Founder Q&A : Employees in multiple states

Debriefing a recent conversation with a founder with regards to whether or not they need to file income taxes in states with remote employees.

Here is the summary:

In recent years, the concept of income tax nexus has gained significant importance, particularly for businesses operating remotely. With states cracking down on income tax filing requirements, it’s crucial for companies to navigate this complex landscape to ensure compliance and avoid potential issues. This article aims to shed light on income tax nexus, its implications for remote businesses, and the factors to consider when determining filing requirements.

What is Income Tax Nexus?

Income tax nexus refers to the connection between a business and a state that triggers the obligation to file income tax returns. Traditionally, physical presence, such as having employees or owning property in a state, established income tax nexus. However, in the era of remote work, discussions surrounding “physical presence” nexus have intensified, causing businesses to reevaluate their filing obligations.

Brian Plunkett, J.D., Sr. Writer Analyst, Wolters Kluwer published this summary.

“States cannot just impose income tax on a business whenever they want to; first there has to be a connection, called “nexus,” between the business and the state. In many states, there will be income tax nexus if the business has substantial economic activity there. Most of the time, physical presence is not needed. Each state has its own income tax provisions defining what activities will create nexus for a business. These provisions may include things like deriving receipts from the state, or having the following in the state:

  • employees;
  • mobile stores;
  • an office; or
  • a stock of goods

The nexus requirement for imposing income tax comes from the U.S. Constitution. But there is also a federal law called the Interstate Income Act, or P.L. 86-272, that protects some sellers from income tax nexus. It applies when a seller’s only activity in the state is soliciting orders for sales of property, where the orders will be approved and shipped from outside the state.”

Implications of Remote Work and Nexus:

The COVID-19 pandemic accelerated the trend of remote hiring, raising questions about the impact on income tax nexus. Many businesses now employ individuals from various states, potentially triggering income tax filing requirements. State governments have become more vigilant, sending notices to businesses reminding them of their obligations.

Understanding Nexus Thresholds:

While each state has its own approach to determining income tax nexus, a common method is the “factor-based nexus standard.” This method considers key factors such as sales, payroll, and property owned within each state. Notably, a payroll threshold of $50,000 or 25% of total payroll often necessitates filing, while exceeding $500,000 in sales may trigger filing requirements in certain states.

The Benefits of Filing in Multiple States:

Filing income tax returns in multiple states can offer potential tax-saving advantages. For businesses located in high-tax states, apportioning income to other states can help reduce the overall tax burden. By strategically allocating income, businesses can optimize their tax positions and potentially realize significant savings.

Tracking Revenue and the Importance of Balance:

Though many businesses haven’t tracked revenue by state in the past, it is increasingly important to start doing so. While exact figures may not be necessary, a general understanding of revenue distribution across states enables businesses to determine filing requirements. The bottom line may tell a story, but a comprehensive view through balance sheets ensures a clearer understanding of the business’s financial health.

Navigating State-Specific Interpretations:

One of the challenges businesses face when dealing with income tax nexus is the variation in state-specific interpretations. Each state may have different rules, thresholds, and regulations, making compliance a complex task. It is advisable to seek guidance from tax professionals well-versed in state laws to ensure accurate filing and adherence to specific requirements.

So now what?

Income tax nexus is a critical consideration for businesses operating remotely, especially in an era where the physical presence paradigm has shifted. By understanding the factors that trigger income tax filing obligations and staying informed about state-specific interpretations, businesses can navigate this landscape effectively. Proactive tracking of revenue by state and strategic apportionment of income can provide tax-saving opportunities, while maintaining compliance ensures long-term success.

Note: This article serves as a general guide and should not be considered professional tax advice. Consult a qualified tax professional for personalized guidance.

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