Tax Implications of Manufacturers Operating in Multiple States (Nexus)
Pre-2018, businesses used physical presence, such as a satellite location or employees working in a state, to determine if substantial nexus was created to require filing sales tax in a particular state. Post-2018, and the U.S. Supreme Court case of South Dakota v. Wayfair, Inc., all states except for Missouri have imposed a “bright-line” sales or receipts nexus test for sales tax. These tests range from $100,000 in annual sales to $500,000 in annual sales depending on the specific state. Missouri will be adopting a bright-line test for tax years beginning on or after January 1, 2023.
The impact of the Wayfair Supreme Court case has been substantial, as it established the connection (nexus) between a remote vendor and a taxing state. This allows the state to increase sales tax revenue by increasing collections as sellers must collect sales tax from customers within the taxing state and pay it to the state, register with the state and/or provide customer/sales date to the state. Some states have also established bright-line tests for gross receipts, payroll and property for the imposition of income and minimum franchise taxes. Several states apply a $100,000 annual gross receipts requirement, while New York State currently has the highest bright-line test for gross receipts of $1,000,000. Each state’s rules and regulations contain many caveats, and each situation should be fully analyzed on a company-by-company basis and a state-by-state basis.
Many manufacturers may be familiar with Public Law (P.L.) 86-272, which prevents states from taxing out-of-state companies on income when the company’s activities in the state are limited to mere solicitation of orders for the sale of tangible personal property such as manufactured goods. However, the receipts from the sales of services or other intangible property are not protected under P.L. 86-272. This Public Law does not apply to franchise taxes, which are taxes imposed by certain states that are not based on income. Typically, they are determined on a different tax base such as assets, net worth or sales. It is important to assess whether a business meets the requirements to file a franchise tax return, even if is protected under P.L. 86-272.
In the ever-changing environment of state income, franchise and sales tax, being proactive is the best way to stay in compliance and avoid penalties. Companies should review state income, franchise and sales tax nexus obligations on an annual basis at a minimum. Many states are adopting bright-line tests for economic nexus, and you may find your company having nexus based on newly adopted rules. There is constant change happening in tax legislation and just because you did not have nexus in a prior year, does not necessarily mean you do not have it currently. Companies should identify and prioritize based on risk and exposure and to also make sure you are registering in applicable states. Often, it is not enough to just file tax returns without also being registered.
Many states offer voluntary disclosure and compliance programs to pay any back taxes owed, as opposed to being caught in the future for failure to comply. The benefits of these programs include the ability for taxpayers to pay any tax due in installments, possible forgiveness of penalties and protection of businesses from tax liens and, perhaps, most importantly, lookback periods may be limited. States also have nexus questionnaires which are forms produced by states. These forms are sent to businesses not currently filing income tax, franchise tax and/or sales tax returns to obtain information concerning the out-of-state company’s business activities and to determine whether those activities subject the company to nexus. They are often sent directly to the manufacturer, not to their tax preparers. They may appear harmless but can often have major tax implications. Companies should make sure that the appropriate people are filling out the questionnaires and that your CPA has reviewed the completed product before submitting it with the state. Communication with your CPA or tax preparer is crucial when you are doing business in new states. This includes increased sales, payroll or property in new states.
Contributing author: Alex J. Nitka, CPA is a tax partner at Dannible & McKee, LLP. Alex has over 13 years of experience in all areas of income taxation, including individual and corporate tax planning, financial planning, multi-state taxation, research and development, New York State income tax credits and ownership transition issues. This article was also co-authored by Alexis Layo, a tax senior at Dannible & McKee, LLP. For more information on this topic, you may contact Alex at firstname.lastname@example.org or (315) 472-9127.