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Tax Trends for Multi-State Businesses

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Tax planning will — and should — look different for each and every business. And when your business operates in more than one state, that tax plan could get complex.

Lots has been happening in multistate taxation over the last few years. Let’s review some of the latest trends so you know what to be thinking about as you build your tax plan for 2024, 2025, and beyond.

Economic Nexus for Sales Taxes

Nexus is a bit of a tricky concept, but let’s try to simplify it.

According to the Due Process Clause in the United States Constitution, a business is subject to a jurisdiction’s tax laws and filing requirements when it has established a sufficient connection — or nexus — with that state. When it comes to sales taxes, nexus laws have been on the move for decades.

Prior to the ecommerce boom, jurisdictions levied their sales tax laws on out-of-state businesses only if those businesses had some sort of physical presence in their state (e.g., they had employees traveling into the state, they stored inventory in that state, etc.). Today, physical presence will generate nexus, but so will economic presence.

When economic presence laws first emerged, most states determined that businesses had nexus for sales tax purposes if they either (1) made a certain dollar amount of sales within state, or (2) completed a certain number of sales transactions within the state. In recent years, states have been simplifying their economic nexus laws by ditching the number-of-transactions test. Let’s look at two recent examples.

  • In 2023, Indiana would impose sales tax collection responsibilities on out-of-state businesses if they had either (1) gross sales into Indiana exceeding $100,000, or (2) 200 or more separate sales transactions into Indiana. This year, legislators passed a law that eliminated the 200 or more separate sales transactions threshold beginning January 1, 2024.
  • Until July 1, 2024, Wyoming’s economic nexus laws include both a $100,000 sales volume and a 200-or-more-transaction threshold. Beginning in July, Wyoming will abolish their transaction threshold and only require out-of-state sellers to collect and remit sales taxes if their sales within the state exceed $100,000.

Because economic nexus laws keep changing, we recommend that you review your sales tax filing responsibilities annually.

Pass-Through Entity Taxes

As of May 2024, nearly 40 states have created a pass-through entity tax (PTET). PTETs may be great options for you and your business, but they can be complex. Let’s review what PTETs are and how they can help.

PTETs were created to solve a very specific problem.

Beginning in 2018, the Tax Cuts and Jobs Act placed a $10,000 cap on state and local tax (SALT) deductions for individual taxpayers. Individuals who pay more than $10,000 of state income tax and/or property tax won’t be able to deduct the full amount. To help their residents with this problem, many states created a PTET.

PTETs are entity-level income taxes that partnerships and S corporations can elect to file in lieu of passing taxable income down to their individual owners. PTETs effectively help circumvent the $10,000 SALT deduction limit because the business will pay the state income taxes directly and deduct them without limitation. Effectively, PTETs transform an individual SALT deduction (which is limited to $10,000) into a business SALT deduction (which has no limitation).

In 2023, Montana and Hawaii joined 34 other states in offering a PTET. Out of the remaining six states that offer an owner-level income tax on business income, only four have not yet proposed a PTET. Clearly, PTETs are trending, and if your business hasn’t considered how to use them, 2024 is the time to talk with your tax advisor about your options. A few things you’ll need to think about are:

  • When you need to make the PTET election, and who needs to approve it.
  • Calculating estimated taxes and paying them timely.
  • How the tax will affect owners that live in different jurisdictions.
  • How the PTET works if your business has more than one tier of pass-through entity ownership.
  • How the PTET works if your business files a consolidated return.
  • Whether your individual owners’ resident states allow them to take a credit for taxes paid to other states via a PTET (not all states do).

State Apportionment

For years, three-factor apportionment was the most common method jurisdictions used to tax out-of-state business taxable income. Multistate businesses would be required to calculate an apportionment percentage based on the (1) sales, (2) property, and (3) payroll that were generated in that state, then calculate their state tax liability using that percentage. However, in recent years, we’ve seen a shift away from three-factor apportionment. More and more states are implementing single sales factor apportionment methods.

  • New Jersey
    Beginning January 1, 2023, business receipts should be sourced to New Jersey using a single sales factor. Under prior rules, businesses used a three-factor formula of property, payroll, and receipts.
  • Idaho
    Beginning January 1, 2022, a multistate business should apportion its income to Idaho based entirely on sales rather than a combination of property, payroll, and sales.
  • Tennessee
    Tennessee is currently phasing out its three-factor apportionment method. Single sales factor apportionment should be fully phased in for years ending on or after December 31, 2025.
  • Vermont
    Beginning January 1, 2023, Vermont now requires remote businesses to source their income to the state based solely on sales rather than a three-factor method where sales were double weighted.
  • New Hampshire
    Beginning January 1, 2023, New Hampshire adopted a single sales factor apportionment method, shifting away from a three-factor method.
  • Montana
    Montana currently uses a three-factor apportionment method to source business income to their state. Beginning in January 1, 2025, business receipts should be sourced to the state using a single sales factor.
  • New Mexico
    New Mexico currently requires most businesses to apportion their income using a three-factor formula, but the state is considering shifting to a single sales factor.
  • Kansas
    Kansas has introduced a bill that allows single sales factor apportionment for certain businesses, but the bill has not yet been signed into law.

Shifting away from three-factor apportionment toward single sales factor apportionment may not alleviate filing responsibilities for businesses, but it could change the amount of income that’s sourced to those states.

How Remote Workers Impact Income Tax Nexus

Since the COVID-19 pandemic, we’ve seen a trend toward remote work. It’s estimated that by 2025, one in five Americans will work remotely. Having remote workers can be beneficial for your business, but it does pose a problem when it comes to your tax filing responsibilities. If you have employees that live in different states, you may need to:

  • Establish payroll tax accounts in those states.
  • Withhold income, payroll, and unemployment taxes in those states on behalf of your employees.
  • Consider how your employees’ presence in those states will impact your business’s income tax filings.

It’s this last issue we want to discuss. When would an employee’s presence in a state create an income tax filing responsibility for your business?

Generally, businesses are subject to a state’s tax laws if they have employees located in and working from that state. This is unlikely to change. Even as remote workers are becoming more and more common, states are unlikely to waive filing responsibilities for businesses that have remote workers residing in their state.

However…

Their remote presence may have less of a tax impact than they previously had. Let’s look at Ohio as an example.

Ohio recently implemented a modified apportionment formula when determining multistate tax liabilities. Instead of apportioning income into Ohio based on the location of their employees, businesses can apportion income by using their employees’ “reporting location,” which can be any place owned or controlled by the employer. If an out-of-state business has an employee living in and working from Ohio, their presence in Ohio may not affect the apportionment percentage that sources business taxable income to Ohio.

Put more simply, while a remote employee’s presence is likely to create a filing responsibility, it may not generate an additional tax liability.

For more information about your multistate tax responsibilities, contact us.

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