Don’t be Blindsided by Business Tax Nexus Requirements Non-compliance Can Be Costly

By Frank G. Sweeney, CPA, Klatzkin & Company, LLP On Mar 10, 2017

Business owners are typically aware of the federal and home state tax filing requirements. However, many do not know that they may be subject to business tax nexus in other states. If you engage in interstate business activities, it is important to become familiar with the tax law in each state. Non-compliance can be costly.

Tax nexus is the term that describes a business connection. Certain activities could cause nexus and an obligation to file and remit sales and use tax, income tax, franchise tax, and/or a variety of other taxes.

Nexus Activities

Nexus is defined on a state-by-state basis. Certain business activities can trigger nexus within a state. These include, but are not limited to:

• Incorporation
• Having legal domicile (an address)
• Having a principal place of business
• Operating from an office or another facility
• Soliciting business
• Employing staff
• Providing goods or services
• Using a trademark
• Owning or leasing tangible personal property or real property
• Making deliveries or engaging in installations
• Servicing equipment and/or accepting returns

Sales Tax Nexus vs. Income Tax Nexus

Businesses with sales tax nexus may not have income tax nexus and vice versa. Usually, state income tax nexus occurs when an out-of-state business earns income from sources within a state, owns or leases property in another state, or employs individuals who are engage in activities that are not protected under interstate commerce laws.

Federal Law Protection

Federal law (PL 86-272) offers certain entities protection from states that would claim tax nexus against out of state business activities. Enacted in 1959, the law protects and promotes interstate commerce. This protection applies to the sale of tangible personal property but not the sale of real estate, services or intangible property. Nor does it address the sale of goods and services online.

Protection under PL 86-272 is limited in that it allows businesses who employ salespeople within a state to solicit sales of tangible personal property that are approved and fulfilled out of state. The delivery of the goods must be by a third party, typically a common carrier, and not the company itself.  Also, the company offering the goods cannot provide customer service support within the state in which the sales representative is soliciting business.

What a Business Owner Should Know

While PL 86-272 can provide protection from income tax, it does not protect a business from a state’s franchise tax, which is imposed on the right to do business in the state and is generally allocated on capital, net worth, or another non-income basis. Some states are also revising their taxing structure to get around the protection that the law affords. Many have replaced their income tax with a non-income-based tax on gross receipts, gross profits, or other methods.

Some states are changing the way that they recognize income for entities that conduct business within their borders. Instead of recognizing income based on gross receipts, payroll and property, plant, and equipment these states are moving toward using sales sourced in and out of state as the sole factor. Also, many states are switching to a market source basis versus a cost of performance basis for recognizing those sales.  If one does business in a state that uses a market source basis of income recognition, sales to customers in that state must be included in the computation of income tax allocable to the state.

Although filing tax returns in multiple states is burdensome, it does not necessarily mean a company will have to pay more money in taxes. Generally, income is allocated to each state, or when it is taxed by two states, a tax credit may be provided by the resident state to offset the taxes paid to another state. This is, of course, dependent on the tax law in each state that the company does business.

The Cost of Not Being in Compliance

States are getting more aggressive in finding companies that are not compliant with filing and remitting taxes. If you are audited and found to be non-compliant, you must pay back taxes, interest and penalties which could go back to the first year that business was done within the state. The cost can be staggering and, in extreme circumstances, it could bankrupt your company. If there was willful intent or gross negligence involved, criminal charges could be filed against you and other responsible officers.

What a Business Owner Can Do

Consult with a qualified tax professional that has experience in this matter if a business activity may have caused nexus. If one comes forward, you may be able to negotiate a far better outcome than if you wait to be audited.

Most states, including New York, New Jersey and Pennsylvania, have a Voluntary Disclosure Program (VDP) to encourage delinquent and unknowing taxpayers to file the appropriate business registrations, tax return(s), and pay current and back tax obligations. The advantage of coming forward prior to being contacted by the state is that you may receive favorable terms which could include anonymity pending an agreement and relief or relaxed interest and penalties. You will also have the time to assess and quantify the circumstances in advance.  In addition, a limited look-back period can be requested which is often granted.  If a look-back period is available, it is generally limited to four years (three prior years and the current year). This alone could make it advantageous to participate.

VDP eligibility requirements vary from state-state. For example, in New Jersey the taxpayer would be eligible if:

• There is no previous contact between them and the state’s taxing authorities or any of its agents;
• They are not registered for the taxes they wish to come forward on;
• They are not currently under any criminal investigation;
• They are willing to pay outstanding tax liabilities and file the prior year returns within a reasonable period.

States sometimes offer tax amnesty for coming forward. The Pennsylvania Department of Revenue is offering an amnesty program. All penalties and half of the interest owed by those who apply and pay delinquent taxes from April 21 through June 19, 2017 will be waived. Individuals and businesses with past-due state taxes as of December 31, 2015, are generally eligible, as well as taxpayers who failed to file for tax periods due on or before December 31, 2015. More information on Pennsylvania’s tax amnesty program is available at www.revenue.pa.gov/taxamnesty.

If you do business in multiple states, it is recommended that you discuss nexus with a certified public accountant who specializes in this area. Consider having them do a nexus study so you are fully aware of your filing requirements. Otherwise, you can could be held liable to pay taxes, fines and penalties in states that you had no idea you are obligated to pay.

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