NFIB

What Online Activities Mean for Multistate Taxes
03/ 28/ 2002

by Barbara Weltman

If you use a Web site in your business, understand what, if any, impact it may have on your liability for income taxes, sales and use taxes, and even employment taxes in multiple states to avoid unnecessary costs (e.g., tax penalties; accounting fees for audit).

State income tax. Selling to customers in other states doesn't automatically mean you're a multistate business. You need a "nexus," which is a connection, to a state in order to be liable for its income taxes. Usually, this means having a physical presence there, such as maintaining an office. But a nexus may also be created through sales representatives or even technicians working for you in another state (workers don't have to be your employees to create a presence in another state). If you do have a connection to another state, then you'll owe income tax based on apportionment of business income. Factors such as sales, payroll and property are used to determine this. If your business is a pass-through entity (partnership, S corporation, or limited liability company) doing business in more than one state, then you, as an owner, will owe income taxes to each such state based on your share of business income and must file tax returns in those states.

Sales and use tax. Whether you're required to collect or pay sales and use tax to multiple jurisdictions is a complex question. The rules vary in the 45 states and the District of Columbia (and the more than 7,500 local jurisdictions) that impose such taxes. Items subject to tax in one place may be exempt in another. A caution: The Internet Tax Freedom Act imposed a three-year moratorium on most state taxes on Internet access, such as AOL monthly charges, and on discriminatory taxes (the moratorium expires on October 20, 2001, but is expected to be extended, probably for an additional five years). Other types of online sales continue to be subject to state and local law. Consult with a tax expert on your potential exposure for sales and use taxes.

Employment taxes. You're responsible for payroll taxes within the state in which your employees work. You can choose to withhold state income tax for an employee's state of residence as well. For example, if your web design company is based in New York, you must withhold New York income taxes from employee wages. You can choose to withhold New Jersey income tax from workers who reside there.

Weltman is an attorney with over 20 years of experience in taxation for individuals and small businesses. She is president of Bwideas.com Inc., found at http://www.bwideas.com.

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This article originally appeared in the January/February 2001 issue of MyBusiness Magazine, NFIB's member magazine.