As a business owner, you may be familiar with the tax related term “nexus”. Nexus, or “sufficient physical presence,” is a legal term used to describe the connection a business has with a state.
In addition to submitting federal tax filings, your company may also be required to file a variety of taxes at the state level. Tax requirements aren’t limited to the state your business is registered or incorporated in. Your business' tax obligations generally depend on its relationship with the states it has sales, property, places of business, and/or employees in. When one of these conditions exist within a state’s boundaries, your business will more than likely be subject to some level of taxation. This is where understanding nexus becomes crucial.
Although rules differ from state to state, here's a quick summary of tax responsibilities:
Does your business sell products or services in multiple states? If the answer is yes, you may be legally required to collect sales tax from your customers. If a business sells goods or services in a state where they have nexus, there is a requirement to register with the state’s tax office and remit taxes collected from customers. With many companies using fulfillment centers (e.g., Amazon), third-party co packers, and satellite offices across the US, states are increasing their requirements for nexus, consequently affecting many small businesses. Failing to collect sales taxes can result in substantial penalties, so take the time to understand your obligations.
Things are a little less straightforward when it comes to corporate income tax. If a business has nexus for sales tax purposes, it does not necessarily mean nexus will exist for income tax. Public Law 86-272 allows non-resident companies to perform the following activities in a state without creating an income tax nexus:
- Solicit sales of tangible personal property (directly or indirectly)
- Provide services that are ancillary to the sales of property
- Have samples for display in the state or other property used for sale (cars, computers, etc.)
- Orders accepted and fulfilled outside of the state
Example activities that can create an income tax nexus include:
- Having employees or providing services in the state
- Having inventory in the state
- Accepting orders in the state
- Selling certain property
A franchise tax is a government fee for the privilege of doing business in a state. Unfortunately, the vast majority of states require the payment of a franchise tax if a business has nexus there. Understanding whether your business needs to pay franchise tax requires a state-by-state assessment. Usually, payment of a franchise tax is based on the net worth of a business, but this is not always the case. If you're unsure, check with your CPA or relevant state authorities.
Gross Receipts Tax
Gross receipts tax, also known as a gross excise tax, is a tax on the gross revenues of a company. It applies to all the business sales made in a state and usually has few or no deductions. While gross receipts taxes may appear similar to sales taxes, they apply to the business (that’s you), not your customers. As of 2015, the only states that have a gross receipts tax are Alabama, Delaware, Florida, Illinois, New Mexico, Ohio and Pennsylvania.
The Bottom Line
Location matters. Some states are more business-friendly than others, so before expanding across state lines, be aware of the tax implications and keep up-to-date with changes. If you own a multi-state business or operate online, remember there are a variety of state taxes that may apply to you!