Risks of Misunderstanding the Impact of Out-of-State Nexus Filing Obligations

At a glance

• The main takeaway: It’s common for businesses to consider expanding operations across state lines, however, it’s important to fully understand the complex tax obligation risks and legal compliance when aiming to expand out-of-state.
• Impact on your business: Businesses who decide not to file in certain states where they have established nexus could not only put their company at risk, but also miss out on potential tax credits.
• Next steps: Aprio’s Professional Service Advisory team can help you better understand your out-of-state filing obligations and whether a nexus study will benefit your business. Schedule a consultation with an Aprio Professional Service Advisory team member today.

The full story:

A common strategy for business growth likely includes expanding operations across state lines. However, this type of expansion comes with understanding the complex tax obligation risks essential for businesses aiming to expand their footprint while maintaining stability and legal compliance. In this article, we will analyze nexus and its importance in state filings as well as keys risks associated with out-of-state tax filings.

Understanding economic nexus

With the change from physical presence to economic nexus, states have become more aggressive in identifying and requiring entities to comply with income tax filing obligations. Traditionally, state tax departments focus on where the percentage of your revenue is allocated, where your employees are located and where your assets are held. Most businesses that operate in multiple states, even remotely, have heard about nexus.

Nexus is the degree of activity that an out-of-state business must have with a state taxing jurisdiction before it triggers a state tax filing obligation. Nexus can be economic, based on a threshold of sales volume in a given time, or physical, created by assets or employees in a state or jurisdiction.

Each state has their own factor presence nexus thresholds based on gross receipts, property and payroll. A company whose apportionment factors exceed the threshold will be considered to have created income tax or gross receipts tax nexus in the state. To add further complication to nexus rules, some states may consider having property or payroll less than the threshold amounts to still create nexus.

With respect to service businesses, most states are going to source your receipts based on the location of customers receiving the services, otherwise known as the market-based method. However, some states source your receipts based on the location of the performed services, often referred to as the cost of performance method. No matter which method your business uses, it is important to keep up with apportionment rules annually and consult with a tax professional who specializes in multistate taxation to help your business efficiently adjust to any changes in the law.

Exposure risks that trigger nexus penalties

When measuring nexus, potential exposure includes sales and use tax and income and franchise tax, but also includes any taxes imposed on the business’s gross receipts. Even if a state has no state income tax, there may be other types of tax filing obligations. Some examples of miscellaneous state tax filings based off gross receipts, include Washington’s B&O tax, Ohio’s commercial activities tax, and Nevada’s commerce tax. You may want to also consider if the business had nexus established in prior years. Filing a current year return may trigger a state to impose prior year taxes, especially if you’ve had employees on payroll in that state for preceding years.

When determining the risk related to not filing in a state that your business may have triggered nexus, it is important to know the potential penalties. Filing penalties vary by state, but can consist of the following:

• Tax due
• Interest
• Late filing penalties, including state failure to pay penalties or state failure to file penalties Non-filer negligence penalties
• State tax liens
• Wage garnishment and other tax levies
• Occupational and other professional licenses suspended or non-renewal
• Business license revocation or non-renewal
• Jail time

The bottom line

Businesses who decide not to file in states where they have nexus could be missing out on potential tax deductions or credits. In addition to tax and penalties, not filing in certain states could disrupt business activity and potentially slow down any interstate commerce. Employees within your business could also be affected by your decisions through state tax withholding and wage reporting.

If your business decides not to file in a certain state and you receive a penalty, please consult your tax advisor on the best steps of action to resolve the issue.

Aprio’s Professional Service Advisory team can help you better understand your out-of-state filing obligations and whether a nexus study will benefit your business.

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