By: Nathan Sykes
As a small business, you’ll eventually be looking at expanding your reach, and that means crossing state lines. The act itself is pretty straightforward — you simply move or open new operations. Of course, it’s more involved than, that but you get the point.
What you’re probably most unprepared for is the multistate taxation system. As soon as your business or organization jumps state lines, this issue becomes a major concern, and one that you’d do well to understand and plan for.
1. What Is Nexus?
Before tax comes into play, you must understand Nexus. It’s also referred to as “sufficient physical presence.” The concept essentially means you’re connected or linked to the region in question, which calls for you to be a suitable contributor to the commonwealth. Any state in which your business has Nexus is a location you can be taxed for.
Step one for any business or professional should be determining Nexuss. Generally, it’s defined as where you own or rent property, whether you employ people in a particular state or generate revenue within a state’s boundaries. When a situation is clearly defined, such as you owning a property in another state, it’s easy to determine your status.
It gets tricky, however, when things aren't so clear-cut. For example, you might be hiring a remote worker or employee, visiting a state for some time but earning funds or even dealing with inventory or a warehouse that’s in a different state.
2. Understanding the Interstate Commerce Tax Act
Public Law 86-272, also called the Interstate Commerce Tax Act, dictates the solicitation of sales across state borders. More specifically, an individual state cannot levy income tax on a company or business that performs the solicitation of sales for tangible personal property and nothing more.
But the law itself is remarkably misunderstood and has been altered considerably over the years in regards to what it means. “Solicitation” specifically has been used in many different ways. From the placement of orders to content or item delivery, it can be used differently depending on the court and state in which it’s applied. Because of this, it’s important that either you — as a manager — or your legal team understand the precedent of this law so that you’re not affected by legal traps related to it.
Generally, your taxable income is apportioned under either the three-factor formula or single sales factor — more likely the former. However, some states use varying apportionment schemes, which means you’ll have to follow a formula you’re not used to or one that differs considerably from the standard.
This factor is something to keep in mind when dealing with taxable income, so you’ll want to understand the laws and regulations regarding the states in which you do business. If you’re stretched across many boundaries, you’ll want to take the appropriate time reviewing this information before your filing.
4. Credits and Incentives
Tax credits and incentives are great, as they can afford you a little extra capital or revenue to distribute elsewhere. The thing about them, however, is that tax day — or at least the weeks leading up to it — is not the appropriate time to start paying attention to them. Many incentives and credits require you to document and collect proof that you’re eligible, so if you discover them last minute, there's a chance said information might not be readily available.
It’s important to sit down with a financial team and group of legal professionals to identify potential incentives and credits your business can take advantage of over the coming year — for the subsequent tax season.
5. Major Transactions and State Tax
This consideration is especially important for SMBs who are in the process of an acquisition, completing a major transaction of some kind or involved in the sale of a subsidiary.
With federal income tax, issues are ad nauseam. Many focus on the large-scale issues, with state income tax being left by the wayside. This situation is unfortunate because there's always the chance that unexpected or evident state income tax problems will arise as a result of a transaction too. This issue could result in hefty fines or audits later down the line, which are troublesome for major organizations and detrimental for small business.
Pay attention to state tax concerns, especially when working with larger organizations. Don’t expect them to consider all angles, because most of the time, they’re most concerned with federal influence.
Cover Your Bases
The central theme of many of these considerations or potential “issues” is that you should invest the time to understand how tax filings — state and federal — factor into the future of your business. Even a small mistake can result in inordinate fees or lengthy financial audits, which are never helpful or light on overall impact. Even major organizations struggle with the legal ramifications and consequences of poor tax handling. The last thing you want is your SMB suffering simply because you were unaware or unfamiliar with particular regulations and rulings.
If you don’t have the time or resources to invest, then absolutely hire a legal team to handle your tax and resulting finances. You can work with them directly to gain a better understanding, cut down on risk and cost and ensure everything is up to speed.
Joshua Lawrence, a partner at Hodgson Russ, a partner at Hodgson Russ, advises, “A number of companies—Avalara and TaxJar are probably the most well-known—specialize in multistate sales tax compliance. They can assist with some of the administrative and practical burdens by automating the determination of tax rates, filing returns, managing exemption records, etc. Such services may also assist in determining the taxability of a company’s transactions.”
He continues, “However, in the case of software and SaaS, where questions of taxability and “sourcing” are often highly fact-dependent and reliant on interpreting case law and rulings, getting the advice of a tax professional, such as an accountant or attorney whose practice includes state and local taxation, is the best way to mitigate the risks associated with misinterpreting state tax laws.”
Staying up to date with state and local tax regulations that will have an effect on your small business is the one of the most important steps in successfully running a business that crosses state lines. Just because your business is small doesn’t mean it can’t have a large outreach, you just need to be aware of the risks and address them correctly.