The Nexus Handbook: 2009

Transcription

1 The Nexus Handbook: 2009 By Diane Kennedy, CPA The single biggest issue for your business in 2009 and beyond is going to be nexus. Nexus means a connection, or a link. In the business tax world, it means having a connection or a link to a state. If your business has a connection, or nexus, to a state, then they have the right to demand tax. And that s what all the fuss will be about in 2009 and beyond. What states can claim to have a connection with you and your business? You might be surprised at the answer. First, let s look at why you should care. Nexus is Both A Tax Issue and A Legal Issue Nexus is both a tax issue and a legal issue. When you make a sale of a product (or provide a service in some states), there is income tax and possibly sales tax to be collected. The problem you might run into is that more than one state will want to collect tax. And, to properly protect your business (and yourself) from liability, you may need to register your business to operate in more than one state. As far as taxes go, states are fighting right and left over the right to tax you and your sales. In the case of a Philadelphia doughnut shop, it s clear. The business has a physical location from which all sales are made. Pennsylvania gets the tax. If your business had a location across the water in New Jersey, you would then have nexus in two states. You would now have to register your business in New Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 1 of 13

2 Jersey and make sure you track income and expenses from that location separately. You will collect and pay New Jersey sales tax on sales made at that shop, and you will pay New Jersey income tax on the company s profits. Even if you don t have a location in New Jersey, you can still have a nexus issue if you cross state lines to provide a service to clients or deliver your products to customers. Most states take the position that when you cross the line and work on their turf, you create an obligation to pay tax on the income you earn there. Over 95% of all businesses have underestimated their tax obligations to other states. Nexus Tip #1: Watch How Much Time You Spend in a State. Some states provide more leeway than others, and they permit you to go into the state for up to 30 days without creating a problem. Other states have a lower threshold, of around days. Other states have no threshold at all. Hawaii and Texas both claim nexus after just a single day within state borders. Texas law provides that if you attend a trade show and do nothing more than offer free information you have established nexus for tax purposes. In a recent case, a seminar promoter got hit with a $1 million+ sales tax bill for FREE seminars that he d given in other states. Nexus and Internet-Based Businesses When you take your business to the web, things really change. You may be sitting in your basement in Los Angeles, creating a website design for someone in Cincinnati, using software that resides on a server in Nevada. You would Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 2 of 13

3 prefer nexus to be in Nevada for lower taxes. California, on the other hand, will insist that because you own the business, worked on the design personally, and live in California, nexus is in that state. Concerned about the IRS? That s probably the least of your worries. States have even less money, and you are their only resource. Let s take it a step further. Let s say your internet business has affiliates. You sit in your office in Arizona, and your servers are in Arizona. So far, so good. You have Arizona nexus. That means the only time you ll have to collect sales tax is if you make a sale to someone in Arizona. Right? Wrong! You may have brought another state into your nexus mix without even knowing it because of your affiliates. An affiliate is someone who advertises for your business on the internet and sends people over to your site. Your affiliate gets paid every time one of his referrals buys something from you. The problem is that some of states have taken the position that if you have an affiliate in their state you ve also created nexus for your business. And that means you need to also collect sales tax in that state. Is this fair? Well, up until recently, the retailer would have won that argument. However, hungry governments in several states are rushing to enact laws that say nexus (and the corresponding obligation to collect and remit sales tax) is where the sale occurs. In other words, New York says that it was your website that caused the sale, and as you live in New York, nexus is there. This is the so-called Amazon law, currently making waves through the internet. Right now, the problem states are Minnesota, New York, North Carolina, and Rhode Island. These states have all Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 3 of 13

4 passed laws expanding their nexus definition. California and Hawaii both vetoed legislation in 2009, but there is no guarantee that the issue won t arise again. Nexus Tip #2: Selling on the Internet? Your Affiliates Could Pull You Into a State for Nexus If you have affiliates who sell your Internet products or services, then you could also have nexus in another state. Here s the list of the trouble states: Minnesota North Carolina New York Rhode Island Most large companies (Overstock.com, Amazon.com, among others) have fired all their affiliates in these states to avoid this problem. Overlapping Tax Laws = Extra Sales Tax on Consumers Let s say your internet business is based in Washington and you have an affiliate in New York (one of the problem states). You make a sale to someone who lives in Washington through your New York affiliate. Washington still claims it has nexus for sales tax, and now, so does New York. Who do you pay? The sad answer is both! Try explaining to your customer why you have to collect sales tax from him for a state he doesn t live in. Where You Live May Put You Out of Business Overlapping taxation laws can be dangerous to you as a business owner if you have an affiliate marketing business. In other words, you find people who want to buy something and send them off to websites where they can find what they want. Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 4 of 13

