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State Tax Traps
Tax and Financial News
November 2000
State Tax Traps
If you drive anywhere in the United States, chances are you have heard of speed traps, but if you are a business owner, have you heard about State Tax Traps? State Tax Traps are anything you didnât know about state taxes and licenses before doing business in another state and didnât think to ask. If you sell product in any state where you are either a non-resident or a foreign corporation, then read on. Even if you are only thinking about expanding your business into another state, read on. You may find food for thought before you take the plunge.
Many business owners have the mistaken notion that they only have to pay tax where the business resides. After all, thatâs where they live and the company ships its entire product out of their plant or store.
Unfortunately, thatâs not the case. You see, there is a concept in the law called ânexusâ. Simply stated, nexus means you have a business presence in a state sufficient to cause you to be taxed.
So, how do you avoid creating nexus â donât have a business presence in the state. Several factors come into play in determining if you have nexus. These factors are sales, property and employees.
Sales â The definition for sales should be a pretty easy concept, donât you think?
Think again. The state that claims the sale for tax purposes depends on many factors.
The first factor is the terms of the sale. Is the product being shipped Free On Board (FOB) Shipping point or Destination? If it is shipped FOB Shipping that means the customer or a shipping company is responsible for the product from the time it leaves the plant. The opposite is true for items shipped FOB Destination.
A second factor to consider is how the product gets to the customer. Do you ship the product in your own truck or by a common carrier? Maybe the customer picks the product up at your plant. Knowing this will help you determine where the sale occurs for income tax purposes.
Even knowing the answers to the foregoing questions isnât enough. Different states have different definitions of what constitutes a sale for income tax purposes. Before you move into a state, we suggest you review the tax laws to determine that stateâs definition.
Property â Where is your inventory located? Do you have it all in a warehouse behind your office? Or, is it located in states throughout the U.S.? Perhaps itâs on consignment to a major customer.
If you have any inventory in a state, you have property in that state. If you maintain equipment or own a building in another state, you have property in that state. If you have property in a state, look very closely at the other two factors in this article. You may have nexus.
Employees â Do you employee outside salespeople? Do they live in your state or another state? To what states do you pay payroll taxes? If the employee has an office, where is that office? In many states, the mere fact you have a salesman visit a customer in a state is sufficient to say you have an employee in that state.
Again, we suggest you investigate what the state you are moving into uses to define your business as having employees in the state. A good place to start is Tax Links at taxlinks.com.
If Iâm Taxable, What do I have to pay?
Youâve done your homework and have determined you are taxable in 10 states other than your state of residency. Now what?
The answer to your question depends on the states in which you are taxable. Some states tax you based only on your income in the state. Some states levy only a capital stock tax, better known as a franchise tax. Some states charge both taxes.
Because of the different taxes charged by the states, the method of determining income and capital for each state can be vastly different. However, many states use a three-factor âapportionmentâ formula to determine taxable income and capital based on sales, payroll and property. Generally, you would be required to determine the percentage of each of these three factors incurred in the state where youâre taxable and then divide the sum of the percentages by three to get an average percent. Multiply this percentage times taxable income and voilaâ, you have an estimate of the your taxable income in that state.
This is a simplistic approach and to get really accurate numbers, you may have to âallocateâ some income such as rents, royalties and non-business capital gains to specific states. However, you can get a fair estimate for planning purposes using the above formula â if the state you are looking at uses the three-factor formula.
One warning about franchise taxes. These taxes are really taxes paid for the privilege of âdoingâ business in a state. Sometimes, people fail to pay these taxes and other state license fees. This could adversely affect a companyâs legal rights. Accordingly, be very careful to pay these taxes whenever applicable.
Other Taxes
So far, we have talked only about income and franchise taxes, but you know states and municipalities charge more than just income taxes. Here are a few of the other common taxes and/or licenses you will have to deal with:
Depending on the state you are entering, there may be more, so be sure to check out all the legal requirements when moving into the state.
Be careful, but donât give away the store
As you can see, there are many different taxes, along with other legal requirements, to consider when moving into a state. You need to retain someone who is competent to determine what your exposure may be. Depending on where your business is going, this may mean a great deal of time spent in research, but it will pay off in penalty and interest savings in the future.
You need to consider one final step after doing all the research. Talk to the revenue departments in each state. We have seen situations where the best research came to one conclusion, only to have the client fill out a questionnaire and be told the opposite by the revenue department. Generally, the conclusion is a company is taxable when the state says they are not taxable.
We suggest you do the research first, and then call those states where you may be taxable. At that point, you have nothing to lose and everything to gain.
