Doing Business Across State Lines

Does your business lease property in another state? Do you have sales people who travel to other states?

You may have multistate tax issues.

There are many types of state and local taxes. Three of the most common are income tax, sales tax and use tax. These taxes may have different names in different states. For example, an income tax may be referred to as a franchise tax, or a sales tax may be called a transaction privilege tax.  The use tax is the twin to the sales tax: if the seller does not collect sales tax, then the purchaser may be required to separately pay use tax.

There is a new breed of state taxes that meld the above. Ohio has a commercial activities tax, which sprung into existence as a replacement to the Ohio franchise tax but bears closer resemblance to a sales tax.

Why should you worry about multistate issues?

A key reason is that states are facing severe budgetary pressures and are looking to aggressively assert their tax laws in order to increase their tax receipts. It used to be, for example, that you did not have to worry about collecting sales taxes for another state unless you owned or leased property in that state or kept employees there. This is now changing.   California, for example, wants Amazon to collect sales tax if it pays a fee to “affiliates” located in California. An affiliate (say a California band) has a hotlink on its website to Amazon. By clicking on that link, one is transferred to Amazon where one can buy the band’s CDs. California believes that is enough reason to pull Amazon into its sales tax regime.

California is not the only state moving to this "affiliate" sales tax theory. New York became the first to do so in 2008, and Connecticut, Illinois, Rhode Island and Arkansas have since passed similar laws.

Did you know that some states subject services to sales tax? If you are performing services in those states, you may have multistate tax issues.

If you do not know you have a liability, you cannot file. Did you know that there is no statute of limitations on how far back a state can go if you never file returns? You could wind up owing 10 years or more in back taxes, plus penalties and interest. Not a problem, you say, as I can file for refund in my state and get that money back. What if the statute of limitations for a refund has expired with your state, but there is no limitation in the new state demanding sales taxes. In that case, you are paying tax twice.

There is a long-standing tax theory called “nexus” that states have to meet in order to pull you into their tax regime. The states have been changing, and aggressively expanding, their definition of nexus. It may be that ten years ago you did not have nexus but that you do have nexus today.

Examples of nexus are:

• An office
• A phone line
• Inventory or supplies in the state
• Office equipment or other property
• Business license
• Employees acting on your behalf
• Employees attending a trade show in the state
• Independent contractors acting on your behalf
• Use of intangible property (like a trademark) in the state

Did you notice the one about the trade show? In 2007 the Texas Comptroller of Public Accounts determined that a seller of dental equipment who attended a one-day trade show was responsible for collecting sales taxes on any sales generated at the trade show. The decision is not totally unexpected, as the salesman did generate quite a few sales and attended the trade show annually. However, many if not most tax planners would have missed this sales tax exposure by reasoning that it is only one day.

States are changing how they are apportioning or allocating multistate income to their respective state. It used to be that states would weigh sales, property and payroll evenly. Many states are now moving to sales only, with no weighting for either property or sales. This is an effort to more out-of-state businesses into their tax system. Why, some states will require you to treat income sourced to a non-taxing state as attributable to them! This is the “throwback” rule, and it is a transparent effort to increase their own tax apportionment.

What if you form separate legal entities to avoid nexus? For example, a manufacturer could have plants in several states but have a separate company make all retail sales.  Some states will assert “affiliate” nexus if any of the affiliated entities have nexus. One equals all. Once an affiliate has nexus, all the affiliates have nexus. In an income-tax environment this is referred to as the “unitary” concept.

It is important that you work with an accountant or advisor proficient in these matters. If you find that you have an issue (especially if the issue has existed for several years) that advisor will be invaluable to you and your business. An experienced advisor may be able, for example, to limit the number of back years that have to be filed with a state, as well as any penalties.