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2020 Year-End State and Local Tax Planning Perspective

In recent years there have been significant changes to the income tax nexus rules. Historically, physical presence was viewed as a requirement to establish nexus and a filing requirement. Today, under the economic nexus concept, which is essentially sales tax nexus for online sales, in-state sourced sales generally result in a filing imposition even without a physical presence. The Wayfair case simply amplified economic nexus for income tax purposes, signaling to all states that economic nexus is sound law.

Economic nexus presents risk and opportunity for service providers. States across the nation use different sourcing rules and methodologies to assign sales to a state. Although many businesses might be subject to nexus, with proper planning, income tax burdens can be alleviated or reduced with sales sourcing analysis. As states continue to shift to using only sales (i.e., single-sales) to compute state income tax, and market-sourcing continues to be prevalent in sourcing sales, businesses are actively reconsidering their sales sourcing approaches to potentially reduce state taxes.

Your business should be considering an Income Tax Nexus / Sales Sourcing Assessment, if:

  • Service revenue streams are derived from multi-state customers/clients;
  • Business’s receipts per state would vary based on possible different sourcing rules, such as:
    • location where services benefit the customer,
    • location of customer’s billing address,
    • location of customer’s headquarters,
    • location of customer’s primary interaction/contacts with the business,
    • location of customer’s order location,
    • location of the customer’s customer (i.e., ultimate customer), or
    • other metrics that could result in a varied sourcing approach;
  • Sales would be subject to special industry sourcing rules, such as financial services, technology (e.g., SaaS, etc.), advertising, transportation; or
  • It has significant tax in any respective out-of-state jurisdiction.

State and Local Tax Workarounds

One of the centerpiece provisions of the 2017 Tax Cuts and Jobs Act (TCJA) was the limitation imposed on state and local taxes (SALT). The TCJA imposed a $10,000 limitation on the amount of SALT that individuals (or pass-through business owners) may deduct for federal income tax purposes. The SALT limitation profoundly impacted many businesses.

Several states responded by enacting various workaround bills to mitigate the impact of the SALT limitation. Some of the SALT workarounds we have seen to date include charitable deductions, payroll tax expense, and pass-through entity taxes. While some of the initial workarounds had their shortcomings, the pass-through entity tax workarounds have gained steam recently. New Jersey is one of the latest states to enact an entity-level tax, known as the Pass-Through Business Alternative Income Tax (BAIT).

However, there are several key issues that businesses need to consider as part of their work around tax planning:

  • Nonresident Credits: Nonresident partners/shareholders of an entity subject to an entity-level tax may not receive a credit in their home states for the entity tax paid, resulting in possible double state income taxation.
  • Dual Estimate Payment Requirements: In some states, the legislation might not alter existing non-resident withholding requirements; thus, overlapping payment requirements may be necessary if individual non-resident taxpayers are subject to both regimes. This applies to estimated payments, not the actual tax itself.
  • Other Considerations: Business owners should keep in mind that the election to pay tax at the entity level is subject to each business’s facts and circumstances and may vary depending on specific state provisions.

Telecommuting

As COVID-19 continues to disrupt the global economy and transform workforces, widespread telecommuting and state budget shortfalls have increased the focus on state taxes. Although telecommuting raises many concerns, some of these central issues put into focus are:

  • Income and sales tax nexus;
  • Income tax apportionment; and
  • State payroll withholding.

Nexus, concerning telecommuting, is relatively straightforward; employee’s presence in a state results in nexus unless a state provides specific COVID-19 relief for such presence. For income tax apportionment, in some states, the consequence of an employee working from a different state could affect sales sourcing and the payroll apportionment factor. For example, the New York City UBT (for non-corporate entities) uses cost-of-performance sourcing, which can lower taxes if employees leave New York to telework in nearby states. Such sourcing is generally determined based on the place where the services are performed.

