Nexus Archives - MGO CPA | Tax, Audit, and Consulting Services

Master State and Local Taxes for Your U.S. Expansion

This article is part of an ongoing series, “Navigating the Complexities of Setting Up a Business in the USA”. View all the articles in the series here.

Key Takeaways:

Understand economic nexus to avoid unexpected tax liabilities when expanding your business into the United States.
State-specific sales tax rules vary widely; compliance avoids penalties and streamlines operations.
Consulting with tax professionals can help you navigate complex state and local taxes, enhancing your U.S. expansion strategy.

The U.S. continues to captivate global businesses, attracting significant foreign direct investment (FDI). It’s easy to understand why: Entering the U.S. market is a strategic move that gives your business access to a vast customer base and a thriving economy. However, this opportunity also comes with the challenge of navigating a complex tax landscape. Understanding the nuances of state and local taxes is crucial to maintaining compliance while refining your U.S. operations.

This article explores critical aspects of state and local tax issues — focusing on economic nexus, sales tax obligations, and the importance of consulting services in navigating these challenges.

Overview of State and Local Tax Complexities

The U.S. tax system is uniquely intricate, with businesses required to navigate not only federal taxes but also the varying tax rules of 50 states and many localities. As a strong influx of FDI drives more companies to establish operations in the U.S., many of these businesses find themselves unprepared for this complex tax environment. Companies must stay compliant across multiple jurisdictions — a challenge that can significantly impact your overall tax burden.

Consider a European company expanding its e-commerce operations into the U.S. The company quickly discovered that a lack of understanding of state-specific sales tax obligations led to non-compliance, resulting in costly penalties and accumulating interest. By consulting with tax professionals, the business streamlined its tax compliance processes and reduced its overall tax liability — highlighting the importance of professional guidance.

Economic Nexus

Definition and Implications of Economic Nexus

Economic nexus refers to a business’s economic activity within a state, which may create a tax obligation regardless of physical presence. This concept gained prominence following the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., which allowed states to require businesses with significant economic activity in a state to collect and remit sales tax (even if the company has no physical presence in the jurisdiction). Since the Wayfair decision, an increasing number of states are applying economic nexus for both sales and use taxes as well as state income taxes through the use of a factor presence nexus standard.

State-by-State Nexus Thresholds

It is crucial to understand each state’s threshold for economic nexus. It’s also important to understand that the economic nexus threshold for sales and use tax may not be the same as the threshold for income tax. For example, in New York, a business with more than $500,000 in sales and 100 transactions within the state must collect and remit sales tax. However, a corporation is not subject to New York corporate income/franchise tax unless its New York receipts equal or exceed $1,000,000. Other states may have higher or lower economic thresholds. Keeping track of these varying standards is essential for proper compliance.

Impact of Legislation

Changes in state and local tax laws, such as those resulting from the Wayfair decision, have far reaching implications for businesses — especially in e-commerce. Your company must continually monitor changes in state tax laws to remain compliant and avoid unexpected tax liabilities.

Infographic-Master-Taxes-for-U.S.-Expansion_v01-11-14-2024

Sales Tax Obligations

Sales tax requirements in the U.S. are state-specific, with each state setting its own rates, rules, and exemptions. This can be particularly challenging if your company operates in multiple states, as you must manage varying tax obligations depending on the jurisdictions where you conduct business. For instance, while a good or service may be subject to sales tax in some states, it may be exempt in others.

Examples of Compliance Challenges

Compliance with state-specific sales tax rules can be complex and time-consuming. For instance, a company might face challenges in categorizing products or services as taxable or nontaxable according to each state’s tax code. Additionally, managing exemption certificates, state and local tax rates, filing deadlines, and keeping up with ever-changing tax laws can create significant administrative burdens.

Industry Specific Considerations

The sales tax challenges facing businesses vary from industry to industry. For example, an e-commerce company selling software-as-a-service (SaaS) may find its revenue is subject to sales tax in some states while not in others. To properly address the issue, the company should understand how the various states source their revenue. Then the company should review those identified states’ laws to determine how they define taxable products and services. Finally, the company needs to understand how each state applies similar laws in their own unique manner. Understanding these nuances is critical for correct tax collection and reporting.

Consulting Services

Role of Consulting in Navigating State and Local Taxes

Given the complexities of state and local tax laws, consulting with tax professionals is crucial. They can help your business understand its tax obligations, develop strategies to minimize your tax burden, and verify you are compliant with evolving state and local tax rules and regulations.

