of a longer tail period specified in the bond is seen on Nevada Surety Bond Posted To Secure Performance Under Title 32 Bond:
The surety agrees that the right of the Nevada Department of Taxation to claim against the surety for taxes, interest and penalties shall accrue upon failure of the principal to comply with said acts or ordinances, and shall be subject to the six year statute of limitation for liabilities...”
Language that demands or requires payment on a bond claim within a specified time period hurts a Surety’s ability to properly investigate and process claims. Obligees can add penalties to bond claims if coupled with the defaulted sales tax obligation, the penalties push the claim the claim beyond bond limit. Below is an example of a demand clause in Ohio Dealer in Motor Vehicle Fuel:
...If the surety does not make payment within thirty days of receipt of notice of delinquency, this amount additionally shall include interest at the rate of six percent per annum from the date the taxes were due and that if the surety does not make payment within ninety days of the receipt of notice of delinquency, this amount additionally shall include interest at the rate of six percent per annum from the date the taxes were due plus a fifteen percent penalty on the taxes due.”
*Note: Ohio can cancel all of the Surety’s bonds on file if they do not receive claim payment within the 90 days.
*Click the above image to view the full list of Tax Bond Requirements
Will Government Stimulus Curtail Surety Losses?
The damage to the Sureties from sales tax bonds will depend on the length of quarantines and small business relief from the federal and state government. Government assistance could reduce business closure and defaults on sales tax payment as long as the closures are relatively temporary.
States in general are providing extensions for personal and corporate tax filings which can lead to more leniency on sales tax payments, but has not been the case so far. The long term success of businesses most affected by the coronavirus epidemic may depend on federal government support.
The CARES Act, at an estimated $2 trillion total, is the largest stimulus so far. The bill includes the Paycheck Protection Program (“PPP”) that provides loans up to 2.5 times the average monthly payroll to relieve distressed small businesses with under 500 employees. Loans through this program are eligible for loan forgiveness up to 8 weeks following the start of the loan if the funds are used for payroll, rent, interest on a mortgage, or utilities including telephone, internet, gas, water, electricity, and transportation. Unfortunately for single employee businesses like gas stations or liquor stores, these loans may not provide enough funds to cover expenses with a loan capped by total payroll expense.
The aggregate amount available under the PPP is $350 billion, which would be plenty if the legislation were reserved solely for very small businesses severely affected by social distancing measures. However, the loan application merely requires businesses to certify that “current economic uncertainty makes the loan request necessary to support the ongoing operations of the Applicant”. While restaurants and other severely affected businesses are carved out from the affiliate rules designed to prevent owners of multiple businesses to apply separately thereby averting the 500 employee limit, there is no particular industry requirement or need to prove economic hardship. Based on the way the banks have handled the PPP thus far, we expect the largest (i.e., the +37,000 firms with 250-500 employees), most sophisticated businesses with deep banking relationships will be first in line to secure the funds.
With funds yet to be distributed as of the time of this writing, it is difficult to determine the impact on Sales Tax Bond principals. While Congress may expand the PPP in the event funds are exhausted before all applications have been processed, the clock is ticking for these businesses, many of which have mere days left before running out of cash, if they haven’t already.
Assuming distressed ultra small business owners are able to access the funds, we can expect the loans to prevent some business closures and give even fewer the ability to wait out the social distancing measures, which would to some extent reduce losses on Sales Tax Bonds.
What Action Can Sureties Take?
There is typically little a surety company can do about impending claims on Sales Tax Bonds already on their existing books of business. Suretypedia wrote this report to help carriers plan and prepare by checking your exposure to the riskiest bond types. However, surety carriers, and their agents, could proactively reach out to their Sales Tax Bond principals to inform them of their options, including government assistance such as the PPP. Surety agents can remind their customers that it’s better to take proactive steps to remain current on bills to ride out the social distancing measures and maintain the surety credit necessary for their business.
For new business and renewals, where allowed, Sureties can tighten underwriting and even avoid the riskier sales tax obligations highlighted in this report altogether. We’ve already heard of some carriers reducing limits they will approve on financial guarantee obligations, such as Sales Tax and Utility Deposit Bonds, and of others who are limiting or even eliminating underwriting authority from agents and brokers to completely control incoming risk.
Please let us know how your surety business is being affected by social distancing and shelter-in place. Email us at email@example.com to add your story to the discussion.