Tech advances like remote work and e-commerce have enabled businesses to dramatically expand their reach, but they also open them up to unexpected income and sales tax liabilities. For example, a New Jersey-based company that only operates in the Garden State – but has one employee who lives in New York City and works remotely – could suddenly find it’s subject to New York business income and sales and use tax, thanks to nexus issues, or the tax connection between a business and a locality.

For many years, nexus was pretty straightforward, especially when a business had a location or employees permanently present in a state, according to Sarah McGahan, a managing director in KPMG US’s State and Local Tax Group — Washington, D.C., National Tax Practice. “Initially, if a business had a physical presence in a state or city, it was generally subject to sales tax collection and remittance requirements. If it did not have any physical space and its sales to the state were all by mail or common carrier trucks, there was generally no nexus for sales tax. But the June 21, 2018, decision by the U.S. Supreme Court in South Dakota v. Wayfair Inc. overturned the physical presence requirement for sales and use tax nexus and required out-of-state retailers who lacked physical presence in South Dakota to nonetheless collect and remit the state’s sales tax if the retailer had $100,000 in sales or 200 transactions delivered into South Dakota in the preceding year.”

Many states were eager to capture sales tax from merchants related to online sales – it’s a lot easier than going after individual residents for the mirror-image use tax – “and they have since enacted provisions similar to South Dakota’s, where sales tax nexus is imposed on nonresident businesses who meet a specified economic threshold,” McGahan explained. “Generally, a remote seller is obligated to collect and remit New Jersey Sales Tax if the remote seller’s gross revenue from sales of tangible personal property, specified digital products, or taxable services delivered into New Jersey during the current or prior calendar year exceeds $100,000; or if the remote seller sold tangible personal property, specified digital products, or taxable services delivered into New Jersey in 200 or more separate transactions during the current or prior calendar year.”

The tax questions can get even thornier if a remote employee moves out of the U.S., she added. “That can create international nexus issues, which can be even more daunting than stateside ones. So, companies need to get a sense of where people are and how long they plan to remain in the location. It can be particularly challenging if you have ‘nomadic’ employees who live out of a recreational vehicle, for example, and are continually on the move. That’s one of the many reasons that business owners should stay in contact with their CPA and other advisers.”

A New Jersey-based staffing company that supplied personnel to a client in Pennsylvania found out about nexus issues the hard way, according to Pamela Avraham, tax partner at Edison-based Urbach & Avraham CPAs. For several years, “The staffing company’s previous accounting firm never told the staffing company that its activity established sales tax nexus with Pennsylvania,” she said. “The state [Pennsylvania] uncovered the activity during an audit and went back a number of years and levied a few hundred thousand dollars of back sales taxes and penalties even though the staffing company had no physical location in Pennsylvania. There are many ways that nexus can be established, so business owners should be sure to keep their accountants and other advisers in the loop about all of their activities.”

Another trap can be sprung when an individual is a member of a partnership that owns real estate in multiple jurisdictions, she added. “Many of our clients are partners in businesses that own real property in more than 15 states, so we have to keep current with the filing requirements for each jurisdiction. It can get pretty complicated, especially since partnerships doing business or owning real estate in other states should consider filing to all states even if there is a loss from the partnership in those states. A partner must file to ensure that his or her loss will be carried forward to subsequent years, when the partner either has income or sells the property at a gain. The carried forward losses will then generally be available to offset the income and/or gain.”

Further, in today’s new remote-working environment, “companies should be aware that if an employee works in another state remotely, the company must file payroll tax returns to that state, and pay unemployment and workers compensation,” she explained. “Companies doing business in other states should verify all taxes at all levels, since several cities and many townships have their own taxes, such as personal property tax, township gross revenue taxes, and city payroll taxes.”