Consulting Strategies for Compliance

Nexus studies: Consultants can conduct nexus studies to determine where a business has tax obligations, helping you avoid potential penalties for non-compliance.
Automation tools: Consultants can assist you with implementing tax automation software to streamline the process of calculating, collecting, and remitting sales tax across multiple states.
Audit representation: Consultants can aid with state tax audits by helping to prepare all necessary documentation, confirm the company is fully compliant with tax laws, communicate directly with the auditor, and provide nuanced arguments regarding tax positions taken.

Tax Credits and Incentives

Consultants can help businesses take advantage of state-specific tax credits and incentives, which could be a deciding factor for where to set up a new facility. For example, states like California offer significant credits for research and development (R&D) activities. Your business should conduct a comparative analysis of the tax incentives offered by different states. A state currently receiving high levels of FDI may offer significant tax credits for R&D activities or job creation, which could be critical for manufacturing companies deciding where to locate their operations. These incentives are often part of state-level strategies to attract more foreign businesses.

Emerging Trends and Future Considerations

Changes in State Tax Policy

One emerging trend is the increasing reliance on sales tax by states due to declining income tax revenues — a shift that may be partially influenced by broader economic trends, including strong FDI inflows into the U.S. Your business can prepare for these changes by staying informed about legislative updates and adjusting your tax strategies accordingly. A state and local tax consultant can play an instrumental role in assisting your company in keeping up with these trends.

Impact of Remote Work

Since COVID, the rise of remote work has further complicated state tax obligations. Companies with remote employees in multiple states may face new tax liabilities even if the business has no other physical presence (like an office). Additionally, as remote work becomes more prevalent, the tax obligations for companies with employees in multiple jurisdictions are becoming increasingly complex, further underscoring the need for proactive tax planning.

Tax Treaty Considerations

While primarily a federal issue, international tax treaties can influence state tax obligations indirectly. For instance, income tax treaties might mitigate double taxation. Although states are not parties to foreign tax treaties, your business should be aware of how state and local taxes may interact with these income treaties.

Preparing Your Business for U.S. State and Local Tax Compliance

Successfully navigating the complexities of state and local tax is a critical part of expanding your business into the U.S. By understanding economic nexus, managing sales tax obligations, utilizing consulting services, and staying ahead of emerging trends, your business can maintain compliance, avoid penalties, and improve its operations in the complex state and local tax environment. As the U.S. continues to attract significant FDI, being well-prepared and staying informed will be key to achieving long-term success.

For further insights and guidance on expanding your business into the U.S., reach out to our International Tax team today.

Setting up a business in the U.S. requires thorough planning and an understanding of various regulatory and operational challenges. In this series, we will delve into specific aspects of this process, providing guidance and practical tips. Our next article will dive into pre-arrival tax planning.

How to Keep Your Growing Tech Company State and Local Tax Compliant

Key Takeaways:

Tech companies have historically faced complex state and local tax challenges, particularly regarding nexus and sales tax.
Understanding product and service classification, customer types, transaction documents, and research and development activities is crucial to navigating tax challenges.
Regular nexus reviews and proactive tax planning can help companies determine compliance, mitigate risks, and identify savings opportunities.

For technology companies, state and local tax (SALT) — particularly issues related to nexus and sales tax — can be a minefield. Here is what you need to know to stay compliant and avoid costly mistakes.

Understanding Nexus and Protected Activities

Nexus determines whether your company has a taxable presence in a state. For today’s tech businesses with customers spanning across the U.S., nexus can be triggered more easily than you might think.

For sales tax purposes, in addition to physical presence, most states have statutes that establish a “bright line test” based on sales revenue and/or transactions. Generally, the rule is $100,000 or more in sales and/or more than 200 transactions occurring in a state. This is referred to as “economic nexus.”
For state/local income tax purposes, in addition to physical presence, some jurisdictions also have a “bright line test” based on the presence of certain factors including property, payroll, or sales in a state. This test is referred to as “the factor presence test.”

Additionally, for net income tax purposes, there is a federal law that protects certain activities performed by taxpayers selling tangible personal property. Public Law 86-272 (PL 86-272) shields most sales solicitation activities — which would normally be subject to income tax — from a state’s jurisdiction. However, assisting with installations, calibrations, or training are among activities typically not protected (even though these tasks may support the sales process). This common selling practice in the tech industry often creates income tax nexus without companies realizing it.

PL 86-272 does not apply to service providers. Thus, to the extent the revenue generated by a tech company is for services (as defined by each state) and the company solely solicits sales in the state, the activity will nonetheless create income tax nexus in that state.

For franchise tax, gross receipts tax and other state/local taxes, nexus thresholds may be far lower than the ones discussed. In addition, the PL 86-272 protections do not apply.

The application of nexus rules by tax type to the tech industry is extremely complex and requires a review by a state tax law professional.

