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- January 30, 2025
State and Local Tax Considerations for I.T. Firms Operating in Multiple U.S. Jurisdictions
Gone are the days when businesses operated from one state. Today, businesses, especially I.T. firms, have pan USA presence. Their workforce, physical offices, and customers are spread across the country.
While this is great for business, it comes with a lot of tax complications. As the USA has a federal as well as state tax system, managing taxation is often a challenge. As a leading I.T. tax expert, we often come across clients who are dealing with such issues. So, we decided to come up with a detailed blog that will explain some basics of state and local taxation for I.T. firms.
So let’s get started.
What is Nexus?
Nexus is the core concept of state tax obligations. In simple words, a Nexus is a connection between a business and a state. This relation gives authority to the state to collect tax from that particular business.
Before the digital revolution, a business had to have a physical presence in a state to establish a nexus. This physical presence could be anything, like an office, employees or even a property. But those days are gone now. I.T. firms and eCommerce businesses are booming.
So, almost every state has expanded their definition of a nexus. They have added “economic presence” to the list of factors that establish a nexus. Result? If your I.T. firm is doing business in a particular state, it might get taxed if the sales go beyond a certain exempted limit.
California has implemented a nexus threshold of $500,000. This means that if your I.T. firm generates more than that via sales of any tangible property and the delivery location of the service in California, you’ll have to pay tax to California. It doesn’t matter whether you have a physical presence in California or not.
Sales and Use Taxes on Digital Goods and Services
This is the most complex one! Even certain I.T. tax experts with little experience might trip here. Sales and use tax applies to digital goods and services like Software Sales.
Some states consider software a tangible personal property if they are delivered via a physical medium. Similarly, certain states exempt software from use and sales tax if it’s delivered electronically. There are some states that treat custom and canned software differently.
Examples:
Texas: If you deliver software in this state in any form (physical or electronic), your income will be taxed. But there is a catch! If you are developing custom software for a specific client, it may be exempted.
Florida: Generally exempts electronically delivered software from sales tax but taxes software sold on tangible media like C.D.s or DVDs.
The taxability of SaaS (Software as a Service) is particularly complex. Some states tax SaaS as a tangible product. But some treat it as a service or even exempt it completely.
Examples:
New York
New York considers SaaS taxable as it provides access to software on the provider’s servers.
Colorado
This state exempts SaaS from sales tax. The reason is that it treats SaaS as a non-taxable service.
State Income Taxes and Apportionment Methods
If your I.T. firm is operating in multiple states, it will have Nexus with all these states. So, it will have to pay corporate income taxes in all these states. This is where things get a bit complicated. You’ll need a reliable tax expert to determine exactly what income will be allocated to each state. You will also need the right apportionment methods to divide your firm’s income among multiple states.
States generally use one of two approaches:
Method #1: Cost of Performance Method
This method allocates income based on where the income-producing activities occur. For I.T. firms providing services, this could mean income is sourced to the state where the work is performed.
Method #2: Market-Based Sourcing
This one’s a different. Here, income is allocated to the state where the customer receives the benefit of the service. This method is becoming more and more common. Result? It will impact I.T. firms that serve customers nationwide.
Examples:
California
This state uses market-based sourcing. This means income from services is attributed to California if the customer is in California.
New Jersey
This state, too, employs market-based sourcing. So, it affects how I.T. firms report income from services provided to New Jersey customers.
Georgia
Georgia uses a single-factor sales apportionment formula. So, it focuses only on the proportion of sales made in Georgia compared to total sales.
It’s very important to get help from I.T. tax experts to deal with these complex processes and taxation. If you miss out even a single state, IRS will come knocking at your door.
Employment and Payroll Taxes with a Remote Workforce
A lot of I.T. firms are shifting towards remote work. So, they have employees spread across the entire country. Payroll taxes vary greatly from state to state for remote workforce.
These I.T. firms have to pay attention to things like State Income Tax Withholding. Here, employers have to withhold income taxes based on the employee’s location.
Let’s say your employee is working remotely from Oregon. Then, you’ll have to register with the Oregon Department of Revenue. Similarly, you will have to withhold income tax from their wages and give it to Oregon State. It doesn’t matter where your I.T. firm is located.
On top of that, almost every state has its own unemployment insurance program. So, the employers have to contribute to these programs. The contribution depends on the wages paid to employees in that particular state.
Some neighbouring states have agreements that simplify tax obligations for employees living in one state and working in another. You will have to consult with a professional I.T. tax expert to determine your payroll tax obligations.
Local Taxes and Business Licensing Requirements
Beyond state taxes, local jurisdictions—such as cities and counties—sometimes impose additional taxes and licensing requirements. For example, many localities add their own sales tax on top of the state rate. It might affect the total tax charged to customers. The best example of it is Chicago, Illinois. Herel there’s an additional city sales tax that applies to certain services. This includes cloud computing and digital entertainment, often referred to as the “Cloud Tax.”
On the contrary, some cities require businesses operating within their boundaries to obtain licenses and pay taxes based on gross receipts or other measures. For example, San Francisco, California. This city Imposes a Gross Receipts Tax on businesses. The rates vary by industry and revenue levels. I.T. firms must register and file annual returns if they conduct business within the city.
Wrapping Up
Operating in multiple U.S. jurisdictions offers immense opportunities for I.T. firms. But it also introduces a host of state and local tax considerations. So it’s critical to consult IT tax experts like CROWNGLOBE. Our experts deal with IT taxation on daily basis. So we know what will help your IT firm stay compliant with existing tax laws. We know how to keep your tax burden at bare minimum and save big on taxes.
We hope this blog has offered you much needed insights into the topic. If you still have some doubts, our experts are always here to help. Reach out for a quick consultation.
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