The Internet and other technological developments have made it easy for companies to do business across state lines. Unfortunately, along with these new business opportunities comes a new set of tax issues.
Whether your business is subject to another state’s income, franchise, sales and use, or other taxes depends on whether you have a substantial connection — or “nexus” — with that state. But the rules regarding nexus vary from tax to tax, state to state and even locality to locality, so understanding and complying with multistate tax obligations can be a challenge. To avoid unexpected tax liabilities, consider conducting periodic nexus reviews.
Defining Physical Presence
Traditionally, having a nexus with a state required a physical presence in that state, such as retail stores, offices, manufacturing facilities or employees. But cash-strapped state and local governments have been stretching the boundaries of nexus in an attempt to bring in additional tax revenues.
The U.S. Supreme Court has held that a physical presence is still required for a state to impose sales tax collection obligations on out-of-state businesses. And a federal law bars states from imposing their income taxes on businesses whose activities in the state are limited to the solicitation of orders for tangible personal property that are approved and filled outside the state.
But many states have reduced to a bare minimum the contact necessary to establish physical presence. In some states, for example, brief trips by out-of-state sales reps are enough to create nexus. And several states now impose sales tax collection liability on out-of-state sellers without a physical presence if those sellers are affiliated with an in-state business or if sales are generated through referrals from an in-state business’s website (so-called “click-through nexus” laws).
The enforceability of these laws is uncertain, though. At least one state’s click-through nexus law has been struck down by the courts as unconstitutional.
In situations that don’t fall within the above rules, such as franchise taxes or income taxes on businesses that sell services or intangible property, a mere economic presence (such as substantial sales to a state’s residents) may suffice.
Looking for Resolutions
Inconsistent state and local tax rules make it difficult for businesses to anticipate and control their tax obligations. There have been some efforts to improve consistency among state tax laws, such as the Streamlined Sales and Use Tax Agreement (SSUTA), which has been adopted by many states, and the activities of the Multistate Tax Commission. But many experts believe that a federal legislative solution is required.
In recent years, lawmakers have introduced several bills in Congress that would make multistate
tax compliance easier. Proposed solutions include:
- Allowing employees to work across state lines for a limited period of time (such as 30 or fewer days) without triggering the other state’s income tax withholding and payment obligations,
- Establishing a bright-line physical presence standard for nexus and a consistent definition
of physical presence for income and other business activity taxes, and
- Allowing states that adopt sales tax simplification measures, such as SSUTA, to impose sales tax collection obligations on out-of-state sellers.
Consult with your tax advisor periodically to find out whether any or all of these measures are
Businesses will need to comply with confusing and often inconsistent state and local tax obligations until Congress simplifies multistate tax compliance…this may not happen anytime soon. Work with your tax advisor now to give your business a nexus checkup by taking inventory of your activities in and connections with various states, ensuring compliance with all applicable tax laws and regulations, and identifying potential strategies for minimizing your tax burden.