Nexus in a Nutshell
When Does a Business Need to File State Income and Sales Tax Returns?
Merrill Barter, Managing Director, Tax Practice
Most businesses now conduct activities in multiple states, and keeping track of these activities while trying to grow a business can be very difficult. However, knowing where the business has activities – employees selling products or providing technical advice to clients, for example – can be important when it comes to limiting the business’s state tax exposure.
There is a common misconception that a business must have a physical location or at least resident employees within a state to be subject to the state’s income taxes and sales tax collection requirements. Unfortunately this is not the case. This article will provide a brief overview of the rules governing when a business’s activities within a state have risen to the level that they may create “nexus” – a term that refers to the “minimum connection” required for a state to subject a taxpayer to its income and/or sales tax filing requirements.
For businesses that sell tangible personal property (TPP), the presence of sales people visiting customers or prospective customers does not create nexus. There is a federal law specifically exempting sales and ancillary activities from creating nexus. The law is quite narrow – some specific activities that will not create an income tax filing obligation include: soliciting orders, including by a resident employee (provided the employee does not maintain or use an office or place of business in the state), providing company cars for use by sales people within the state, and recruiting and training sales people.
But if a company’s employees conduct activities outside of or in addition to sales, then a filing requirement may exist. Following are some activities commonly performed by employees which may create nexus within a state:
- approving or accepting orders;
- delivering product in company-owned vehicles;
- providing warranty service;
- making repairs or providing maintenance or service to the property sold;
- installing or supervising the installation of the property sold;
- providing technical assistance/services, such as engineering assistance/design services, unless the purpose is solely to facilitate the solicitation of orders;
- consigning stocks of goods or other TPP
For businesses that sell anything other than TPP – services or software, for example – the federal law protection for sales activities described above does not apply. If a service business, such as a law firm, accounting firm, engineering or architectural firm is visiting customers in multiple states, even just to solicit new business, it is likely that a filing requirement exists.
If a business’s employees conduct any of the above activities, or almost any activity, within a state that imposes a sales tax, then a filing requirement will exist. And, importantly, the federal protection for sales activities that prevents income tax nexus does not apply for sales tax purposes. For example, if the employees of a New Hampshire business that sells office furniture visit customers or prospects in Maine and their sole purpose is to solicit orders (any orders being approved in New Hampshire), then no income tax filing requirement will be created. However, the business will have nexus for sales tax purposes, and will be required to register with the State and collect sales tax. This is a common “trap” for businesses, and we encourage you to understand that sales tax nexus is triggered much more easily than income tax nexus.
This time of year, as businesses are pulling together their tax information and working with their accountants and tax advisors, presents a good opportunity to review the company’s state activities. States are very diligent in their efforts to identify businesses with filing requirements, and while there is a cost related to state tax compliance, the cost of not complying can be much greater. If a business with unmet state income and sales tax filing obligations “gets caught,” interest will apply, and penalties will likely be imposed. If sales tax has not been properly collected, the business could be on the hook for taxes that were not actually its liability, but instead should have been paid by its customers. But at that point it will be impractical to obtain it from customers. The liabilities can compound very quickly.
The general information covered above can be supplemented with the following previous articles that delve into specifics:
- Apportionment of Service Revenue - An Overview
- Economic Nexus
- Voluntary Disclosure: How to Come Clean and Limit Your State Tax Exposure
If you have any questions, please contact Merrill Barter or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.