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:
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:
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:
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:
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.
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:
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.