Introduction
All states are becoming more aggressive in locating non-filing businesses, particularly those operating largely outside their state. Unfortunately, many businesses first realize their filing obligation to another state when visited by the state’s auditor. An analysis of your company’s connections, or “nexus”, to the states it touches, directly and indirectly, will be beneficial regardless of whether your business is a start-up or established, expanding or contracting.
Each state’s laws for determining whether your company has a filing obligation vary, but all states are limited by the “minimum contacts” standards established under the U.S. Constitution. Adding to many companies’ confusion, there are separate standards applied for sales and use tax nexus and income tax nexus. For instance, a company with a representative in a state may not have an income tax filing obligation but may have a sales tax obligation.
The Risk
A company should not find comfort in its distance from its customers’ states. States have numerous ways of discovering a company’s activity: an audit of your customer reveals your invoice, your company’s online advertising lists a local phone number, your in-state agent innocently mentions your business during an audit.
The consequences of not filing can be severe. A state’s statute of limitation generally begins to run when a return is filed. Thus, for unfiled returns, state statute of limitation laws will not limit an aggressive comptroller or revenue department from seeking long overdue tax returns and payments, plus interest and penalties. If your company properly reports sales taxes, the seller is merely collecting the tax from the buyer. If your company fails to collect the sales tax, your company will be forced to pay the tax on behalf of the buyer, even if the buyer could have presented you an exemption certificate. And, your payment can rarely be recovered from your customers. With the national average sales tax rate being 8% of the sales price, few companies can painlessly absorb the cost of failing to file six or more years’ sales tax returns. Conversely, a company can be equally harmed by erroneously collecting sales tax or filing income tax returns in states in which it no longer has, or never had, an obligation.
The Solution
Many tax attorneys and large accounting firms offer state tax nexus studies or reviews. These nexus studies or reviews will evaluate your business and its direct and indirect connections to states and will provide written determinations regarding your state filing obligations. Tax advisers can be hired on a state-by-state or comprehensive basis, or may be hired simply to coordinate your in-house compliance efforts.
The tax adviser may offer voluntary disclosure services to minimize the past returns required to be filed and minimize the penalties and interest. With proper planning your company may actually receive a refund depending upon whether income allocations can be adjusted or if certain states’ filings are determined unnecessary. Further, some customers may have paid use tax for which your company may be entitled to a credit.
When choosing a tax adviser for nexus issues, you should consider a tax attorney or an accountant with a legal background. Often, Federal laws and court opinions alone restrict how far states typically will go to tax out-of-state companies, and the states’ guidance to accountants often reflects the states’ expansive intent. Hence, using state guidance without knowledge of the states’ legal limitations will lead to unnecessary filings. Make no mistake, nexus determinations are legal opinions.
The Laws
The governing laws for nexus determinations evolved through court decisions, particularly U.S. Supreme Court cases regarding the Commerce Clause and Due Process Clause of the U.S. Constitution.
For sales and use tax nexus, physical presence in the state is required, but, once found, often is conclusive of the company’s sales and use tax collection and filing obligation. Typical elements indicating sales tax nexus and physical presence can be seen by viewing Maryland’s sales tax nexus statutes:
♦ Permanently or temporarily maintaining, occupying, or using any office, sales or sample room, or distribution, storage, warehouse, or other place for the sale of tangible personal property or a taxable service directly or indirectly through an agent or subsidiary;
♦ Having an agent, canvasser, representative, salesman, or solicitor operating in the state for the purpose of delivering, selling, or taking orders for tangible personal property or a taxable service; or
♦ Entering the state on a regular basis to provide service or repair for tangible personal property.
Notice, agents and other non-employees can create a physical presence. Hence, states can find your company has sales tax nexus even if a single employee has never visited the state. Nonetheless, some states will provide their own safe harbors for policy purposes. For instance, some states with large convention industries exclude a company representative’s physical presence if there to attend a trade show.
For income tax nexus, the Commerce Clause and the Due Process Clause similarly limit states, but, to the behest of companies and their advocates, courts have been reluctant to similarly require companies to have a physical presence. There are; however, separate limitations only applicable to income tax nexus determinations. In 1959, the U.S. Congress, using the power granted it through the Commerce Clause, enacted Public Law 86-272. PL 86-272 provides a safe harbor for certain activities under which states cannot impose an income tax filing obligation.
Further intricacies based upon court opinions and based upon each state’s law will determine whether nexus does indeed exist. Since company facts often fall into nexus gray areas, it is your adviser’s knowledge of these intricacies that will be needed to accurately determine your company’s filing obligations.
The Relevant Facts
When beginning a nexus study or review, the adviser will likely have you complete a questionnaire regarding your company’s activities. Some typical questions to companies include the following:
In state X:
♦ Does the company have a place of business?
♦ Does the company have employees of independent contractors?
♦ Do the representatives have home offices?
♦ Do the representatives use company property, such as laptops?
♦ Does the company have any equipment, inventory, product samples?
♦ Does the company install or repair its product?
♦ Does the company participate in trade shows, host sales meetings, or train users?
♦ Do out-of-state employees or representatives visit?
Each state is different, so the conclusion reached from your responses will also differ.
Conclusion
Many companies take an unnecessary risk by not filing required state returns, particularly sales tax returns. By proactively determining your company’s tax nexus issues, you can minimize your company’s exposure to unexpected tax audits and assessments. Tax professionals can assist you with these nexus determinations and are trained to minimize the burdens of any discovered issues.
For further information or to have a sales tax nexus review performed for your business, please contact Jeff Rogyom at (410)929-4578. Please review the Disclaimer page regarding use of this website and its information.
