State and Local Tax: Basics to Consider

7/8/2022 - By Arthur Orzame, JD

As the growth plans of a business include expanding into new states, there are numerous tax, licensing and permitting issues to consider.

Even if your business already operates in more than one state, you should be aware that in recent years many states have become more and more aggressive in enforcing tax and licensing requirements. In fact, many companies have entered into neighboring jurisdictions for several years prior before realizing they were non-compliant with their state and local tax filing requirements, inadvertently incurring added taxes, penalties and interest.

Whether you are just now thinking of expanding into another state or already are a multistate business with concerns about compliance, here are some basics to consider.

Income Taxes

To evaluate your exposure to various taxes in another state, you must first understand the concept of “nexus.” The term is used in tax law to describe a situation in which a business has a connection or presence in a state, therefore subject to that state’s tax laws. For income tax purposes, nexus is generally established if your company meets one of three triggers:

Generating revenue in the state;
Owning or leasing property, inventory or equipment in the state; or
Having employees working in the state.

Specific nexus requirements vary from state to state. Yet, generally, if your company meets any of these triggers you will be subject to state income tax on a portion of your net income. Note, however, that the apportionment methods used to determine how much of your company’s net income is subject to tax will vary from one state to another.

Franchise Taxes

Some states charge franchise tax for the privilege of being chartered or operating in the state. The amount of tax is not calculated on income, but rather on assets, net worth or capital stock of the company.

Sales and Use Taxes

For sales tax purposes, nexus traditionally was established only if your company had a physical presence in the state. That has changed in recent years, as most states have enacted economic nexus legislation that generally requires an out-of-state seller to collect and remit sales tax once the seller meets a threshold of sales transactions or gross receipts activity within the state. As such, no physical presence is required.

Withholding and Payroll Taxes

Employees who live in one state and work in another are generally required to pay income tax to the state where they work. As such, your company must set up an account and withhold the required taxes in that state. Fortunately, many states have established reciprocal agreements with neighboring states, in which they agree not to impose income taxes on each other’s residents. These greatly simplify things for workers and employers alike, but you’ll need to check whether such an agreement is in place.

Business and Professional Licenses

If your company does not have a physical office in a state, it may be required to hire a registered agent in the state to obtain the necessary license to do business. As a business, you will be subject to the specific professional or trade licensing requirements of the state and local jurisdictions where you will be working. The initial license applications often must be accompanied by a financial statement, which in some cases must be audited by a CPA. Experience requirements, examinations, forms and filing fees also vary from one jurisdiction to another. Finally, you must also comply with local project specific permitting requirements.

The costs for the various fees, licenses and permits may not be prohibitive, but they’re not insignificant, either. What’s more, the administrative costs required to ensure compliance should also be considered.

Questions?

We have a team particularly specialized in State and Local Tax to resolve tax problems without resorting to litigation wherever possible. Reach out to our team for more information!

About the Author | Arthur Orzame

Arthur is a director in the Tax & Accounting Services practice of Saltmarsh, Cleaveland & Gund. He has over 20 years of public accounting experience specializing in all areas of state and local taxation. Arthur consults on tax and compliance issues related to individuals, partnerships and corporate entities, providing complex multistate planning strategies aimed at minimizing state tax liabilities. He has worked with clients in the retail, financial services and manufacturing industries and before joining Saltmarsh, was a director at a national firm.