News & Events

You Could Owe Taxes in Another State and Not Know It

February 17, 2009

Does your company own or lease property outside of its home state? Does it conduct sales or operations in more than one state? Do members of your staff live in a state different from the one in which they work? If you answered “yes” to any of these questions, you could owe taxes in more than one jurisdiction.

Multistate income taxation affects many companies and some don’t even realize it.

Are you exposed?

It’s up to the individual state to decide if a company is subject to its income tax by determining whether or not the company has a nexus — or a connection — with it. Although nexus is determined on a state-by-state basis, certain activities or circumstances within a state usually guarantee it exists, including:

• Having legal domicile or a principal place of business;
• Maintaining an office or other facility, or owning property;
• Having payroll;
• Rendering services; and
• Soliciting orders.

The level of nexus required varies depending on the tax involved. The three most prevalent state taxes are sales and use, corporate income, and franchise. Federal law prevents states from claiming income tax nexus if contact within the state is limited to the employment of salespersons or independent contractors whose only function is to solicit sales for out-of-state approval and fulfillment.

How can you reduce liability?

Establishing nexus with a state doesn’t necessarily increase your tax exposure. Take corporate income taxes, for example. Many states determine the portion of your income subject to their tax using a three-factor formula based on the percentage of your sales, property and payroll attributable to the state. Others use a single-factor formula based just on sales. You may be able to reduce your tax bill by apportioning some of your income to a state with a lower tax rate.

For example, say your company is based in State X but makes substantial Internet and mail order sales in State Y, where it has no physical presence. State X’s business income tax rate is 8%, while State Y’s is only 4%. Both states apportion income using the same formula.

Assume your company’s taxable income is $1.5 million. If your company has no nexus with State Y, all of its income will be taxed by State X, for a tax liability of $120,000 ($1.5 million x 8%). But if your company established nexus with State Y, some of its income could be taxed at the lower 4% rate, reducing its overall tax bill.

Exactly how much tax could be saved would depend on a variety of factors. And of course, before taking steps to establish nexus with State Y, you’d also need to consider the other potential business and tax consequences.

Are you in compliance?

To avoid paying too high a tax bill or being exposed to penalties for not filing in required states, carefully consider state income tax filing requirements in all states for which nexus potentially exists. Discussing your business’s interstate activities with your tax and legal advisors can help ensure you stay in compliance.

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