Crossing state lines for a project can be a savvy way to boost the bottom line. But doing so can also mean dealing with new and complex tax issues such as dealing with nexus. Establishing an economic presence may make you subject to state and local taxes.
With many revenue-strapped states stepping up their tax compliance, it’s more important than ever to understand your responsibilities should you head out on (and over) the border. Multistate taxation missteps have tripped up many businesses over the years.
Nexus or not?
When determining your tax eligibility, governments consider whether your company has “nexus” in their respective states, meaning your presence there is significant enough to subject you to taxes.
Generally, having employees or owning or leasing property in a state creates nexus. Other activities that can qualify you for nexus include maintaining a local bank account, accepting orders for your merchandise or using a local phone number. Many states have minimum thresholds for establishing nexus, so you might not be subject to certain taxes in a state if you perform only a few service calls a year there.
The standards for nexus vary from state to state and from tax to tax — you may need to pay “use” tax in a state, for example, but not income tax. In addition, local rather than state governments collect taxes in some places. Make sure you know to whom you’re answering.
Assessing Income Tax
If your company does establish nexus in a state, you’ll need to assess the income tax impact. Specifically, you and your tax advisor should sit down and “apportion” your income to determine how much tax you’ll owe in each state.
The formula is typically based on your company’s sales, payroll expenses and tangible property. If you’re working in more than one state, track these costs and revenues carefully so you can apportion your income correctly.
Some states give the same weight to sales, payroll and property in their apportionment formulas, while others weight one of the factors more heavily. These formulas also change regularly — a growing number of states have shiftedrecently to sales-only apportionment formulas, for example.
Consider Other Taxes
Aside from facing income taxes in other states, you may also be responsible for a number of other types of taxes in those states (i.e. Washington’s State Business & Occupation (B&O) tax), including payroll taxes and sales and use taxes. Some states even have variations that you might not expect, such as the “transaction privilege” tax for nonresident contractors or subcontractor-specific sales and use taxes that a general contractor may have to pay if the sub in question doesn’t.
Indeed, sales and use tax rules in general will likely be a challenge. If you bring equipment or materials across state lines, the new state may charge use tax for the item.
On the bright side, sales and use taxes are mutually exclusive. So, if you have to pay use tax for your equipment or materials, you can generally get a refund on sales tax you paid in your home state. But you’ll need to track use taxes yourself and then submit the information to the state or local government that collects it.
Other Items to Consider
In addition to your tax responsibilities, working in a new state comes with plenty of other to-dos. You’ll most likely have to obtain a license and tax identification number in that state — even if you’re already licensed in your home state.
Expanding into a new state also means more paperwork. Fortunately, some states allow S corporation shareholders, partners in a partnership or limited liability corporation members to lighten the load by filing a composite income tax return. Look where you leap when it comes to out-of-state jobs and you’ll stand a much better chance of succeeding.