Small Business Taxes & ManagementTM--Copyright 2007, A/N Group, Inc.
Many smaller businesses spend their entire existence doing business in just one state. That's often the case for service businesses. But it's also not unusual for a business to operate in more than one state, particularly if it's located near state lines. Another situation that's encountered is moving a business to a new state. Dealing with these issues is not as complicated as it sounds.
Doing Business in a State
The first issue to deal with is what constitutes doing business in a state. We won't go into detail here since it's an involved topic and varies from state to state. Rather than worry about the fine points, let's look at the clear cut situations.
If you have employees in a state or own or lease property in a state, you're probably doing business in that state. That means you'll be liable for income taxes and other filings. On the other hand, if your only connection with a state is that you have an agent (not an employee) in the state who can take orders (but not bind the company), you ship goods into the state by common carrier (e.g., UPS, FedEx, etc.), you're most likely not doing business in the state.
For example, Madison Construction, Inc. is a Sub S corporation incorporated in New Hampshire. Madison does home construction and renovation in New Hampshire. As a favor to a long-time customer, Madison does a $100,000 remodeling job on a home in Vermont. Madison employees drive to Vermont each day and Madison brings it's trucks and equipment into the state. Madison would be doing business in Vermont.
Some states provide a de minimus exemption. That is, if the sales are minor or the entry into the state infrequent, the company is not considered to be doing business in the state. A $100,000 remodeling job would not be de minimus; two service calls a year by a technician for a minimal amount of time might be.
Best advice? Talk to your accountant or tax adviser.
Foreign vs. Domestic Corporation
We're not talking about foreign country. The term here refers to a corporation, partnership, etc. that's incorporated, etc. in a different state. For example, Madison Inc. was incorporated in New Hampshire. If it does business in Vermont (or any other state) it's termed a foreign corporation in that state. It's the way most big corporations do business. They're often incorporated in Delaware and register as foreign corporations in the various states in which they do business. You don't have to set up a new corporation in every state in which you intend to do business. (Although sometimes there can be valid reasons for doing so.)
Operating as a foreign corporation is rarely a disadvantage. Once registered, a corporation or other entity in a foreign state generally has all the rights and privileges of a domestic corporation or other entity. There are some exceptions so you should talk to an attorney knowledgeable in the area. There's usually no problem with a regular corporation, but not all states recognize S corporations. And the rules get more complicated for limited liability companies (LLCs).
The first step is generally to register the entity. That's usually done with the Secretary of State (go to www.smbiz.com/sbrl041.html for a link to the Web sites of all the states). There may be a one-time as well as an annual fee. It won't break the bank, but it can be a nuisance.
If you're doing business under an assumed name (for example, Madison Construction Inc. has a division called Madison Excavating), you will probably have to file additional papers in the state or in each county in which you intend to do business.
Check out any special business licenses needed. If you're a plumbing contractor, you know you'll need to get a license in the state in which you're going to operate. But license rules vary widely. In one state a licensed plumber may be able to do simple wiring for a furnace; in another state an endorsement or additional license is needed. Some counties and towns require an additional license.
If a company is doing business in a state, it will probably be required to file income, sales, and employment tax returns.
For example, since Madison Construction Inc. is doing business in Vermont, it must register for income and withholding purposes and file a Vermont S corporation return and withhold Vermont state taxes from employees' pay. The employees would have to file a Vermont tax return for the wages earned (they'll get a credit for those taxes on their resident income tax return). In addition, the shareholders of Madison will have to file individual income tax returns in Vermont reporting the Vermont income. (Some states, including Vermont, allow the S corporation shareholders, partners in a partnership, or LLC members to file a composite return instead of individual tax returns. The tax effect is similar but the paperwork is significantly reduced.) In addition, if Madison is required to collect sales tax on Vermont sales, it will have to register, collect and pay sales tax on its sales. And don't forget to check the rules on workmen's compensation and unemployment insurance.
Note. Doing business for sales tax purposes and doing business for income tax purposes often come under different sets of rules. You may be required to collect sales tax, while not being subject to income tax. Again, the rules vary widely. Check with your attorney or tax adviser.
Why register? If you're not registered to do business in the state, you may have difficulty bringing suit against a customer who won't pay or another party with which you have a dispute. Check with your attorney on your rights. If you don't file tax returns in the state the statute of limitations never begins to run and the state can go after back taxes to the date you first did business in the state. That can be very expensive, particularly when interest and penalties are added.
Some states are more aggressive than others in tracking down out-of-state companies. The internet has made it easier for states to identify companies operating in their state. While having a telephone listing doesn't mean you're doing business in that state, it might be a trigger that could result in a questionaire asking about your activities in the state.
Will you pay extra taxes by doing business in more than one state? It depends. You shouldn't be taxed twice on the same income. Multiple taxation is avoided by apportioning income based on a three-factor formula--sales, payroll and property. A simplified example is the easiest way to explain it.
Example--Madison does business in New Hampshire (its home state) and Vermont. It's total taxable income for the year was $150,000. Total sales were $800,000; Vermont sales were $120,000. The sales factor for Vermont is 0.15 ($120,000/$800,000). Assuming Madison has no payroll or property in Vermont, it would pay tax on 15% of its income, or $22,500 in Vermont. It would use a similar approach in computing the taxable income in New Hampshire.Most businesses will have to also compute the payroll and property factors, add them up and divide by three. Some states use variations, but the theory is similar.
You can see that if you do business in more than one state you might want to make sure your accounting is up to par. The income allocation requires you to track sales, know where your payroll expense was incurred, and how much property you have in the state at the beginning and end of the year.
All this sounds like a lot of work, but it becomes easy very quickly. Ask your accountant for help. On the other hand, it probably doesn't make sense to set up an office or register in a state if your sales there are likely to be minimal or your profit margins on those sales will be below average. Forgoing the sales or subcontracting to a local business or using a distributor in the state might be a better move.
Moving to a New State
What if you're moving into a new state and stopping operations in the old? For example, Madison decides to move to Vermont and cease all operations in New Hampshire. If there's little or no chance of having sales in the old state, it probably makes sense to withdraw to save fees and avoid having to file tax returns (even if only the minimum tax is due) in the old state.
Since corporations, partnerships and LLCs are entities of the state, you'll have to register as a new entity in the new state. Simply dissolving the old entity and starting a new one is likely to have tax consequences. That's particularly true for corporations. There are other options. For example, you can set up a new corporation in the new state and merge the old corporation into the new. You accomplish your business purpose without any adverse tax consequences. Sole proprietorships don't present a tax problem, nor do one-member LLCs. The tax consequences and state rules for partnerships and LLCs vary. Get good advice from your tax adviser and attorney.
Copyright 2007 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536
--Last Update 08/27/07