Determining nexus for multi-state income tax filings for businesses
Establishing “nexus” of a corporation’s business activity determines the state or foreign country which has jurisdiction to impose an income tax or franchise tax measured by net income. For businesses generating revenue in multiple states, or doing activities that generate revenue that originates in another state, nexus is extremely important when determining tax liability.
For example, a consulting business could be based in Michigan, with its employees and owner never leaving the state to conduct their work. However, if the revenue they generate is from a project based in California, then both Michigan and California could jointly claim nexus, and the corporation would be responsible to pay tax in both states. There can be relief from double taxation, however, as Michigan, for instance, allows for a credit
for tax paid to another state on the same income .
Rules vary from state to state as to how to apportion the income or loss to each involved state. The rules also differ depending on the type of revenue being generated, such as from services, tangible products, royalties, rents, etc. For example, some states, like Michigan, determine that service based revenue is sourced to Michigan if more than 50% of the costs of that project are performed in Michigan. This is called “cost of performance” sourcing. Other states, like California, source service based revenue based on where the benefit is received; this is called “market based” sourcing. Additionally, some states will use a payroll and/or property factor in conjunction with the sales factor to determine how much income should be allocated to their state.
Knowing the current sourcing rules is crucial in determining which states a business is responsible for filing a tax return. It is also important to keep abreast of the states rules as they continue to change over time.
For assistance determining the nexus of your businesses revenue for purposes of paying state income or franchise taxes, please contact a ShindelRock tax professional.