H2R CPA Blog

Could Your Remote Employees, Sales or Services Be a Multi-State Tax Liability?

Many growing businesses unknowingly create state filing obligations long before they open an office or hire employees in a new state. Remote workers, online sales, service revenue, and third-party fulfillment providers, as examples, can all create state income tax nexus and unexpected filing requirements.

State Income Tax “Nexus” is the connection between a business and a state that allows the state to impose an income or franchise tax filing obligation. Over the last few decades, states have broadened what counts as a sufficient connection, especially with the shift to e-commerce and remote work. Each state’s rules for determining nexus can vary; however, most states use one of three common standards:

  • Physical Presence
  • Economic Presence
  • Factor (Bright-Line) Presence

Physical Presence Nexus

The traditional nexus standard is physical presence. If your business has people, property, or performs services in the state, you generally will have income tax nexus there. This is the strongest standard and is universally recognized because it is tied to the business’s physical footprint. Activities to look out for when determining nexus using the physical presence standard include:

  • Employees that work in the state, including remote employees working from home
  • Owned or leased property in the state such as offices, warehouses, stores, and equipment
  • Inventory that is stored in the state, including inventory held by third-party logistics providers or fulfillment centers
  • In-state services such as installations, repairs, training, implementation, or warranty services that are performed on-site
  • Agents acting on your behalf – some states treat independent contractor activity similar to employee activity

A simple rule of thumb: if your business has people, property, or performs services in a state, you should evaluate whether a state income tax filing obligation exists.

Economic Presence Nexus

The standard that many states have begun moving to is economic presence nexus. This standard focuses on whether you have meaningful economic activity in the state, which is typically measured by sales that are sourced to that state. This means that you can have nexus in a state even if you have no physical footprint in the state. Many states are adopting this approach as remote selling becomes more common. States can implement the economic presence standard in one of the following ways:

  • Sales-based thresholds: A business is considered to have nexus once in-state receipts exceed a specific threshold. These thresholds vary by state and may be adjusted over time.
  • Substantial economic activity: This is essentially a “catch all” in which states can consider revenue, customer base, or in-state sourcing of receipts.

With economic presence, revenue alone can be enough to create a filing obligation, even without a physical footprint in the state.

Factor (Bright-Line) Presence Nexus

Factor presence nexus is also known as “bright-line” nexus. This approach uses thresholds for the three apportionment factors, property, payroll, and sales, to determine whether an out-of-state business is “doing business” in the state. This standard is very clear – if you exceed any of the thresholds, you have nexus in the state. The Multistate Tax Commission (MTC) adopted a model factor presence standard that many states use as a template. The thresholds in this model are:

  • Property in the state exceeding $50,000
  • Payroll in the state exceeding $50,000
  • Sales/receipts in the state exceeding $500,000
  • Or 25% or more of total property, payroll, or sales are attributable to the state

The model also can be adjusted for inflation, and states that use factor presence often create their own threshold amounts, so each state may have a different threshold for each factor.

Important Considerations Regarding Revenue Sourcing

Market-Based Sourcing

Businesses that provide services or other intangible goods must be aware of Market-Based Sourcing for revenue. This is when revenue is attributed to the state in which the customer is located or receives the benefit of the service, not where the service is performed. If a business provides services to customers located in a certain state and the receipts exceed that state’s revenue threshold, the business will be deemed to have nexus, even if they do not have any physical presence in the state. Industries that are most affected include Software as a Service (SaaS), consulting, digital products, online education, and subscription platforms. These businesses can easily create nexus in multiple states and need to be aware of when their sales are approaching that state’s revenue threshold.

Public Law 86-272

On the other hand, businesses that sell tangible goods must be aware of the protections of Public Law 86-272. This protects sellers of tangible personal property from triggering state income tax nexus, even if their receipts exceed the state’s threshold and would otherwise result in a filing requirement. The law states that a state generally cannot impose a net income tax on an out-of-state seller if the seller’s only in-state activity is the solicitation of orders for tangible personal property, the orders are sent outside the state for approval, and (if approved) the goods are shipped or delivered from outside the state. It is important to note that this protection can be invalidated by common website activities such as chatbots providing post‑sale assistance, accepting returns online, providing online training or troubleshooting, tracking customer usage, offering personalized recommendations, or storing cookies that perform non‑solicitation functions, so it is critical that businesses monitor their website functionality for unprotected activities. A final note on Public Law 86-272 is that it only applies to net income tax and does not apply to sales and use tax, gross receipts tax, and other non-income-based business taxes.

Bottom Line

A few simple questions that businesses can consider when beginning to determine if they have a filing obligation in a state would be:

  • Physical Presence – Do we have a physical footprint in the state?
  • Economic Presence – Do we have meaningful economic activity in the state?
  • Factor Presence – Do we exceed any of the state’s bright-line thresholds?

If the answer is yes to any of these questions, while considering market-based sourcing for service businesses and PL 86-272 for sellers of tangible goods, a study should be conducted to determine if there is a filing requirement.

Reach Out to Learn More

If you need to determine if your business has triggered nexus in a state and whether you may have a new filing requirement, reach out to the Tax Strategy Group at H2R CPA.

Share: