Is Your Business Properly Registered Everywhere It Operates?

Growth is a wonderful thing for driven small business owners. However, entrepreneurs should be aware that expansion—hiring an out-of-state employee, entering a new market, or building a warehouse in a different state—creates additional compliance obligations. Many business owners enter new states without realizing they may have created additional registration, tax, payroll, or reporting obligations. Even reaching a certain level of online sales transactions or revenue from customers in another state can trigger new compliance responsibilities.

Could your business have compliance obligations in other states? Now is the time to assess your situation and take the proper steps to make sure your business enters next year fully compliant.

In this article, I’ll cover some key factors that trigger various compliance requirements, what’s at stake if your business fails to fulfill those requirements, and I’ll give you a practical checklist of what to review before the end of the year.

Key Considerations: Are You Transacting Business In Another State?

What Is Foreign Qualification?

Foreign qualification is what certifies a business formed in one U.S. state to conduct business in another U.S. state. To become foreign qualified (authorized to conduct business in another state), a business registered as an entity in its home state must file a state foreign qualification form and other documentation with the state where it wishes to operate, and they must fulfill certain compliance responsibilities there. It’s important for business owners to determine if their activities in another state require them to register for foreign qualification.

Selling products or services on an interstate basis doesn’t necessarily mean a business is considered “conducting business” outside of its home state. The criteria vary from state to state.

The most common conditions that trigger the foreign qualification requirement include:

• Has one or more employees living or working in the state and is paying payroll taxes there
• Has an office, store, warehouse, or other physical location in the state
• Holds regular in-person meetings with clients or customers in the state
• Is structured as an LLC, corporation, or limited partnership in its home state
• Has applied for a business license in the state
• Secures or collects debts from customers in the state

Reaching a sales or income threshold might contribute to the need to become foreign qualified, but generally that alone does not constitute transacting business to a point that requires foreign qualification. Again, states’ rules vary for when foreign qualification is required. Note that even if an entity doesn’t have to foreign qualify, it might have other state-level obligations because of nexus.

What Is Nexus?

Nexus is a key factor used to determine whether a company has obligations in another state. Nexus means establishment of a connection. If a business entity has established a substantial connection (i.e. nexus) in a state, it could be subject to state sales tax, state payroll taxes, state income tax, foreign qualification and other compliance requirements. Nexus can occur in several ways:

• Physical nexus: This is when a company has employees, agents, brokers, representatives, or subcontractors working on behalf of their entity in another state. It also applies when an entity has tangible property—such as a brick-and-mortar store, office, real estate, vehicles, or warehouse in the state.
  • Examples of physical nexus:
    • A company based in California has employees located in Nevada and New Mexico. The business would be considered to have physical nexus in all of those states.
    • A business entity in Virginia has tangible inventory stored in a warehouse in New York. The company has physical nexus in Virginia and New York.

• Economic nexus: Economic nexus is established when a business in one state reaches a certain sales revenue threshold (or number of sales transactions) in a 12-month period (some states have annual thresholds and some have rolling 12-month thresholds) in another state. When reaching a sales threshold, a business may need to remit sales tax in the other state. Many states consider a business to have economic nexus when they are making $100,000 in sales revenue annually in their jurisdiction—whether they have a physical presence or solely sell online. Some states have higher thresholds.
  • Examples of economic nexus:
    • A business is located in California and has annual sales over $100,000 in Arizona and Colorado. The business would have nexus in all three states.
    • A business is located in Ohio and has received 200 orders annually from customers in Arizona and Colorado. The business would have nexus in all three states.

