BDO Indirect Tax News

United States - State and local tax considerations beyond sales tax: A guide for inbound businesses

The U.S. consists of 50 states and numerous local tax jurisdictions, each with its own unique set of rules and regulations. For organisations operating in the U.S., state and local taxes typically make up the majority of their overall tax burden. While most inbound companies should be aware of the economic nexus rules for sales tax following the 2018 U.S. Supreme Court decision in the Wayfair case, many are still unfamiliar with other state and local taxes and reporting requirements. As a result, inbound companies may unknowingly incur tax liabilities, leading to penalties and interest for noncompliance. This article lists key state and local tax obligations generally applicable to inbound companies and highlights the importance of regularly reviewing and analysing activities to ensure compliance.
Sales taxes
Sales and use tax regimes are operated independently by each of the 45 states and the District of Columbia that have such regimes. Some states also have local sales and use taxes that are administered by local municipalities and counties (e.g., Colorado and Louisiana).

The criteria for establishing nexus vary by state, but one common way is through physical presence, such as owning or leasing property (e.g., office space, warehouses, fulfilment centres), having company-owned property located in the state (e.g., inventory, machinery), employing people (e.g., including employees, agents, affiliates or independent contractors) or providing services at customer locations.

Alternatively, a business can establish economic nexus with a state if it exceeds a sales volume or transaction threshold. This means having sales of tangible personal property, electronically transferred products or services that exceed a specified dollar amount (usually around USD 100,000) or a certain number of separate transactions (usually 200 or more). Some states use either the volume-of-sales or the number-of-transactions test, others only require that the volume of sales exceeds a specific threshold, and two states—Connecticut and New York—require that both volume of sales and transactions tests are met. Some states have higher thresholds, such as California and Texas, with a USD 500,000 volume-of-sales threshold, or Alabama and Mississippi with a USD 250,000 threshold. It is important to note that many states only include taxable sales in determining economic nexus, so businesses need to determine if their sales are subject to tax in a state before assessing nexus and filing requirements.

It is a common misconception among inbound companies that their nexus in a state was only established after the Wayfair decision. However, if a company utilised a third-party logistics provider, a marketplace with a fulfilment model where the company retains title to the inventory or a similar distribution network, physical nexus with the state likely was present before the company's economic nexus with the state.

Inbound sellers making sales through marketplace platforms should understand their nexus and collection obligations. Marketplaces are typically only required to collect and remit sales tax on transactions that take place through their platform. However, if inbound companies have established nexus in a particular state and make sales through both a marketplace and their own online storefront, they have the responsibility to withhold and remit sales tax on the sales made through their own storefront. It is important to note that inbound companies that qualify as marketplace facilitators need to determine their nexus and collection obligations under marketplace facilitators laws, which are now applicable in all states where sales tax is imposed.  

Each state has its own set of taxable transactions based on specific statutes, regulations and administrative guidance. States often update their definitions of taxable sales and may expand them to include a broader range of transactions. For example, many states have enacted new laws or revised interpretations of existing law to include digital products and software products and services.

Inbound companies should analyse nexus-creating activities, as well as perform a taxability analysis, to determine whether their products or services may be subject to sales tax in states where they operate.
Use taxes
Purchases made over the internet, through toll-free numbers, mail-order catalogues or from out-of-state locations may be subject to use tax if sales tax was not paid at the time of purchase. For example, if a product is purchased in a state without sales tax and then brought for use in a state with sales tax, it will be subject to use tax. Similarly, if a product is purchased in a state with a lower tax rate than the state where it is used, use tax should be paid on the difference in rates.

Use tax also applies when property is initially purchased for resale but is later consumed or used within the business. Inbound companies may have use tax liabilities when providing free samples and giveaways from their inventory.

