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Doing Business Out of State? State Tax Nexus Explained

 

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If you are a business owner operating in multiple states, you could face tax obligations without even knowing it.  Determining whether these states have a legal right to tax your out-of-state business depends on whether your business has “nexus” with the state.  For state tax purposes, the term “nexus” describes the amount and degree of business activity that must occur before a state can subject the company’s activities to income tax, and/or allow the state to require sales and use tax collection.  The issue of nexus is complex: It involves constitutional law, federal and state judicial decisions, and state laws and regulations.

Nexus can be a hidden danger for a company with a multistate presence.  Certain activities might cause nexus for sales and use tax, income tax, franchise tax or other business taxes.  One key to successfully navigating these provisions is for tax professionals to review the statutes and rulings of each state in which a business might be considered as doing business.  The connection might not be obvious, particularly for sales and use tax.  Also, some states levy types of taxes that might not be familiar to business owners, such as those on gross receipts or business activity.

For sales tax nexus, Federal law requires a state to have “substantial nexus” to a seller to require that seller to collect sales and use tax.  The definition of “substantial nexus” has always been a subject of debate between states and businesses.  Generally, it means having a physical presence in the state, whether by salesperson, contractor, location, etc.  Owning or leasing tangible personal property or real property in the state is usually considered to establish sales-and-use-tax nexus.

Having nexus for sales tax purposes does not necessarily mean a business will have nexus for income tax purposes, as a higher level of business activity may be required.  Historically, state income tax nexus has been created when an out-of-state company derives income from sources within the state, owns or leases property in the state, or employs personnel who engage in activities that go beyond those “protected” under federal interstate commerce laws.  Under Public Law (PL 86-272), states imposing a tax based on net income may not impose that tax on out-of-state businesses whose only connection with the state is the solicitation of orders for sales of tangible personal property when such orders are approved and shipped from outside the state.

Although PL 86-272 offers protection from income tax, it does not offer protection from a state’s franchise tax, which is imposed for the privilege of doing business in the state and generally based on an apportioned capital, net worth or another non-income base.  Currently, a number of states impose a franchise tax.  Generally, a business with sales tax nexus will be subject to the state’s franchise tax.

Gross receipts taxes are imposed on the seller and are similar to a privilege tax.  It should be noted that taxes based on gross receipts are not sales taxes, even if the same sales receipt impacts both the seller’s gross receipts tax liability and the purchaser’s sales or use tax liability.  Because gross-receipts and other business taxes are not based on net income, they are not subject to the protection of PL 86-272. Thus, a business with even minimal activity within a state could find itself subject to one of these taxes.

Not only are states enacting non-income-based taxes and aggressively broadening the concept of nexus, they also are seeking to capture a larger proportion of the taxable income of multistate businesses by replacing the traditional, equally weighted payroll, property and sales apportionment with formulas based predominantly or solely on the percentage of sales to customers in the state.

Since tax obligations vary from state to state, an understanding of multi-state filing responsibilities is critical.  States have gotten more aggressive with non-conforming businesses, especially in today’s economy.

bgr CPAs can help your business by providing a nexus study.  The goal of a nexus study is to gain an understanding of your nexus creating activities in each state based on each state’s laws, administrative guidance, court decisions, etc.  We start with a questionnaire with concise survey questions to help us determine if any of your business activities create a nexus in one or more states.  Once your questionnaire is complete, we prepare a state nexus report that explains each state’s nexus law and also lists the potential nexus consequences of each of your business activities.

Please feel free to contact us with any questions or if you would like a nexus study prepared for your business, please contact David Houston CPA, MST at dhouston@bgrcpas.com or (410) 418-4400.