Does your business owe taxes in other states?
Posted On: 8-4-2015 | Posted By: Katie Barthel, CPA, and Jessica Lehmen, CPA
As we all know, your business is required to file tax returns in the state in which you primarily do business, and in the state in which your business is located. But do you owe taxes to other states?
It’s possible you have filing requirements in other states if it is determined that you have “nexus” with those states. Read on to learn more about the concept of nexus.
What is nexus?
According to the United States Constitution, a business is subject to a state’s tax laws and filing requirements when it has minimum contact or connection with that state. This minimum contact or connection is what we call “nexus.” Once nexus is established, the states can impose income, franchise, and gross receipts taxes. Businesses can also be required to collect and remit withholding and sales or use tax.
How do you get nexus?
How exactly does your company get nexus? Quite often, the answer to this question is, “it depends on the state!” The courts have been working for years to determine which activities generate nexus in a state, and the answer can be different for each state and type of tax administered. The two chief ways to create nexus are to have physical presence or economic presence in a state.
Physical presence is the traditional nexus standard and is the easiest to interpret. This standard asserts that the presence of employees or property within a state’s borders is sufficient to generate nexus. If your employee or independent contractor is based out of a state at any point during the year, it’s likely that you have nexus. Storing or using any of your business property in a state, either permanently or temporarily, is also likely to generate nexus. For some states, even one day of physical presence is enough contact to generate nexus.
The economic nexus standard comes into play when physical presence does not exist, yet a company is nonetheless able to exploit that particular state’s market. The economic connection necessary to generate nexus can include using a trademark or having an affiliate in that state, or even simply generating a certain volume of sales in that state. While the states have issued some guidelines on how they determine economic nexus and there have been quite a few court cases regarding this issue, none have been heard by the U.S. Supreme Court, making the economic nexus standard highly interpretive and dependent on the state.
Which nexus standard does my jurisdiction use?
In general, sales and use taxing jurisdictions highly favor the physical presence nexus standard, while income, franchise, and other business taxing jurisdictions are moving toward adopting an economic nexus standard. There are, however, a few well-known exceptions to these generalizations.
Click-Thru Nexus & Sales Tax
As we stated above, sales taxes are largely assessed when a business has physical presence with a state. However, in 2008, New York enacted what is commonly known as the “Amazon Law” that subjects an internet retailer to sales taxes based on the concept of “click-thru nexus.” Click-thru nexus exists when: (1) an internet retailer in State A uses a resident in State B to advertise its products on a website geared toward other State B residents; (2) a sale is made based on this advertisement; and (3) the internet retailer in State A pays a sales commission to the resident in State B. Following the Amazon Law, the internet retailer would now have sales tax nexus in State B. Similar click-thru nexus provisions have been added by quite a few states, including Missouri.
Public Law 86-272 & Economic Nexus
The Interstate Income Act of 1959, more commonly known as Public Law 86-272 (“P.L. 86-272”), has been a lifeline for many wholesalers and retailers looking to expand into different markets. P.L. 86-272 allows a business to send representatives into a state to solicit orders for tangible property without being subject to that state’s income tax. The stipulations of this law are as follows: (1) the orders must be fulfilled from outside the taxing state; (2) the law does not apply to franchise taxes, but only to taxes based on income; and (3) the law only applies to sales of tangible personal property, not of real or intangible property.
Why is nexus so confusing?
Nexus standards are controlled by the U.S. Constitution, but both federal and state courts have interpreted them differently over the course of tax history. Interstate commerce has changed drastically over the last 50 years. E-commerce and cloud computing have changed the way the average company does business, and the guidelines that applied 20 years ago are no longer relevant in today’s climate. As the economy has more complex cross-border transactions, businesses are pressing for stricter guidelines from each state on how it will interpret these nexus standards.
When your business is expanding into another state, you have more to consider than just the tax filing requirements. By doing business in another state, you are often required to complete non-tax related filings such as Secretary of State annual reports and registration fees. If you are going to hire an employee in another state, be aware that employment laws also might not be the same.
If you think your business may be at risk for other states’ taxes, contact your WK advisor at (573) 442-6171 or (573) 635-6196.