nash_100In the context of business taxation, “Nexus is a term which describes a level of activity, connection, or “ties” to a state or locality, which would cause an entity to be subject to taxation by that state or locality.

One need only look at a current newspaper, magazine, or watch the evening news to realize the states are hurting for revenue. The recession and high unemployment of recent years has taken its toll on most state coffers and the states are looking for sources of revenue to refresh them. As a result, states are taking a hard look at business taxes.

Audits of businesses by state taxing agencies are up, and many states are hiring additional auditors and designing sophisticated computer programs to target specific potential non-compliance areas. If your business hasn’t been audited by a state agency recently for some type of business tax, it likely will be in the future.  We have seen a significant increase in sales, use, and income tax audits.

Generally if your business has a “physical presence” in a state, you will have established nexus and are likely subject to income tax in that state.  Physical presence can come from the obvious such as having employees, contractors, subcontractors, or sales personnel in a state or renting property.  However, physical presence can also come from the not-so-obvious such as warranty and repair services, or it can be attributed to your business from the activities of a related entity such as a parent company or holding company.

Due to changes in how businesses operate in what is now a global marketplace, many states are moving towards an “economic nexus” standard rather than the traditional “physical presence” standard.  This standard has been aimed at businesses that earn income in a state and enjoy benefits from doing business there such as income received from licensing a trademark, making loans, issuing credit cards, etc.  Some states are also moving away from a traditional state income tax and getting their state revenues by adopting a gross receipts tax or a net worth tax.

Why should you care? State and local tax laws are complex and continually evolving and because of the significant dollars involved, quite frequently state tax issues are resolved through the courts.  An audit can take months (and in some cases years) from the time you get the audit notice to when the audit is closed.  During the audit period you can expect to have your business records closely scrutinized by the auditor and you will likely need the services of a good CPA to get you through the process.  If you have your “ducks in a row” so to speak before you ever get an audit letter you can reduce the amount of penalties and interest assessed.  And remember, when a tax return was required, but never filed, the statute typically never starts running and therefore never closes.  This means you can be subject to audit for many past years.

What should you do? Talk to your tax adviser about your business activities and try to identify the states for which you have a filing requirement.  States frequently send out nexus questionnaires; if you receive one of these questionnaires, NEVER complete and return it without first discussing it with your tax adviser.  Many times states will send these out phishing for information about your business and one wrong answer can really get a state coming after you for taxes for which you may not even be liable for.  Be courteous and prompt with state auditors.  Having closed two state tax audits for clients this week, I can tell you a little courtesy can go a long way in building goodwill with an auditor.