Beware The Out-Of-State Tax Bite
by: Randall Wells, CPA
It’s not uncommon for companies
along the Gulf Coast to conduct business in more than one state.
With the current economic troubles leading to ever tightening budgets at
the state level, it is not surprising that some cash-strapped states may look at
multi-state companies as a source of additional tax dollars. Considering this
environment, it is in your company’s best interest to review your interstate
activities to ensure you’re in compliance with the states’ various tax laws.
When can a state tax your
company?
Determining when a state has a
right to tax your company is not always straightforward.
In general, your company must have nexus, or a certain level of
connection, with a state before that state has the right to levy a tax on you.
The level of nexus required may vary depending on the state and the type of tax
involved (e.g. sales and use taxes, corporate income taxes, or franchise taxes).
Many early nexus cases involved sales and use taxes. Technically, the consumer
is responsible for those taxes, but because of the impracticality of collecting
them from individuals, states have placed this burden on the seller.
Traditionally, a physical
presence in a state has been required to trigger a responsibility for collecting
sales and use taxes, but some state courts and legislatures have been expanding
the limits of the physical presence standard.
For example, maintaining inventory, creating agency relationships, or
having employees enter a state to provide technical support can potentially
create nexus and trigger filing requirements.
These changes can pose real challenges in an era when many companies are
trying to take advantage of advances in technology, with the intention of making
it easier to do business remotely with customers in states or countries where
they have no physical presence.
To keep up with the changing times, some states have passed legislation
minimizing the level of activity required to establish a physical presence.
Others have attempted to impose sales and use taxes on businesses that have no
physical presence in the state but have an agency-like relationship with an
in-state retailer or a warranty service provider.
Nexus can be good or bad
Establishing nexus with a state
can increase your tax exposure, but in some cases it does the opposite. For
example, consider corporate income taxes. Many states determine how much of your
income is subject to their tax using a three-factor apportionment formula that
considers the percentage of your sales, property and payroll attributable to the
state. (In some states, the sales factor is double-weighted.) Others use a
single-factor formula based on sales.
If you’re able to apportion some of your income to a state with a lower
tax rate than your home state, it can reduce your tax bill. On the other hand,
should a state determine that you have nexus, and you have not paid the
appropriate taxes or filed returns, the state has the ability to assess tax for
prior years even if you already paid the taxes to another state.
The number of years that a state will go back is often longer than your
ability to amend previously filed returns to offset the additional tax.
Business over state lines
Due to the need for states to obtain additional sources of revenue, they’ll likely continue to extend the geographical reach of their tax laws to capture more revenue from companies operating across state lines. To help avoid paying duplicate taxes or incurring a large unexpected tax bill, consult with your tax advisor, who can review your company’s interstate activities and assist you with identifying and reducing your exposure to out-of-state tax liabilities.