Multi-State Taxation
By Kenneth H. Bridges, CPA, PFS March 2011
Our business clients often conduct business in multiple states, and our individual clients often work in more than one state, own real estate in multiple states, or have ownership in flow-through entities with income from other states. This article provides a brief overview of the general rules of multi-state taxation.
Individuals – Most states tax their residents on their worldwide income, while permitting them a credit for taxes paid to other states, so long as the effective rate paid to the other state does not exceed the effective rate paid to the state of residence on that same income. To the extent that you work in another state or have income from real estate in another state (e.g. rental income or gain from the sale of property) you may be subjected to that other state’s income tax. Additionally, if you own an interest in an S-corp, LLC or partnership with income from other states, your income from that entity may be subject to other states’ income tax.
Corporations – In addition to being subject to the income tax of their state of domicile, corporations are potentially subject to income tax in any other states with which they have “nexus”. What constitutes taxable nexus varies by state, but companies will almost certainly have taxable nexus with any state in which they own property or maintain an office. Provision of services within a state will typically result in taxable nexus with that state, and licensing of intangibles within a state may also result in taxable nexus. Public Law 86-272 provides a limited safe harbor from state income taxation for companies that sell tangible personal property where the company’s only physical contact with a state is in-state solicitation of orders which must be approved outside the state with shipment to occur from a point outside the state. Assuming a company has taxable nexus with a particular state, its income subject to tax in that state is generally determined by multiplying its overall taxable net income by an “apportionment” percentage. Historically, most states computed the apportionment percentage as the numerical average of three factors – property, payroll, and sales – computing the percentage of each of those factors within the state as compared to the amounts everywhere. In more recent years, many states have begun to move away from equally weighting these three factors to more heavily weighting the sales factor (in some cases using only the sales factor). This methodology tends to reward companies based in the state (who likely have a larger percentage of their property and payroll in the state compared to the percentage of their revenue derived within their home state) and punish companies based outside the state (which may have very little property or payroll within the state, but derive revenue from the state). Georgia is amongst the states to have moved in this direction.
Flow-through entities – Most states recognize the flow-through status of entities like partnerships, LLCs and S-corps. However, the individual owners of these entities are subject to the state’s income tax on income from the entity, and many states require the entity to remit the income tax on behalf of its nonresident owners. Some states permit the entity to file a composite return on behalf of its nonresident owners, enabling the shareholders or partners to avoid the necessity of filing an individual return with the state. Some states also have entity level taxes that can apply.
Sales and use tax – Sales tax rules vary by state, but in general most states subject to the sales tax the sale or rental of tangible personal property. Many states, such as Georgia, exempt from the sales tax the sale of most services. While the tax is technically a tax on the buyer, the seller is generally obligated to collect and remit the tax. Since the tax is based on gross receipts, even an unprofitable company with minimal exposure to income tax can have substantial exposure for sales tax if it fails to properly collect and remit the tax. In addition to the sales tax, a business may also be liable for “use tax”, to the extent that one of its vendors does not collect from it the sales tax on the sale to it of an item subject to the sales tax.
Property tax – In most states, real estate, business tangible personal property and certain personal use assets like automobiles, motorcycles and boats are subject to a tax on the value of the asset.
Payroll tax – If a company has employees providing services within a state (even though the employees may be resident of another state and providing services there only temporarily), then the company likely has an obligation to withhold that state’s income tax and pay its payroll taxes.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.