Filing requirements may be based on gross revenues, not net income, so nexus violations can lead to a number of unpleasant consequences. “In some cases, the fact that a company is doing business in another state may trigger a requirement for the company to register with the local secretary of state and potentially pay a minimum annual tax or other fee,” according to Avraham. “A company may avoid detection for a while, but if it ever sues a local client for something, like nonpayment of an invoice, the out-of-state business may find that it does not have standing to bring suit since it never completed the proper registration. It’s like being penny-wise and pound-foolish.”

A variety of circumstances can trigger nexus issues, “and they are not always readily apparent,” warned Levine, Jacobs & Co. LLC member Michael Karu. “Generally, nexus depends on a business’ physical presence in a city or state. So, if a New Jersey business opens an office in New York City, the company now has nexus in New York City and state and may be required to file certain tax returns.”

One of Karu’s New Jersey-based clients has employees working remotely from a dozen states, “and the business has to file income tax returns in each one, even if no tax is due. In a case like this, an income tax filing is generally necessary if sales are generated in the same state in which a remote employee lives and works. This issue exploded during the COVID-19 pandemic, when remote work arrangements suddenly became commonplace. The exact amount of income tax due to nexus is usually, but not always, based on an apportionment of the company’s total sales divided by sales made in that particular state; and local corporate income taxes may also be due.”

There was a time when multistate nexus issues were mainly confined to large companies — but today, when even the smallest of businesses typically engage in e-commerce activity and have employees who work remotely, “The need to consult with your CPA or other advisor is even more imperative,” according to Yahaira Mendez, a partner at PKF O’Connor Davies (PKFOD), LLP. “Depending on the circumstances, a business could have nexus exposure for corporate income tax, sales tax or both.”

She recently represented a client – which has about 20 to 30 employees scattered across the U.S. and currently leases one conference room in a shared-office space building in New York – in a city tax audit. “Even though the business has a New York City address as its headquarters, it really has a very limited physical presence there,” she said. “The client has a few employees who live in the city. The city auditor needed to determine which employees work from the New York City office or their home in the city to ensure that the correct revenue was being sourced to New York City.”

Jill Cantor, senior manager in PKFOD’s State and Local Tax Practice, noted that even if a company has no physical presence at all in a particular state, the business may be deemed to have nexus – and is therefore required to file sales tax returns – if its sales revenue and/or volume of transactions pass certain thresholds, which vary by state.

She added that, “For income tax, almost one-third of the states apply ‘bright line,’ or specific factor thresholds for nexus. Further, although no specific thresholds exist, the very act of earning income in the state and developing a market in the state may trigger nexus. So, the process of determining where a business has nexus and is required to file is complicated. A detailed sales and income tax nexus analysis may be required to determine a company’s potential exposure.”

Added Mendez, “States are increasingly eager to boost their revenue, so we’re seeing more and more sales tax and income tax audits. Federal and state authorities are also taking a closer look at the way companies classify independent contractors. The concern is that, in some cases, they are really employees and the business may be misclassifying them as independent contractors to avoid paying benefits and employer payroll taxes. In some cases, taxpayers may not be aware of the classification guidelines, and that’s why it’s more important than ever for business owners to talk to their tax advisers.”

In some cases, PKFOD may take on a new client that did not realize it had filing requirements for one or more states and, after doing an analysis, the CPAs may determine that its nexus exposure stretches across multiple years. “If they suddenly begin filing now, the business could be red-flagged by the state and the auditors could assess tax liability, plus interest and penalties for many years in the past,” warned Cantor.

“In this situation, where the state has not previously contacted them for an audit, we would suggest that we perform a review to determine their tax exposure for past years. Then, if our client agrees, we would contact the state – without revealing the client’s identity – and if available, participate in the state’s Voluntary Disclosure Agreement program,” she said.

“This way, we offer to disclose the tax liability and later remit payment if the state, in turn, agrees to limit its audit to certain number of years – usually a three or four year ‘lookback,’ although this varies by state – and agrees to waive any penalties. This is a ‘win-win’ for the taxpayer and the state, as the taxpayer comes clean while reducing its overall exposure, and the state collects some tax revenue that it was not aware existed.”