Income and Sales Tax Nexus – Do I Really Need to File Returns?
By David M. Donnelly, Senior Manager, Tax & Business Services
Whether you have an existing business or you are starting one, congratulate yourself—in any business environment, this is no easy feat. However, in the time of COVID-19, it’s even harder. But while you focus on sales and operations, do not forget the tax man. You may think that you already have too much to do, let alone worry about taxes. But don’t think this way!
In the tax world, there is a term called “nexus.” It loosely refers to the ability of a taxing jurisdiction to bring you into their world, i.e., make you subject to tax. In the old days (before e-commerce) nexus was usually based on physical presence, meaning you had to have a brick and mortar location with employees, etc., or you had to be sending in sales people to do more than mere solicitation in order to have a filing requirement.
In 2018, the Supreme Court decided South Dakota v. Wayfair, Inc. in favor of the state of South Dakota. Following that decision, retailers with annual in-state sales exceeding $100,000 or 200 separate transactions must collect sales tax and file sales tax returns with that state. This is for retailers that are located both inside and outside the state. Crazy but true!
The above relates to sales tax, but what about income/franchise tax? If your business is a corporation or LLC, it was formed under the laws of a particular state. At a minimum, you must file an annual return in that state. But what if you have locations in other states, such as a factory or warehouse? What if you have employees going into that other state or have meaningful sales there? In those cases, you might have to file there.
Sales tax is a trust fund tax. As a business owner, the sales tax you collect is held in trust and then remitted; for example, when a customer goes to a restaurant and receives a $100 bill for food and drink, there will most likely be a few additional dollars for sales tax. These additional dollars need to be collected by you and then remitted to the taxing authority. If they are not, you and/or any other “responsible person” will be personally liable. A business, its owners, and responsible parties that fail to collect and remit sales tax quite often find themselves out of business or bankrupt.
An important reason to file income/franchise tax returns in other states is that if your business ever has to bring a lawsuit in that state, your company generally needs to be qualified to do business there as a foreign corporation. Registering to do business in another state generally involves minimal paperwork and a certificate of good standing from the state in which your company was incorporated/formed. If this is an issue, consult with your attorney and get caught up on compliance.
It is especially important to comply with your tax filing requirements if you work in a highly regulated industry (such as liquor or entertainment). Different jurisdictions have different taxes and filing requirements. For example, did you know that New York City has a commercial rent tax? Imagine having to pay a tax on the rent you pay to your landlord! While it has been reduced over the years, it is still on the books and has caught some businesses off guard. Don’t let this happen to you. Past due taxes, plus penalties and interest, add up quickly.
Filing returns and making tax payments in a timely manner also have other benefits. If your business is compliant, there should not be any significant penalties or interest charges. In addition the statute of limitations sets a limit of three years after filing, after which the taxing authority can’t audit that return.
Opening and running a business can be a great experience. However, what happens if you realize after the fact that something should have been filed but wasn’t, or taxes should have been paid that weren’t? Many jurisdictions have “voluntary disclosure” programs that encourage businesses to catch up on filing outstanding returns. Often, penalties aren’t assessed and payment terms can be very favorable. The important thing to realize is that it is better to come forward than to be tagged by a taxing authority.
Another area where businesses can run into problems is classifying their workers. Are they really employees, subject to payroll, or are they independent contractors? The latter designation means that these individuals have their own businesses and are not subject to your control. While this sounds simple, it really isn’t. Many business owners have made costly mistakes in this area.
Please do not ignore the compliance aspect of your business. Marcum can help with everything from setting up shop and structuring your business to filing returns and successfully managing your business. Get ahead of any problems to ensue your business success. Now get back to work!