Business owners must assess their risk and exposure to State income taxes.  For many businesses, gone are the days when only one state income tax return is filed at tax time.

As budgets become tighter in virtually every state, it is inevitable that states look to taxpayers for additional sources of revenue. Increasingly, states have been using multi-state taxation as a way to raise additional revenue. Compounding the problem for businesses is the fact that it is easier than ever to do business anywhere or with anybody in the country…and it’s just going to get easier. 

As your business continues to expand, it’s important to be mindful that your business may have income tax or reporting obligations in multiple states. Each state has its own complex tax laws, thresholds for filing, and definitions of nexus. Although it’s nearly impossible nor practical for a business to know every state tax law, every business is required to be compliant with the states they do business in. The seemingly monumental tasks of ensuring compliance with state tax law starts at the ground level; with you simply asking questions and assessing where you do or will do business. Below is a summary of considerations and questions we want you to be thinking of as we approach tax season.

Do you have customers in other states?

Simply having out-of-state customers might not necessarily create a filing requirement, but it is certainly the point where you need to start digging in to where exactly you are doing business. If shipping a product, it is important to determine and document where the customer takes possession of the product. If you are performing a service, you should determine where the services are performed and whether the location of those services is essential to the overall result of your services. It is a best practice for every business to be tracking which states their customers are coming from. Most states apply an economic nexus standard, where you can generate nexus just based on the level of sales.

Do you have physical locations in multiple states?

Opening a physical location, operating a warehouse, or satellite office in another state almost certainly constitutes nexus in that state. Once you establish physical presence in another location, it’s crucial to track the revenue and expenses, inventory, or other significant activity measures by each location. If you own or rent real estate in another state, the income directly produced by said real estate is generally taxable to the state where it resides.

Do you have remote employees working in other states?

Hiring or allowing employees work remotely has become much more prevalent in the 2020s. If you hire someone works remotely in another state, it will generally create payroll tax filing obligations within that state. And, when you file a payroll tax return in a state, your business gets on the “radar” for that state for income taxes. Many states have what’s called a “payroll factor” on their income tax returns; where a portion of taxable income must be allocated to the state based on payroll. It is also important to consider whether having an employee in the state is essential to a revenue stream or customer.

Are you marketing in other states?

Public Law 86-272 can protect “mere solicitation” for orders of tangible goods from out-of-state taxation, but it does not apply to services. Additionally, any coordinated or targeting marketing campaign in a state likely will constitute nexus within that state. There is also a consideration referred to as “cookie nexus”. Several states assert that placing cookies on customers’ computers can create a physical presence in that state. If you have a significant marketing budget or are leaving cookies, you might review where the efforts are concentrated to see if it can be deemed significant to certain states.

Does your business have any shareholders or partners in another state?

A “silent” partner or shareholder who is strictly an investor will not automatically trigger nexus in many states. However, if a partner or shareholder actively participates in the business from another state, then you should look at the circumstances of what work they’re performing to determine if your business has tax-filing requirements in that state.

Do you regularly travel to meet clients in other states?

If a key part of a service you are providing involves travelling to a client location, most states would consider this as doing business in their state. To help assess whether client travel is substantial enough to establish nexus, your business might review the travel expenses, the time spent in a different state, and the revenue generated.

Do you attend seminars, conferences, or trade shows in other states?

Yes, even attending an event on behalf of your business can create nexus in another state. To be clear, simply attending an event probably will not trigger nexus, but active marketing such as setting up a booth, instructing seminars, demonstrating a product, or otherwise soliciting business at the event can establish a physical presence in that state.

While these scenarios are not exhaustive, it’s a good starting point to think about your business’ state tax exposure. If you answered yes to any of these questions, please contact your tax professional at Dowell Group. If you do end up filing in other states, fear not, we’re here to help you. While additional filings may seem cumbersome and feel like an additional tax burden, working with us to help stay compliant will make the process easier and give you peace of mind that you’re doing what’s best for your business and mitigating or minimizing penalties and interest that could be assessed. Not to mention, all states have provisions to avoid double taxation, so a liability in a new state may result in a credit in your home state, which can often nearly be a complete offset.

If you would like additional information or have any questions, please contact your tax professional directly, or call us at 847-934-0300.