Multi-State Taxation For Public Companies: How To Avoid Costly Penalties

Key Takeaways:

• Public companies face growing complexity in state and local taxes due to evolving nexus and apportionment rules.

• States are increasingly aggressive with audits, particularly after major transactions or large increases in federal taxable income.

• A proactive, state-specific approach to tax planning is essential as laws, interpretations, and audit practices continue to evolve.

For public companies, state and local tax (SALT) compliance isn't just a routine formality; it's a high-stakes puzzle that's constantly changing. Organizations face increasing scrutiny as states get more aggressive with audits, expand definitions of nexus, and reinterpret long-standing protections like Public Law (PL) 86-272. Add in new tariffs, remote workers, digital services, and the uncertain future of federal tax reform, and the multi-state tax landscape has never been more complicated.

This article explains what your company needs to know to stay compliant, reduce risks, and avoid costly missteps.

Economic Nexus and Apportionment Changes

Determining where you owe state taxes has become increasingly complex as states have fundamentally changed the rules for both sales tax nexus and income tax apportionment. These parallel developments create overlapping compliance challenges that require careful navigation.

Sales Tax Nexus

Economic nexus rules have evolved rapidly since the U.S. Supreme Court's 2018 decision in South Dakota v. Wayfair. Prior to that decision, the standard for establishing a nexus obligation to register, collect, and remit sales tax was based on physical presence — having a brick-and-mortar location, employees, or property in the state. Today, states apply revenue and/or transaction thresholds to determine nexus for out-of-state sellers. This does not remove the consideration of physical presence, it is merely an added concept. If you have physical presence, you automatically have sales tax nexus (as it was before South Dakota v. Wayfair).

Income Tax Apportionment and Sourcing

For income taxes, states historically used a three-factor formula based on property, payroll, and sales. But most have moved toward a single sales factor approach over the past decade. The result is a complex patchwork of rules large corporations must navigate.

In states moving toward a single sales factor apportionment formula, the three-factor formula may use a heavily weighed sales factor while others use a single sales factor formula for certain businesses. Corporations may be required to use one formula (such as single sales factor), while partnerships may be subject to another (such as an evenly weighted three-factor formula). In addition, some states utilize industry specific apportionment formulas.

Another trend can be found in the sourcing of service revenue in determining the sales factor. States are moving from a cost of performance model, where the income producing activity is performed to market based model, location where the customer receives the benefit. These changes complicate sourcing decisions, especially service-based or digital businesses where the "market" isn't always clearly defined.

The Revenue Sourcing Challenge

Income tax apportionment now hinges on a critical question: Where should revenue from services be sourced? To the state where the customer is billed? To the state where the ultimate consumer uses the service? To multiple jurisdictions if there are users in different states? The answer varies by jurisdiction. Getting it wrong can trigger audits and retroactive assessments.

Companies face additional challenges managing compliance when customers have a distributed workforce. A billing address alone is no longer a reliable sourcing mechanism when customers might consume services or software across state lines.

Technology has come a long way in helping companies track sales across jurisdictions. Still, reviewing service agreements, user contracts, and customer usage patterns is crucial — especially if you operate in media, advertising, or software as a service (SaaS), where sourcing may depend on the end user's location rather than the billing address.

The Modernization of PL 86-272 and the Rise of Online Activity

Another area undergoing dramatic reinterpretation is PL 86-272. Enacted in the 1950s, this federal law was designed to protect businesses from state income tax if their only activity in a state was soliciting orders for tangible goods. But with most commerce now happening online, states have begun updating their interpretation of what constitutes "unprotected" activities.

Some states now argue that digital functions — such as offering a chatbot, accepting job applications online, or providing customer support through a website — go beyond mere solicitation. Proposed regulations in California and New Jersey, and controversial enforcement efforts in New York and other states, will likely set precedent in the years ahead. Public companies selling tangible personal property that rely heavily on technology must keep tabs on these developments.

Tariffs, Digital Goods, and the Expanding Sales Tax Base

Adding another layer of complexity, some states are expanding their sales tax base to capture more digital transactions. Louisiana, Maryland, and Texas have recently passed or clarified laws on the taxation of software as a service (SaaS), digital goods, and cloud computing services.

Further complicating matters, new import tariffs may affect how companies price goods and what constitutes the taxable base. If a public company chooses to pass tariffs on to consumers, is the added cost included in the sales taxable base? Few states have addressed this clearly to date. As states decide on their stances, companies must reevaluate how their systems track and calculate tax.

Audit Risks

States are aggressively pursuing audits to meet budget shortfalls. California and New York remain two of the most aggressive, but states like Massachusetts, Illinois, Michigan, and Wisconsin are stepping up their audit activity in corporate income and sales taxes.

Audit triggers often include:

• Significant increases in federal taxable income without a corresponding state adjustment

• Sales of a division or business asset without reporting income to the state

• Filing a return one year and not the next

• Switching from unitary to separate reporting or vice versa

• Filing an income or gross receipts tax return without filing a corresponding sales tax return or vice versa

• Reporting sales but not filing income taxes in a state where you have employees, including remote workers or a digital presence

If you receive a state nexus questionnaire, don't respond too hastily. We've seen companies admit to a long history of in-state sales without understanding whether those sales were exempt or protected under PL 86-272 — inadvertently opening themselves up to audits for prior years.

Organizational Complexity and Structuring Challenges

Companies with multiple subsidiaries must track entity-specific revenue to manage effective state tax rates. In some cases, restructuring entities or realigning business functions across legal entities may offer tax savings. But it requires deep knowledge of each state's rules and an understanding of industry-specific tax rules.

Property tax issues also come into play if you plan to expand, relocate, or consolidate facilities. Valuations can drift over time, and high assessments are often worth challenging. Credits and incentives based on job creation or capital investment may offer further opportunities, but you need to track them carefully, as they change frequently.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.