Practitioners who understand the business tax rules in their home jurisdictions sometimes face unanticipated exposures when a growing business client expands across state and local lines. This blog highlights some of the income tax and sales and use tax pitfalls that could arise for such businesses and their advisers.1 Through familiarity with potential exposures and the exercise of caution, unnecessary tax expense and exposure can be avoided.
Expansion-Related Nexus
Most U.S. states have income taxes and sales and use taxes. Income taxes are typically imposed directly on business entities (or owners in the case of pass-through structures). Sales taxes are typically imposed on purchasers of taxable goods and services, but a collection obligation is imposed upon the seller. Moreover, a reciprocal use tax is imposed upon a purchaser when sales tax is not collected by the seller or, in certain situations, when a seller is viewed as the ultimate customer.2 Failure to satisfy sales or use tax collection and reporting obligations can subject sellers to liability for the tax, plus interest and penalties.
Some level of connection, or “nexus,” must exist for a business entity to be subject to a state’s or locality’s taxing jurisdiction. Physical presence used to be required for a taxpayer to be subject to collection obligations for sales tax purposes, but those days are gone. Now, all states that impose a sales tax have adopted “economic nexus,” with varying monetary or number-of-sales thresholds for becoming subject to tax responsibilities. For income tax purposes, some jurisdictions use an economic nexus while others apply more traditional “factor presence” nexus principles, with varying thresholds as to when a taxpayer is deemed to have a sufficient connection to become subject to tax.3 Not understanding the thresholds and the company’s sales, property, and/or payroll within a state can lead to missteps.