Navigating Sales Tax Complexities

In addition to nexus, sales tax rules can vary significantly from one jurisdiction to another, making compliance challenging for tech companies. Two main factors drive this complexity:

1. Product and Service Classification and Documentation

Different states may classify your product/service in different ways, affecting its taxability. This is especially true in the tech industry where states are continuously examining the definition of software as a service (SaaS). For example, one state might conclude your product/service is software while another state may classify it as data processing. State auditors will review your revenue streams, documentation, etc., to make the determination. This conclusion matters as some states tax data processing while others may not.

The classification also matters in the application of sourcing rules by state. For example, sourcing software revenue may differ state by state. It may be sourced based on where the software or server is located in one state and where the user is located in another state. The complexity arises in applying two (2) sets of rules on the revenue generated from the same transaction.

2. Customer Type

The taxability of your product/service can also depend on the type of customer you sell to. Nonprofit organizations, healthcare facilities, government entities, and wholesalers may be exempt from sales tax in certain jurisdictions. Keeping accurate exemption certificates is essential when selling to a mix of taxable and exempt customers to avoid over collecting or under collecting taxes.

Exploring Tax Credits and Incentives

In addition to understanding your nexus and sales tax obligations, your company may also benefit from exploring tax credits and incentives available at the state and local level such as:

R&D Tax Credits

Tech companies frequently engage in research and development (R&D), which can qualify for substantial tax benefits. Similar to federal R&D tax credits, many states offer R&D credits that can help reduce your overall tax burden.

Environmental Incentives

As your company expands, you may invest in new office space or facilities, incorporating environmentally friendly technologies. Some states offer environmental tax credits that can help you reduce costs while contributing to sustainability initiatives.

4 Key Strategies for Staying SALT Compliant

Keeping up with state and local tax laws can be overwhelming — especially when they are constantly changing. Here are strategies to help you stay compliant:

1. Understand Your Obligations

Staying compliant starts with understanding how your products and services are classified for both income and sales tax purposes. Each state may treat your offerings differently and understanding whether your product and/or service is taxable, and at what rate, is critical. Additionally, you need to assess your support and sales activities to determine whether they are protected activities, such as those covered by PL86-272, or if they create taxable presence (nexus).

2. Simplify with Software

Sales tax software can help streamline your compliance process. Many tech companies operating in multiple states use this tool to add sales tax automatically to customer invoices. The software calculates the tax rate for each location based on state, local, and district level rules. It can also help with tracking transactions and automating sales tax filings, reducing errors, and saving time.

3. Document Your Decisions

Meticulous documentation is key to maintaining compliance, especially if your company is subject to an audit. Keep records of decisions on tax classifications, nexus determinations, and exemptions. This documentation will be invaluable during an audit — helping you prove that your company acted in good faith and followed the appropriate processes.

4. Conduct Regular Reviews

As your business grows, so do your tax obligations. It is important to periodically review your nexus footprint — especially when expanding into new states or hiring remote employees. A nexus review assesses your corporate and selling activities by state to determine if your company has tax nexus and therefore potential tax exposure and filing obligations. Regular nexus reviews will help you collect and remit sales taxes and pay income and gross receipts taxes in all necessary jurisdictions and avoid penalties for non-compliance.

Taking a Proactive Approach to SALT

As your tech company expands into new markets, staying ahead of state and local tax (SALT) obligations becomes increasingly important. Regular nexus reviews and proactive tax planning not only helps you avoid costly mistakes but also positions your company for sustainable growth.

How MGO Can Help

With extensive experience working with technology companies and a dedicated SALT team, we can help you effectively navigate the complexities of state and local taxes. Through our nexus review process, we analyze your multistate activities — including sales, payroll, and property presence — to develop a tailored SALT compliance plan and resolve outstanding liabilities resulting from unpaid taxes in various jurisdictions.

In addition, our Tax Credits and Incentives team can help you determine if you qualify for any state and local tax credits to offset your tax burden.

Reach out to our team today to gain clarity on your SALT obligations and protect your business.

State and Local Tax Risks and Opportunities for Your Vineyard or Winery

Key Takeaways:

Vineyards and wineries often navigate sales and use tax requirements in multiple jurisdictions, with different rules, rates, and exemptions in each state.

Promotional activities, such as “buy one, get one free” offers, hosting wine tastings, and online advertising can unknowingly create use tax exposure.

Sales tax compliance software often doesn’t address excise and gross receipts taxes, such as Washington’s B&O tax and Ohio’s CAT.

Navigating state and local taxes (SALT) is challenging for any business that sells across state lines, but it can be particularly challenging for vineyards and wineries.

