The majority of small businesses don’t file taxes outside their home state. This is simply because they are typically local and don’t have physical locations or connections to any other states. But in our current interconnected and virtual world, small businesses have access to employees not only in other states but across the globe. Hiring a contractor in a different country can have its own implications but thankfully none that will affect the businesses US taxes.

Hiring an employee or contractor in a different state can be problematic, as it easily creates a nexus in those states. The recent marketplace sales tax rules have created a hot topic and small business owners might not realize that having a contractor in another state can create not just sales tax nexus but income tax nexus too. This means you not only have to collect sales taxes but also file and pay income taxes.

For the most part, multistate tax planning is for large companies that are taxed as C corporations. If you own a business that has flow through taxation you are unlikely to benefit from multistate taxation, but you still need to address it. Here’s what business owners can do to manage compliance and tax implications in multiple states:

Register in your home state
Your business has to be registered in the state you live in. Unless you have zero participation in your business, you have nexus in your state of residency. For most small businesses, registering in a different state means more state registration fees with no tax savings but potentially higher taxation. Registering in a different state only helps in very specialized situations and should only be implemented if you’ve discussed it with your CPA.

Watch out for extra taxes
The additional tax burden for small businesses that operate in multiple states can mean double taxation. Not all states offer a credit for taxes paid to another state. It’s entirely possible to pay tax on the same income in two different states. If you live in a state with no income tax, like Texas or Florida, it can mean having to pay state income tax on part of your income.

Manage filing costs
Small business owners don’t have the tax preparation budget of large companies. Unfortunately, tax preparation costs for multistate filings can be substantial. Once you determine which state you need to file in, you might find your apportionment rate is zero so you don’t have taxable income. So you have to decide if you will file or not. If you try to comply with all state laws, which each state expects, you might find that the cost is greater than the potential penalty for not filing the returns.

When in doubt, collect sales taxes
If you might have nexus then you should collect sales taxes. Keep in mind that sales taxes typically won’t impact your sales. There is no way to go back to your clients and ask them to pay sales tax for past purchases. The government will assume the sales taxes are built in when you don’t collect them. If you have a small margin on what you sell this can mean the difference between making money or losing it.

Don’t believe the gossip
Ideas and gossip are always floating around the business community about establishing your business in state X vs state Y. For example, some Californians wrongly believe that a Wyoming LLC will save them money on tax. Unless you operate the business itself in WY, this strategy will only cost you extra money in filing fees paid to WY. If you are a California resident, you will pay tax on any income you generate, regardless of the state your company is registered in.

So, are there scenarios where companies can benefit from multistate tax planning? The short answer is yes but only if your company is taxed as a C corporation with offices and people across different states. For the rest of small business owners that benefit from flow through taxation, multistate taxes will mean higher administrative costs and potentially more taxes. Pay attention to where you might have nexus and make sure you relay the information to your tax preparer or CPA to ensure you stay compliant.