Do you represent a company that owns
or leases property outside of its home state? Does it conduct sales
or operations in more than one state? Do members of its staff live
in a state different from the one in which they work? If you
answered "yes" to any of these questions, your client could owe
taxes in more than one jurisdiction.
Multistate income taxation affects
many companies - and some do not even realize it.
Are you exposed?
The laws of each individual
state control 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,
The level of nexus required
varies depending on the tax involved. The three most prevalent
state taxes are: 1) corporate income, 2) franchise, and 3) sales
Income tax nexus is the term
used to describe the types of contacts necessary to establish a
state's right to impose an income tax obligation. A corporation
generally is subject to income tax in the state in which it is
incorporated, and also may be subject to income tax in any other
states in which its property, employees, or other agents are
physically present on a regular and systematic basis. A corporation
which has income tax nexus in a state will also have nexus for
franchise tax and sales tax.
Federal Public Law 86-272
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. However, Public Law 86-272
does not prevent states from claiming franchise tax or sales tax
nexus when a corporation is soliciting sales within a state. Also,
Public Law 86-272 only applies to solicitation of sales of tangible
personal property. Solicitation of sales of services or intangible
property are not afforded protect from imposition of an income
Franchise tax is a tax that
corporations pay for the privilege of doing business within the
state. Depending on the state, the franchise tax may be levied
based on percentage of profits, capital stock, net worth of the
business, assets or the amount of property held within the state.
It is not uncommon for a company to be subject to a franchise tax,
but not an income tax in the same state. Beginning in 2009,
Massachusetts will require companies that do business in the state
to pay either the franchise tax on net worth or tangible assets
even when Public Law 86-272 protects the company from income
A business must collect
sales tax from its customers when it has a direct or indirect
physical presence in a state, known as sales tax nexus. Failure to
recognize that sales tax nexus may exist in a state, even where
there is no income tax nexus in that same state, can result in
exposure for uncollected sales tax.
How can you reduce your overall
state tax liability?
Establishing nexus with a
state does not necessarily increase your tax liability. Take
corporate income taxes: Many states determine the portion of your
income subject to their tax using a three-factor apportionment
formula based on the percentage of your sales, property and payroll
attributable to the state. Others use a single-factor apportionment
formula based just on sales.
States generally require a
taxpayer to be subject to income tax in more than one state before
they are allowed to apply an apportionment formula. When
corporations are allowed to apportion their income sellers of
tangible property determine their sales factor by dividing the
amount of sales delivered to customers in a state by total sales.
Many states, including Massachusetts, have a sales "throwback rule"
which can cause sales delivered into states where the corporation
is not subject to tax to be included in, or thrownback to, the
numerator of another state where the corporation is
Having nexus in another
state may enable you to reduce your tax bill by apportioning some
of your income to a state with a lower tax rate and reducing your
apportionment in a higher tax rate state. For example, say your
company is based in Massachusetts but makes substantial Internet
and mail order sales in Florida, where it has no physical presence.
Massachusetts' business income tax rate is 9.5%, while Florida's is
only 5.5%. Both states apportion income using the same
Assume your company's
taxable income is $1.5 million. If your company has no nexus with
any other state, all of its income will be taxed by Massachusetts,
for a tax liability of $142,500 ($1.5 million x 9.5%). But if your
company established income tax nexus with Florida, some of its
income could be taxed at the lower 5.5% rate, reducing its overall
tax bill. The portion of the company's income subject to tax in
Florida would not be subject to tax in Massachusetts.
A company will be considered
to be taxable in another state only if that state has jurisdiction
to tax the company, whether or not it imposes such a tax. If a tax
return is not filed in another state, Massachusetts will presume
that the company is not taxable in that state. A tax filing that is
not required, but rather is made on a voluntary basis, will not be
sufficient evidence to support that a company is taxable in such
Exactly how much tax could
be saved would depend on a variety of factors. But given the fact
that the Massachusetts Legislature may consider a proposal to
increase the corporate tax rate to 10.5%, the highest rate in the
country, any redistribution of taxable income from Massachusetts to
another state will result in a reduced overall tax liability. Of
course, before taking steps to establish nexus with another state,
you would also need to consider the other potential business and
Are you in
Filing requirements for
multistate corporations vary considerably from state to state. The
requirements are further complicated when the company with nexus is
a member of a group of affiliated companies. Some states require
each taxpayer with nexus in the state to file a separate return,
while others require or allow related taxpayers to report income on
a combined or consolidated basis.
Businesses that sell, rent
or lease a product collect and remit sales taxes to a variety of
jurisdictions. In general, vendors who have made any sales that are
subject to sales or use tax and purchasers who are required to pay
the use tax must file returns on a monthly, quarterly, or annual
To avoid paying too high a
tax bill or being exposed to penalties for not filing in required
states, carefully consider state income tax and sales 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, and may in
fact reduce your company's overall state tax bill.