Does your company operate in multiple states? If so, you may owe state and local taxes to some of those states, even if you do not realize it. While it may be difficult to determine whether your activity in other states triggers a tax liability, ignorance is no defense, and the penalties for noncompliance can be steep, making this a critical issue for small businesses.
The concept of nexus is the degree of business activity in a state necessary to make your business subject to some or all of that state’s taxes. To further complicate matters, what establishes nexus for one type of tax might not establish nexus for another. For example, a physical presence is needed for sales tax nexus, but not necessarily for income or franchise taxes. Even determining what constitutes a physical presence varies by state.
For example, consider income taxes. If your company has income tax nexus in a state, you must file income tax returns and pay income tax in that state. A number of situations can trigger income tax nexus in a state, including but not limited to:
- Employing workers,
- Performing installations, repair or warranty work,
- Leasing or owning property (including inventory),
- Attending trade shows,
- Leasing to customers, and
- Holding meetings or conducting training.
In addition to the above, some states consider nexus to be created simply by having sales to customers above a certain threshold amount, even without any physical presence. Since states vary so much, a nexus determination for one state may not hold true for another state.
Importantly, there is a federal law that provides that no income tax filing responsibility is created, even if a business has nexus, provided that certain conditions are met. Specifically, if a business sells tangible personal property, no income tax returns are due if: (1) the business’s only activities in the state are the solicitation of sales and taking and accepting orders by employees or independent contractors from customers in that state, and (2) such orders are approved and fulfilled from outside that state. No such protection is offered to service providers.
In the wake of the recession, states and municipalities are seeking to boost revenue by prioritizing the collection of taxes from out-of-state companies. Some states have even created new departments devoted exclusively to finding out-of-state companies that should be paying taxes but are not (In Texas, this is known as the Business Activity Research Team, or “BART”). States are also taking advantage of cross-border agreements with other states’ departments of revenue to share information and are collaborating with federal customs agents. In this environment, it is critical that businesses identify their state tax obligations (known as a nexus study).
If you discover after the fact that you owe state and local taxes, you may be able to take advantage of a voluntary disclosure program. Most states now offer such programs, which eliminate or lower penalties and interest on unpaid taxes and limit the look-back period. The Multistate Tax Commission offers a voluntary disclosure program that allows you to negotiate a favorable settlement agreement with multiple states through a single point of contact. It is important to note that such programs are only available if a business comes forward prior to being contacted by a state’s department of revenue.
Seek the services of a legal or tax adviser before implementing any ideas contained in this blog.