Transportation companies should carefully consider sales and use tax nexus issues. Crossing state lines for a job may be a way to boost the bottom line, but doing so may also mean dealing with complex tax laws. States are adopting far-reaching rules and interpretations on the issue of nexus and it is important to understand your responsibilities.
WHAT IS NEXUS?
Nexus is known as, “the level of contact that must exist between a taxpayer and a state before the state has the authority under the U.S. Constitution to assess a tax.”
Many states are increasing the number of audits, thereby allowing states to collect more revenue without enacting new taxes or increasing tax rates. These state audits are unexpected and taxpayers are shocked to learn they are not in compliance and may face substantial tax and penalties as a result.
State income tax nexus may be attained through one of three primary actions:
- A physical presence
- An economic presence
- Through the ownership of a pass-through entity satisfying either the physical or economic presence standards
Physical nexus is created if a company maintains a temporary or permanent presence of people (employees, agents or representatives) or property (inventory, offices or warehouses) within a state. A permanent presence is deemed to be that which is substantial and long-term. Whereas, temporary presence may be created through visiting customers or prospects, or even minor attendance at trade show events.
Economic Nexus, also known as a “factor presence test,” may establish nexus with a taxing state, even though the business entity has no physical presence, but only makes sales to customers in the state. Under this test, there is no need to have any physical connection with the state. Under the factor presence standard, states will be deemed to establish nexus if the level of activity exceeds a certain threshold. Not all states have adopted the economic nexus approach, however, the number of states participating is growing. California, Ohio and Washington are the more active states applying the economic nexus standard.
For the states requiring a physical presence, many business entities may be protected from potential state income tax assessments under a long-standing Federal law. Public Law 86-272 prevents states from taxing out-of-state corporations on income derived from business activities within the state if their activities are limited to “mere solicitation of orders” and the orders are approved and filled from outside the state.
Does this apply to my transportation company?
Generally, having employees or owning or leasing property in a state creates nexus. Other activities qualifying you for nexus include:
- Maintaining a local bank account
- Accepting orders for your transportation services
- Using a local phone number
A nexus study was done by Sabrix, Inc. and the results showed that 95 percent of the companies surveyed underestimated their nexus issues. The most common items companies overlooked were:
- Independent contractors – agents acting on behalf of the company may create nexus
- Services – performing services in other states may create nexus
- Trade shows – spending a single day at a trade show in another state may create nexus
There are many complexities with today’s cross-border business climate requiring careful consideration because of unforeseen nexus issues. Smith Schafer can help you navigate the laws to ensure your state income tax obligations are correctly calculated and reported. Transportation has been a key practice area of ours since 1971. Our Transportation Group, comprised of numerous professionals, is committed to serving over 110 Minnesota transportation entities.