Operating in Multiple States May Have State Tax Implications

KENNETH TORNHEIM, CPA, CFE

Nothing is certain but death and taxes. While this may apply to federal taxes, state taxes are a bit more uncertain. Manufacturers and distributors operating in more than one state may be subject to taxation in multiple states. But with proper planning, you can potentially lower your company’s state tax liability.

What is nexus?

The first question manufacturers should ask when it comes to facing taxation in another state is: Do we have “nexus”? Essentially, this term indicates a business presence in a state that is substantial enough to trigger that state’s tax rules and obligations.

Precisely what activates nexus depends on that state’s chosen criteria. Common triggers include:

• Employing local workers;
• Using a local telephone number;
• Owning property in the state; and
• Marketing products or services in the state.

Depending on state tax laws, nexus could also result from installing equipment, performing services, and providing training or warranty work in a state, either with your own workforce or by hiring others to perform the work on your behalf.

A minimal amount of business activity in a state probably will not create tax liability there. For example, an original equipment manufacturer (OEM) that makes two tech calls a year across state lines will probably not be taxed in that state. As with many tax issues, the totality of facts and circumstances will determine whether you have nexus in a state.

What is market-based sourcing?

If your company licenses intangibles or provides after-market services to customers, you may need to consider market-based sourcing to determine state tax liabilities. Not all states have adopted this model and states that have adopted it may have subtly different rules.

Here is how it generally works: If the benefits of a service occur and will be used in another state, that state will tax the revenue gained from the service. “Service revenue” is generally defined as revenue from intangible assets — not the sales of tangible personal property. Thus, in market-based sourcing states, the destination of a service is the relevant taxation factor rather than the state in which the income-producing activity is performed (also known as the “cost-of-performance” method).

Essentially, these states are looking to claim a percentage of any service revenue arising from residents (customers) within their borders. But there is a trade-off: Market-based sourcing states sacrifice some in-state tax revenue because of lower apportionment figures (Apportionment is a formula-based approach to allocating companies’ taxable revenue.) But these states feel that, even with the loss of some in-state tax revenue, they will see a net gain as their pool of taxable sales increases.

Is it time for a nexus study?

If your company is considering operating in another state, you will need to consider more than logistics and market viability. A nexus study can provide insight into potential out-of-state taxes to which your business activities may expose you. Once all applicable income, sales and use, franchise, and property taxes are factored into your analysis, the effect on profits could be significant.

Bear in mind that the results of a nexus study may not be negative. If you operate primarily in a state with higher taxes, you may find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state by, say, setting up a small office there. Your ORBA tax advisor can help you understand state tax issues and provide a clearer picture of the potential tax impact of your business crossing state lines.

For more information, contact Ken Tornheim at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

American Rescue Plan Act: Employee Retention Credit Extended Through 2021

BRANDON W. VAHL, CPA, CFE

The Employee Retention Credit (ERC) keeps getting better. Established by last year’s CARES Act, the credit is designed as an incentive for businesses to keep employees on the payroll despite the financial impact of the COVID-19 pandemic. Originally, the ERC allowed businesses to claim up to $5,000 per employee for wages paid in 2020. But recent legislation extended the credit through the end of 2021 and increased the maximum credit to $7,000 per quarter or $28,000 per employee for 2021.

Related Read: Make the Most of the Employee Retention Credit

CARES Act creation

The CARES Act provided eligible employers with a fully refundable tax credit against the employer’s share of Social Security payroll taxes equal to 50% of up to $10,000 per employee in qualified wages paid from March 13, 2020 through December 31, 2020.

Employers were eligible for the ERC if either:

• Their operations were fully or partially suspended (See “What Is a Partial Shutdown?”) under a COVID-19-related governmental order; or
• They suffered a significant decline in gross receipts, defined as gross receipts in a 2020 calendar quarter that were less than 50% of gross receipts in the same calendar quarter of 2019.

For businesses with more than 100 employees, qualified wages were limited to wages paid to employees who were not working. However, smaller businesses could claim the credit for all employees regardless of whether they continued to work.

Consolidated Appropriations Act extension

The Consolidated Appropriations Act (CAA), passed last December, extended the ERC to wages paid in the first two quarters of 2021 and increased the available credit from 50% of up to $10,000 in qualified wages for the year to 70% of up to $10,000 in qualified wages per quarter. The law expanded eligibility for the credit by defining a significant decline as gross receipts in a 2021 calendar quarter that are less than 80% of gross receipts in the same calendar quarter of 2019. Employers that did not exist in 2019 may use the corresponding quarter in 2020 to measure their decline in gross receipts in 2021, and certain employers may use the immediately preceding calendar quarter.

The CAA also increased the small business cutoff from 100 to 500 employees. In other words, all businesses with 500 or fewer employees may claim the credit for wages paid to eligible employees, regardless of whether they continue working.

Related Read: Businesses Provided a Lifeline: CAA Enhances PPP Loans and Extends Employee Retention Credit

American Rescue Plan Act updates

In March 2021, the American Rescue Plan Act (ARPA) extended the ERC to qualified wages paid through the end of 2021. Although the credit is now applied against the employer’s share of Medicare rather than Social Security taxes, any excess credit, as before, is fully refundable. So, an employer eligible for the ERC in all four quarters of 2021 can potentially receive credits totaling $28,000 per employee for 2021 (70% × $10,000 × 4).

The ARPA also expanded eligibility for the credit in the third and fourth calendar quarters of 2021 to two types of employers:

1. “Recovery Startup Businesses”
   These are employers that opened their doors after February 15, 2020, have annual gross receipts of $1 million or less, and are not otherwise eligible for the ERC. These employers may claim the credit for the last two quarters of 2021, up to a maximum credit of $50,000 per quarter in the aggregate.
2. “Severely Financially Distressed Employers”
   This includes employers whose gross receipts in a calendar quarter have declined by more than 90% from the same quarter in 2019 (or, in some cases, the same quarter in 2020 or the immediately preceding quarter). These employers may claim the credit for all wages, regardless of whether employees continue working, even if they have more than 500 employees.

Get the credit you deserve

Originally, under the CARES Act, the ERC was not available to businesses that received Paycheck Protection Program (PPP) loans. But the CAA permitted PPP recipients to claim the credit both prospectively and retroactively to March 13, 2020, to the extent it is not based on wages paid with a forgiven PPP loan.

If your business has been affected by the COVID-19 pandemic, you are potentially entitled to tax credits as high as $33,000 in 2020 and 2021 for each employee you kept on the payroll ($5,000 in 2020 plus $7,000 per quarter, or $28,000, in 2021). Your ORBA CPA can help you amend your 2020 returns, if necessary, to claim the correct amount.

What is a partial shutdown?

Employers are eligible for the employee retention credit (ERC) in a calendar quarter if their operations are “fully or partially suspended” during that quarter as a result of a COVID-19-related governmental order. Fully suspended seems straightforward enough, but how do you know whether your operations are partially suspended?

In early guidance, the IRS defined partial suspension to mean that “more than a nominal portion” of an employer’s business operations are suspended. But what does “nominal” mean? IRS Notice 2021-20 provides an answer.

According to the notice, a portion of an employer’s business operations is “more than nominal,” for purposes of the ERC, if either:

• Gross receipts from that portion are at least 10% of total gross receipts; or
• Employee service hours in that portion are at least 10% of total employee service hours.

Both measurements are based on the corresponding 2019 calendar quarter. Although the notice is limited to the 2020 tax year, the IRS will likely apply the same definition of “partially suspended” for 2021.

For more information, contact Brandon Vahl at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.