Do You Know Where You Do Business?

By Vincent Salvagni, CPA (Dec, 2009)

Many times, the efforts to grow your business can take you outside the borders of the state where you reside. A business that begins in New York State can at times find itself transacting in Pennsylvania, New Jersey and other bordering states simply as a response to the limited demand for their product or service in New York. Many larger companies expand the scope of their business to every state in the Union. While crossing borders can be an answer to top line growth, state tax issues, when ignored, can just as quickly create tax headaches. Some of these issues arise in the form of nexus, apportionment, and Federal/State differences.

NEXUS

In general, nexus, with respect to state income tax, refers to the level of business activity you must have in a state in order for that state to impose a tax on your entity's income. What makes that issue so complex is that nexus requirements vary from state to state. Public Law 86-272, 15 U.S.C. 381-384, restricts a state from "imposing a net income tax on income derived within its borders from interstate commerce if the only business activity of the company within the state consists of the solicitation of orders for sales of tangible personal property, which orders are to be sent outside the state for acceptance or rejection, and, if accepted, are filled by shipment or delivery from a point outside the state." Basically, if you are a New York company that merely solicits business from a Pennsylvania company, but approves the sale and ships the item via common carrier from New York, the sale is a New York sale. However, if you have salesmen employed in Pennsylvania, you ship the item via your delivery truck (not a common carrier) into Pennsylvania, or you have a warehouse located in Pennsylvania that ships the item, you have established nexus under Pennsylvania state law. In summary, anything you do that can be construed by a state as "doing business" in their jurisdiction can be used against you to establish state nexus.

APPORTIONMENT

Once you have established the need to file in a state other than your home state, you then need to review the requirements for calculating that state's apportionment. While it's possible in some states to report a direct allocation of income and expenses to their state, most others use an apportionment percentage. Many states use a three factor calculation to calculate the percentage of your income that will be taxed by their jurisdiction. The amount of your sales, payroll and tangible property in their state compared to your total sales, payroll and tangible property everywhere are used to generate an apportionment percentage. That percentage is then applied to your total taxable income and used to calculate the tax at the state level. Other states, including New York, have strayed from the three factor calculation and now use a single-sales (or gross revenue) factor to generate apportionment. Either way, the information you use to calculate your apportionment is subject to scrutiny by that state. Accurate records of sales, inventory, tangible assets and payroll on a state by state basis can help to serve as a basis for your position.

FEDERAL / STATE DIFFERENCES

Just when you think it can't get any more complicated, each state can exercise their right to decouple from certain Federal tax laws. A popular item is the decoupling from Federal bonus deprecation. Bonus depreciation, under the provisions of, and subject to the limitations of, the American Recovery and Reinvestment Act of 2009, allows businesses to write off 50% of the cost of certain depreciable property acquired in 2009. This is an extension of previous bonus depreciation provisions and can assist businesses in mitigating their year end income tax liability. New York, and approximately 30 other states, have decided that they will not follow the bonus depreciation provisions and therefore require a separate calculation to determine what the adjustment for state depreciation expense should be. Additional complexity is found in the fact that there is no standard recalculation of state depreciation. Each state has their own method for recalculation and many have an additional required tax form that has to be filed to support the adjustment.

These are only three of the many issues that can complicate the multi-state tax arena. The challenging process of determining your filing requirements and the corresponding calculations can be a very daunting task, so we at Dermody, Burke & Brown have developed the expertise to assist you with your decisions.

 

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.

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