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. Further complicating 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 (with one major exception). 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 (typically over $500,000), even without any physical presence. Since states vary so much, a nexus determination for one state may not hold true for another state.
The one major exception noted above relates to a federal law known as Public Law 86-272, which 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:
- 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
- Such orders are approved and fulfilled from outside that state.
Taxpayers need to be careful not to exceed the protected activities of Public Law 86-272; otherwise, they may create a corporate income tax filing. For example, sending employees into a state to perform installation or repair services, or having salespeople engaging in activities above and beyond solicitation, may create a filing responsibility.
Because states are being so aggressive in this area, and because there is no statute of limitations if a taxpayer has never filed any returns, it is important to know where you may have a filing responsibility and what the potential exposure could be (known as a “nexus study”). If a nexus study shows that you may 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.
To determine if your business activities establish nexus, contact a state and local tax professional at LGT.
Seek the services of a legal or tax adviser before implementing any ideas contained in this blog.