Multistate Law Firms Could Have a State Tax Nexus Filing Obligation: 3 Big Questions Answered

August 17, 2022

By: Julie Chesebro, CPA; Ella Corry, CPA

At a glance

  • The main takeaway: Whether your law firm has a multistate presence due to physical office locations, remote employees, or both, you may be required to file a state tax nexus.
  • Impact on your business: Hiring remote employees in new states will likely create state income tax filing requirements.  Multistate law firms need to be mindful of the different types of taxes, filing obligations and varying deadlines amongst each state.
  • Next steps: Aprio’s Professional Service Advisory team is up to date on state tax nexus requirements and can help you understand your filing obligations.

Schedule a consultation with an Aprio Professional Service Advisory team member today.

The full story:

In the ever-changing state of the workplace, we have seen a growing number of employees living, working and temporarily residing in other states. For law firms, and other companies, remote work has complicated the tax filing requirements for companies who previously operated in one state, potentially creating a state tax nexus in additional states. Law firms who want to keep talent on board are left with big questions regarding their state tax nexus filing obligations for each state where employees reside.  

Understanding state tax nexus

State tax nexus determines the level of tax jurisdiction between a state and an entity, i.e., when your business activity meets a specified dollar amount threshold within a state. Determining the appropriate level of state tax nexus is complex as rules and regulations vary between states.

How much income is taxed in each state?

Generally, apportionment is the method used by states (who each have their own approach) to determine the portion of income taxed in that specific state for multistate entities. Most states have developed a formula that includes the percentage of revenue sourced in the state versus the total revenue generated. Some states also include the proportion of assets and payroll into this calculation. States vary on how they determine which revenue is sourced to their own state, typically falling into one of two categories:

  • Market-based sourcing, the most common category, is where the state sources receipts based upon the location of where the customer benefits from the services that are provided.
  • Cost-of-performance is where receipts are assigned to a state based on where the service is performed.

Is any income nontaxable to nonresidents in each state?

Taxpayers must be aware that states have varying rules that may benefit them as multistate entities — most are fairly standard, however, Wisconsin and Virginia standout. For example:

  • In Wisconsin, if a professional services partnership is doing business in the state, each partner is taxed only on their share of Wisconsin income if they perform services physically in that state.
  • In Virginia, the state does not tax guaranteed payments made to non-residents.

What credits and adjustments are available in my home state for taxes paid to other state or income taxed in other states?

Typically, all income is taxed to your home state, but a credit for taxes paid to other states may be available to reduce the overall impact of multistate taxation. Also, in certain states that do not have state income tax, such as Tennessee and Texas, you may be able to exclude a portion of income on your home state tax return.

The bottom line

Determining your specific filing requirements is complex as rules and regulations between states vary. If your law firm is a multistate entity, it’s critical to be mindful of the different types of taxes, filing obligations and varying deadlines amongst each state. Your dedicated tax advisor should be up to date on all rules and regulations associated with state tax nexus and filing requirements. Aprio’s Professional Service Advisory team can help you carefully review each state tax nexus to make sure your law firm understands the requirements and meets your filing obligations.

Schedule a consultation with an Aprio Professional Service Advisory team member today.