5 You get referral income every time someone buys. However, if you re located in Minnesota, New York, North Carolina, or Rhode Island, you ve just created a problem for some of the businesses you sell for. By allowing you to market and drive people to their websites, they have now become responsible for collecting and paying sales tax from your referral customers. But that s okay. Most vendors with affiliate programs have chosen to simply drop their affiliates in problem states. If you are an affiliate marketer and are based in NY, MN, NC, or RI, your home state tax laws might have just put you out of business. Nationally Mandated Sales Tax One possible solution is a project called the Streamlined Sales Tax Initiative, or the SST program (SSTP), may gain approval. While no one is 100% behind it, it does answer the question of how to handle overlapping state sales tax laws. The SSTP would change nexus for online purchases to consumers. This is called destination sourcing. Businesses would become responsible for collecting sales tax on every single sale. And that could be a lot of work for you. You would need to track sales tax requirements for all 50 states (and in some cases, additional municipalities), collect the tax, and get the tax to the right state at the proper time. That would create some massive challenges. On the other hand, it could also create a massive opportunity for software programmers. To become effective, the SSTP needs to be adopted by three quarters of the states, and then it needs to be enacted by way of a federal Constitutional Amendment. Many states need to make adjustments to their own state constitutions to allow for the change to a destination sourcing tax. States also Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 5 of 13

6 need to make sure that all municipality-based taxing is in order. This is proving to be harder than it looks, as municipalities aren t happy about giving up revenue. States are also having trouble reaching an agreement on what is and what isn t taxable. The SSTP has strong support in some states, lukewarm support in some states, and no support in others. It s certainly something to be aware of, although it will not likely become effective for several years, if at all. In October 2009, Wisconsin became the 20 th state to sign up as a supporter of the SSTP. Initially, this seemed like a bad idea, but as states are redefining what it means to do business inside their state boundaries it is becoming more and more complicated for the business owner. One agreement, and a move to destination sales tax, would simplify at least defining what is subject to the tax. Of course, it will make it mandatory for every business to collect sales tax for every sale. Digital Download Sales Tax One big problem with moving outside your own state boundaries is that the states do not consistently agree on what is subject to sales tax. We have the Amazon tax, the nexus issue with affiliates. Now meet the itunes tax, the tax on digital downloads. Only it s not just related to itunes and it s not just for music downloads. It s for any audio, video or written download. It might even include sales tax that must be collected for a membership site charge. Right now, the following states will charge a sales tax on digital downloads and most likely membership sites: Alabama Arizona Colorado District of Columbia Hawaii Idaho Indiana Kentucky Louisiana Maine New Jersey New Mexico South Dakota Tennessee Texas Utah Washington Wisconsin Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 6 of 13

7 Nexus Tip #3: If You ve Got Nexus in Another State You Must Know the Sales Tax Rules for That State Just because something isn t subject to sales tax in your home state, doesn t mean it s not subject to sales tax in another state. Once your nexus expands, you have to become an expert on a whole other set of tax laws. (HINT: If your tax advisor isn t virtual, there is a good chance that the only laws he or she knows are your own state s. You might need to think beyond your borders.) Nexus for Your Other Business Taxes You might have a nexus issue with other states for more than just sales tax. If your business has nexus that puts you in line for that s state income tax, you could have more tax issues than you realize. For purposes of this section, we ll say state income tax, but the fact is that s not even that simple. For example, Texas doesn t have a state income tax. Instead Texas has a gross margin tax. That means that the total gross is subject to the tax, with very few deductions. Or, in the case of Hawaii businesses, there is a gross receipts tax. New Mexico has the same thing. So be careful about where your business may be building nexus. We call that the nexus footprint. The more nexus footprints you leave, the more tax you re liable to pay. Nexus Triggers Employees and independent contractor relationships can create nexus. All states take the position that having an employee located in a state will create nexus for your business in that state. So, if you have a virtual assistant working from his home in California, and your business is located and operated in Arizona, guess what! You ve got a nexus issue and an obligation to register and pay tax in California. Many states now take the same approach to independent contractors. Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 7 of 13

8 If your head is spinning, you aren t alone. A recent study conducted by the taxcompliance organization, Sabrix, Inc., indicated that 95% of businesses surveyed had a nexus issue they were unaware of. It s not something you can put your head in the sand and ignore, either. States are becoming extremely aggressive in the quest for tax dollars. California recently passed legislation claiming that out-of-state businesses that receive 25% or more of their income from California customers have a nexus obligation in California. Massachusetts attempted to pass a law forcing New Hampshire retailers to collect and remit sales tax from Massachusetts customers. This prompted New Hampshire to pass a law forbidding retailers from collecting the sales tax for other states. It s a funny problem until you consider the problem one retailer had with shops in both Massachusetts and New Hampshire. His New Hampshire shop complied with the New Hampshire law and his Massachusetts shop was then penalized by Massachusetts. He appealed to the US Supreme Court who so far has not agreed to hear the case. Expect this kind of over-reaching to continue until the federal government or the U.S. Supreme Court steps in to moderate the issue. Nexus from a Legal Perspective Don t forget to look at the legal perspective of nexus as well. If you are operating in multiple states you want adequate legal protection in all of those states. You ll want to be able to chase down and perhaps sue people who don t pay their bills. Plus, you ll want to be able to protect yourself from an angry or injured client. If you are operating in a state without being registered you are putting your business at risk for no real benefit. Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 8 of 13

