Expanding your business operations across state lines can create significant opportunities for growth and long-term success. It can also bring tax implications that can be challenging for an entrepreneur to navigate. Without a clear compliance strategy in place, you could face significant penalties, administrative burdens, and unexpected tax bills. While multi-state compliance can quickly outpace a company’s internal capabilities, it’s crucial to have the guidance of a skilled tax professional who can help you plan for expansion and avoid potential pitfalls.
Identify the Nexus
The first step in navigating multi-state tax filings for a growing business is to identify whether you have a tax obligation in a specific state at all. This is determined by whether your company has a nexus in that jurisdiction. The nexus refers to the minimum connection a business has with a state to trigger tax liability, and is primarily categorized into two types:
- Physical nexus: A physical nexus exists when your company has a tangible presence in a state, such as an office, warehouse, employee, or storage facility. Participating in a trade show or having a remote worker in the state can also create a physical nexus.
- Economic nexus: Economic nexus refers to the connection between a state and a business that allows the state to require the business to remit sales tax. Each state has a certain threshold for sales revenue or the number of transactions a business can have in the state to trigger these requirements, regardless of physical presence.
Businesses should also be aware that the affiliate nexus and the “click-through” nexus can trigger a tax obligation. An affiliate nexus is created when an affiliate or subsidiary helps a business maintain a market in the state. A “click-through” nexus is established when an out-of-state seller partners with a resident of the state who promotes a seller’s website by sharing referral links in exchange for a commission.
Understand the Taxes Involved
Businesses with a presence in more than one state may be subject to various types of taxes. Understanding which taxes apply is essential to managing multi-state tax filings. These taxes may include:
- Income and franchise tax: Once a nexus is established, a state may require a company to file income or franchise tax returns.
- Sales and use tax: Depending on the company’s activities and nexus, it may be required to collect and remit sales tax on taxable transactions or report use tax on purchases.
- Payroll and employment taxes: Companies with employees in multiple states may be required to withhold and remit state income taxes, unemployment insurance taxes, and other employment-related taxes in those jurisdictions.
Certain states may also impose industry-specific taxes, which create additional compliance obligations. It’s important to monitor changes in tax laws of each jurisdiction where the business has a nexus.
Strategically Apportion Income Across States
Businesses operating in multiple states must apportion their income in the various jurisdictions in which they operate. Apportionment helps ensure that each state taxes only its fair share of a company’s revenue, preventing double taxation.
While most states use a “single sales factor” to apportion income, some use a formula that reflects business activity conducted within their borders. The formulas typically consider sales, property, and payroll. Under the apportionment rules, companies can lawfully allocate income to states with more advantageous tax rates to reduce their total tax liability.
Assess State Tax Credits
Many states offer tax credits and incentives. Businesses should evaluate the availability, eligibility requirements, and limitations of these credits in any state in which they have a filing obligation. While credits from one state cannot be used to directly offset tax liabilities in another, strategic planning is vital.
Contact an Experienced Tax Professional
If your business is expanding into several states, a knowledgeable tax professional can help you plan for growth, ensure compliance, and avoid costly mistakes. At Rolleri & Sheppard, CPAs, LLP, we offer a wide range of tax services to companies of all sizes. Contact us online or call (203) 259-CPAS to schedule a consultation to learn how we can help you advance your business objectives.
