Does your company operate in multiple states? If so, there’s a good chance that you owe some state and local taxes (SALT) outside your home state. But many closely held private businesses are unaware of their SALT liabilities.
While it’s sometimes difficult to determine whether sufficient business activity has taken place in another state to trigger SALT liability, this usually isn’t a valid excuse for nonpayment. The penalties for nonpayment can be steep, which makes complying with SALT obligations critical for small businesses.
The concept of nexus
To know when SALT liabilities may be triggered, you need to understand the concept of nexus. This describes the degree of business activity that must be present in a state before your business is considered to have a presence there and becomes subject to that state’s taxing jurisdiction.
Taxes that could fall under SALT liability include income, payroll, franchise, and sales and use taxes. But what establishes nexus for one type of tax might not establish nexus for another. Let’s take a closer look at nexus for income tax.
If your company has income tax nexus in another state, you must file an income tax return and pay income tax in that state. Your company doesn’t have to maintain a physical presence in a state for nexus to kick in. A number of situations can trigger nexus from an income tax standpoint, including:
- Employing workers who reside in the state,
- Performing installations, repair or warranty work in the state,
- Leasing or owning property (including inventory),
- Leasing to customers in the state, and
- Holding meetings or conducting training in the state.
Even attending trade shows could trigger nexus. Nexus requirements differ from state to state, so you’ll need to check with each state for its specific requirements.
In general, if your company generates income from any source located inside a state, nexus will apply to income tax. One exception is salespeople who live in and make sales in a state, but with the orders being fulfilled in another state.
There are a few specific scenarios in which nexus won’t apply to state income taxes. These include:
- The solicitation of sales and taking of orders in another state by employees or independent contractors of a business,
- The acceptance of such orders by customers in another state, and
- The filling of orders from inventory located in another state.
But keep in mind that such scenarios might establish nexus for other taxes, such as sales and use taxes.
Defining nexus consistently
To provide some degree of consistency in defining nexus for income tax liability, the Multistate Tax Commission has created an optional model statute that defines nexus based on a certain amount of economic activity. Among the states using the model statute are California, Colorado, Connecticut, Kansas, Michigan, Ohio and Washington.
According to the commission’s “Factor Presence Nexus Standard for Business Activity Taxes,” nexus applies for income tax purposes if, during the tax period, a company 1) possesses at least $50,000 of in-state property, 2) processes at least $50,000 of in-state payroll, or 3) makes a minimum level of sales into a state. The sales minimums vary from one participating state to the next, ranging from $250,000 to $500,000. This model also applies nexus for income tax purposes if at least 25% of a company’s total property, payroll or sales occurs in a state during the tax period.
Making SALT collections a priority
As states and municipalities seek to boost revenue in the wake of the recession, many have prioritized the collection of taxes from out-of-state companies. Some states have created new departments devoted exclusively to finding out-of-state companies that should be paying SALT but aren’t.
In addition, more states are taking advantage of cross-border agreements with other states’ departments of revenue. They also are sharing audit findings with each other and collaborating with federal customs agents.
In this environment, it’s critical that businesses understand their SALT obligations and pay all taxes due in a timely manner. Be sure to consult with your tax advisor for more detailed guidance with regard to your potential SALT liabilities.