Small business owners who provide services or products across state lines are often puzzled about the taxes they have to pay in places where they don’t maintain a physical presence. Increasingly, states are levying so-called privilege taxes -- in the form of an income tax, a franchise tax based on net income, a gross receipts tax, or some kind of hybrid tax that may include several factors -- on interstate commerce, and it can be difficult for an individual to understand what taxes are owed (or if anything really is owed). What’s the solution? A CPA-led nexus study.
What is “nexus”?
Nexus refers to the requirement for companies doing business in a state to collect and pay tax on sales in that state. Nexus occurs when a business has a presence in a state (see more below) and then is subjected to state income and sales taxes for transactions made in that state. Note that business activities, not just a physical presence, can establish nexus. For example, an online retailer’s use of an in-state party to host an advertisement and subsequently paying that in-state party a commission for sales generated from the advertisement could generate “click-through nexus” and subject the business to tax.
States define nexus differently, which makes establishing nexus difficult, but you can generally expect things like business licenses, gross receipts, payroll expenses, or telecom tax filings to be factors in the decision. Ultimately, nexus describes the amount and degree of business activity that must be present before a state can tax that business’ income.
What is a Nexus Study?
In a nexus study, your accountant will review all relevant records and circumstances, and question you and your employees about your business so that the connections your company has in each state can be clearly identified. That will establish nexus in each state. From there, we’ll advise you on how to register and file in each state.
Why is a Nexus Study Performed?
Quite simply, a nexus study minimizes risk and brings companies into compliance.
Thanks to increasingly sophisticated technology, states have an increasingly easier time detecting businesses that are operating within their jurisdiction and also have not filed correctly. Simple things like information on your business cards, phone listings, or how mail is addressed can easily be found and used to create nexus for net income in a state. State revenue departments now routinely query vendor files of customers within the state. This creates huge opportunities for “getting caught”. In addition, states routinely change their position on nexus. For these reasons, we urge a nexus study to avoid unnecessary tax burdens.
Besides paying taxes, what else do I do with the results of my nexus study?
Compliance is key, but depending on your business structure and its activities, we may find that it’s better for you to establish nexus in one state over another depending on its tax rates. We could also find that reducing nexus in certain states could significantly reduce the costs you incur filing multiple tax returns. Restructuring the business to isolate the nexus-creating activities may also be in order.
If you’re well established in a state and have not been paying taxes, coming forward voluntarily with a request for a voluntary disclosure agreement frequently provides relief from tax for all but the most recent three or four years and the waiver of penalties. Fessing up has its privileges! This forgiveness is only available to businesses who initiate the process, however (not those that get caught), so it’s in your best interest to get started right away. Give us a call for help.
Have you had a nexus study done on your business? If not, what’s holding you back? Please comment below!