States are increasingly becoming more aggressive in asserting when a seller of products or services has significant nexus within the state for sales and use taxes - especially as more business is being transacted over the internet. You can learn more about the nexus tax issues as they relate to Pennsylvania by visiting the website for PA Department of Revenue As a CPA providing tax services in Allentown PA I can guide you through the maze of filing complexities related to various state laws.
But first, let me define what “nexus” means in the context of state income taxes. Nexus is a term that describes the amount and degree of activity a business engages in, or has a presence in a state before a state is entitled to assess tax on the income generated within that state. Once this criteria for nexus has been established within the state, it is the business’s responsibility to collect and remit taxes in that state.
Generally, nexus is created for income tax purposes based on three factors: First, when the business derives sales within the state. Second, owns or leases property within the state. Third, employs people in the state engaged in activities that exceed simply solicitation. As to how much activity or in what combination of these factors is necessary to establish nexus in a state is defined by state statute, case law or regulations. Therefore, as you can imagine, nexus tends to vary from state to state. So, it’s necessary to do some research about the state involved to determine that state’s specific requirements. However, all states are limited by Constitutional principles, judicial doctrine and federal law.
Now, with regard to nexus as it relates to sales and use taxes: The states have increasingly become more aggressive in claiming a seller has sufficient nexus in their state for purposes of sales and use tax collection. They will look for interstate activities, relationships and assets of unregistered businesses who have customers in their state. So, here are some general guidelines to help businesses determine their sales and use tax collection obligations.
Know the physical presence law. In 1992 a U.S. Supreme Court decision, Quill Corp vs. North Dakota, held that a seller must have a physical presence in a state before the state can require sales tax collection. But, as with state income tax laws, the types of physical presence that creates nexus do vary from state to state. For this reason, it is very important to review state statutes, regulations, tax agency rulings and court decisions within the state in question. Our firm can help you in that process by utilizing our various tax research tools to find these answers – and more importantly, know how to interpret those answers.
Know where your property is located. By this I mean where is the location of your company’s inventory, products on consignment, leased property, real estate, warehouses, equipment, computer servers, and vehicles. Even some types of intangible property such as computer software could potentially create nexus.
Know where your employees are and their activities. Any employee, independent contractor, sales agent or representatives working in a state could create nexus. As explained above, because states all vary in their definitions, exceptions, length of time limits and the activities involved within the state, there is no universal nexus rule in this area. Generally, however, the activity must somehow relate to your sales. However, in one ruling “the crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for sales.”
Look at the substance of transactions and relationships you have in the state. Some states are broadening the types of relationships which can create nexus. For example, a few states take the position that if a seller and an in-state business have a specified relationship and the in-state business is involved in promoting sales for the seller or has similar products or company name, the seller must collect sales tax in that state.
In April 2008, The state of New York modified its sales tax law to create a presumption that a seller is soliciting business through resident representatives if it compensates them directly or indirectly for referring customers. Therefore, sellers who allow associates who reside in the state to place a link on their own website and earn commissions for sales generated when customers click through that link may be subject to sales tax collection obligations in New York. Amazon.com and Overstock.com were two companies that had filed suits challenging this law’s constitutionality. Amazon.com recently lost that suit. Most states, however, still treat advertising alone as not creating nexus.
Let your business beware. In order to protect yourself from past due tax liabilities and the related penalties and interest it is important to be aware of your business and internet activities across state lines. What starts out as just an individual’s sale of a few used items on an auction website might evolve into what a state would consider a business with sales tax collection obligations. Often times before you know it, the company is then offering new services such as on-site training, or now new employees might start working out of state and create new tax collection obligations they were previously unaware of.
So, if all of this sounds complicated from a tax reporting standpoint – you’re right, it is. So, you better be sure to work with a CPA who is experienced in filing tax returns for multi-state activity businesses. Due to the complexity of all these state issues, preparing the state allocations and tax returns is usually a far more complicated and time consuming part of the overall tax return preparation process than doing the federal return – especially when you start to get nexus filing requirements in three or more states.
The bigger issue though, even before getting to the actual preparation of the corporate tax return is: does your current accounting system sufficiently capture and track the activity on a state by state level to provide the needed detail to make these state tax return allocations? At a minimum, your accounting system should be both capable and properly setup in order to capture gross sales, employee wages, independent contractor payments, property and equipment acquisitions, leasing expenses etc on a state by state level. For example, if you are using QuickBooks, one way to do this is by establishing “class codes” on a state by state basis so that transactions can be parsed into seperate states.
As a company if you try to approach the preparation of the tax returns without considering what you should do first at the accounting structural level, you are putting the cart before the horse and ultimately will make the task even more difficult when it comes tax time