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SALT-ED Q&A: When do I pay taxes in another state?

Dec 15, 2014

Q: When do I pay taxes in another state?

A: As tax season draws closer and closer, people often question whether a business must file a tax return in another state. The question is answered by asking whether a business has acquired “nexus” in a state.

Nexus is the degree of activity that an out-of-state business must have before a state can enforce a right to file and collect taxes. Nexus is established when a business has a physical connection with a state through employees, property, or other action.

The nexus standards are different for income and sales taxes.

Income Tax Nexus

Generally, income tax nexus is created by having property or payroll in a state. There are some very limited rules that allow exclusion for sales of tangible personal property, but these rules are very narrow and limited to specific sales activity. Many states assume income tax is due when a company is “directing business” to a state or creating a “market” in a state. Some large states such as California and New York have created “economic” nexus rules whereby a business has nexus simply by conducting a minimal amount of sales in a state without any physical presence. Beginning January 1, 2015, New York requires an income tax return for any business with $1 million in New York sales. California requires a return for sales of approximately $529,000 or if a company has 25% of its sales, payroll, or property in California.

Sales Tax Nexus

Because of e-commerce, the sales tax nexus rules are becoming more complicated as states try to capture lost revenue. Typically, sales tax nexus is created by a physical presence. This presence is established through the presence of a salesperson or in many cases an independent sales representative. Nexus may also be established through trade shows or business relationships. A single customer visit can easily create sales tax nexus.

More recently, several states have passed rules asserting sales tax nexus through the use of another company’s website to generate sales, known as “click through” nexus. Initially used to target large Internet retailers such as Amazon, these rules attach nexus to companies that pay other companies for each sale. For example, suppose a retailer sells hubcap covers and contracts with a motor magazine website to place an advertisement. For each sale generated through the motor magazine’s website, the hubcap manufacturer agrees to pay $1. In the states with “click through” nexus, if the Internet sales in a state equal or exceed $10,000, nexus is established. Once nexus is established, the hubcap manufacturer must collect sales tax on every sale into this state, regardless of whether it was generated from the motor magazine website or not.

The consequence of not understanding the nexus rules and not reviewing a company’s position annually can be very costly. Let’s assume a company established nexus seven years ago through the use of an independent sales representative. Because a sales tax return was never filed, a state will seek sales taxes, interest, and penalties for all sales in the state for the past seven years. With states like Wisconsin, which has an 18% interest rate, the final assessment can be fatal for a small or even medium-sized company.

Once Nexus Has Been Established

Should a company immediately file a return once nexus has been established? No. If you suspect nexus has been created, you should contact your Wipfli professional. Suddenly filing a return of any kind has the potential of creating an audit and a tax assessment going back a number of years. Nexus is a very complicated issue, with court challenges occurring on a regular basis. Wipfli professionals are knowledgeable about these court cases and other nexus exceptions to help you navigate the national business landscape.