Multistate Taxation: Avoiding Costs and Hassles

Last week’s blog post talked about how multistate taxation works and got into some of the nitty gritty details of nexus, public law 86-272 and then the typical multistate apportionment formulas.

For purposes of this blog post, I’m going to assume that you’ve either read that post or know about this stuff.

What we’re going to do here is talk about the simple ways a small business can avoid the costs and hassles of paying taxes and filing tax returns in a bunch of different states. I’ve got seven tips for you.

Multistate Taxation Tip #1: No Telecommuting Employees

Let me give you the easiest, more powerful tip to use first: Don’t hire people who work out of state.

If you don’t employ people in other states, you’ll probably sidestep both income and excise taxes in other states.

Furthermore, you will also greatly simplify your payroll processing and state unemployment and disability insurance stuff.

Hiring a bunch of people in a bunch of different states—when you really don’t need to—is the easiest “big” mistake you want to avoid.

By the way? If you’ve allowed your employees to set up camp in a bunch of different states? You’re not alone. Lots of small businesses end up doing this before they realize that this is a mistake.

Multistate Taxation Tip #2: No Accidental Ownership of Property

While we’re on the subject of tripwires that cause nexus, let me also point out that you don’t want your business to own property (or to rent property) in other states unless you really really need that property in that other state.

By the way, if you’ve already got people and property scattered over a bunch of states, you can work to corral these people and the property into your home state or into a smaller set of states over time. If some year you don’t have payroll or property in state, you probably won’t have nexus.

Note: You can’t avoid nexus in your home state where you operate. So you’re not adding a state tax return or incurring additional state taxes by moving people or property to your state.

Multistate Taxation Tip #3: Use Public Law 86-272

If you’re selling tangible property in other states, you want to be sure that your activities and any payroll in those other states is protected by public law 86-272.

As I noted in last week’s blog post, if someone (you or an employee) only solicits for orders to sell tangible personal property, that protects you from income taxes in that state. So, if you have some employee who works half time on this “mere solicitation” and then half time doing accounting, what you should consider doing is moving that accounting work onto somewhere else’s plate who works in your home state.

Multistate Taxation Tip #4: Work the Apportionment Formulas

If your operation produces the same multistate footprint year after year, you may want to think about rearranging your business’s operations so that the states’ various apportionment formulas produce a different, lower result.

If you operate in states that weight payroll and property, for example, you could work to stick all of your payroll and property into the state with the lowest tax rate. Or if you can’t stick all of your property and property into the state with the lowest tax rate, you can try sticking more of your payroll and property there.

Multistate Taxation Tip #5: Consider Low-Tax and Zero-Tax States

Related to the tip about working the apportionment formula, you ought to at least consider the option of intentionally moving your residency and your firm’s base to a low-tax or a no-income tax state.

But keep in mind—and sorry if this is obvious—that all states are going to tax businesses in one way if not another. Washington state, for example, doesn’t levy income taxes on businesses or individuals. But Washington State does hit businesses with an excise tax that runs roughly between .5% and 1.5% of revenue.

Dumping a state with a high income tax rate and moving someplace like Washington State might make sense for some firms to consider… and other firms would only see their state tax burden rise.

Note: Washington State service businesses pay the 1.5% state excise tax. Most other businesses pay around a .5% state excise tax on revenues.

Multistate Taxation Tip #6: Exit Low Profit High Cost States

This is a little negative, but let me just say here that some states (surely intentionally) make it nearly impossible for out-of-state small businesses to profitably operate within their borders.

If you encounter a situation like this, make sure the optimal solution isn’t simply to leave the state and cede any prospective customers and clients residing there to local firms.

Multistate Taxation Tip #7: Do Proactively Comply with State Tax Laws

A final tip: You really do want to proactively comply with any state tax laws especially if you’ve got more than a minimal presence, are particularly visible, or have any excise tax liability. (Sales tax is an example of an excise tax.)

The state of limitations doesn’t begin to toll (or run out) until after you file your tax returns. Accordingly, if you never file tax returns in some state in which you’ve got nexus, you’re leaving yourself with a ticking time bomb.