Preface: Multi-State tax is an area of increasing relevance to many entrepreneurs. Does your business have nexus? The following blog is an introduction to multi-state tax and Public Law 86-272.

An Introduction to Multi-State Taxation

As commerce and business circumferences develop for entrepreneurs, multi-state tax compliance becomes increasingly important. 46 states and Washington DC impose a net income on tax on businesses with nexus in their state. Nexus is a technical term for the degree of business activity that subjects a business to a specific state tax jurisdiction. A business may have nexus if it is doing business outside its home state, maintains a place of business outside the state, or has income that another state could tax. Methodologies on the business-level tax vary from state, i.e. franchise tax, income tax, combination of an income tax and franchise tax, or a capital stock tax. More than half of the states have a franchise tax on capital stock that taxes the privilege to hold property in the state, while say Ohio has a Commercial Activity Tax based upon gross receipts.

Most state tax liabilities start with federal taxable income and contain modifications that either add or subtract from federal taxable income, e.g. depreciation, contributions, state income taxes. A multi-state tax filing most often has an apportionment methodology that calculates business income taxable to the specific state. Typically this is a three factor apportionment on a ratio, e.g. in Pennsylvania it is payroll, property and sales. However, fewer than 15 states still use this formula for standard apportionment. Many states weight the formula to sales, or just use the sales apportionment (sales-in-state/sales-outside-state.) Alternative methodologies are applied in specific industries, say transportation, that may use a formula based upon state miles or state revenue miles, or banks that use an apportionment on say state deposits.

Generally nonbusiness income, i.e. interest or dividend income, is allocated to states on the characteristics of the income or property from which the income is earned.

Multi-state tax on income is then determined from the state base income * the apportionment percentage * the state tax rate. Sometimes a business will be eligible for state tax credits, e.g. R&D credits, reducing the applicable state tax liability.

While nexus is required before a tax jurisdiction can impose tax, bright line nexus thresholds that numerous states adhere to include: $50,000 of property; or $50,000 of payroll; or $500,000 of sales; or 25% of total property, total payroll or total sales in the state. The Multi-State Tax Commission clarified activities protected from nexus under Public Law 86-272, revised in 2001. Specifically protected are i) solicitation of orders by in in-state resident or representative of the company as long as business isn’t maintained in the state other than in a home office, ii) furnishing and setting up display racks, and advising on company product without charge, iii) provision of vehicle for sales team on protected activities. Public Law 86-272 protects some additional activities in some instances from nexus, such as: i) recruiting, training, and evaluating sales employees, ii) setting up display racks, ii) maintain company cars, iii) holding sales meetings in hotels, iv) general advertising, v) handling occasional credit disputes, vi) assisting and advising wholesalers in obtaining suitable product displays in retail stores.

However, Public Law 86-272 doesn’t protect collecting funds, or providing non-sales representatives and technical assistance to customers, i.e. service or installation of equipment. Therefore, if you sell $30,000 of inventory or equipment to a customer in a nexus state, you should be registered to do business in instances where collection enforcement may be required. You should understand, if a new customer asks if your business is registered to do business in their specific state; they may really be inquiring if they can get a chance card to pass go, and collect $200 from your business.

Other activities that are not protected under Public Law 86-272 and require state registration include: i) repairing or providing maintenance or service to the property sold or to be sold, ii) installation upon or after shipment or delivery, iii) investigation, handling, or otherwise assisting in resolving customer complaints, iv) securing deposits on sale, v) conducting training, seminars or lectures, vi) approving or accepting orders, vii) maintenance of a place of business.

Each state has its own list of activities that it deems immune or non-immune from nexus. If your business is conducting sales outside its home state, you should have a conversation with your CPA, annually, to determine nexus thresholds, and applicable registrations.