The State Tax Trap: Why Multi-State Reporting Matters
Running a business in the United States often feels like one big operation. But from a tax perspective, it’s not.
Running a business across multiple states is actually like playing 50 different board games at the same time. Each game has different rules, different pieces, and different penalties when you mess up. The worst part? Most founders don’t even realize they are playing until they get hit with a bill.
The United States is not one unified tax system; it is 50 separate tax jurisdictions stitched together. While federal law is consistent, state laws are chaotic. If you operate in more than one state, you cannot simply choose to pay tax in your home state.
If you get apportionment wrong, you can end up being taxed on 120% of your income.
Here is what you need to know to avoid the traps of multi-state compliance.
The "Secret Remote Employee" Mistake
The most common trigger for multi-state tax issues is the "Secret Remote Employee."
Imagine a company based in Oregon allows an employee to move to Colorado. The company keeps running payroll as if the employee is still in Oregon. To the founder, nothing has changed. To the state of Colorado, everything has changed.
That one remote employee creates Physical Nexus in Colorado. Suddenly, the company owes:
Colorado withholding tax
Colorado unemployment tax
Colorado corporate income tax
Often, Colorado sales tax compliance
Colorado usually finds out when that employee eventually files for unemployment. That is when the state sends a bill for years of back taxes plus penalties.
Understanding Nexus: The Invisible Fence
Think of Nexus like an invisible fence around every state. Once you step inside that fence, that state gains the right to tax you. You can step inside that fence in two ways:
1. Physical Nexus This is "boots on the ground." You create physical nexus if you have:
An office or coworking space
An employee or dedicated contractor
Inventory (Note: Amazon FBA inventory counts)
2. Economic Nexus You can owe tax in a state without ever setting foot there. Most states use a threshold of $100,000 in sales OR 200 transactions.
That "OR" is dangerous. If you sell 200 items for $5 each, you have only made $1000, but you have crossed the transaction threshold. You now have to register and collect sales tax.
Myth Buster: Many founders believe SaaS (Software as a Service) isn’t taxable. Wrong. More than 20 states tax SaaS exactly like a physical product.
The Three Types of Tax You Need to Know
It is vital to distinguish between the different types of taxes because they are triggered differently.
1. Sales Tax (Transaction Tax)
This is triggered by sales volume or physical presence. Even if your business loses money, sales tax still applies. Warning: Sales tax is considered "trust fund money." If you fail to pay it, the state can come after you personally.
2. Income Tax (Profit Tax)
Triggered when you have substantial activity in a state. Hiring employees or providing services often removes the protection of operating out of state
3. Gross Receipts / Franchise Tax
This is where many startups get hurt. These states tax you even when you lose money. They tax revenue, not profit.
Washington (B&O Tax)
Texas (Franchise Tax)
Ohio (CAT)
Nevada (Commerce Tax)
Delaware (Franchise Tax)
The Problem States
While every state has rules, a few are notorious for catching founders off guard:
California: Known for aggressive enforcement. You create nexus once you pass $500k in sales. Even if you just "manage" the company from CA, the state may treat the entire business as operating there. plus, there is an $800 minimum franchise tax just for existing.
Texas: Texas has no income tax, but it has a "Margin Tax" based on revenue. Service businesses usually cannot deduct COGS. Even if you are under the $2.47M threshold, you must file a "No Tax Due" report or risk having your entity forfeited.
New York: Famous for the "Convenience of the Employer" rule. If your company is NY-based and a remote employee works elsewhere, NY may still tax 100% of their wages.
The Compliance Trinity
Once you cross nexus in a new state, you generally owe three things (The Compliance Trinity):
Income or Franchise Tax Return
Sales Tax Return
Annual Report (Filed with the Secretary of State)
Do not overlook Foreign Qualification. If you are doing business in a state (signing contracts, holding bank accounts, having employees) but haven't registered with the Secretary of State, you are operating illegally. You can be fined, and perhaps worse, you lose the right to sue anyone in that state.
Summary: When to Call a Pro
Don’t let taxes stop you from hiring great people or expanding to new markets. Multi-state growth is good—but compliance is not optional.
You should book a consultation with a CPA if you are:
Hiring your first remote employee.
Crossing $100k in sales in a new state.
Using a 3PL or Amazon FBA (inventory creates nexus).
Signing big contracts in new states.
Planning to operate in aggressive states like CA, NY, TX, WA, or PA.
The right setup today prevents a six-figure tax bill tomorrow
