This blog breaks down the five most common multistate tax mistakes companies make—and how to stay compliant, avoid penalties, prepare for future tax issues, and look into planning opportunities (it’s not all bad, there is some good too).

State and local governments have continued to expand their reach; which requires taxpayers to be continually wary of potential state and local tax obligations. Many taxpayers have common misconceptions with respect to their state and local tax obligations which can end up costing unaware businesses time and money to become compliant. 

Quick Takeaways

• Hiring even one employee in another state can trigger tax obligations.
• Sales alone, without employees, can require tax filings in certain states.
• A federal tax loss does not mean you owe nothing to the states.
• States proactively track down noncompliant businesses.
• It's your responsibility, not the state's, to stay informed.

Fact or Fiction- 5 Key Misconceptions about Multistate Tax Obligations

Assumption - I hired 1 person in a new state; this can’t really affect my business tax obligations, right?

Incorrect – hiring even a single employee in a new state is considered having a physical presence with the state, and can trigger several state tax filings including state income/franchise taxes as well as sales/use taxes. In addition that new employee likely creates some type of withholding obligation on behalf of the employer; which could include withholding/payment of state income taxes, unemployment, paid family leave, 

Assumption – My business had an employee who is just travelling into the state or I don’t have an employee and only make sales into the state. Therefore, I don’t owe state taxes, correct? 

Incorrect – many states can establish filing requirements with a taxpayer for having representatives visit a state including trucks making deliveries. The nature/amount of visits to a state could require the business to withhold state taxes from the employee(s). Also even without having an employee visit a state; just having a certain amount of sales to customers in a state create filing obligations for the business with respect to income/franchise and sales/use taxes. 

Assumption- My business is in a loss on its federal income tax return, any state tax obligations are minimal, right? 

Incorrect – many states have franchise taxes which calculate the tax due using total gross receipts or net worth (assets net liabilities). Therefore, it is very possible for a business to be in a loss for federal income tax purposes but generate a significant tax liability based on franchise taxes.

Assumption – I can assume that the state will never find out I have this tax obligation, correct? 

Incorrect – states now more than ever are becoming increasingly sophisticated with respect to reviewing records and discovering businesses operating in the state who have not disclosed tax obligations. This can occur through states auditing your customers and discovering their transactions with your business. It can also occur because your business has registered for one tax type (payroll) but has not filed returns for another tax type (income/franchise, sales/use, etc.) in that same state. They often find links to your company when auditing one of your customers or vendors.

Assumption – I’m assuming the state will let me know about how a change of law will affect my business?

Incorrect – The state will put out guidance typically through regulations on how it interprets existing taxing statutes regarding tax types. These regulations may even include examples, but it is on the business itself to understand the state’s guidance and implement the required systems necessary to manage taxes. 

What can businesses do?

Navigating the ever-changing state and local tax landscape can require a business to understand the ins and outs of not just 50 states (and some cities, counties, and parishes), but also the tax types (income, franchise, sales, use, property, unclaimed property, withholding, etc.). 

FAQ- Multistate Tax Obligations

1. What is economic nexus, and how is it different from physical presence?
   Economic nexus is based on sales volume in a state, while physical presence includes offices, employees, or reps.
2. How can I tell which states I owe tax to?
   Start by mapping where your employees, sales, and contractors are located—then check each state’s rules,  or better yet, contact a SALT advisor.
3. What happens if I ignore a state’s filing obligation?
   You may face back taxes, interest, penalties, and audits. Some states have lookback periods of  more than 3 years.
4. Can I fix past multistate tax mistakes?
   Yes. Your tax advisor can help you with voluntary disclosures or create remediation plans with state authorities but you need to get ahead of a state or locality reaching you first.

Worried About Multi-state Tax Traps? Let’s fix that. KLR’s SALT team can help you understand where you stand, where you're going, and how to stay compliant every step of the way.