When does our business need to file income tax returns in other states?
When a business operates in multiple states, it can be challenging to determine its state income tax obligations. One of the most critical concepts to understand is state income tax nexus. This refers to the connection or level of presence that a business has in a particular state that triggers the obligation to pay state income taxes in that state. In this article, we will explore what creates state income tax nexus for a business. Also when they need to file a tax return in a state.
What Creates State Income Tax Nexus for a Business?
There are several factors that can create state income tax nexus for a business, including:
- Physical Presence: A business has physical presence nexus in a state if it has a physical location, property, or employees in that state. For example, if a business has an office, warehouse, or store in a state, it has physical presence nexus in that state. Similarly, if a business has employees who work in a state, it has physical presence nexus in that state.
- Economic Nexus: Economic nexus refers to the minimum level of economic activity that a business must have in a state before it is required to pay state income taxes. Economic nexus can be triggered by factors such as the volume of sales or the number of transactions that a business has in a state. The specific threshold for economic nexus varies by state.
- Affiliate Nexus: Affiliate nexus, also known as click-through nexus, occurs when a business has an agreement with an affiliate in a state who refers customers to the business through links on their website. If the affiliate generates a certain amount of revenue for the business, the business may be required to pay state income taxes in that state.
- Factor Presence Nexus: Some states use a factor presence test to determine whether a business has nexus in the state. This test looks at the level of a business’s property, payroll, and sales in the state and compares it to the level of the business’s property, payroll, and sales worldwide. If the percentage of the business’s property, payroll, or sales in the state exceeds a certain threshold, the business may have factor presence nexus in that state.
When Does a Business Need to File a Tax Return in a State?
Once a business has created nexus in a state, it is required to file a tax return in that state and pay state income taxes on the income generated from that state. The specific rules for when a business needs to file a tax return in a state vary by state and depend on factors such as the amount of income generated in the state and the type of business activity.
As you can expect there are 50 states in the United States and with that comes 50 different sets of state income tax laws and rules, not to mention sales tax, property taxes and further licenses and fees that are charged by states.
What happens if we don’t file in states where we have nexus?
In many cases a business will make state filings in the jurisdiction that they started the business in and then assess from there on an annual basis. Quite often business leaders take a “look the other way” approach and neglect to file in states that they have nexus. While this may work for a period of time, it is our experience that this strategy backfires for a couple of reasons. First, the states are continuing to take action to scout out non-filers. As an example, many states have their own revenue department offices within California to enforce their state’s tax laws within California. Other states have so-called revenue agents looking for businesses that are not in compliance.
Second, at the time that you go to sell your business the legal and professional teams for the buyers have become tough in this area. We have experienced clients who have had to set aside a portion of their proceeds in an escrow account to take care of state tax issues once the new owners are filing in the proper states.
How do I properly navigate state income tax nexus?
As you can see, state income tax nexus is a complex business issue that is continuing to impact more and more businesses as they grow and sell into other states. There are two primary ways that you can go about taking care of this for your business. First, you can search out each state’s revenue department and then research the tax laws on their websites and determine if you meet filing thresholds. Second, you can reach out to our team at Whittaker and we can perform a state income tax nexus survey for you and determine which states you have exposure and the scope of that exposure. In either case this is a topic that you need to keep abreast of and not run afoul of the long-reaching taxation arms of the various states.
If you would like further information, please contact someone on our tax team at Whittaker. Or Click the link below to start the process.