The words “tax” and “surprise” are rarely welcomed together. Here’s how you can avoid an unpleasant surprise as you expand your business.
One of a startup’s most unpleasant surprises can come from state income taxes. Companies that receive early funding and ramp up hiring often discover that new employees trigger the need for new state income tax returns. When you hire the right talent in a state where you are not yet doing business, you may suddenly find your company with new state income tax returns to file—and pay.
How do things get so complicated and expensive so quickly?
While each state has its own minimum filing requirements, generally having an employee in a state creates “nexus”—that is, a relationship between the tax authority of the state, and the corporation—and thus the legal obligation to file income tax returns. Even when creating a “co-employer” relationship using a Professional Employer Organization (PEO), states still count the employee as legally the responsibility of the company for income tax purposes.
And you cannot ignore income tax filing obligations, at least not for long. Once a company registers in a state for payroll tax, the state knows the employee is there. It may take a few years for the state’s tax department to catch up, but eventually you will get a nice letter asking you about your activity in the state and inviting you to file the delinquent income tax returns.
As a practical matter, many states have no minimum tax and a company in a loss position will not owe back taxes, penalties, or interest. Other states have minimum taxes—California, for example, is among the highest at $800 annually, and delinquent taxes have penalties and interest added on.
In addition to avoiding penalties and interest, filing required returns can give a company the benefit of establishing net operating losses (NOLs) that can offset taxable income later. Waiting to file until the company is profitable means losing the benefit of those early NOLs, and ultimately paying much more in state taxes.
Each year VPTax clients benefit from our easy-to-follow electronic process for collecting tax information, and our Tax Directors’ ongoing dialogue with their companies. They appreciate that we surface these issues early and help leaders make smart tradeoffs between talent and tax burdens when necessary. The company makes the decision, we make sure it’s never the result of an unpleasant surprise.