Expanding into new territory can be an exciting and profitable opportunity. But, if that expansion leads a company beyond their state’s borders it can also lead to complications in how they are taxed.
Understanding the implications of multi-state taxation is one of the most complicated things for any payroll department. Here’s a breakdown of what companies operating in more than one state need to consider.
- Nexus: The concept of nexus is what determines whether or not a company falls under the taxation jurisdiction of a given state. A company establishes nexus in a state if you generate revenue, employ people or own or rent property there. Even a small amount of any of these activities creates nexus in the state and will open your company up for taxation by that state.
- Withholding laws: Employees working in multiple states do not need to pay extra taxes. That’s good for the employee, but it makes withholding more complicated for the payroll department. There are a number of different methods to manage multi-state withholdings depending on how the employee splits their time. Withholding will need to be done on a case by case basis and it’s critical that the payroll department conducts all the appropriate research and stays up to date on changing laws.
- Reporting: Like withholding, there is no catchall solution for tax reporting for employees working in multiple states. Some states have reciprocity agreements where they agree not to tax nonresidents working in their state. The employer may wind up owing different amounts of payroll tax in different states.
- Apportionment: If a company does wind up having nexus in multiple states, then the business will need to figure out how much tax it owes in each place, this is called apportionment. Generally, apportionment is determined by splitting your income into thirds. One third represents where profit is generated, another where the company owns property and another where payroll occurs.The tax in each of those thirds is then divided among the states where that business activity occurs. There are some exceptions to this and many states have different rules, which is why it is so important to have a competent payroll department.
- Don’t forget other taxes: Sales tax and other state excise taxes are also considerations that all businesses that sell something need to consider. Even if a company has not established nexus in a state, these types of taxes can still apply if they sell anything at all in the state. It’s important to always double check if the business you’re doing in a state could involve sales tax or something like franchise taxes.
Adding the burden of multi-state taxation to a payroll team can easily overwhelm it. Before expanding into a new state, consider enlisting help from an HRO or PEO company like LBMC Employment Partners. To learn how LBMC EP can help your company expand, contact us today.