Most business owners understand the term “Nexus” as having enough contact with a state before that state can require a business to collect its tax or otherwise subject it to its taxing authorities. Without “Nexus” there is no obligation to file a return with that state.
The “Nexus” standard is becoming more complicated and complex as states are attempting to broaden their tax bases and increase their tax collections. For sales tax purposes some states are not using a physical presence test but are looking at “economic nexus standard.” What this means is that the state sets a threshold of sales either based on dollar volume or number of transactions in their state. Once the threshold is met a sales tax requirement is imposed on the Company. Compliance is a major problem for Small Businesses.
If you are in a Service Business and you are doing business across state lines how are you sourcing your sales for purposes of state income taxes? Many states have shifted to a single–sales factor based on where the customer is receiving the benefit “Market Based Sourcing.” There are some states that use a “Cost of Performance” approach which looks at where the income-producing activity is performed. If the majority of the costs are incurred in one state that state may get 100% of the sale apportioned to it whereas other states that use cost of performance” may prorate the sales based on where the costs are incurred. Again compliance is a major problem for Small Businesses.
These issues are often brought up when a Company is on the sales side of a transaction and the buyer wants to understand the risk involved and wants to quantify the amount. We have seen sales prices get reduced and/or money set aside into escrow accounts when a buyer becomes aware of improper state reporting. In addition, if you are buying a business you would want to be aware of the risks associated with your acquisition. Please feel free to reach out to us to get a nexus plan in place or an evaluation of your processes. It could save you thousands of dollars!
Written by Howard Flitt, CPA, Founding Partner