Sales tax gets most of the attention, but state income and franchise taxes follow SaaS revenue too. Once a company sells to customers across the country, the question is not whether it owes other states but which ones, and how much of its income each can tax.
Why P.L. 86-272 does not help much
Public Law 86-272 bars a state from imposing a net income tax on a company whose only activity there is soliciting orders for sales of tangible personal property that are approved and shipped from outside the state. SaaS is generally treated as a service or intangible, not tangible property, so the protection usually does not apply. Many states also take the view that interactive internet activities go beyond solicitation.
How nexus is created
| Basis | Examples |
|---|---|
| Physical presence | Employees working from home in the state, an office, servers or inventory |
| Economic nexus | Sales into the state above a threshold, regardless of presence |
| Factor presence | Property, payroll or sales above set dollar amounts, a model several states follow |
| Registration | Qualifying to do business in the state |
Remote employees are the most common trigger for early-stage SaaS companies. One engineer working from another state often creates both payroll and income tax obligations there.
Apportionment
A multistate company divides its income among the states where it has nexus using an apportionment formula. Most states now use a single sales factor: the share of the company's sales sourced to that state.
Market-based sourcing
Most states source service and SaaS receipts to where the customer receives the benefit, rather than where the work is performed. In practice, revenue is sourced by customer location: billing address as a starting point, refined by where users are when the contract supports it.
A worked example
A company has $10,000,000 in revenue and $1,500,000 of taxable income nationally.
| State | Sales sourced there | Apportionment | Income apportioned |
|---|---|---|---|
| California | $2,500,000 | 25% | $375,000 |
| New York | $1,500,000 | 15% | $225,000 |
| Texas | $1,000,000 | 10% | Texas taxes margin, not income |
Each state then applies its own rate, credits and minimums.
Gross receipts and margin taxes
Some states tax receipts or margin rather than net income: Texas franchise (margin) tax, Washington business and occupation tax and Ohio commercial activity tax are common examples. These can apply in loss years and have their own thresholds.
Minimum taxes and registrations
Many states charge a minimum tax or fee to corporations doing business there. California's minimum franchise tax is a familiar one, and California's doing-business test includes sales into the state above an inflation-indexed threshold.
What to do
- Map employees, contractors and property by state.
- Source revenue by customer location each year.
- Compare each state's thresholds and decide where filing is required.
- Register and file going forward; consider voluntary disclosure for past years where exposure is material.
We review nexus each year from payroll and billing data and prepare the state returns that follow.
Sources
- 15 U.S.C. §381, Imposition of net income tax (P.L. 86-272) (Cornell LII)
- California Franchise Tax Board, Doing business in California
- Multistate Tax Commission, National Nexus Program
- IRS, State government websites
Questions founders ask
Is income tax nexus the same as sales tax nexus?
No. They are separate tests with separate thresholds. A company can have sales tax nexus in a state without income tax nexus, and the reverse.
Does a loss mean no state tax?
Not always. Many states impose minimum taxes, and some tax gross receipts or margin rather than income, so tax can be due in a loss year.