To ensure compliance with use tax, inbound companies should have a system in place to review their purchases and ensure sales tax compliance, where applicable. If sales tax was not charged on a taxable product, the company should self-accrue and remit use tax in a timely manner.
Income taxes
A business must comply with state taxes based on income (some states may also refer to these taxes as franchise or excise taxes) in all jurisdictions where it has enough minimum contact to establish nexus.

Similar to sales tax, income tax nexus may be created through physical activities described above and where the company’s sales exceed factor-based or bright-line economic nexus standards or have an apportionable factor. In addition, some states assert corporate income tax nexus when a corporation has a “substantial economic presence” or “significant economic presence,” and others assert nexus to the “fullest extent of the U.S. Constitution.” Economic thresholds for income tax purposes may vary from a state’s sales tax economic nexus provisions. For instance, to establish the presumption of economic nexus with Pennsylvania for corporate net income tax, a corporation must have receipts sourced to the state totalling over USD 500,000 but for sales tax purposes, the threshold is significantly lower at USD 100,000.

The threshold to establish nexus for state tax purposes is generally lower than what it takes to establish a permanent establishment for federal income tax purposes. Thus, a business may be subject to state income tax in states in which it has nexus without having a permanent establishment for U.S. federal income tax purposes.

The U.S. has concluded income tax treaties with numerous countries, which address the issue of double taxation on income generated from cross-border transactions and promote foreign investment. However, states are not bound by federal income tax treaties and may subject effectively connected income (ECI) to tax. The determination of whether a state follows U.S. income tax treaty protection, how ECI or state taxable income is determined, filing methodologies (e.g., separate entity or unitary combined group) and reporting methodologies (e.g., water’s edge or worldwide) varies by state.

Inbound companies should consider whether their activities may be protected under a federal law that limits states from imposing a tax on a company's net income if the only business activity within the state is the solicitation of orders for sales of tangible personal property, which are then shipped or delivered from outside the state (Public Law (P.L.) 86-272. However, P.L. 86-272 does not protect against taxes based on gross receipts, net worth or indirect sales and use taxes imposed by states.

Inbound companies should regularly analyse where their activities establish nexus and how to comply with income tax obligations, which vary from state to state.
Net worth taxes
Several states impose capital stock taxes or franchise taxes, which are often reported on the same return as the state's income tax. Unlike income taxes, which are based on a business's net income, net worth taxes are based on a business's net worth. Generally, net worth is calculated using the business's net assets, although the specific formula or methodology for determining net worth varies from state to state. It is important to note that because net worth taxes are not based on net income, the protections afforded under P.L. 86-272 generally will not apply.

In general, net worth taxes are imposed at much lower rates than income taxes, typically ranging from 0.02% to 0.3% of the business's net worth. Additionally, certain states that levy a net worth tax, such as Georgia and New York, have a statutory cap on the maximum net worth tax liability that can be imposed each year.
Gross receipts taxes
Several states—such as Ohio, Oregon, Texas and Washington—enacted taxes that are measured by gross receipts or modified gross receipts in lieu of or in addition to state income taxes. For instance, Oregon introduced the Corporate Activity Tax (CAT) effective for tax years on or after 1 January 2020 for the privilege of doing business in the state. If the Oregon commercial activities of a business or unitary group are USD 750,000 or above, the business must register for the CAT and may be subject to tax if its activity exceeds USD 1 million. Oregon CAT may apply in addition to Oregon corporate excise or income tax measured by net income.

While Texas does not have an income tax, the state imposes a franchise tax that is based on a taxable entity’s margin. In general, the margin of a taxable entity is its total revenue subject to state statutory exclusions modified by one of four ways: (1) total revenue times 70 percent; (2) total revenue minus cost of goods sold; (3) total revenue minus compensation; or total revenue minus USD 1 million.

The protections afforded under P.L. 86-272 do not apply to gross-receipts taxes.

