By: Satya Yeruva
Business entities which have operations in more than one state are typically required to file income tax returns in each of those states. Businesses often must report income in each state that they do business. Income allocation depends on certain rules, which vary by state. Work with a trusted tax professional to ensure you remain compliant with multi-state taxation regulations.
Step 1: Determine your Tax Nexus in a state
Businesses must file income tax returns in a state if they have a “nexus,” which means doing qualifying business in a state. Each state has its own rules for what establishes a tax nexus. Some states require a physical presence or employees in order to create a nexus, while others just say that “doing business” in a state creates nexus.
The first step is to analyze whether a business has tax nexus in a state. This determines whether the business is required to file an income tax return in the state or not.
Extension for Certain FBAR Filers
The US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued FinCEN Notice 2019-1 on December 20, 2019. This notice extends the deadline for certain individuals that need to file a Report of Foreign Bank and Financial Accounts (FBAR) for calendar year 2019. These FBAR filers will be granted an automatic extension to April 15, 2021.
The regulations have also simplified requirements for electronic signatures for withholding agents. Withholding agents can now accept an electronically signed withholding certificate by the recipient after verifying additional documentation or information as required. The withholding agent must act in good faith and have no reason to believe that the data provided is incorrect.
Step 2: Revenue Allocation or “Sourcing” Rules
Next, businesses need to split up or allocate their total revenue to each of the states where they have a tax nexus. Every state has its own rules for allocating revenue. Some states have “market-based sourcing,” whereby revenue is allocated to a state if the customer is based in that state.
Other states follow “cost of performance,” where revenue is allocated to the state if the income-generating activity is performed there, irrespective of where the customer is located. Specific rules vary by state.
Businesses must allocate revenue to each state that they operate in, based on that state’s sourcing rules.
Step 3: Apportionment of net Income
Net income is a business’s total revenue minus its total expenses. A business needs to apportion or divide its revenue and expenses for tax purposes to each state where it has a nexus.
Federal net income is divided between states based on the “factors” used in that state. Most US states follow a three-factor formula, which looks at the state’s proportion of the business’s total revenue, payroll expenses, and property. These states take an average of the three factors to determine what percentage of the business’s net income they can tax. Other states use just one or two of the three factors.
Finally, businesses must apportion their net income between states based on the factors that are used in each respective state.
The above rules for multi-state income taxes are general, and each company’s tax obligations will vary. Meet with an experienced Chugh CPA to assess your business’s multi-state income tax return requirements and help you file compliant corporate tax returns.