Multi-State Taxation Issues to be Aware Of
November Energy Advisor: Businesses Must be Aware of Income Tax Issues When Expanding into Other States
Your business is expanding. Not just in your home state where the company headquarters is located, but also in neighboring and non-neighboring states. It is exciting times when your business is growing, developing and morphing into a success. Keep in mind that there is something that a business should not lose sight of during this expansion. The creation of nexus and the potential exposure to state income tax liabilities in these new states should not be overlooked by your business.
State Taxing Authorities Actions
State taxing authorities are actively targeting in-state and out-of-state companies for all sources of tax dollars. Tax dollars from state income tax are one of the main targets, especially income tax revenues generated from out-of- state companies.
State taxing authorities are growing increasingly aggressive in identifying potential taxpayers. Their tactics range from surprise visits, random audits and the business activity or nexus questionnaire. Taxing authorities may cast a wide net, querying every registered business in a given industry. Thanks to improved data sharing capabilities, revenue agencies are cooperating across multi-state areas, leaving no leaf unturned.
A routine business activity questionnaire can easily wind up in your company mail and get ignored (or worse, the wrong person within the company responds and provides inaccurate answers). Other times, companies feel they must respond either “yes” or “no” to the questions, when they would be better served by attaching a detailed written response. The bottom line is that responding to what may appear to be routine questions should not be taken lightly.
The term nexus is used in tax law to describe a situation in which a business has a presence in a state and is thus subject to state income taxes. Nexus describes the amount and degree of business activity that must be present before a state can tax an entity’s income.
Nexus for income tax purposes is generally created when an entity derives income from sources within the state, owns or leases property in the state, employs personnel in the state in activities that exceed “mere solicitation,” or has capital or property in the state. The requirements vary from state to state.
Many companies have mistakenly clung to protections afforded by Public Law 86-272, a 1959 Federal statute that prohibits states from taxing the net income of an out-of-state business whose only business activities within the state consist of merely “soliciting” orders for the sale of tangible personal property in which orders are sent outside the state for approval and are filled by shipment or delivery from a location outside the state.
Public Law 86-272 does not apply to sales of services, real property nor intangible property. This 1959 law has become outdated because for the past several years, many companies generate revenues from sources other than the sales of tangible personal property. While efforts have been made in Congress to update Public Law 86-272, it has not yet occurred. Meanwhile, states apply constitutional principles to determine what activity of a business in a state makes that business subject to state income taxes. The results have not been consistent from state to state.
Each state may have a different approach as to what their nexus guideline or rule is when Public Law 86-272 does not apply. Generally, these approaches involve some angle on economic nexus or another type of nexus standard.
Every Case is Unique
Unfortunately, the definition of “solicitation” can vary by state and can get extremely complicated. The issues relating to whether a business has a nexus in a state and is thus subject to the state’s taxing authority is complex and each state views the concept of nexus differently.
Business owners are well advised to seek competent tax and accounting counsel before responding to a state’s request for nexus or business activity information, even if they feel they have no tax liability in that state.
At Herbein, our experienced tax and accounting professionals can provide invaluable guidance and help in formulating an appropriate response to state tax revenue authorities, determining whether your company has nexus in a specific state and also in providing your company with the potential income tax exposure for the states that you are doing business in.
For additional information or if you have any questions, please contact David Cordier at firstname.lastname@example.org or your Herbein tax advisor.
David F. Cordier, CPA, MST