Key Takeaways:
- Expanding into new states with remote hiring, sales growth, or service delivery can trigger complex tax obligations due to differing nexus and sourcing rules.
- Regular reviews of economic nexus thresholds and state-specific taxes like commercial activity and franchise taxes help avoid costly surprises.
- Proactive SALT planning helps growing companies stay compliant and reduce risk when preparing for a future sale of the business.
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As your organization scales across state lines by hiring remote employees, opening new locations, and increasing online sales, you face a patchwork of state and local tax (SALT) rules. What may seem like straightforward growth can quickly trigger new filing obligations, hidden tax liabilities, or compliance issues that impact your bottom line.
Understanding and managing these complexities is crucial. In this article, we outline several situations that can disrupt your SALT compliance and provide guidance on how to address them through careful planning and regular nexus reviews.
What Is Nexus (And Why It Matters)
Nexus is the legal connection between a business and a state that allows the state to impose tax obligations. There are two main types:
- A company creates physical nexus by having a tangible presence in the state, such as an employee, office, warehouse, or inventory.
- Economic nexus typically applies once a business surpasses a certain threshold of sales or transactions in a state — even without a physical presence.
Before the Supreme Court’s South Dakota v. Wayfair decision in 2018, most states relied primarily on physical nexus. Now, nearly every state has its own version of economic nexus. For sales tax, many states base economic nexus on $100,000 in sales or 200 transactions, but thresholds and rules vary from state to state. While income tax economic thresholds, also called factor presence nexus, are generally higher.
3 State and Local Tax Compliance Risks to Watch Out For
If you are not tracking where your sales originate, are not aware of each state’s sourcing rules, or rely on multiple sales channels (like Amazon, physical stores, and a direct-to-consumer website), it’s easy to cross economic nexus lines without realizing it.
Here’s a closer look at these three potential minefields:
1. Income Sourcing Rules and the Risk of Double
Service-based companies face an added layer of complexity due to sourcing rules for income tax purposes.
Market-based sourcing states allocate income based on the customer’s location. For example, if a Nevada-based company provides services to a California customer, that revenue is assigned to California.
Performance-based sourcing states allocate revenue to the service provider’s location.
It sounds simple enough, but consider this example. Your team in California, a market-based state, provides remote consulting services to a client in Texas, a performance-based state. Both states claim the right to tax that revenue and the overlap results in double taxation (or underreporting if your business incorrectly assumes only one state applies).
Adding to the complexity are throwback and throw-out rules, which can affect apportionment, but in different ways.
Throwback rules generally apply to companies that sell tangible property. If the revenue isn’t taxable in the destination state, sales may be “thrown back” to the state where the sale originated. For example, suppose a California-based company ships goods to South Dakota (where it has no nexus). California may require the revenue to be included in its own sales factor. Whether a transaction is “not taxable” in the destination state involves a detailed analysis and varies by jurisdiction.
Throw-out rules, on the other hand, can apply to companies that sell property, services, or intangible property. In these states, certain sales that aren’t taxable in any state must be excluded from the denominator of the apportionment formula. This reduces the denominator, which may increase the portion of income apportioned to the throw-out state.
Because throwback and throw-out rules interact differently with tangible goods, services, and intangibles, understanding your business model and where you’re considered taxable is essential to correctly applying these rules.
2. Multiple Sales Channels and Sales Taxes
Sales tax is a trust tax, meaning you collect it on behalf of the state and pass it through to the taxing authority. If you don’t collect it properly, you might be left footing the bill.
Some common compliance missteps for online sellers include not registering or collecting sales tax after crossing economic nexus thresholds and overlooking sales facilitated by third parties, like Amazon, that may or may not be remitted on your behalf.
For example, say you only make $90,000 in direct online sales in a state with an economic nexus threshold of $100,000. You don’t collect sales tax because you believe it’s not necessary. However, you also sell on Amazon. An additional $15,000 in sales on Amazon pushes you over and creates an obligation to collect and remit sales tax.
State tax authorities know it’s tough to go after small businesses, so they go after marketplace facilitators like Amazon, Etsy, eBay, and Shopify. They may collect and remit sales tax on your behalf for sales through their platforms, but not for direct-to-consumer sales through your website.
3. Remote Work Expands Nexus for Income and Sales Tax
While remote work expands your potential talent pool, it can also expand your potential state tax exposure. Hiring an employee in a new state automatically creates physical nexus, triggering potential obligations such as:
- State income tax filings
- State and local sales and use tax filings
- Employment tax registration
- Business license requirements
- Property tax filings if you provide equipment to the employee
Even if the employee does no direct client work, internal roles like IT or accounting still create nexus.
Other Potential SALT Traps
Beyond standard income and sales taxes, states are creating new ways to capture revenue.
For example, gross receipt taxes — such as Oregon and Ohio commercial activity taxes (CATs) apply even if there is no corporate income tax. And states can assess franchise taxes based on capital or net worth rather than income. These taxes may be reported as part of the income tax return or as a separate liability.
The Role of Proactive Planning
Growing companies often wait until a state sends a notice or an auditor shows up. By that point, your options may be limited and you may face potentially high penalties.
Instead, we recommend a proactive approach that includes:
- Nexus reviews: Identifies where you currently have SALT obligations based on physical and economic nexus.
- Reverse sales tax audits: Uncovers instances where you may have inadvertently overpaid on your sales tax and are entitled to a refund.
- Contract analysis: Reviews how service contracts define location and performance to apply appropriate sourcing rules.
- Voluntary disclosure agreements (VDAs): Where exposure exists, these programs limit your lookback period and reduce or eliminate penalties (invaluable if you’re preparing for a future sale of the business).
How MGO Can Help
We help corporate clients navigate the full scope of multi-state tax challenges — from initial nexus assessments to ongoing compliance. If you’re entering a new market, hiring out-of-state employees, or preparing your company for a transaction, don’t leave SALT compliance to chance — a conversation today can help prevent costly surprises tomorrow.