• Income Tax Nexus: When an income tax nexus is established, the state has the authority to require the business to file an income tax return and pay state income tax. Income tax nexus can arise from physical presence—such as an office, store, warehouse, or employees—or, in many states, from substantial economic activity such as sales, property, or payroll in the state. If a company has income tax nexus in a state, it generally must file the state’s income or franchise tax return and pay any resulting tax. Please note that if an entity has income tax nexus in multiple states, then the income will need to be apportioned to each state based on the apportionment rules. Consulting an accountant can be very helpful to ensure the business handles apportionment correctly. The business entity might also need to foreign qualify in the state. Nexus rules vary by state, so a business with income tax obligations in one state may not have them in another despite similar activities. Income tax nexus is different from sales tax nexus: a business required to collect and remit sales tax in a state might not necessarily owe that state income tax.
  • Examples of income tax nexus:
    • A Virginia-based company rents a warehouse to store inventory in North Carolina.
    • A consulting firm based in Colorado sends employees into California to perform services for clients.
    • A retailer based in Pennsylvania has employees in Ohio who accept orders, deliver goods in company vehicles, provide repairs, or install products.
    • A business exceeds a state’s economic-nexus threshold—for example, a specified number of in-state sales, property, or payroll.

The Consequences of Non-Compliance

A business opens itself to some significant risks if it fails to foreign qualify in any states where it’s considered to be doing business or has nexus. Consequences could include:

• Fines
• Interest due on missed or late filing fees or tax payments.
• Payment of back taxes for when the company was conducting business in the state but hadn’t yet foreign qualified or registered for the required tax accounts.
• No legal standing for bringing suit in the state

Q4 Compliance Checklist

Here are practical steps to take to make sure your business has all its required registrations in place and compliance requirements on its radar for where it conducts business or has nexus.

1. Review employee locations: Where do they live and where do they work? This is vital information for determining whether your company has new foreign qualification or income tax withholding responsibilities.
2. Review business locations: Offices, warehouses, distribution centers, retail stores, and other property—whether owned, leased, or rented by your company—are a key determining factor indicating physical nexus in a state and whether foreign qualification is required.
3. Review sales activity by state: Have your company’s sales (including online sales) in a state reached or exceeded that jurisdiction’s dollar or transaction threshold for when sales tax registration, collection, and remittance is required? Check states’ current thresholds, since these change often.
4. Evaluate nexus exposure: Nexus thresholds and rules differ by state, so if you have a multistate business, conduct a state-by-state nexus review. A business should review nexus whenever it hires remote employees, stores inventory, performs on-site services, attends trade shows, or reaches significant sales levels in another state.
5. Confirm foreign qualification registrations: Compare the states where you’re operating against the states where you’re registered with the Secretary of State. Check that each registration is active and in good standing.
6. Confirm payroll registrations: When a business has an employee living in one state and working in another, each state’s payroll rules apply for that employee, and they might owe state income tax in multiple states. However, some states have reciprocal agreements with other states, whereby an employee only owes tax in their state of residence. The states with reciprocal agreements usually require an Employee Withholding exemption to be filed for the state the employee works in. Arizona, for example, has several reciprocal taxation agreements—including with California, Indiana, Oregon, and Virginia—that exempts residents of those states who work in Arizona from income tax withholding there. Keep in mind that reciprocity affects the employee’s withholding, but an employer may still have registration duties in the state where the employee works.
7. Confirm unemployment insurance and workers’ comp registration for out-of-state employees: These have the potential to be missed when hiring remote workers.
8. Close inactive payroll and tax accounts: Reach out to the appropriate state and local agencies to close any accounts that your business no longer needs. For example, if you’ve let go your only remote employee in a state, you’ll want to close your payroll withholding account. Or if you’ve stopped selling products in a state and no longer meet the thresholds for sales tax nexus, you’ll want to close your sales tax account. Until accounts are closed, your business might be expected to file reports or pay fees even if you have no sales or employee activity in the state.
9. Withdraw from states where operations have ceased: When no longer conducting business in a state, an entity must formally withdraw its foreign qualification. Failing to do so will leave that company on the hook for filing annual reports, paying fees, and filing tax returns even if it’s not actively operating there.
10. Calendar annual report deadlines: If a business’s home state and states where it’s foreign qualified require an annual report, record those due dates on a calendar so you can prepare to file them on time.

Checking for Compliance Gives Peace of Mind

Completing a compliance audit like the one above before year-end requires some time and effort, but the peace of mind it provides—and the headaches it helps avoid—make it well worth your attention. Because states’ rules can vary widely for when foreign qualification is required and what constitutes nexus, consider discussing your situation and potential issues with your CPA, attorney, or other trusted compliance professional.