Even before the global pandemic forced unprecedented levels of work from home, companies around the U.S. had begun to reevaluate where their employees could best do their work. Their newfound flexibility brings new complexity as employers buy into the concept that they can hire people in other states to work remotely and thereby obtain the employees they are looking for.
If a Vermont company (call them “Vermont Widgets”) employs two persons who work from their homes in New York, is Vermont Widgets then “doing business” in New York such that Vermont Widgets should register to do business in New York? Is the question affected by the fact that every aspect of its operations and manufacturing, except the two people working in New York, are in Vermont? Does the type of work being performed by the New York employees affect the determination? If the New York employees were both part-time, would that matter?
The first impulse of Vermont Widgets may be not to register. Once a company registers to do business in another State, it probably will have to file tax returns in that state. There may be other ramifications as well, including regulatory compliance, depending on the type of business the company is in.
Adding to the quandary is the point that the burden of making this determination rests with the company (Vermont Widgets). No state notice is required to hire an employee in another state. How would New York know that Vermont Widgets has two employees in New York?
Actually, New York will know. When a company has an employee in a state, it has a payroll in that state. As a result, the state is aware of the company doing business in their state. In New York, the employees will pay tax on their income from Vermont Widgets. Vermont Widgets must report that income. On the other hand, a state like Florida, where there is no income tax, might be thought of as a different calculus. Legally, it is not. If a company should register, it should register. Is an unregistered company with an employee(s) in Florida more likely to go undetected? Maybe. Our advice would be to register.
What about a situation where a company has employees that regularly come into a state to do business, but there are no employees resident in the state or company offices located in that state? The case law indicates that a company that regularly has operations in a foreign state has a “nexus” with that foreign state and should register.
What about hiring a consultant in another state? The question becomes whether the consultant is truly a consultant or an employee being called a consultant. If the consultant has other customers, sets their own hours, has their own office, uses their own computers, doesn’t use the company’s name or domain in their email signature (as well as other factors), they may be considered a consultant. But, if the “consultant” has no other customers, works full time for the company, works at the company’s office and/or the company supplies their office equipment and directs their hours and manner of working, then they are probably going to be considered employees.
In some cases, specific business activities are established as being exempt from foreign qualification. Knowing these exemptions (ie: consulting with your lawyer) can help you make informed decisions about registering and where you feel comfortable hiring remote workers. All states offer some form of “safe harbor” for business transactions that do not merit foreign qualification. For example, Pennsylvania, New York, Kansas, Florida, and Nebraska allow for out-of-state businesses to settle lawsuits (but not bring them) or have an in-state bank account without the need for registration. A company may not be doing business if it maintains a business bank account, defends a legal proceeding, solicits orders that require out-of-state acceptance or fulfillment, or simply owns property. We note that a company that is not registered to do business in a state generally cannot bring a lawsuit in that state’s courts.
How Is “Doing Business” Generally Defined?
Most states advise on what does not constitute “doing business” as opposed to what does constitute doing business in their state. That effectively leaves business people in a position of having to prove that they are not doing business in a state – in other words, they have to prove a negative. There is case law guidance that a company is “doing business” in a state when it transacts a substantial part of its ordinary business therein. We do not find this vague guidance helpful, nor do we think that most states agree. Our view is that the threshold for registering is low and that fighting with a state over this issue can be unduly expensive.
Doing Business Online Changes Things
Online businesses confront the “doing business” question every day. For example, a business that occasionally ships to customers in a state may not be required to qualify to do business, but it may be required to withhold and pay sales tax. Registering to collect and pay sales tax is a different process from registering to do business. The essential point is that out-of-state vendors should be subject to the same sales tax requirements as in-state vendors, regardless of whether they are actually “doing business” in the state for registration purposes.
What is the Exposure for Failure to Register
Penalties for doing business without proper registration can be severe. Different states have different penalties for failure to qualify, including fines that can accrue over time and be substantial. The burden of making this determination rests with the company. We have seen situations where a company did not register in a foreign state when they first started operating the foreign state, never thought about the issue again while doing business in the foreign state for years and then, out of the blue, was faced with fines for failure to register. One scenario where this can happen is if the company gets involved in a lawsuit.
The prospect of filing and paying taxes in multiple states can sound like more of a detriment than is really the case. As a general matter, states give credit for taxes paid in other states. There may not be perfect symmetry because different states have different tax rates and tax structures. But, a company’s tax advisors should be attuned to avoiding or minimizing double taxation.
Because states have such varied regulations about foreign qualification, in situations where there is not a strong presence in a given state, making the determination as to whether to register can be difficult. The risk if a company does not register is that if it is later determined that it should have registered, penalties and taxes may have accrued. This makes the potential exposure harder to quantify. You may decide that an ounce of prevention is more than worth a pound of cure in the future.