The U.S. is very much a national economy — even small businesses aren’t restricted to their hometown communities. Many companies don’t know that certain activities give rise to filing requirements for income, payroll and/or sales taxes in other states.
At the same time, it’s no secret that states are having trouble making ends meet, so they are using creative ways to find companies doing business from out of state.
“States essentially are looking to find new sources of tax revenue, without increasing taxes on the folks in their own state. It’s really easy to tax the people who don’t vote for you,” says Brad Greenberg, a director of tax in SS&G’s Chicago office.
Smart Business spoke with Greenberg about being proactive with your state tax filing requirements.
How would a business know if it had a filing requirement in another state?
There are more than 11,000 taxing jurisdictions in the U.S., whether states, cities or counties. With state and local tax filing requirements, the keyword is nexus — a minimum physical connection, often through sales or delivery trucks, attending a trade show or having contractors service a machine you sold.
If you make sales to a state, you probably have a responsibility to remit sales tax. However, if your activities are restricted to sales, you may not need to pay income tax. Payroll taxes are more black and white — if you have an employee based out of another state, you’ll have a payroll tax requirement.
If your employees are working on a project in another state, depending on the length of time and that state’s tax requirements, you may need to withhold state income taxes. Rules are so varied that Congress introduced legislation for a 30-day minimum rule. In addition, some states use a concept known as economic nexus to determine filing requirements, such as Ohio’s commercial activities tax, or if you sell $500,000 or more to California, even over the Internet.
What are states doing to find businesses?
States are cross-referencing taxpayer information from various departments to generate lists of companies that are remitting payroll taxes, but aren’t remitting sales or income tax.
Then, states send out letters. One is an audit or assessment that says ‘you’ve been doing business in our state. We think you should be filing sales and/or income tax returns.’ Any business receiving this letter needs a professional to investigate whether or not a filing requirement existed. If one does, you must file returns; if there isn’t, the adviser can help explain why filing requirements don’t exist.
The other kind of letter is a nexus questionnaire, which asks about your business activities. Don’t ever try to fill out one of these yourself. They are written to create more taxpayers for that state. Tax professionals can help ensure you answer the questionnaire completely and accurately, truly reflecting your business activities, without leading the state to believe there is a filing requirement.
Why is it helpful to be proactive?
You want to sit down with your tax adviser and take a close look at your multi-state activities to recognize any issues. If you happen to be doing business in a state where you potentially owe tax, there are mechanisms to minimize your liability, interest and penalties. Your accountant can ask the state for a voluntary disclosure agreement. If you voluntarily come forward, you’ll likely have a shorter look-back period, and in many cases forgiveness of penalty.
What if the business provides services?
A professional services firm can perform work for out-of-state clients on site or virtually. The income tax filing requirements depend on whether the states in which you perform the work, and where your customers are located, apportion income based on where you provide the service (‘cost-of-performance’ method) or where the customer realizes the benefit of the service (‘market’ method). So it’s important to keep good records with respect to where employees are working on each client engagement. The rules are complex and differ from state to state.
You don’t want to be subject to the hassle of audits or filing back tax returns, or to face penalties and interest. An accountant with a strong background in state and local tax can help manage these risks. ●
Brad Greenberg is director of tax at SS&G Chicago. Reach him at (847) 676-2000 or [email protected].
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