Because state tax traps are very tricky and not always readily apparent, we suggest that when moving into a new state, they are also a very important consideration. Donât be confused. You thoroughly research each states requirements and taxes before you go forward. Give us a call and let us help you get the answers.
Many business owners have the mistaken notion that they only have to pay tax where the business resides. After all, thatâs where they live and the company ships its entire product out of their plant or store.
Unfortunately, thatâs not the case. You see, there is a concept in the law called ânexusâ. Simply stated, nexus means you have a business presence in a state sufficient to cause you to be taxed.
So, how do you avoid creating nexus â donât have a business presence in the state. Several factors come into play in determining if you have nexus. These factors are sales, property and employees.
Sales â The definition for sales should be a pretty easy concept, donât you think?
Think again. The state that claims the sale for tax purposes depends on many factors.
The first factor is the terms of the sale. Is the product being shipped Free On Board (FOB) Shipping point or Destination? If it is shipped FOB Shipping that means the customer or a shipping company is responsible for the product from the time it leaves the plant. The opposite is true for items shipped FOB Destination.
A second factor to consider is how the product gets to the customer. Do you ship the product in your own truck or by a common carrier? Maybe the customer picks the product up at your plant. Knowing this will help you determine where the sale occurs for income tax purposes.
Even knowing the answers to the foregoing questions isnât enough. Different states have different definitions of what constitutes a sale for income tax purposes. Before you move into a state, we suggest you review the tax laws to determine that stateâs definition.
Property â Where is your inventory located? Do you have it all in a warehouse behind your office? Or, is it located in states throughout the U.S.? Perhaps itâs on consignment to a major customer.
If you have any inventory in a state, you have property in that state. If you maintain equipment or own a building in another state, you have property in that state. If you have property in a state, look very closely at the other two factors in this article. You may have nexus.
Employees â Do you employee outside salespeople? Do they live in your state or another state? To what states do you pay payroll taxes? If the employee has an office, where is that office? In many states, the mere fact you have a salesman visit a customer in a state is sufficient to say you have an employee in that state.
Again, we suggest you investigate what the state you are moving into uses to define your business as having employees in the state. A good place to start is Tax Links at taxlinks.com.
If Iâm Taxable, What do I have to pay?
Youâve done your homework and have determined you are taxable in 10 states other than your state of residency. Now what?
The answer to your question depends on the states in which you are taxable. Some states tax you based only on your income in the state. Some states levy only a capital stock tax, better known as a franchise tax. Some states charge both taxes.
Because of the different taxes charged by the states, the method of determining income and capital for each state can be vastly different. However, many states use a three-factor âapportionmentâ formula to determine taxable income and capital based on sales, payroll and property. Generally, you would be required to determine the percentage of each of these three factors incurred in the state where youâre taxable and then divide the sum of the percentages by three to get an average percent. Multiply this percentage times taxable income and voilaâ, you have an estimate of the your taxable income in that state.
This is a simplistic approach and to get really accurate numbers, you may have to âallocateâ some income such as rents, royalties and non-business capital gains to specific states. However, you can get a fair estimate for planning purposes using the above formula â if the state you are looking at uses the three-factor formula.
One warning about franchise taxes. These taxes are really taxes paid for the privilege of âdoingâ business in a state. Sometimes, people fail to pay these taxes and other state license fees. This could adversely affect a companyâs legal rights. Accordingly, be very careful to pay these taxes whenever applicable.
Other Taxes
So far, we have talked only about income and franchise taxes, but you know states and municipalities charge more than just income taxes. Here are a few of the other common taxes and/or licenses you will have to deal with:
Business License
Certificate of Occupancy
Sales Taxes
Use Taxes
Annual registration with the Secretary of State
Depending on the state you are entering, there may be more, so be sure to check out all the legal requirements when moving into the state.
Be careful, but donât give away the store
As you can see, there are many different taxes, along with other legal requirements, to consider when moving into a state. You need to retain someone who is competent to determine what your exposure may be. Depending on where your business is going, this may mean a great deal of time spent in research, but it will pay off in penalty and interest savings in the future.
You need to consider one final step after doing all the research. Talk to the revenue departments in each state. We have seen situations where the best research came to one conclusion, only to have the client fill out a questionnaire and be told the opposite by the revenue department. Generally, the conclusion is a company is taxable when the state says they are not taxable.
We suggest you do the research first, and then call those states where you may be taxable. At that point, you have nothing to lose and everything to gain.
Because state tax traps are very tricky and not always readily apparent, we suggest that when moving into a new state, they are also a very important consideration. Donât be confused. You thoroughly research each states requirements and taxes before you go forward. Give us a call and let us help you get the answers.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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