In the United States, we are free to pack up and move ourselves and our families to any state in the union and no one questions us or even our motives. Sometimes people move because of climate – warmer, colder, dryer. Sometimes people move because of income taxes. Some states have income taxes, some do not. Some have high sales taxes; others have no sales tax. Since the pandemic, many employees stopped commuting to the office and started working from home. Then, it occurred to many people that home can be anywhere they want if they do not need to commute to work. So, they moved.
All of a sudden, employers in the United States – including MSPs – now find they have employees in other states. They are also finding that they have new rules to follow as a result of those remote employees in other states. Instead of knowing and complying with one set of laws for their state, they are juggling multiple states’ laws without ever having considered starting a satellite office in that state to navigate interstate commerce.
They are also finding that they have new rules to follow as a result of those remote employees in other states.
What I am about to describe in detail is uniquely an American problem. Our international friends have tax rules much simpler than ours. VAT and Harmony taxes are simple. You pay taxes on purchases. You collect taxes on sales. There’s a difference between the two amounts. Send it in. The rate is uniform throughout each country or province.
The United States is blanketed with multiple taxing jurisdictions, each one having its own rules and its own rates. How is a business owner supposed to keep up with all the rules in their own jurisdiction, let alone multiple jurisdictions?
What is Nexus?
Nexus is defined simply as:
noun: a connection or series of connections linking two or more things.
If you think of Nexus as it “Connects Us.” Con-nex-us. Drop the Con. Nexus
If you have a connection to another taxing jurisdiction, then you may be required to collect and remit taxes to them.
The landmark case of South Dakota v. Wayfair redefined what constitutes Nexus and opened the doors for states to begin making up their own rules. As a natural result, there is no shared definition of nexus across all 50 states. However, most states can agree on a few basic principles:
1. Physical Presence – Occupying, using, or maintaining a presence in the jurisdiction
2. Worker- Employee, representative, agent, salesperson, etc.
3. Sales volume – Gross sales of taxable items or number of transactions meet a state minimum, usually $100,000 in annual sales or 200 transactions in one year.
The Court eliminated physical presence as the standard rule for creating Nexus in a jurisdiction. It is one of the factors, and the first one considered, but not the only factor. In addition to the above basic principles, there are additional factors that can affect Nexus. These are known as Economic Nexus and generally follow the sales volume thresholds noted above, although the amounts vary by state.
>> Click-through Nexus – Seller makes commission payments to an in-state resident for orders arising from a click-through referral on the resident’s website. This does not include banner ads and must meet a minimum sales threshold.
>> Affiliate Nexus – Holding an interest in or owning an in-state retailer that sells a similar product line.
>> Marketplace Nexus- Online retailers operate their business in a state and provide e-commerce, customer service, payment processing, and marketing.
>> Economic Nexus – Sales volume meeting the threshold.
There are 45 states plus Washington, DC that require the collection and remittance of sales and use tax. States not participating in sales and use tax are: Alaska, Delaware, Montana, New Hampshire, and Oregon. However, most of those states have other taxes such as income tax and payroll tax. If you have Nexus for one type of tax, you have Nexus for all taxes in that jurisdiction.
If you have Nexus for one type of tax, you have Nexus for all taxes in that jurisdiction.
I recall an MSP client located in Delaware. They hired independent workers around the country to perform IT services remotely based on tickets received in their PSA. One worker was not incorporated and working independently in California. The Delaware company dutifully prepared a 1099-NEC for the worker and was contacted by the Franchise Tax Board to file annual reports and pay the annual business license fee of $800 per year and file an annual tax return to report California income earned. By hiring that remote worker, any customer inside the State of California that opened a ticket, whether worked by the California worker or not, was now California earned revenue and taxable. This is how Nexus works.
Where MSPs should start
Once Nexus is established in a state, county, or local jurisdiction, your MSP is subject to all taxes and licensing requirements. If this is a new state for your company, the place to start is to register your company as a foreign company with the Secretary of State Corporation Bureau. This filing is required in all 50 states and authorizes you to transact business in that state.
Filing is required in all 50 states and authorizes you to transact business in that state.
Other registrations required may include:
>> Department of Revenue to collect and remit sales and use taxes
>> Employer tax registration for withholding tax if you have an employee in the state
>> Also, unemployment taxes, disability taxes, and worker’s compensation insurance
Be sure to file all required returns when due. Contact your accountant for help with this. Also, consider separating your income to include all sales within that state for easy annual tax reporting. You will be required to file an annual tax return with the states where you transact business, and your accountant will need an easy way to allocate the revenue between them.
Sales tax audits
It should come as no surprise that states are actively looking for additional revenue since the pandemic. Many states have stepped up their auditing efforts and are targeting specific industries for sales and use tax audits. In the past two years, I have represented businesses in five sales tax audits. Each one was chosen for failing to report any use tax purchases in the prior three years. The likelihood that you purchased items for use in your business and paid sales tax on each item is slim. This is a common audit trigger.
IT companies can be audit targets
IT companies are especially targeted for two reasons.
First, MSPs buy high-ticket technology items and have resale certificates on file with the vendors supplying them. Chances are better than average that you did not pay sales tax on your internal purchases.
The second reason IT firms are targeted is the SaaS v. software sales v. support argument. Is the resale of Microsoft 365 products the sale of a product or the delivery of a service? Does a license count as software? The answers will vary state-by-state and auditor-by-auditor. By monitoring a computer using RMM, are you supporting the hardware? Are you supporting the software on that computer? What is included in your managed services bundle? If one thing in your bundle is taxable, the whole bundle is taxable.
What is included in your managed services bundle? If one thing in your bundle is taxable, the whole bundle is taxable.
Sales tax auditors are targeting remote sellers and online retailers for Nexus. They are also auditing credit card purchases, Amazon purchases, and PayPal activity. You will need to show proof that you paid sales tax on all of those purchases. Without proof, all purchases are deemed to not include sales tax and will be assessed accordingly in the audit. Keep your receipts.
You can start now to protect yourself against a future audit with a few simple tasks:
1. Perform a Nexus study
2. Determine tax liability on your products & services
3. Match your sales tax revenue to your P&L and tax returns
4. Look for voluntary disclosure amnesty programs
5. Contact the state for determination on products & services
– This is called a Private Letter Ruling
6. Keep purchase receipts for three years
– Attach copies to transactions in your accounting system
7. Maintain current and accurate resale & exemption certificates
If you are audited for Nexus
If your MSP is selected for an audit, do not go in alone. Have your accountant represent you at all times and minimize direct contact with the auditor. The auditor will use a “sample period” for purchases and will assume it is a normal month. Look for large or unique transactions and ask the auditor to treat that item separately from the sample. Always request abatement of penalties.
There are two great websites with a wealth of information and resources on this topic.
You can try to avoid interstate commerce in your business for a little while, but eventually, the topic will come up. Be prepared and informed and take the steps you need to comply. But don’t wait until they ask.
Tell us your thoughts at the Modern MSP Facebook Group.
ABOUT THE AUTHOR
Rayanne Buchianico provides MSP accounting and PSA Consulting services to IT Professionals and is the owner of ABC Solutions, LLC. Rayanne is a member of the ModernMSP community and a frequent contributor to the ModernMSP blog in addition to her own podcast, PSA Impact.