With the advent of e-commerce and a vast array of national distribution networks available, taking your wares across state lines has never been easier. But if your business activities in another state reach a certain point, you could face interstate tax issues for which you’re not completely prepared.
What is Your Business Presence?
When it comes to out-of-state tax liability, the not-so-secret password is “nexus.” This is the term states use to indicate that your business presence in their territory is substantial enough to subject you to their tax rules and obligations.
So what creates nexus? This is where things can get tricky. Each state may approach nexus a little differently. But there are some commonalities. If you employ workers or own (or even lease) business property in a given state, for example,
you likely have nexus there.
A state may look to other evidence as well. Actively marketing your products or services there may trigger nexus, as could using a local phone number, maintaining inventory in a state and accepting orders there.
On the other hand, the mere existence of a minimal amount of business activity may not create nexus. Say you venture across the border to perform a handful of service calls a year. That probably wouldn’t create nexus. And if you have a salesperson going into the state to solicit business but not accepting orders, and no other activity in the state, you may not have nexus. But you need to look carefully at all of your particular facts and circumstances and the nexus thresholds for the state in question.
If a state does define your company as having nexus, how it taxes you will depend on the state. Some will want you to pay sales or use tax but not income tax. Others will assess business income tax based on an allocation of, among other things, sales and in-state facilities. Still others could levy a nonbusiness income tax on rents, dividends and interest, or a franchise tax on your company’s net worth and net income generated within the state.
Turn a Disadvantage into an Advantage
The idea of being taxed in another state may seem a bad thing: “Just what we need, more taxes!” But it’s not necessarily a disadvantage.
- First, you can generally avoid multiple taxation on the same income by apportioning your income among the states in which you’re subject to taxation. In fact, most states require that you do so – though the factors they use to calculate taxation, and how those factors are weighted, may vary.
- Second, you may be able to turn this apportionment to your advantage. For instance, Company X is headquartered in a state with a relatively high corporate income tax. It does a certain amount of business in neighboring states with lower income taxes, but not enough to create nexus. By expanding its operations into those states — let’s say establishing a satellite office and boosting sales — Company X could be able to trigger nexus and lower its tax bill by allocating some income to the less-taxing states.
- Of course, taking a major step like this needs to involve more than just tax planning. It should involve strategic planning. Do you genuinely feel as if your company could excel in an out-of-state market? Is the competition vulnerable? Ask yourself questions such as these before proceeding.
Clarify Your Nexus Situation
Interstate taxation is complex. To get a clearer picture of your situation, you can:
1. Undertake a nexus study. Whether you’re already operating in another state or only thinking about doing so, ask your tax advisor about doing a nexus study. Under this process, your advisor will seek to identify the taxes to which current or prospective business activities may expose you and help determine the effect of state and local taxes on your bottom line.
2. Check out the Streamlined Sales and Use Tax Agreement. As of this writing, more than 40 states as well as the District of Columbia have signed on to this effort. It was created more than a decade ago in an attempt to standardize tax definitions, procedures and rates related to how sales and use taxes are applied. That’s not to say it’s been completely successful;
results may vary even in states abiding by the agreement. But its website contains a wealth of useful information.
3. Contact the Multistate Tax Commission’s National Nexus Program. The commission can help companies prepare for prospective tax compliance issues and, perhaps more important, provide assistance in resolving disputes with taxing states.
Under the program, you may anonymously contact a state to request a review and advice regarding your tax situation. The program itself performs the review and helps negotiate a resolution of any conflicts, only after which is your identity revealed. Visit its website at http://www.mtc.gov.
The Internet Continues to Evolve
It bears repeating: Interstate tax liabilities can vary widely depending on where you operate and how much (and what kind) of business you do in those other states.
And the details are important. Failing to properly register and remit out-of-state taxes could saddle you with costly back payments, penalties and interest. Work with your tax advisor to ensure you’re ready for anything.