Inbound companies should track their physical and economic activities in the states that impose gross receipts-based taxes to ensure compliance.
Local taxes
In addition to state taxes based on income, gross receipts and/or net worth, certain states have local jurisdictions that require the filing of a gross receipts or income-based tax return (e.g., California local business taxes, New York City, Philadelphia Business Income and Receipts Tax, Pennsylvania Business Privilege Taxes, Virginia Business Privilege and Occupational License Taxes (BPOL), Washington local B&O taxes, West Virginia B&O, etc.) if there is nexus with the jurisdiction. The tax base and rates may vary based on the taxpayer’s business activity. To the extent local taxes are based on gross receipts or net worth, protections afforded under P.L. 86-272 may not apply.

Inbound companies should review whether states where they have operations empower local jurisdictions to impose local taxes, as these may be easily overlooked.
Employment taxes
States that have a personal income tax mandate employers to deduct taxes from the wages of employees who work within the state. Companies that fail to monitor the travel of their sales team or other employees outside their home state may face potential liabilities for payroll taxes and unemployment insurance. In certain cases, an employer may be required to withhold taxes in every state where their employees work, even if it is for a single day (e.g., Michigan) or if a specific threshold of in-state compensation is met (South Carolina, at USD 800).

Inbound companies with employees in the U.S. should consider monitoring travel of their employees outside the home state to ensure compliance with payroll laws.
Property tax
All states tax real property and approximately 38 states tax personal property. Real estate taxes on commercial real property are generally levied on the estimated value of the property assessed by state and local governments. Inbound companies that lease real property, such as an office or a warehouse, may be responsible for real property taxes under the lease agreements. In addition to this, certain jurisdictions, such as Florida, New York City and Philadelphia, impose commercial occupancy or rent taxes on leased property.

Personal property taxes are imposed by state or local governments on certain income- producing tangible personal property used in business, such as vehicles, equipment, furniture and business supplies. In 13 states where personal property tax is imposed on inventory, there is usually a freeport exemption, which exempts businesses from paying the tax if their inventory is shipped to an out-of-state destination within a specific timeframe.

Inbound companies that own or lease real property and have income-producing assets in the U.S. should review and assess their property tax obligations.
Unclaimed property
All 50 states and the District of Columbia have laws regarding unclaimed property, which require companies to report and remit various types of property that have been unclaimed or dormant for a defined period. Unclaimed property can include both intangible and tangible assets, depending on the laws of each state. Examples of common unclaimed property types are uncashed payroll or commission checks, unused vendor checks, unresolved voids, unredeemed gift certificates and gift cards, customer credits, layaways, deposits, refunds, and rebates, overpayments, unidentified remittances and accounts receivable credits, including those that have been written off and recorded as income or expense (such as bad debt or miscellaneous income). The periods of dormancy vary by the type of property and range from one to 15 years.  

Reporting unclaimed property ensures that it can be returned to its rightful owner. The jurisdiction for unclaimed property is determined by the state where the owner's address is located. In cases where the owner's address is unknown, for an inbound company, this is often the state where its U.S. subsidiary is incorporated or formed.

Lack of procedures to determine when sufficient time has passed to trigger the requirements to timely remit unclaimed property to the state results in exposure. Audits are now common across all industries and businesses of all sizes, and they can cover a period of 15 years or more. These audits are typically conducted by third-party firms that work on a contingency fee basis and have a multistate scope.
State and local credits and incentives
Companies that are investing in the U.S. and making substantial capital investments, creating jobs or support desired business activities may be eligible for a range of incentives at the state and local levels. States often target tax credits toward desirable industries or activities they wish to develop, such as manufacturing or R&D, or promote growth in underdeveloped areas with programs such as the enterprise zones. These incentives can include tax credits, abatements, cash grants, land grants, low-interest loans and other benefits.

To take advantage of these incentives, it is crucial for companies to develop a well-defined strategy to identify and secure them. By doing so, companies can reduce both upfront and ongoing operational costs associated with their investments in the U.S. and help strengthen the company's relationship with the local community in which it operates.

Angela Acosta
Ilya Lipin
BDO in United States