Payroll withholding presents challenges too. Most states source employee wages to the state where the employee performs the services; however, with “Convenience of Employer” rules, such as those in New York, there is added complexity. These rules, some of which preceded the pandemic, essentially require non-resident wages to be sourced to the state’s office where the employee is assigned. This could result in double withholding requirements for the employer. Some of the key issues impacting payroll withholding decisions include:

  • States that employ reciprocity agreements [change bullets to match those above]
  • States with convenience of employer rules
  • Temporary versus permanent employee relocations
  • COVID-19 payroll tax relief measures
  • Employee mobility and telecommuting are here to stay, and businesses must adapt and plan for the many tax issues that arise.

Considerations for Changing Residency

Now that you can work from home, are you considering a move to another state? Perhaps to a low-tax or no-tax state? If so, you’re not alone, and here are some of the things you should be considering.

Your move generally can change your domicile if you intend to permanently leave your home to establish a new, fixed, and permanent home somewhere else. Domicile is any place you regard as your permanent home—the place to which you intend to return after a period of absence (e.g., a vacation, a short-term business relocation, educational leave, etc.). You can have only one domicile at any point in time, although you may have more than one place to live or residence. Once established, your domicile continues until you move to a new location with the intent to establish a fixed and permanent home there. However, moving to a new location, even for a substantial period, does not change your domicile if you intend to return to your domicile. This is the case for many taxpayers that have moved out of their home during the pandemic with the intention of moving back after it subsides.

Domicile is based on many factors, including your intent, which is based on where you register to vote, maintain a driver’s license and vehicle registration, have family ties, etc. The burden of proof is upon the person asserting a change of domicile. They must show an intention to abandon their previous domicile to establish a fixed and permanent home in a new one. Proper planning and understanding of their current home states’ residency rules are imperative if contemplating a domicile change.

Monitor Nexus Developments

Doing business across state borders yields significant risks because each state has its own statutes and regulations on doing business within the state. Further, the impact on the State and Local Tax function continues to become more complex as many states have expanded their requirements for compliance.

Prior to June 2018, the U.S. Supreme Court interpreted sales tax nexus under the Commerce Clause as a minimal physical connection with a state; however, in the Wayfair case, the Supreme Court expanded greatly the meaning of nexus to include sales into a state by a remote seller.

Sales tax nexus standards have changed rapidly since the Wayfair decision and now the criteria for determining nexus varies from state-to-state. In addition, many states have adopted economic nexus standards for income tax, which were enacted prior to Wayfair. Therefore, companies need to prepare for these evolving standards and analyze whether they have an obligation to collect and remit sales tax, and to file income tax returns, in many jurisdictions, not just those in which they have physical presence.

Even if companies have performed “nexus reviews” in the past, they should consider updating the results because several states have enacted or updated their economic nexus thresholds, sales may have exceeded the existing thresholds, or physical nexus requirements may have been reached.
Following is a list of things to consider:

  • Review existing and pre-Wayfair nexus footprint, including inventory held by marketplace facilitators
  • Assess post-Wayfair filing obligations
  • Evaluate income tax, sales and use tax, and other indirect tax nexus
  • Determine potential tax exposure for prior periods
  • Consider options to limit exposure (e.g., Voluntary Disclosure Agreements, Amnesty, etc.)
  • Assist with communication to stakeholders in the organization
  • Review product and service mix
  • Analyze sales sourcing on a state basis for determining income tax nexus
  • Develop nexus and tax matrix
  • Take advantage of current exemptions
  • Review and consider automation needs
  • Prepare and file registrations as necessary
  • Develop SALT processes to meet compliance requirements
  • Prepare for tax audits
  • Address changes in the organization (e.g., New Lines of Business, Modified Sales Force Activity, Marketplace Facilitator/Provider Inventory Locations, etc.)
  • Continue to monitor changes to economic nexus and tax laws
No action should be taken without advice from a member of Withum’s State and Local Tax Services Team because tax law changes frequently, which can have a significant impact on your specific planning possibilities. Reach out to discuss your individual situation as year-end approaches.

Authors: Barry Horowitz, CPA, MST | bhorowitz@withum.com, Jim Bartek, CPA | jbartek@withum.com, Lejdi McNair | lmcnair@withum.com, Jason Rosenberg, CPA, CGMA, EA, MST | jrosenberg@withum.com

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