Sourcing Service Revenue – A SALT Challenge
When businesses expand and obtain new clients in states they never had before, it’s exciting, but beware, it can also significantly complicate tax compliance.
If your company is a firm with projects in multiple states, the company should be aware of the growing trend surrounding revenue sourcing. States have been changing how they source service revenue for the past few years. Traditionally, most service businesses were only performing services in their home state. The cost of performing the service usually occurred in the same state as the benefit of the service received by the customer. Thus, a business only had to look to the laws of its home state to determine whether it owed tax on income from such revenue. Fast forward to 2022, and many, if not most, businesses are performing services across the US and internationally. As a result of this transition, determining which state the service revenue should be sourced has become increasingly complex.
With the shift to a nationwide business landscape, most states have moved from the cost of performance-based sourcing method to a market-based method for sourcing service revenue. However, not all states have decided to make a sourcing change. Some states remain committed to sourcing revenue based on the cost of performance method. Understanding a state’s sourcing rules is extremely important in determining a company’s income and franchise tax liability, as well as where a company has a filing obligation.
Rules – It’s Complicated
Both market-based rules and cost of performance rules vary on a state-by-state basis. A market-based state could determine its market based on where the benefit is received, where the service is received, where the service is delivered, or where the customer is located.
Under the cost of performance rules, when performance occurs in multiple states, service revenue may be attributed to the state where most of the work is performed (all-or-nothing). Other states will assign the service revenue on a pro-rata basis, based on the amount of costs incurred in each state.
To complicate matters further, because of the states use of two different sourcing methods, it is vitally important to be aware of the tax implications. The mixture of states in which a company conducts business could result in service revenue being sourced to multiple states. The consequence could be double taxation of the revenue or no taxation of the revenue at all.
Noncompliance or incorrect use of a sourcing method can have a significant impact on your bottom line. With tax authorities continuing to be aggressive with audits and enforcing compliance, now is the time to fully understand how revenue sourcing applies to your organization and the impact of state and local tax rules and regulations.
Join us on our upcoming webinar to learn about the different state methods of sourcing service revenue. We will also be covering state and local tax reminders, remedies, and recent developments.