If your company does business solely in one state, it probably owes tax to that state, as well as to the federal government. Many companies, however, operate across state lines, and therefore, may owe tax to more than one state. In the current economic slowdown, some states are endeavoring to address tax shortfalls by aggressively seeking more tax from companies based in other states.
Types of tax
State taxes come in several categories. The most common include
• income taxes. If your company has net income from operations within a state, that state may tax those profits.
• sales taxes. These taxes generally are imposed on the retail sale of goods (that is, when goods are sold to an end user). The buyer usually pays this tax, but the seller is ultimately responsible for collecting the tax and remitting the money to the state.
• use taxes. Buyers who avoid sales tax on a purchase will generally owe a use tax on it. A use tax is a tax on the storage, use, or consumption of tangible personal property within a state. In some states, use taxes also apply to purchases of certain services. Use taxes are complementary to sales taxes; if a taxpayer pays sales tax on an item or service, it will be exempt from use tax.
• For example, suppose a company based in Maine purchases goods from a supplier located in Massachusetts and uses the goods in Maine. If the company in Maine does not pay a sales tax, it will owe a use tax. Use tax rates are the same as sales tax rates.
• other taxes. States sometimes also employ a variety of other taxes in addition to or in place of the taxes discussed previously. These include franchise taxes, which are taxes imposed for the privilege of doing business in that state, and taxes on a taxpayer’s gross receipts.
Complex connections
Even if your company has some out-of-state activity, it may not owe any or all of these taxes to every state in which it operates. Generally, your company’s tax obligation will depend on whether its activities in a given state are sufficient to create nexus. This term describes a connection to a state that reaches a level justifying taxation. If a company has nexus with a state with regards to a particular type of tax, it will be subject to that tax in that state.
Although the principle of nexus is easy to understand, determining when a business has nexus with a state for a specific type of tax can sometimes be anything but easy. Within broad parameters prescribed by the U.S. Constitution and certain federal laws, each state can set its own nexus standards, and these standards can vary widely from state to state. Also, within the same state, the standards for nexus for one type of tax can be significantly different than for another type of tax. In addition, because the ways that companies do business are constantly changing (for example, selling through the Internet and employing telecommuters), and the states are constantly seeking to expand the boundaries of nexus in order to increase their potential tax base, the rules in this area are seldom stable. Activities or situations that, in the recent past, may not have been a source of nexus with a particular state may now or in the future result in a company’s being taxed by the state.
The bottom line is that states differ in what they consider nexus, and the rules in the area are continuously evolving. Due to the very serious repercussions that having nexus with a state can cause, many cases challenging a state’s assertion of nexus have come before different states’ courts, with varying outcomes. Before you expand your operations beyond your home state, check the nexus laws of the new states in which you are planning to do business and decide whether the business opportunities justify the potential tax cost. Our office can help you learn about the nexus rules in states your company has targeted for business.