Income Tax Obligations for Businesses Filing Sales Tax
Short Summary: If you have sales tax nexus in a state, you might owe income tax in that state as well. But having sales tax nexus does not automatically mean you have an income tax obligation, or nexus. Check with your CPA to determine if you owe income tax in a state.
What are the income tax obligations for businesses already filing sales tax returns? This is one of the most common questions we get from our clients at the end of the year. Does a business need to pay income tax in all of the states where they have a sales tax permit? The answer, unfortunately, depends.
If you’re curious about this same issue, please read on.
The core issue for the business is determining whether or not your business has “nexus.” Nexus is a legal term that means that sufficient contact has been made with a jurisdiction, and that jurisdiction can require you to pay a tax.
Generally, states try to stretch their taxing authority as far as constitutionally possible. In fact, South Dakota overextending their nexus laws led to the groundbreaking Wayfair v. South Dakota Supreme Court Ruling in 2018.
Nexus laws are constantly changing, so it is important that you have a professional team of tax experts you can rely on to stay up-to-date.
The Three Main Types of Nexus
Your business might have nexus for one type of tax, but not for another. Most businesses are concerned with three types of nexus when doing business in states outside of their home state:
- Sales and use tax nexus
- Income and franchise tax nexus
- Nexus for the purposes of registering or qualifying with the Secretary of State’s office
When you are trying to determine if your business has nexus, you first need to determine what kind of nexus you are trying to analyze. The confusion with sales tax and income tax nexus is that they are similar, but not exactly the same.
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Let our team of professionals help you determine where you have nexus, register for permits and file your returns.
Sales and Income Tax Nexus Are Similar, but Not the Same
Now we are getting closer to that original question. What are the income tax obligations for businesses in states where they owe sales tax? When determining if your business has nexus for income tax purposes, you should consult with a professional who understands the intricacies of the states you are involved in. You might have income tax nexus in many of the states where you have sales tax nexus, but you might not. And if you can avoid paying for tax return preparation, then you’re a winner!
Generally speaking, there are two primary ways of having sales tax nexus: having sufficient physical presence in a state, or meeting certain economic nexus thresholds. Sales tax nexus is complex, and we won’t go into all the details here, but what you need to know is that many of the criteria that create sales tax nexus can also create income tax nexus. But just because you have sales tax nexus does not automatically mean you have income tax nexus.
While a physical presence and economic nexus might be the bright-line test for sales tax nexus, it does not determine income tax nexus. In fact, a company can have multiple employees in a state creating a physical presence and yet they don’t have an income tax obligation. That is because of a federal law, Public Law 86-272, that creates a shield from income tax, even where there is a physical presence.
Does Public Law 86-272 Protect Your Business From Income Tax Obligations?
Public Law 86-272 states that “No state… shall have the power to impose (an) income tax… if the only business activities within such states (are) the solicitation of orders … for the sales of tangible personal property, which … are sent outside the state for approval or rejection, and, if approved, are filled by shipment or delivery from outside the state…”
In short, Public Law 86-272 creates a “safe harbor” for some activities with respect to income tax nexus. Basically, a company can have employees busy soliciting sales in the state and not create nexus for income tax.
You should pay special attention to the fact that Public Law 86-272 applies only to net income taxes and the sale of tangible personal property. Public Law 86-272 will not protect you from franchise or other taxes that are not based on income. And if you are selling something that is non-tangible (such as services) then Public Law 86-272 will not protect you. Oh, and make sure you are fulfilling orders outside of the state, or this law won’t protect you.
And to make things a little more confusing, what is not considered “tangible” for sales tax purposes (like software) may not be considered tangible for income tax purposes. So you might sell something that isn’t subject to sales tax, but subject to income tax. Moral of the story? Hire a CPA to give you specific advice on where you have income tax nexus and if Public Law 86-272 applies to your business.
What about economic nexus?
One relatively new trend is for states to take the stance that for income tax purposes, a physical presence is not necessary for nexus. Rather, income tax nexus can be based on directing activities at customers in the state. This is often referred to as economic nexus. But you should know that the thresholds for economic nexus for income tax purposes and for sales tax purposes may be different.
Just because you have economic nexus in a state does not mean you have income tax nexus!
Where Do You Go from Here?
If you’re uncertain on where your business owes income tax you should consult with a CPA. If you are looking for a CPA that specializes in your industry, feel free to contact us and we’ll send you our preferred list of CPA partners who can help.
If you’re interested in having us eliminate the stress of sales tax for you, check out our Done-for-You Sales Tax Service.
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