As companies expand their operations and attract customers in additional states, they enjoy a host of new opportunities, but these opportunities can also create new challenges. One of the critical challenges that arises with multistate business activity is the increasingly complex system of taxation.
When a company is doing business in a state, it becomes subject to that state’s tax return filing and payment requirements. This may include income, gross receipt, and/or sales tax.
Understanding Multistate Tax Liabilities
In 2018, the U.S. Supreme Court’s Wayfair Decision changed how a company’s tax nexus is determined in a state. Instead of allowing only physical presence—like an office or warehouse—to create state nexus, the court ruled that economic activity, such as selling products or services online to customers in a state, can establish state tax nexus. This change means companies may now have to file income tax returns, incur entity-level tax liability, and collect and remit sales taxes in more states, counties, and cities than before.
Complying with State Tax Obligations
Adding to the complexity is the fact that each jurisdiction determines how a company establishes nexus in the state and may even have varying rules for different types of taxes in the state. Most commonly, states have different rules for what activities create nexus for income tax versus sales tax, with sales tax nexus rules generally having lower threshold standards. Companies need to identify and monitor:
- Where they are shipping products or where customers are receiving the benefit of services provided.
- The level of economic activity that would establish nexus in the applicable state(s).
- Their current sales within a state or jurisdiction.
- How close they are to, or whether they have exceeded, a state nexus threshold.
Companies also need to understand the various sales tax exemptions available in each state. For example, some states offer sales tax exemptions for certain categories of goods or services, or for sales to tax-exempt organizations.
If a company isn’t paying attention to its multistate activity, they may be surprised to learn they’ve established economic nexus in another state for one or more types of state taxes. Companies are likely to have different viewpoints about how much time, energy, and resources they want to put toward identifying their multistate tax obligations. However, it’s important to understand that ignoring those obligations may lead to issues later.
Multistate Taxation M&A Implications
Beyond traditional compliance obligations, failing to track multistate activities and identify potential state tax implications may become an issue during a merger or acquisition. Multistate tax activities are extensively examined during the due diligence process to determine whether a company is materially compliant and whether any unknown filing or tax payment obligations exist.
Before an acquisition, the buyer will conduct a due diligence review. During the review, the buyer will typically examine a sales distribution report provided by the target company to determine where they believe economic nexus may exist.
Additionally, the buyer will look to the target company’s employee headcount by state to determine where physical presence nexus may exist. They will then compare these analyses with the target company’s state and local tax filings across key tax types: income, gross receipt, and sales tax.
Any outstanding or undetermined exposure will raise questions and sometimes require additional analysis. This can slow down the closing of a transaction. In these instances, it’s common for the buyer to “hold back” a portion of the sale price to cover any estimated multistate tax obligations, penalties, and professional fees to reduce or eliminate future exposure. These costs can be large.
To prevent potential surprises, it’s important for companies with interstate sales and remote employees to pay close attention to their multistate activities and the resulting compliance and payment obligations.
Navigating Multistate Taxation and Staying Compliant
Since the Wayfair Decision, conducting business in multiple states has made multistate taxation a very complex and challenging process. To avoid costly surprises and potential problems, it is critical for companies to put forth best efforts to comply with their multistate tax obligations.
Our State and Local Tax (SALT) team understands the complexities of multistate taxation across all types of state taxes and can assist with these challenges. Contact one of our tax professionals for help with identifying and monitoring multistate tax obligations, ensuring compliance, and avoiding potential surprises.