Multi State S Corp Advice

Client is a single owned S Corp registered in TX. All of the employees / offices are located in TX. Business provides AI consulting services to TX clients, but also serves clients in various states. These are often large one time contracts and annual revenues associated to each state will often exceed nexus thresholds set by each state. For example, in 2021, CA sales exceeded the CA sales threshold of $637,252 and CO sales exceeded the CO sales threshold of $500,000. Additionally, the states fluctuate from year to year and no state returns have been filed previously from past accountants. Based on this, would I be required to file an S Corp return for each state as well as an individual non-resident return? Would the entity have to register in each state year to year? Thanks for any guidance.

Based on this, would I be required to file an S Corp return for each state as well as an individual non-resident return?

Yes
Consider pass through entity tax elections where available.

Would the entity have to register in each state year to year?

Probably.

#2 is technically correct, but when I worked at a firm and we had these type of clients, they would let the client decide.
The partner would explain the issue to client and put it in some kind of a formal communication like a client letter. If the client chose to file in the state, we would file. If not, we wouldn't. The client was advised about a potential state registration requirements too, but the firm didn't provide the registration service.
The economic nexus issue isn't always so clear cut. The revenue may exceed state threshold, but states differ on tangible vs intangible revenue, COP vs Market based sourcing, who the ultimate customer is, etc. For example if service is provided to a customer in state A but their business headquarters and the invoice is in state B, there's can be ambiguity where nexus exists.
In many cases there can be enough ambiguity to give client a choice on filing.

Prefacing that I'm not an attorney, but why would a business register as a foreign entity with the state's secretary of state if the business' only connection to the state is that clients are within the state and receive the benefit of services there? Do most states have an economic nexus for "doing business" in this context?

These are often large one time contracts

Many states also have a provision that if the business is not carrying on regularly in that state then no filing is required.

Agree with LDCPA...explain the filing requirement for each state each year to the client and let them decide. I've had clients that wanted to file in every state that they started doing business in to never have to worry about it coming back later. Other clients choose not to file in other states until the other state sends them a letter.

Prefacing that I'm not an attorney, but why would a business register as a foreign entity with the state's secretary of state if the business' only connection to the state is that clients are within the state and receive the benefit of services there? Do most states have an economic nexus for "doing business" in this context?

Economic nexus is now the primary method of nexus in most states. Some require registration with the SOS, others just want a tax return. Depends on each one, which is why I oh-so-love multi-state filing requirements. I advise clients of the needs and let them decide. Conservative ones will file in every friggin' state needed, less conservative will say "don't worry about it if it isn't at least six figures since I do not expect to deal with them again."

I obtained further clarification from the client in that all of the work is being done in TX, including any deliverables. So there aren't any services actually being provided in these other states, the customer is only located there.

CA defines sales as a "(1) Sales from services are in this state to the extent the purchaser of the service received the benefit of the services in this state" (Section 25136) - So as long as the customer received the benefit of the consulting service in CA, it would be considered a taxable sale?

CO would include the service "In the case of the sale of a service, to the extent the service is delivered to a location in Colorado;"

It appears both states (market based sourcing) would consider the consulting services as taxable sales in the states even though the work was performed outside the state?

Definitely for CA. The relevant case is Bindley. The OTA said income paid by the CA company was CA sourced. They ignore economic nexus thresholds for services. https://ota.ca.gov/wp-content/uploads/s ... 053019.pdf

You said that the returns have not been filed in prior years. Be sure to CYA. State in writing that returns are required and that they remain exposed for prior years and that the statute of limitations does not run on returns that were required and not filed. I have seen CA come after someone 20 years later....the annual $800 plus taxes and interest gets expensive.

Of course, the atty should check SOS filing requirements. He probably has to register.

Going forward, don't forget about the S corp's ability to pay the PTE to get around the SALT cap. You are too late for 2022 unless they change the law. Payments was due 6/15.

Seriously consider zeroing out the profit via W2 wage payments to the owner(s). Not great from a FICA standpoint, but if some state says, “You should have filed with us!” then you can file there, knowing that an X% apportionment percentage times a zero profit is $0.

Definitely for CA. The relevant case is Bindley. The OTA said income paid by the CA company was CA sourced. They ignore economic nexus thresholds for services. https://ota.ca.gov/wp-content/uploads/s ... 053019.pdf

You said that the returns have not been filed in prior years. Be sure to CYA. State in writing that returns are required and that they remain exposed for prior years and that the statute of limitations does not run on returns that were required and not filed. I have seen CA come after someone 20 years later....the annual $800 plus taxes and interest gets expensive.

Of course, the atty should check SOS filing requirements. He probably has to register.

Going forward, don't forget about the S corp's ability to pay the PTE to get around the SALT cap. You are too late for 2022 unless they change the law. Payments was due 6/15.

Ah that is a great case for this situation. Thank you, I will certainly write out the consequences of this along with prior years and see how they want to proceed.

Seriously consider zeroing out the profit via W2 wage payments to the owner(s). Not great from a FICA standpoint, but if some state says, “You should have filed with us!” then you can file there, knowing that an X% apportionment percentage times a zero profit is $0.

This is interesting. The owner is looking at over ~ $1M in profits and I think the medicare savings would still exceed the state tax, but I will have to run the numbers now.