Effective January 1, 2014, Massachusetts has changed the way that it taxes businesses providing services to Massachusetts customers (business or individuals). As a result of the change in law, businesses located outside of Massachusetts serving Massachusetts customers may now be subject to Massachusetts tax for the first time. For New Hampshire based businesses, this may mean that a portion of their business income is subject to taxation by both Massachusetts and New Hampshire!
Regulations for the new apportionment rules are still in draft form, but they may negatively affect many businesses, both through increased record-keeping and increased tax. The following are answers to some frequently asked questions on this issue:
What types of businesses are affected?
The new regulations potentially affect all entities with clients or customers located in Massachusetts, including those operating as corporations, s corporations, partnerships, trusts and sole proprietorships, even if the services are provided and/or performed in New Hampshire.
What industries are affected?
Generally service businesses such as management and consulting services, financial services, investment and brokerage services, accounting services, legal and lending, credit card processing, architectural and engineering services, advertising and graphic design services, and custody and fiduciary services, to name a few.
If I don’t have employees or offices in Massachusetts, am I affected?
Nexus describes the amount and degree of business activity that must be present before a state can tax an entity’s income. The Massachusetts Supreme Court has applied a very broad definition of nexus. They have held that mere economic presence (and not physical presence) is sufficient to create substantial nexus (a requirement to file) in Massachusetts.
How much Massachusetts activity is required?
The courts and regulations have not defined what constitutes ‘substantial economic nexus’ in Massachusetts. If a taxpayer has limited activity in Massachusetts, the strategy may be to file tax returns reflecting that limited activity in order to start the running of the statute of limitations.
I have never been audited by Massachusetts; why do I need to worry about this now?
In the past, service businesses may have had economic nexus in Massachusetts. However, under the old apportionment rules, if the business filed a return, the apportionment methodology used would have resulted in zero apportionment and zero or the minimum tax owed to Massachusetts. Thus, there was no concern about non-filing. With a change in the apportionment methodology to ‘market based sourcing’, service businesses will now have sales sourced to Massachusetts which will result in the allocation of net income to Massachusetts and a resulting income tax owed.
Isn’t the Massachusetts tax rate lower than the New Hampshire tax rate on business profits? What’s the big deal?
Unfortunately, businesses that are affected by the change in Massachusetts apportionment most likely will not see a reduction in their New Hampshire tax liability. New Hampshire continues to use a ‘cost of performance’ methodology for apportioning business income. Since the New Hampshire methodology has not changed, New Hampshire tax will stay the same with the addition of tax owed to Massachusetts on sales sourced to that state.
What do I need to do now?
Businesses should review their accounting systems to ensure that they have systems in place to capture the data required to comply with the law. These systems should be in place well before the end of 2014 to allow for the preparation of the 2014 income tax returns. A review of business practices and a nexus study can be conducted to minimize the effect of state tax law.
The Commonwealth of Massachusetts is close to finalizing the regulations in this area. The draft regulations are detailed and complex and specifically define how different business types must allocate sales, based on the type of service provided. We are available to assist you in assessing the impact of the change in law on your business and to help you determine how to gather the records and apply the sourcing rules. We highly recommend that you review these issues well before the end of the year to avoid surprises, so that strategies can be developed to minimize the impact of the tax.
Please call our office at your convenience if you would like to consult with one of our professionals on this issue.
This information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Any tax advice contained in this communication is not intended or written to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties. Please contact our office (603-627-3838) for more information on this subject and how it pertains to your specific tax or financial situation. Howe, Riley & Howe, PLLC would be happy to answer your tax and financial questions regarding these issues or other matters that may be of interest to you or your business.