Year-End State and Local Tax Planning Perspective

In recent years there have been significant changes to the State and Local Tax Nexus rules. Historic physical presence nexus standards are long past. Today, almost all states employ economic nexus concepts, whereby merely having sales sourced to a state generally result in a filing requirement even without a physical presence. The Wayfair case validated economic nexus for sales tax purposes and 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 the sales factor as the sole measure of apportionment, 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 a State and Local Income Tax Nexus and Sales-Sourcing Assessment if:

One of the centerpiece provisions of the 2017 TCJA was the $10,000 limitation on state and local taxes (SALT) that individuals (including pass-through businesses) may claim as an itemized deduction on their federal returns. The SALT limitation profoundly impacted many business owners.

Several states responded by enacting pass-through entity taxes (PTETs) as a workaround to mitigate the impact of the SALT deduction limitation for the owners of pass-through entities. As of the end of 2022, over half the states have enacted PTETs, making the availability of PTETs more commonplace rather than the exception. While some state PTETs are mandatory, most are elective.

Prior to making a pass-through entity election, there are several key issues that businesses need to consider:

As the economy continues to evolve, widespread telecommuting, the looming economic downturn, and state budget shortfalls has increased the focus on state taxes. Although telecommuting raises many concerns, some of these central issues put into focus are:

Nexus in respect to telecommuting is generally straightforward. An employee’s presence in a state creates nexus unless protected by P.L. 86-272. Virtually all state COVID-19 relief provisions have expired. For income tax apportionment, in some states, the consequence of an employee working from a different state could affect sales sourcing, payroll, and the property factor for state tax apportionment. 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 also presents challenges. Most states source employee wages to the state where the employee performs the services; however, with “Convenience of the 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:

Employee mobility and telecommuting are here to stay, and businesses must adapt and plan for the many tax issues that arise.

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 are not alone, and here are some of the things you should be considering.

In order to change one’s domicile, an individual must physically move to a new jurisdiction with the concurrent intent to make the new jurisdiction their fixed and permanent home. Individuals domiciled in a state are subject to that state’s taxing authority on all their income.

Domicile is the 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). As a practical matter, you can only have one domicile at any point in time, although you may have multiple residences. Once established, domicile continues until you affirmatively establish a new domicile. Individuals establish a new domicile by moving to a new location with the concurrent intent to establish a fixed and permanent home there. However, moving to a new location, even for a substantial period of time (e.g., a multi-year work assignment), does not change your domicile if you do not intend to remain in the new location permanently. Individuals who moved out of their primary homes during the pandemic with the ultimate intention of moving back generally remain domiciled in their original home states. Individuals who maintain a second residence in another state may also find that they are statutory residents of the states where they temporarily resided if they spent substantial time at the other residence.

Determining where an individual is domiciled requires a subjective analysis of several factors, including, but not limited to:

Additional factors demonstrating your intent to permanently move include registering to vote, obtaining a driver’s license and vehicle registration in the new state. The burden of proof is upon the person asserting a change of domicile. The person must show an intention to abandon their previous domicile and 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.

Additional considerations when planning a change of domicile include:

With economic nexus the law of the land, the concepts of state tax have been turned upside down. Now, businesses are first required to consider whether it has sales sourced to a state in order to determine if it has nexus. Best practices include examining a taxpayer’s sales tax nexus footprint at least annually. With sales tax, the issues of taxability review, the use of marketplace facilitators, and exemption certificate management have garnered more analysis in a post-Wayfair world.

In the aftermath of Wayfair, the Multistate Tax Commission (MTC) has targeted one of the remaining lifelines businesses have to shield them from income tax economic nexus; P.L. 86-272.

On August 4, 2021, the MTC voted to adopt a revision to its “Statement of Information” whereby a business could lose P.L. 86-272 protection solely by engaging with customers through the internet. In 2022, both New York and California issued guidance that they were adopting the MTC’s revised Statement of Information. It is expected many other states may adopt the MTC’s guidance implicitly through their MTC conformity provisions. The federal law known as P.L. 86-272 was passed over 60 years ago and it prohibits a state from imposing income tax on businesses that only sell tangible personal property (TPP) AND its activities in a respective state do not exceed the solicitation of orders. For many years, even preceding the Wayfair case, for income tax, it has been generally accepted that economic nexus has been the law of the land, unless a business was otherwise protected by satisfying P.L. 86-272.

MTC’s guidance provides examples of when the use of an interactive website will tarnish P.L. 86-272 protection, which activities include:

The MTC’s revised statement adoption could result in significant income tax liabilities for many remote businesses, as many of these businesses use a website or app to interact with its customers. Even if businesses have performed nexus or P.L. 86-272 review in the past, they should consider having such studies refreshed, considering many of the recent developments the last several years.

Sales and use taxes can be a significant financial burden if proper procedures are not in place and appropriately maintained. Companies should periodically review their sales and use tax process and procedures, including, but not limited to:

Please note sales tax could be a significant factor in the event of a merger, acquisition, or request for funding. If the sales tax function is not reviewed periodically, a due diligence review may uncover exposures. Therefore, companies should periodically perform a review of their sales and use tax procedures.

Authors: Barry Horowitz, CPA, MST | [email protected], Jim Bartek, CPA | [email protected], Jason Rosenberg, CPA, CGMA, EA, MST | [email protected], Jonathan Weinberg, JD, LLM | [email protected], Courtney Easterday | [email protected], Rebecca Stidham, CPA | [email protected], Zhoudi Tang, CPA | [email protected]

Disclaimer: No action should be taken without advice from a member of Withum’s Tax Services Team because tax law changes frequently, which can have a significant impact on this guide and your specific planning possibilities.