Navigating the Tax Complexities of Interstate Commerce
By John A. Denison, Jr., Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: jdenison@cbh.com

Managing and paying multistate taxes is a complex task for any business, but especially for distribution company owners whose operations and deliveries of goods often traverse the nation. Doing business in other states can result in varying tax consequences, such as incurring higher tax liabilities in some states and producing tax savings in others.

Before expanding your operations into other states, you’ll want to plan for the tax impact on your distribution business. Different states assess different taxes, using various methods and rates. Examples include the following:

• Business income tax based on allocation of sales, in-state facilities a company owns and maintains, activities and offices of sales representatives, and even independent contractors operating on a company’s behalf
• Nonbusiness income tax on rents, dividends and interest
• Franchise tax on a company’s net worth and net income generated from business activities conducted within a state
• Sales tax on goods delivered in the state and sales of related product warranties or services, including drop shipping of merchandise to customers

As you determine your company’s potential tax liability, consider whether you’ll need to adjust your pricing strategies to adequately cover your liability and remain profitable. Operating in certain states may be cost prohibitive.

The Nexus Web
The effect of income tax on your distribution business ultimately depends on the types of connections it develops and maintains with different states — also referred to as nexus.
In effect, states specify the minimum physical presence on which they can justify state income taxes against sellers operating in their respective states. Thus, as a seller, your business must comply with any statutes and regulations for registering with a state and collecting and remitting taxes to the state.

More specifically, the different types of nexus your business can establish and maintain with a given state include:

Business situs. This includes states where you maintain company property (such as offices, wholesale store outlets, storage warehouses and distribution facilities), employ staff or work with other business representatives.

Physical presence. Even without an office or other facilities in a state, temporary presence of your employees, agents or property may subject you to a state’s taxing jurisdiction — for example, the use of company trucks or personnel to deliver products and services into the state.

Commercial domicile. This is the state where your business is headquartered. You’re liable for taxes in your commercial domicile, when applicable, only on the business you conduct in that state and, if state law provides, on all of the nonbusiness income of the company (such as dividends and interest).

Corporate domicile. This is the state in which your company was incorporated or chartered, which may differ from your commercial domicile. You may be liable for all business taxes levied in your corporate domicile.

Economic presence. Even if you have no physical presence, some states may levy taxes based on “economic” benefit or activity, such as on income-generating trademarks your company owns, business transacted through the Internet, or products shipped into the state, even if delivered by common carrier. Ohio’s commercial activities tax is a good example, imposing a low tax rate on “gross receipts” from Ohio sources.

Increased Scrutiny
Be aware that simply qualifying your company to conduct business in a state may trigger tax obligations with that state, so you’ll want to make an informed decision before taking your business across state lines.

Also note that, to boost revenues, state governments are working to increase tax rates and dedicating more resources to collect taxes from businesses engaging in interstate commerce with their states. To this end, states may employ staff to conduct Internet searches and use field auditors to catch noncompliant companies doing business in their states. In particular, states are increasingly looking for any opportunity to tax companies based on economic presence nexus.
If a state determines that your company has failed to properly comply with its registration requirements and proper payment of tax liabilities, your company may be assessed back taxes with costly penalties and interest. Some states also maintain information sharing arrangements with each other by which they both may track down companies evading tax obligations.

Complex Challenges
As you engage in interstate commerce, expect to encounter a range of tax compliance challenges along the way because of the complexity of dealing with different states and their varying statutes and regulations.

States may vary not only in the types of taxes they assess and the tax methods and rates they use, but also in their approach to consolidated tax returns, business tax structures and net operating loss deductions. You can effectively anticipate and plan for these challenges by involving your professional tax advisor early in your business expansion plans.

John is a Tax Partner with CB&H and a member of the Firm’s Private Business Group.