Nexus Requires Compliance and Begins by Filing Tax Returns

“Nexus” is a fancy Latin word that refers to the relationship of a taxing jurisdiction that enables it to subject your business to taxation. In addition to your business’s home state and city, other states and local jurisdictions where you conduct business can have nexus.

In the past, nexus was determined by a physical presence such as a branch office or construction location, but e-commerce has extended the definition of nexus. Nexus requires a business to file returns for sales tax and for income or franchise taxes. If you don’t file, your company may be liable for past due taxes, penalties and interest.

Sales Tax Nexus

The laws regarding a state’s right to impose sales tax can be very complex, often with different states imposing different thresholds for what can create tax in each. If you have an employee in a new state or buy some machinery there, that alone can subject you to sales tax. Although these activities may mandate a contractor to file sales tax returns in that jurisdiction, that does not mean the company will owe taxes there. So, it is imperative that you are aware of the administrative burdens of entering new jurisdictions, as non-compliance can be costly. The same state can also have different standards for different taxes, such as income and sales tax.

As a construction business owner, you generally collect sales tax on the total charge to the customer for any repair, maintenance and installation services provided. You hold that money until you file your sales tax return and remit the proper amount to the taxing authority. If taxes are not collected and paid, your business will be liable and could face penalties and interest. Many businesses go bankrupt due to their failure to collect and remit sales taxes.

Income/Franchise Tax

You already file income/franchise tax returns in the state and jurisdiction where your company is based. However, if you have locations in other states, such as an office or warehouse, or employees traveling into another state or generating meaningful sales there, you may need to file tax returns there as well.

It’s critical to stay up to date on filing income/franchise tax returns in all appropriate jurisdictions. If your business ever has to bring a lawsuit in that state, your company must be qualified to do business there as a foreign corporation and filing tax returns supports this qualification. Most states require minimal paperwork and often a certificate of good standing from your home state to register to do business in another state. Your attorney can help you with filings and compliance issues.

When doing business in multiple states, it is imperative to know how each state computes and allocates its overall net income and, subsequently, how that net income is taxed. If you generated $1M of income in a year, but half your sales are attributable to State A and the other half are attributable to State B, does that mean you are taxed on $500k in each state? Potentially, each state has different rules for computing and allocating income. You may need to track revenue on a job-by-job, state-by-state basis and track the equipment and labor employed in each. How to do this depends on how each state allocates their income and whether they factor in sales, wages and/or property employed in and out of the state.

Voluntary Disclosure Programs

If you find that your construction business has not been paying sales or income/franchise taxes properly, you will likely be liable for back taxes, penalties and interest in each state and/or jurisdiction. A positive note is that the statute of limitations is set at three years after filing, after which the taxing authority can’t audit your return.

If you realize after the fact that you should have filed in a tax jurisdiction but did not talk to your tax consultant about filing an amended return, you may also be liable for back taxes, penalties and interest. However, many states and taxing jurisdictions have “voluntary disclosure” programs that encourage businesses to catch up by filing outstanding or amended returns. In many cases, penalties are waived, and payment terms can be very favorable. Keep in mind that it is better to voluntarily come forward than to be found out by the taxing authority. If you have any questions about nexus and what it may mean for your business, please contact us.

Contributing Author: Shawn T. Layo, CPA, is a tax partner at Dannible & McKee, LLP with over 24 years of experience in taxation and planning for individuals and closely-held companies. He is responsible for overseeing tax engagements for a variety of clientele with a focus on construction, architectural and engineering, multi-state corporations and high-net-worth individuals. For more information on this topic, you may contact Shawn at slayo@dmcpas.com or (315) 472-9127.