By: Erica Horn, CPA, JD | ehorn@deandorton.com and Maddie Schueler, JD, LLM | mschueler@deandorton.com
Nearly two years ago, we published an article on the proliferation of dollar and other thresholds set by states that, if exceeded, would result in a business having to collect the states’ sales tax. Before a state can exercise its taxing authority over a business, the business must have “nexus” with the state. Nexus is a connection with a state, sufficient under the United States Constitution, to allow the state to require the business to pay tax.
The trend toward using dollar and other thresholds started with sales tax after the United States Supreme Court’s decision in South Dakota v. Wayfair. But, the states have expanded this approach to cover income and other taxes. This article provides an update on where the states stand on nexus for income taxes.
First, a little background…
Traditionally, states equated both sales and income tax nexus with a physical presence. This meant that unless a business had employees or property (i.e., an office, inventory, etc.) in the state, the business was not subject to the state’s income tax or required to collect the state’s sales tax. This requirement still exists in most states, but, as the economy has evolved, so have the states. States now have much broader nexus statutes. For example, XYZ Corp., located in State B, might have nexus in State A if XYZ has leased property, independent contractors, an interest in a pass-through entity, or attempts to sell goods or services in State A.
Now, to those thresholds
At least 25 states and two major metropolitan areas, Philadelphia and San Francisco, have adopted a “doing business” or “factor presence” standard. The “doing business” standard covers a broad range of business activity, and “factor presence” is a fancy name for dollar thresholds. These two standards are collectively referred to as “economic nexus.”
“Doing business” means everything from licensing intangibles in a state to leasing property, using independent contractors, or having an interest in a pass-through entity doing business in a state. “Factor presence” thresholds range from “any amount” of sales, property, or payroll to $500,000. For example, businesses have nexus for purposes of Tennessee’s excise tax (the state’s income tax equivalent) if they have more than: (a) $500,000 of sales into Tennessee or 25% of total sales into Tennessee, (b) $50,000 of property in Tennessee or 25% of total property in Tennessee, or (c) $50,000 of payroll in Tennessee or 25% of total payroll in Tennessee.
With many employees working from home due to the pandemic, the payroll factor has taken on special significance this year. An employee working from home in a different state than the employer’s office or plant location could create nexus for the employer by exceeding the state’s payroll factor. Almost half of the states have issued guidance on this issue.
What should I do to minimize my exposure?
To minimize your exposure, consider the connections you have in other states, such as property, people, and sales. These connections could create income tax nexus. If you think you may have an income tax liability for prior years, many states have a voluntary disclosure process where you can work with the state to comply with its tax laws. In exchange, the state agrees to limit the period for which you owe back taxes and may agree to waive penalties that would otherwise be due. A tax professional can help you evaluate your exposure and determine the best method for achieving compliance.
This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).