Expanding your business across multiple states comes with different rules than just being in one place. This is especially true when dealing with taxes and incorporation.
This guide highlights basic questions and answers about these two topics and, along with consulting a professional like an attorney or accountant, can help you navigate each area more smoothly.
First, what is incorporation?
What does incorporating my business actually mean?
Incorporating a business means to turn your idea into a company that is officially recognized in the state you establish it in. When you incorporate, you set up a legal entity separate from yourself. This entity can live and move wherever the owner wants it to.
Currently, no state requires that an owner actually live in the state where they have incorporated their business. However, you must register to do business in the state where your business is located and maintain an address within the state to receive communications.
Where should I incorporate?
One of the most important things to decide when you set up your business is whether to incorporate in the state you are doing business in or in another state. If you primarily do business within one state, incorporating there is often the best decision because it is less expensive.
To incorporate in another state, you will need to qualify to do business as a foreign company in that state. This comes at a cost, namely, annual report fees and taxes from both the qualifying state and the state of incorporation. So even though incorporating in a state with extremely low or no corporate income tax sounds like a terrific advantage, it may not be if you still need to qualify to do business in the state you operate in.
If you are forming a business in multiple states, it is smart to incorporate in the most business-friendly state and foreign qualify in the others. Online businesses usually choose “Tax Haven” states like Nevada or Delaware. It makes sense to incorporate in a state where the taxes are low because a corporation must pay taxes at the rate established by the state they incorporated in.
How can I get help if I need it?
As you make this decision, be sure to do your research and consider all options. To get assistance, visit the state’s website to help you become familiar with the laws and requirements applicable to your business and consult a professional to get their advice and recommendations.
What about taxation?
How do I know if I should charge sales tax?
If you own and operate an online shop that sends products to multiple states, it can be difficult to figure out how to handle sales tax. For orders placed from within or delivered to your own state, you should collect your state’s sales tax. Generally, you only collect sales tax from another state when you have some type of physical presence (like a store or warehouse) in that state. This physical presence is called “nexus.” However, the Supreme Court ruled in 2018 (South Dakota v. Wayfair) that even if a business does not have a physical presence, a state can mandate that they must collect sales taxes if they have more than $100,000 in sales or 200 transactions within the state.
As a business owner, you are responsible for collecting the current sales tax on all transactions that require it. After the taxes are collected, you will need to send them to the appropriate state. Many require monthly sales tax returns.
Why is nexus important?
As mentioned before, “nexus” is a business’s physical presence within a state. When you have nexus in a state, your business must collect taxes from your sales there.
In the past, nexus was usually limited to something like a store, corporate office, or warehouse; basically, it was a permanent physical structure in an actual location. Now, the definition has expanded to include even temporary ways of getting sales (like a rep at a convention in another state).
There are even nexus that target how you get your sales. For example, some states have an affiliate nexus rule. This applies if you’re affiliated with a business and sales are generated from the connection (as in a referral). A click-through nexus is when your company receives sales referred by another business. This often happens when you link out or run ads from another website, which brings potential customers to you.
When you have determined that your business has nexus in a state, you must register for a sales tax permit there. Then, you are obligated to charge sales tax to customers in that state, along with any county or district taxes. Finally, you must file sales tax returns in that state.
Once my business operates in multiple states, how do I get taxed?
If you conduct business across multiple states, you are subject to multistate taxation. The only states that can tax you are those you have nexus in. The general rule for nexus is that you must employ people, own property, or generate sales in a state to have nexus there.
There are smaller ways to trigger nexus too. For example, even if you were only in a state for a few hours but generated sales at a convention, you have nexus there. You have nexus in a state if you have employees that telecommute from there or rent a warehouse to store inventory. Most states will say that soliciting orders from other states does not create nexus, but if it goes further, like the purchase order is signed, that does create it.
When you have nexus in a state, you must pay income taxes on part of your profits. This is sometimes determined by a three-factor apportionment formula, which breaks your income up into thirds and allocates each one based on how it is spread across the states. One chunk is allocated to or split among where the revenue is generated, another to where the company owns property, and the final to where the payroll occurs.
How can I get help if I need it?
Understanding multistate taxation may seem complicated, but there is help available if you need it. A business advisor, business attorney, or accountant can offer guidance and help you keep up with any tax law changes that may affect you.
If you are a small business, check out the U.S. Small Business Administration’s website for a list of recommended local partners that offer business counseling. Here, you can find resources like a SCORE mentor or your local Women’s Business Center, Veteran’s Business Outreach Center, or Small Business Development Center. Often, this counseling is provided free of charge or for a nominal cost. They can also direct you to the appropriate professional for tax or legal advice.