Generally, you have to file in another state when your company creates a connection with another state. This connection, which is often called nexus, is created when you have people, property, or sales in the state. The amount of wages, sales or property in a particular state helps determine if your connection is substantial enough to require filing. The threshold for creating nexus is lower for sales tax so it is common for an entity to have sales tax nexus but not income tax nexus. On the other hand, creating income tax nexus in a state means you will probably have to file sales tax returns.

Nexus is created when your company becomes connected with a state. Nexus describes the amount and degree of business activity that must be present in a state to subject you to the states taxes. The connection usually has to be significant for nexus to be created. A company becomes connected with a state when they have revenues, an office, employee, inventory or a warehouse in the state.  The connection can also be made through the use of an affiliate, drop shipping, or temporarily selling at a trade show. The definition of nexus is different for each state and different for each type of tax. Once nexus is created with a state, the company should file all relevant tax returns. We can help you sort through the nexus rules to make sure you are meeting all of your filing obligations.

Nexus is created when you are of “doing business” or “engaged in business” in a state. Federal law requires a state to have “substantial nexus” to a company to require them to collect sales tax, but the definition of substantial is often debated.   In 1992, the Supreme Court decision in Quill Corp. v. North Dakota (1992) confirmed that, under the Commerce Clause of the U.S. Constitution, vendors with no physical presence in a state did not have nexus requiring them to collect sales tax, even if they makes sales to customers in that state.  Although, this law has stood for long time, states are finding ways to challenge this rule and are using “economic nexus” standards to attribute sales to remote sellers.

In addition to having a physical presence in a state, the 45 states that have sales taxes will assert that the following activities also create nexus: Regular and systematic solicitation of customers in the state, Advertising in the state, Utilize an affiliate who acts on your behalf in the state. Companies must be careful about what they are collecting tax on. The taxability of products and services and often different in each state. Once you create sales tax nexus in a state, we can help you register with the state and get you setup to meet your filing obligations.

The definition of nexus is different for income taxes and sales taxes. Income tax nexus generally requires more substantial business activity than that needed for sales tax.  State income tax nexus is created when an out-of-state company owns property in the state, has employees in the state, or derives income from sources in the state. There are some activities that are protected.  Under 15 USC § 381 (commonly referred to by its 1959 enacting legislation, PL 86-272) states can’t impose a tax based on or measured by net income on out-of-state taxpayers whose only connection with the state is the solicitation of orders for sales of tangible personal property when such orders are approved and shipped from outside the state.

Trying to capture more revenue, some states have replaced their income taxes with non-income-based taxes, which makes it easier to create nexus. Washington, Ohio, and Texas are some of the most notable states. These taxes are often based on gross receipts and because the taxes are not based on income, a company with minimal activity in a state is likely to be subject to these taxes.

Composite taxes and nonresident taxes apply to nonresident shareholders of pass-through entities such as S corporations, Partnership, and LLCS’s.  For discussion purposes here, the terms “shareholder” and “partner” are interchangeable. When a company because subject to income tax nexus in a state, the state often requires the company to withhold taxes for any shareholder who is not a resident of the state.

In the case of composite taxes, the company pays the tax and files a return on behalf of the shareholder and the shareholder does not have to file a tax return with their personal return. For nonresident taxes, the shareholder files a state return with their individual taxes and claims the tax paid on their behalf by the company to offset the state tax liability. Both types of taxes paid by the company on behalf of the shareholder are treated as distributions by the company to the shareholder.