What it means
In a federal country, taxes are levied at more than one level. The national government taxes at the federal level, while each state sets its own taxes with its own rates, exemptions and filing rules.
A company with customers or staff in several states may therefore face many different regimes. The main state-level taxes are income tax on individuals and businesses, sales and use tax on goods and some services, property tax, and payroll taxes.
Some states have no income tax or no sales tax but rely more on other taxes. The rates and rules are set by each state and change from time to time, so they should be checked at the time of filing.
A key concept is nexus, meaning a connection with a state strong enough to make a business liable for its taxes. Nexus can come from having an office, staff or inventory in a state, and in many states from exceeding a certain amount of sales.
Once a business has nexus, it must register, collect any required taxes and file returns. For income tax, a company with activity in several states divides its profit among them using apportionment.
A common method uses the share of sales made in each state, though some states use property and payroll as well. The company multiplies its income by the apportionment percentage and the state's tax rate.
Complexity brings cost and risk. Different filing dates, forms and definitions mean that many businesses use tax software or advisers, and mistakes can lead to penalties and interest.
Remote work has added to the difficulty, since an employee working from home in a new state can create a tax obligation. Planning is legitimate but must follow the rules.
Businesses can review where they locate staff and inventory, and claim incentives and credits offered by states to attract investment. Tax advice from a qualified professional is a sound investment for any firm expanding across state lines.
In practice
Real-world examples
Example 1
A software company hires its first remote employee in a new state. The finance manager checks whether this creates a tax filing obligation. She registers for payroll tax and files an income tax return in that state. She also updates the payroll system so that withholding follows the employee's work location.
Example 2
An online retailer sells goods to customers across the country. It reviews its sales by state and finds it has passed the sales threshold in three states. It registers there and starts collecting sales tax at checkout. The finance team also reviews past sales to see whether any tax is owed for earlier periods.
Example 3
A manufacturer is choosing a site for a new plant. It compares property tax rates, incentives and payroll taxes in two states. The total tax cost over ten years helps decide the location. The incentives offered by one state are weighed against its higher payroll costs.
Think of it
Imagine driving across a country where every county has its own speed limit, road signs, and driving rules. What is legal in one county might get you a fine in the next, even though you are on the same highway.
Formula
Calculation
State income tax = taxable income x apportionment percentage x state tax rate
Suppose a company has taxable income of $2,000,000 and total sales of $40,000,000, of which $12,000,000 are made in one state. The apportionment percentage is 12,000,000 / 40,000,000 = 0.30, or 30%. The income attributed to that state is 2,000,000 x 0.30 = $600,000. At an assumed state rate of 5%, the tax is 600,000 x 0.05 = $30,000.Case study
Seen in the real world
Brookhaven Home Goods is an illustrative, fictional online retailer that sold nationwide but had only registered for sales tax in its home state. Its sales grew to $9,000,000 a year, with $1,500,000 going to customers in a second state.
A state notice informed the company that it had passed the sales threshold two years earlier. The unpaid tax at an assumed rate of 6% was 1,500,000 x 0.06 = $90,000 per year, or $180,000 for two years, plus penalties and interest.
The company negotiated a settlement, registered in all states where it had nexus and added automatic tax calculation to its checkout. The illustrative lesson is that growth across state lines creates obligations that must be monitored from the first sale.
Watch out
Common mistakes
- Assuming that tax rules in the home state apply everywhere the business trades.
- Ignoring the tax effect of remote employees working in other states.
- Overlooking the sales thresholds that trigger registration, particularly for online sellers.
Questions
People also ask
What is nexus?
It is a link between a business and a state, such as staff, property or a sales volume, that makes the business liable to that state's taxes.
Do all states have income tax?
No, some states do not tax personal income, but they usually raise money through other taxes.
How often should a business review its state tax position?
At least once a year, and whenever it opens a new location, hires in a new state or has a large rise in sales.