State and Local Taxes for Business Owners: Part 2 – Strategies for Determining Nexus
In the first article of this state and local tax series, the various types of nexus a business can have in a state was discussed. Unsurprisingly, it can be more difficult than expected for a business owner to determine whether or not they have nexus.
For physical nexus, one might be able to simply ask a few simple questions like, “Do we have any employees in the state?” or “Is there any inventory being stored in the state?” However, even questions like this can get a little complicated when the answer might be that there are employees sometimes traveling to a state but only a few times during the year. At what point is there a filing requirement? It depends on the state.
Nexus Determinations
To determine where a business has economic nexus, it is crucial that a business owner has good numbers. To determine sales by state, the business must be able to track where its sales are coming from. Sourcing rules often depend on the type of transaction – whether it is the sale of property, services, or intangible assets (e.g., software, etc.).
For a product being manufactured and then shipped, the sale is typically going to be sourced to where the item is shipped. For a sale where an employee is travelling to a different state to perform a service, it would typically be the state where the service is being performed. However, it can be a little bit more complicated to figure out sourcing in other situations. For example, if an employee is sitting in Maryland performing a service on their computer for a customer located in Pennsylvania, who gets the sale?
The answer to this question lies in the type of sourcing used by both the state where the service provider is located, as well as the state where the customer is located.
- Market or Destination-Based Sourcing – States that use market or destination-based sourcing take the position that a sale is attributable to their state when a customer is receiving the benefit of the sale in that state. Pennsylvania and Maryland both use market-based sourcing, so both states would agree that the sale would be sourced to Pennsylvania.
- Cost-of-Performance or Origin–Based Sourcing – These sourcing rules take the position that a sale is sourced to where the majority of the costs to perform the service are being incurred. Most states used this method many years ago, but it is more common now for a state to use market-based sourcing.
See any issues here? If Maryland instead used Cost-of-Performance based sourcing, the same sale could be taxable in both states.
The next question a business owner is going to ask after discovering they may have nexus in a state is what to do about it. For answers to this question, keep an eye out for our next article in this SALT series on nexus and tax obligations, or reach out to our seasoned and experienced tax professionals if you have questions or need help navigating the complexities of state and local tax. You can also learn more about our services by visiting our Tax service page.
