Tax Implications of Doing Business Across State Lines
Remote Workers and Employers May Find Sticky Tax Issues
If your company is growing and expanding into other states, or if you have employees who live across state lines, several considerations can help you anticipate and manage the state and local tax (SALT) implications.
Increasingly more Kansas and Arkansas companies are dealing with payroll withholding, income taxes, and sales taxes in non-resident states, and the number may be growing thanks to a confluence of recent and ongoing events.
Wayfair Ruling – Sales Tax Implications
Nexus is the principle that determines whether a company’s activity in a state triggers the income tax and sales tax compliance requirements in that state. Nexus is the amount and degree of a taxpayer’s business activity that must be present in order for the taxpayer to become subject to the state’s taxing power.
States have different approaches for determining nexus, the two most common being physical presence nexus and economic nexus:
- Physical presence nexus means that a company has nexus in a state if it has property and/or payroll in that state. In other words, it is physically present in the state. This includes rents, business equipment, land, etc.
- Economic nexus is doing business in a state, such that the company is deriving financial gain from customers in a state. Some states have defined economic nexus in terms of statutory thresholds of a company’s apportionment factors (property, payroll, and/or sales). This is referred to as factor presence nexus.
Now, a company that has a minimum volume of sales in a state – whether or not it has a physical presence – may be subject to that state’s sales tax. Additionally, it could be subject to a state’s income tax if that state has factor presence statutes in place.
For decades, to be subject to income tax and sales tax filing obligations, a company must have had a physical presence in a state, as states followed a physical presence standard. Over the last decade, the concept of economic nexus became the new standard for state income tax purposes while the physical presence standard remained in place for sales tax purposes. This all changed with the 2018 U.S. Supreme Court ruling in South Dakota v. Wayfair, which instituted economic nexus standards, more specifically factor presence standards, for sales tax. The ruling eliminated the requirement that a company have a physical presence in a state to be subject to sales tax compliance (including collecting and remitting sales tax and filing returns) for selling in that state.
COVID-19 and the Rise of Remote Work
Remote – or “virtual” – work has become ubiquitous since the pandemic sent millions of people home to work from dining room tables, couches, and home offices. In some cases, employees are working from homes that are in a different state than the one in which their employers are located. This is especially true in smaller states and in large metropolitan areas located near state lines, like Kansas City.
Normally, merely having an employee living and working from home in a different state qualifies as “physical presence” and, hence, triggers nexus regardless of whether sales are being made to customers in the state. However, many states have issued directives saying that during the pandemic they will not consider an out-of-state company to have nexus simply because it has employees working remotely from their homes in those states.
But what will happen when the COVID-19 crisis is over?
Many companies have found advantages in having employees work remotely during the pandemic, and it is likely that more workers will be permanently working remotely even after the pandemic is over. So, many employees who live across state lines who were not previously working from their homes may do so in the future. Presumably, the states that have relaxed nexus rules during COVID-19 will go back to the old model, introducing SALT consequences for companies that are not dealing with them now.
Before your company implements new policies around remote work, it would be advisable to learn about the SALT implications if you have employees who live across state lines.
Top Issues to Consider
Whether your company’s activity in another state is due to an expansion of your business – with a facility, employees or sales in that state – or just the residency of employees in that state, here are the top SALT issues you will encounter:
- Individual income tax and payroll withholding for an employee. Merely having employees who live across state lines triggers nexus for the employee income tax and payroll tax withholding. While this likely does not cost any money for the company, it may introduce complex new rules for your finance department or your payroll provider to follow. There could be some immaterial costs for employers if they withhold taxes for employees in additional states, including costs for state filings and having a payroll provider add a state to employees’ withholdings.
- The majority of states levy income tax based on economic nexus, which is determined in part by whether a company has “purposeful direction of business toward the state.” In these states, the level of sales does not necessarily matter; it is the intent of the company and its activity in the state. In the handful of states that follow factor presence nexus standards, a company could be subject to income tax if sales (or even property and/or payroll) are above a certain level in a non-resident state. As such, expansion of your business could result in income tax compliance in non-resident states merely because it makes sales to customers in those states.
- Sales tax. After the Wayfair ruling, many states imposed sales taxes on out-of-state companies making sales within their borders above certain revenue levels and/or above a certain number of transactions.
- Miscellaneous additional compliance filings.
State Incentives May Offset Costs
If your new SALT obligations are due to expansion of your business into another state, state-sponsored business expansion incentives may help offset some of the taxes. There are many such incentives, and they vary significantly from state to state, but here are a few examples:
- Arkansas – The Advantage Arkansas Income Tax Credit provides state income tax credit to companies creating jobs. This is based on payroll of new full-time permanent employees hired because of a project. This map shows the benefits of the program as well as the job creation requirements.
- Kansas – The Kansas High Performance Incentive Program (HPIP) provides tax incentives to qualifying employers who pay above average wages and invest in certain types of training for their workers. The HPIP program provides a 10% tax credit for companies that make a capital investment of at least $50,000 at the company’s facility. In the five Kansas City metro counties of Douglas, Johnson, Sedgwick, Shawnee and Wyandotte, the threshold is $1 million. The tax credit has a 16-year carryforward provided facilities requalify.
- Missouri – The Missouri Quality Jobs program provides tax benefits for certain businesses and nonprofit organizations that create jobs with wages higher than the local county’s average wages. Employers also must offer health benefits and pay more than 50% of the premiums for coverage in order to qualify. The tax incentives can include retention of payroll withholding taxes, as well as refundable tax credits.
- Nebraska – The ImagiNE Nebraska Act (LB1107) provides credits, refunds, and exemptions to Nebraska businesses. Under LB 1107, $25 million in credits and refunds will be available in 2021 and 2022, increasing to $100 million in 2023 and 2024. The law incentivizes business for employee retention and job training, as well as providing a refundable income tax credit for property taxes paid. It also provides a tax credit for producers of eligible renewable chemicals.
If your company could benefit from more insight about state and local tax issues, please reach out to your Adams Brown advisor.