9 If you do find you have a nexus obligation in more than one state, registration is relatively simple. It s typically a two-part process: once with the secretary of state s office, for the business structure, and once with the Department of Taxation, to take care of sales and income tax obligations. When registering your business into another state remember that all of the same types of obligations will now apply in that state, too. You will need to have a resident agent and file annual reports in that state, as well as in your home state. Remember, you ll need to track your income and expenses by each extra state as well. Come tax time, you ll need to file a tax return for each state in which you have nexus. Talk to your bookkeeper about the best way to track those based on the software program you are using. Determining Your Business Nexus When it comes to determining the nexus of your business, start by answering these questions: (1) Where do you live? If the business has multiple owners, where do they live? (2) Where is the work being done? (3) Where is your business inventory stored? (4) Where does your business inventory ship from? (5) Where are your website servers located? (6) Where do your customers or clients live? (7) Where are your employees or independent contractors located? (8) Where are sales people (including affiliates) located? (9) Where do you give presentations or hold live events? Keep it simple. If you are located in Connecticut and you operate a service-based business, form your business in Connecticut. It doesn t matter how you deliver Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 9 of 13

10 the service to the client (unless you work on-site at the client s location in another state). You re going to be considered a Connecticut business by state tax authorities. If your business has multiple owners, look at their involvement in business operations. A passive money partner, who doesn t perform a service or do anything in the business doesn t always create nexus. Depending on the laws of their home state, they may be considered simply an investor. Don t get caught up in the Nevada/Delaware/Wyoming incorporation game. The old strategies of attempting to create Nevada nexus simply by establishing a mailing address, virtual office, bank account, etc., are just that: old, and no longer valid solutions. Unless you have a specific business purpose in the state, you won t gain anything by setting up a business structure there, particularly when it s clear that your business has nexus somewhere else. Nexus Tip #4: Be Strategic With Nexus. If you have state tax requirements in more than one state, leverage one state against another. For example, if you are subject to income tax in California and gross receipts tax in Texas, move deductions to the California allocated income. Texas Margin Tax (the gross receipts tax) allows a deduction for (1) cost of goods sold, (2) 30% of gross receipts or (3) compensation. The expenses can move to California (wherever legally possible) and Texas can take the flat rate deduction. Look Out for Audits The IRS has already doubled the number of auditors in the field in President Obama has called for quadrupling the number of auditors within the next five years. Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 10 of 13

11 But the IRS is least of your problems. State tax auditors are often more aggressive and give more power then IRS tax auditors. Here are some states to watch out for: Most Unfair and Unpredictable States for Audits: #1: California #2: Massachusetts #3: New Jersey #4: New York #5: Michigan In some states, the state auditors are allowed to interpret, or re-interpret state regulations to fit certain fact situations. In other words, you may get assessed a tax when three years ago, you would not have been. The court of appeals will be to that state, which most likely is broke. Most Aggressive at Asserting Nexus for State Tax: #1: New Jersey #2: New York #3: Massachusetts #4: Maryland #5: Michigan There are two possible tax situations with nexus: sales tax and income tax. I m using income tax as a generic description. You could be in Texas, New Mexico or Hawaii where there is a tax based on some calculation of gross receipts. Or, in California where there is a tax based on gross receipts, income and everything in Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 11 of 13

12 between. Just to keep it simple, though, for now, let s use state income tax to define the other than sales that, generally based on income, a state may assess. An aggressive state for state tax purposes is looking for a reason to pull you into their jurisdiction and make you start apportioning your income. Cross into their boundaries and you ll be responsible for calculating a percentage of your income for their state. This gets tricky if you have states that use different parameters for determining how income is calculated in the state. One of our clients ended up having 105% of their income subject to income tax because of a formula that included compensation and inventory stored in one of the subject states. Most Aggressive at Asserting Nexus for Sales Tax #1: New York #2: California #3: Massachusetts #4: New Jersey #5: Texas Most of the challenges lately have been about sales tax defining nexus and then determining what products and services are subject to sales tax. Nexus is a big issue now for business owners, and likely to become an even bigger issue in coming years. Action Steps Action Step 1: Take the business nexus test above. Do you have a possible nexus footprint in another state? Action Step 2: Discuss your nexus status with your tax strategist. Do you need to collect sales tax in another state? Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 12 of 13

13 Action Step 3: Are you subject to tax in another state? What strategy can you do to minimize the tax consequences? Action Step 4: Do you have the right home state for your business? Action Step 5: Do you need a nexus expert on your team or do you have the resources you need? Copyright 2009, Diane Kennedy and US TaxAid Series, LLC. All rights reserved. Page 13 of 13