Various excise, sales and use, and gross receipts taxes can apply in different jurisdictions. Not following the complex web of tax rules and regulations can lead to audits, penalties, and even the loss of your license. Fortunately, with the right guidance, you can follow the various state and local tax requirements and even reduce your tax burden.

Understanding Sales and Use Tax Registration and Licensing

Sales and use tax registration and licensing requirements vary by state and depend on whether you ship products directly to consumers. Not all states allow direct-to-consumer shipping, adding another layer of complexity.

Evaluating your sales and use tax exposure requires answering several questions:

In which state and local jurisdictions do you have nexus? Sales tax nexus is a connection between your business and a tax jurisdiction that allows the state or local government to impose sales tax on your business. Most states levy a sales tax, and some, including California, Louisiana, and Tennessee, allow localities to impose their own taxes. You can have physical nexus in a jurisdiction by having employees or a location in the area or economic nexus by meeting a threshold for gross receipts or number of transactions.

Are you properly registered and paying taxes in that jurisdiction? Some industries might gamble on the cost-benefit analysis of registering and paying sales tax in multiple jurisdictions, but vineyards and wineries must prioritize compliance to maintain their licenses. If your winery has a license or distributes alcohol products in a state, it has nexus and should comply with all relevant tax obligations — regardless of economic thresholds.

Are you taking advantage of sales and use tax exemptions in each jurisdiction? Exemptions differ by state. For example, California offers a partial sale and use tax exemption for winery equipment used in manufacturing — such as grape crushers, de-stemmers, presses, bottling equipment, and fermentation tanks. Many states also offer resale exemptions, allowing winemakers to purchase tax-free raw materials like citric acid.

Do you have the proper documentation in place? If you take advantage of exemptions, you must have the right documentation. Without proper records, selling the business or facing a sale and use tax audit can be complicated and costly.

A reverse sales tax audit can help you answer these questions. During a reverse sales tax audit, a professional reviews your invoices and purchase orders, researches applicable laws, and thoroughly documents your exemptions. A reverse sales tax audit can also help assess whether you have overpaid sales tax due to missing available exemptions. If that is the case, you can review prior returns, find potential overpayments, and file amended returns to secure refunds.

Unique Vineyard and Winery Sales Tax Issues

The nature of the wine business brings some unique challenges to sales and use tax compliance. Here are a few issues to consider:

Promotions and Use Tax

Many wineries conduct “buy one, get one free” offers without realizing they must pay use tax on the free item and remit it to the state.

Often, a simple change of wording in the promotion, like changing it to “Buy 2 and get 50% off the total,” can eliminate use tax exposure.

Store Displays

Another area of concern is giving displays to stores. If the winery doesn’t sell the display to the store, the winery IS the final customer. If the winery didn’t pay sales tax on the display purchase, it must report and pay use tax on the item.

Event Marketing and Advertising

Many vineyards and wineries deploy sales representatives to host events without realizing this can create physical nexus in many states.

Examples include hosting wine tastings, holding educational events, and participating in festivals and music events.

Even online advertising can unintentionally establish nexus, so it’s crucial to work with an advisor who understands the industry and can help you find potential sales and use tax exposures.

Excise Taxes and Gross Receipts Taxes

Sales and use taxes aren’t the only taxes vineyards and wineries need to consider. Many states also levy excise taxes and/or gross receipts taxes. These are often more aggressive than sales tax because they’re levied on gross receipts with minimal exemptions. Some examples include:

Washington’s business & occupation (B&O) tax

Ohio’s commercial activity tax (CAT)

Texas franchise tax

Tennessee business tax

While excise and gross receipts taxes often have low rates, they can add up over time if not addressed promptly.

Don’t assume full compliance because you use sales tax compliance software. Some popular tax compliance solutions do not cover gross receipts taxes like Washington’s B&O tax, leading to potential oversights.

How We Can Help

From compliance with sales and use tax requirements to identifying and documenting relevant exemptions, MGO’s State and Local Tax team can review if your vineyard or winery still is compliant and doesn’t overpay your state and local tax liability.

Four Steps to Recover Sales Tax Overpayments with a Reverse Tax Audit

Sales and use tax rates and regulations change often, and the rules vary widely from state to state. As a result, many businesses find themselves “over-complying” with sales tax rules and neglecting potential savings. For taxes that have already been paid (and that are still within the statute of limitations), you can submit a claim for refund — through a process that is often referred to as a “reverse audit.” In this video, we explore how collaborating with our State and Local Tax team can help you perform a reverse audit to improve your bottom line.

To read more about Reverse Sales Tax Audits read our article here.

To get started working with the MGO State and Local Tax team, click the link HERE.