Multi-State Tax Issues for Construction Firms

Knowing the right moves can help defend against trouble down the road.

No matter what you thought about the style of LeBron James' famously over-hyped decision in July to leave the Cleveland Cavaliers for greener pastures with the Miami Heat, you had to admire the man's move from a tax standpoint. 

That's because Florida is one of the few states - and the only one among James' reported suitors - that levies no state income tax.  Nor is there a city income tax in Miami. 

Neither of these tax advantages would have been available to him had he remained a Cavalier.  James would have continued to face Ohio's state income tax of 5.925 percent, plus a Cleveland city tax of two percent.

And the tax bite would have been even harsher had James gone to the Knicks.  In New York, top earners there are saddled with combined state and city income taxes of 12.85 percent, reportedly the highest in the nation.  And that's on top of the IRS's take.

Clearly, it pays to think through the tax ramifications of where you choose to do your work - whether you play hoops for a living or are in the construction business.

Several aspects of the multi-state tax game make this a particularly compelling truth these days.  For instance, consider that:

  • there are more than 13,000 tax jurisdictions in the United States, each with varying rules and regulations on how income, payroll, sales, property and inventory are taxed;
  • states are awash in red ink, and are turning over every rock they can find in search of  revenue;
  • when it comes to tax laws across state and local jurisdictions, the only thing that is constant is change.

As the economy continues to seek solid footing, many contractors are being forced to go further afield to compete for work that keeps employees busy and the project pipeline full.  So it is essential that business owners understand the tax landscape from state to state, and the impact that competing regulations can have on sales, income, taxes and profits.

Establishing Tax Nexus
Originally the Latin word for "relationship," nexus in modern tax parlance refers to a business entity's relationship with a specific tax jurisdiction, usually at the state level. 

The process of determining nexus is a complex one, due to an overlapping - and sometimes contradictory - crosshatch of state, federal, constitutional and judicial mandates used to determine whether an entity doing business in a particular state has sufficient nexus to be subject to that state's taxation.

Because the statutes that determine nexus vary from state to state, an uninformed business owner who undertakes a project outside his firm's home state runs the risk of failing to recognize whether that project is generating enough activity to make it necessary to register with the guest state, file a state tax return there and, if owed, remit taxes to that state. 

With states on hieghtened alert for new sources of revenue, it is more important than ever for construction firms with multistate operations to identify the nature and extent of their contacts with those states and to verify that all filing obligations are being met. 

An informal or formal "nexus study" similar to the ones that we've conducted for a number of our construction clients will help verify that your company is in compliance with all cross-border requirements and policies.  After all, the stakes have never been higher.

Determining Apportionment
If nexus is indeed established, then it becomes the obligation of the business to apportion the amount of sales, payroll and tangible property that is connected with the out-of-state work, and to collect and/or pay taxes according to laws and policies of the guest state.  

Every state (as well as the federal government) has its own specific formulas for determining this apportionment.  In fact, some states carry specialized apportionment formulas for specific industries.  While some states apply equal weight to each factor in their formula, others double-weight or "super-weight" a single factor, such as sales income, in order to eliminate the advantage of out-of-state companies with limited physical in-state presence.

And as you might expect, the apportionment formulas are in constant flux.  In cases where the sales factor is a significant part of the apportionment formula, several states have changed the definition of "receipts" used in the method for calculating a company's sales.  Other states have begun using the "cost of performance" concept to determine the source a particular sale. 

This shifting landscape brings up an important point.  A company that works to ensure its compliance with regulations in one or more states in a given year, and then sits back with  "mission accomplished" satisfaction, would likely be setting itself up for potential problems further down the road. 

What's at Stake for Contractors
The reality is that tax laws change.  Definitions change.  Formulas and methods of calucations change.  And court challenges at the state and federal level continually push and pull at the boundaries of generally accepted reporting and filing practices for out-of-state firms.

If your firm does business across state lines - or if you are contemplating doing so - it will definitely be in your best interest to obtain professional tax and/or legal advice to make sure you are in compliance with the latest regulations, and that you maintain that compliance.  Because with each state you add to your sales and service territory, you also join the potential audit pool for that state. 

In fact, it doesn't take the notoriety of Lebron James for tax authorities to keep tabs on your cross-state earnings.  With the advances in IT that now allow states and the IRS to find and share information, states are now able to track virtually anyone - from the salesman who travels out of state for one day to pitch a project, to the Massachusetts contractor who makes a presentation to a potential client in Florida.

Bill Rucci is a partner in the Boston area accounting and business advisory firm Rucci, Bardaro & Barrett PC.  He heads the firm's Construction Business Services Group, which includes among its clients several construction companies doing business in multiple states. 

For a complimentary copy of "State Tax Nexus Checklist - Frequently Asked Questions on State Nexus Questionnaires," compiled by the American Institute of Certified Public Accounting (AICPA) contact Mr. Rucci at (781) 321-6065 or [email protected].