In recent years, state governments have focused their resources on ensuring that taxpayers maintain compliance with specific state rules and regulations. Some state governments are enduring financial difficulties and are aggressively seeking additional tax dollars from taxpayers to help recover from deficits.
If your business operates in multiple states, you may be subject to state income taxation in a particular state if your business has nexus in that state. Nexus is commonly defined as a “connection” to a place. The term nexus is also used to describe the presence that a business has in a state and the degree of activity that the business engages in within a state.
When a business produces an income or loss for tax purposes, state law will require that the business income or loss be apportioned between jurisdictions based on a formula dictated by the state. While each state addresses the requirements for nexus differently, the factors listed below are the most common ones used for determining state taxable income.
Some states place different weights on a three-factor formula, and some states will use a single-factor formula based only on sales to determine taxable income:
1. Income derived from sources within the state.
2. Property owned or leased within the state.
3. Employees active within the state.
It is important to note that all businesses regardless of entity type may be affected by state tax nexus. Partnerships, corporations and sole proprietors are treated differently for federal tax purposes, and most states conform to federal rules for determining characterization of a business entity as a corporation, a partnership or a disregarded entity.
All entities, regardless of type, are required to follow the same basic nexus guidelines in determining state filing requirements.
Business operators need to be aware of the requirements for tracking sales, property and employees by state to maintain adequate accounting records. As a general rule, accounting records should be substantial enough to provide the following information:
1. Track sales revenue of goods or services by state. If goods are being sold or services provided in multiple states, it is important to track sales by state. If a business has a physical presence in a state, the business should review filing requirements for sales and use tax.
Even if a business is not subject to state income taxes, there may be other tax consequences to consider such as city and local taxes.
2. Understand where your property is located. Property includes fixed assets, inventory, consignment goods and leased and rented property. Tracking property by location is important because many local counties and cities impose a personal property or ad valorem tax based on the amount of property held within a specific jurisdiction.
3. Know where your employees are located and evaluate their activities within a state. Paying an employee wages within a state could subject the business to payroll taxes and could create nexus for income tax purposes. In many states, the employment tax liability rules are distinct from the income tax nexus rules and should be considered separately.
With the recent difficult economy, businesses may be looking for customers in other states to try to maintain or expand their business. At the same time, state governments with declining revenues are looking to make sure that tax is collected on all economic activity within their jurisdictions.
Whether you are new to interstate commerce or have been operating in other states for awhile, we recommend that you consult with your tax adviser as rules and regulations for state taxation are constantly changing.
Joel Stettler, CPA, is a tax manager at Hancock Askew & Co. LLP. He can be reached at 912-234-8243 or firstname.lastname@example.org.