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The Colonel knows why your business might have to file returns in other states

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Tax returns for other states are an expensive annoyance. It can be even more expensive and annoying if you don't file them.

State governments love to tax out-of-state businesses. It's very tempting for politicians to pick the pockets of taxpayers who don't vote in their elections. Aggressive taxing agencies with improved abilities to spot potential pockets to pick are making it harder for out-of-state businesses to ignore state filing requirements.

There are two sets of restrictions on states that want to tax your business. The first is the Constitution, which requires there to be some connection to a state before a business can be taxed. The Supreme Court's Quill decision of 1992 imposed a "physical presence" test. This limit has been eroded over the years by aggressive states that have asserted an "economic presence" limit. States using the "economic presence" test consider the presence of "intangible" assets in a state, like trademarks, to be enough to subject a business to tax. Iowa successfully taxed KFC Corporation under this argument even though KFC had no presence in Iowa other than franchisees using KFC trademarks for their chicken outlets in Iowa.

The second limit on states trying to impose income taxes is PL 86-272This law, enacted in 1959, prevents states from taxing income of some out-of-state companies even if they otherwise could tax them under the constitution. This law protects corporations whose only activity in a state is solicitation of orders that have to be approved and shipped from out-of-state. This protection only applies to income tax. That means businesses may be required to collect sales tax and pay "doing business" taxes in a state without being required to pay income tax. It provides no protection to businesses that do more than "solicit." Providing warranty or other services in a state is all it takes to put you over the line.

The inevitable question: Should I just ignore other states and wait for them to catch me?  That has always been hazardous, and it becomes a worse bet every year. If you don't file a return in a state where you are taxable, the statute of limitations never expires, and your potential tax liability never stops growing

States have more tools than ever to spot non-filers. "Data-mining" is the best gift to state revenue departments since the invention of the auditor. If you have an employee in a state, it's only a matter of time before they notice if you don't file business returns there. If you own property, they can match up property tax records with income tax filings. They can use building permits or other local licenses to identify people who should be filing. They can walk back customer Use Tax reports to you if you are a vendor.

The Moral: As your business grows, be sure to discuss with your tax pro your activities in other states. Otherwise state revenue departments may have expensive and unpleasant surprises for you down the road.

-Joe Kristan

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