State and Local Tax Planning

"Nexus" is simply the legal term for the connection between your business and a state that's strong enough to let that state tax you. No nexus, no filing obligation, no matter how much money the business makes. Establish nexus, and the state can generally require you to register, file, and pay, on the share of income (or sales) properly attributed to it. There are two broad ways nexus gets created.

Physical presence nexus

This is the traditional standard: an office, a warehouse, inventory stored in a fulfillment center, a job site, or an employee physically working in a state generally creates nexus there. It predates the internet-driven changes to sales tax law and remains a valid, independent basis for nexus in every state. A single employee, even one working from a spare bedroom, typically counts.

Economic nexus (the Wayfair standard)

In 2018, the Supreme Court's decision in South Dakota v. Wayfair upheld a state's right to require an out-of-state seller to collect and remit sales tax based purely on economic activity, no physical presence required, once the seller's sales into the state crossed a defined threshold (South Dakota's own law set that at $100,000 in sales or 200 separate transactions annually). Most states with a sales tax adopted similar economic nexus thresholds afterward, commonly built around $100,000 in annual sales, though the details (whether a transaction-count alternative exists, whether the threshold counts gross or taxable sales) vary and continue to be adjusted state by state.

Several states have extended a similar economic-nexus logic to income tax through what's often called "factor-presence nexus," where crossing a sales, property, or payroll threshold in a state creates an income tax filing obligation even without a physical presence. This is not universal and the thresholds are not standardized, so it has to be checked state by state rather than assumed from the sales tax rule.

Of every nexus trigger businesses miss, this is the most common: a single remote W-2 employee working from home in a state most businesses have never had to think about creates physical presence nexus there in most states, for income tax, and often for franchise tax and payroll withholding as well. It doesn't matter that the business has no office, no customers, and no other connection to the state. The employee's home is treated as the business's presence.

There's a narrow federal protection worth knowing about, and worth not over-relying on: Public Law 86-272 shields some out-of-state sellers of tangible personal property from state income tax, but only if their in-state activity is limited to soliciting orders. It never protected service businesses, and a remote employee who does anything beyond pure solicitation (answering support tickets, doing administrative work, providing services, managing accounts) forfeits the protection for the business in that state. For most modern remote-first businesses, especially service and software companies, this protection either never applied or evaporates the moment the employee does normal remote-work tasks.

Once a state has nexus over your business, apportionment is the formula that decides what share of your total income that state actually gets to tax. The traditional approach, built on the Uniform Division of Income for Tax Purposes Act, is a three-factor formula: a state looks at your payroll, property, and sales located in-state as a percentage of the same figures company-wide, then generally averages the three percentages to get its apportionment share.

Most states have since moved to some version of single sales factor apportionment, where only your sales into the state (not payroll or property there) determine the taxable share. The practical effect for a services or software business: your biggest customer states, not the states where your team physically sits, tend to drive the largest state tax bills. This is precisely why remote hiring and sales growth can pull a business's SALT exposure in different directions at the same time, more sales in a state raises the apportionment share there under a single-sales-factor rule, while a remote hire in an entirely different state can independently create nexus with a comparatively small apportionment share.

Since 2018, individual taxpayers who itemize have faced a federal cap on deducting state and local taxes, originally $10,000 regardless of filing status. For business owners in high-tax states with large pass-through income, that cap could mean losing a federal deduction for a large chunk of state tax actually paid. In November 2020, the IRS issued Notice 2020-75, signaling that regulations would permit a workaround: if an S-corp or partnership pays state income tax at the entity level instead of passing the full liability to owners, that tax is deductible as an ordinary business expense on the entity's federal return, outside the individual SALT cap entirely.

Since that notice, most states with a personal income tax have enacted their own version of this pass-through entity tax, often called a PTET or "Taxed PTE" election. The general shape is consistent: the entity elects (usually annually) to pay state tax on its income directly, the entity deducts that payment federally, and owners then either exclude the taxed income from their personal state return or claim a credit for the tax the entity already paid, depending on the state's specific mechanism. Beyond that shared shape, the details diverge sharply: election deadlines, tax rates, which entities qualify, how nonresident owners are treated, and whether the election is a one-time choice or has to be renewed each year all differ by state. This is not a "set it and forget it" election; it needs to be evaluated every year, in every state where the entity operates.

One more moving piece worth flagging clearly: the federal SALT deduction cap itself rose to $40,000 for 2025 and 2026 under recent legislation, up from the original $10,000. That materially changes the math for business owners whose state tax bill sits closer to that higher cap; the PTET election may now save less federal tax than it did a few years ago, or none at all, depending on the owner's specific state tax liability and income level. Every PTET decision needs to be re-modeled against current-year numbers rather than repeated from a prior year's playbook.

Illustrative example, not a specific client outcome, and not a specific state's actual rules; figures are simplified for illustration. A consulting S-corp is headquartered and taxed as a resident in State A. It hires one remote employee living in State B, and over the course of the year its client base grows so that a meaningful share of its total revenue comes from customers located in State C, even though nobody on the team lives there and it has no office there.