US state tax exposure even without a physical presence
International companies are often surprised to discover that they have significant US state tax liability, even though they have no actual presence in that state.
There is great variety in the activity required before a US state may legally tax a company. It is common for a business activity to create a connection or ‘nexus’ in one state but not in another — even when a company has no physical presence in that state.
There are four ways that states can create nexus without any physical presence:
- Economic nexus — Most states have adopted rules mandating that nexus is created by having a sufficient economic presence in it. For instance, a non-US company that sells a certain dollar amount of products to customers in California, and other states, will have state income and franchise tax nexus by virtue of its sales activity in the state.
- ‘Click-through’ nexus — Broadly, this is the idea that even though a company may not have a physical presence (such as employees or property), the company should be subject to tax because of an in-state affiliate’s online activities. States argue that it is fair to tax companies that sell in a state and benefit from its legal system, while avoiding taxation simply by using an affiliate’s online presence to physically conduct its in-state business. Click-through nexus is generally a response to the rise of internet retailers that sell into a state from outside its borders.
- Traveling sales reps — Some states assert that traveling sales reps can create nexus for sales tax and even income tax. This essentially subjects a company to sales tax if the company has a sales representative traveling to that state, operating on its behalf, and the relationship between the contractor and the company creates an agency relationship.
- Independent contractors — The actions of independent contractors can also create nexus for international companies who hire them. For example, in Texas, hiring a contractor to provide warranty work, repair or installation creates nexus in the state for the company that paid the contractor. The following examples create nexus in some states:
- Collecting delinquent accounts
- Contracting for fulfillment
- Investigating credit worthiness
- Installation, warranty repairs and repossession
State taxation is complicated and diverse. If you’re an international company trading in the US, it’s important to consult a US state and local tax professional to assess any liabilities.
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