Small Business Consultants Beware

Over the past few years, state revenue departments have been getting creative in making new tax laws to capture non-resident income taxes. If you are an individual operating as a sole-proprietor consultant or service provider to customers out of your own state, here is what you need to know.

This could be you

• You could owe state income taxes to a state you never visited or worked in.
• Non-resident employees doing the same work you do as a consultant may not have to pay state income taxes while you must.
• Federal law protects non-residents from state revenue attacks, but only if you sell tangible property (like pencils, watches and other physical property). It generally does not protect those who provide services.
• Every state can be different. Just because you know your state’s rules, do not assume other states follow the same guidelines. Nor should you assume other state laws are logical or reasonable.

What can you do?

If you are a consultant providing services to out-of-state customers, here are some tips.

• Research the states rules – Research your customers’ state tax laws for non-resident service businesses. Also review that state’s non-resident employee wage rules. See if they treat them both the same way.
• Become a temporary employee – If non-resident rules are different for consultants versus employees, consider becoming a part-time employee or temp employee. Adjust your bill rate to allow for the employer paying half of your Social Security and Medicare.
• Physical presence – If you conduct your work in the out-of-state location, a non-resident tax return is usually due. But this is not always the case.
• Service or product? – Remember, selling product across state lines is different than providing a service. Nexus laws and tax cases make physical presence required. But here too, there can be exceptions.
• If in doubt, ask for help – The best advice is to ask for help. This area of tax code is rapidly evolving. There are no national guidelines and states like California and Michigan are very aggressive. Exceptions in state rules make mistakes easy to happen. This can lead to you owing taxes to another state based on your out-of state activities.

Small service businesses cannot readily defend themselves against large state revenue departments so they are becoming victims as one state tries to take another state’s income tax revenue. While you may receive a credit in your home state for taxes paid to another state, it is not always easy to do and penalties are often applied. Your best defense is knowledge.