Moving Across State Lines

If expansion plans call for doing business in other states, factor in tax liability.

When you say you want to grow your manufacturing company, what does that mean? It may entail expanding your physical plant or warehouse or introducing new products. It could also mean opening new markets by conducting business in multiple states. However, before branching out over state lines, consult with your tax advisor.  

What taxes could you be subject to?

Another state can apply its sales and use, income or franchise tax to your business if you’ve established a sufficient connection, or “nexus,” with that state.

Historically, nexus required a physical presence in the state, such as offices, manufacturing facilities or employees. Physical presence is still required today to trigger sales and use tax collection obligations, but many states require only a minimal presence to establish nexus for income and franchise tax purposes — and the courts have often agreed.

Federal law prohibits a state from taxing a company’s income if its only activity in the state consists of soliciting orders or sales of tangible personal property that are approved and shipped from outside the state. But this law doesn’t apply to intangible property. Thus, several court cases have allowed states to tax an out-of-state firm’s income on intangibles, such as trademark licenses or credit cards, even though the firm had no physical presence in the state. A substantial economic presence was sufficient.

Franchise tax — a tax on the privilege of doing business in a state — often requires even less of a connection. Simply soliciting orders or sales in the state may be enough.

How might you trigger “nexus”?

Whether your company is exposed to multistate taxation depends on many factors, including the nature of your business, the tax laws in each of the states in which you do business, and your activities in those states. Nexus is determined on a state-by-state basis, so if you plan to expand into two or more neighboring states, you may face different rules for each.

That said, some activities or circumstances within a state will generally trigger nexus. One example is having legal domicile or a principal place of business there, of course. But even just maintaining an office or other facility there will probably do the trick. Rendering services of any kind, performing warranty repairs or hiring others to provide them, or soliciting orders will also create a strong likelihood of nexus.

Therefore, the best course of action is to learn each prospective state’s rules and project your tax liability before expanding. Doing so will limit or eliminate any unpleasant surprises that could make the expansion less beneficial than you’d anticipated.

Can multistate taxation have a positive impact?

Multistate taxation isn’t necessarily a bad thing. For example, to avoid multiple taxation of the same income, most states require that you apportion income among the states where you’re subject to income tax. This typically is done using a formula based on a company’s sales, property and payroll in each state, though states weight each factor differently and some use only one or two of the factors.

Suppose that your company is located in a state with a very high corporate income tax, but you do a significant amount of business in states with low or no income taxes. Because you lack nexus with those states, all your income is taxed by your home state.

But if you create nexus with one or more of those states (by setting up a small office, for example, in a state where your sales are significant), you may be able to allocate some income to those states and lower your overall tax bill. 

Taking your business on the road

If you’re working to expand your customer base, taking your business across state lines is an obvious step. But it’s also a step that shouldn’t be taken without plenty of planning. In addition to training a sales force and ensuring you have products in place, you need to consider the tax ramifications of conducting business in other states. Your business tax advisor can help you make a smooth transition. 

Copyright © 2013 Thomson Reuters / BizActions.