State and Local Tax: What Every Manufacturer Needs to Know

The following article is adapted from a conversation originally recorded for The Manufacturing Minute podcast, hosted by Megan Meador, Audit & Assurance Partner and Manufacturing & Distribution A&A Practice Leader at Brown Edwards. The discussion has been edited and formatted for readability while preserving the key insights shared during the episode.

In this episode, Megan sat down with Brown Edwards Partner Rich Hedley, one of the firm's State and Local Tax (SALT) Practice Leaders. With more than 25 years of public accounting experience, Rich advises closely held businesses across a variety of industries, including manufacturing, on complex state and local tax matters. As states continue to face increasing revenue pressures and tax regulations become more complex, manufacturers are finding themselves under greater scrutiny from state taxing authorities.

Their conversation explores the evolving SALT landscape, common areas of risk and exposure for manufacturers, and practical steps businesses can take to stay compliant while minimizing unexpected tax liabilities. Whether your company operates in multiple states, is experiencing growth, or simply wants to better understand today's tax environment, this discussion offers valuable insights for manufacturing leaders.

Why Manufacturers Should Care About SALT

Most of our listeners are in the manufacturing and distribution space, so why should they care about state and local taxes? Rich’s answer made it clear that SALT, as he likes to call it, can have a significant impact on a manufacturer's cash flow and operational decisions. Federal tax is complicated enough, but with state tax you're dealing with thousands of jurisdictions, each with its own rules. And it isn't just income tax. You're also talking about sales and use tax and property tax.

As Rich put it, cash flow is king for manufacturers, and the consequences of ignoring multi-state issues can be very costly. Penalties and interest can add up quickly and eat into the cash a business needs for its operations. The first issues he tends to see are Nexus issues, because manufacturers need to determine where they are required to file returns, not just income tax returns but sales and use tax returns as well.

Understanding Nexus

To put it simply, Rich explained that Nexus is just a connection between a taxpayer and a taxing jurisdiction, and that connection has to be sufficient enough for the state to impose a tax, whether that's income tax, sales tax, or property tax. The phrase he kept coming back to was "sufficient enough." Many states have differing laws governing what connections rise to that level, and while there are similar themes from state to state, there are still a lot of nuanced differences. That's exactly where Brown Edwards can help manufacturers navigate the rules.

Physical presence almost always creates Nexus. When Rich talks about physical presence, he means your people, your employees, your property, your inventory, machinery, and equipment. If you have a physical presence within a state, that's almost always going to create Nexus. But the key point manufacturers need to understand is that physical presence is no longer the only standard, which adds to the complexity. Economic nexus and factor presence nexus are becoming more and more prevalent, and most states want to move away from physical presence being the only determination.

Why? Because everything is online these days. Businesses don't necessarily have to have a physical presence in a state to do a lot of business there, so states are becoming more aggressive in using economic nexus standards because they don't want to miss out on tax revenue.

How Economic Nexus Is Measured

Over the past several years, the definition and measurement of Nexus has changed dramatically, so I asked Rich to explain economic nexus. He told me it's measured by a business's level of economic activity within a state, almost always using one or both of two metrics:

• Revenues or gross sales within the state.
• Number of transactions within the state, though many states are moving away from this and focusing mostly on gross sales.

For sales and use tax purposes, there is a bright-line sales number that creates economic nexus, and for most states that figure is $100,000. Some states set higher thresholds, but the vast majority land at $100,000. Where states still use the number-of-transactions method, the typical trigger is 200 transactions or more within that state.

Rich also explained how gross sales are measured by state, which is typically through destination-based sourcing. For manufacturing, for both income and sales and use tax, the sale is measured by the location of the business's customer, in other words, where the product is being shipped to. And to make matters more complicated, economic nexus standards can differ for income tax versus sales and use tax. While sales tax purposes have a bright-line test, not all states have a bright-line test for income tax economic nexus, which makes it harder for businesses to evaluate whether they should be filing an income tax return.

Once You Have Nexus: Registration and Apportionment

So what happens once Nexus is established? If you're a manufacturer shipping product into multiple states, what's the next step? Rich walked us through it. Once it's determined that you have Nexus in a state, the next step is registering in that state for the applicable tax. After that comes determining what your tax actually is, which is done through apportionment.

Quite simply, apportionment is a method to determine the business taxable income subject to tax in a particular state. At its most basic, it's a formula: total sales within the state divided by total overall sales of the company, which gets you a percentage. You then apply that percentage to federal taxable income, subject to state adjustments. States don't always conform to federal tax law, and Rich noted you see this most often with tax depreciation. Federal law allows 100 percent bonus depreciation, but many states don't adhere to that, so you have to make an adjustment to arrive at state taxable income.

To make things even more complicated, apportionment rules vary by state. Some states use three-factor apportionment, which adds payroll (your wages in the state divided by overall wages) and property (your property in the state divided by overall property) to the sales factor. Those factors can be weighted differently as well, so just because two states both use three factors doesn't mean they treat them the same way. Many states are moving toward a single sales factor approach, concentrating only on sales within the state divided by overall sales.

A bright spot for manufacturers: Rich pointed out that some special apportionment factors are designed specifically for manufacturers, and Virginia is one of those states. Virginia is typically a three-factor apportionment state for most businesses, but if a company meets certain criteria, which is typically wage-based, paying employees a certain amount above the norm, it could potentially use single sales factor apportionment. Why would you want to? If all of your employees and property are in Virginia, you're effectively at 100 percent on those two factors. If you're only averaging a small amount of Virginia sales compared to other states, a single sales factor can lower your apportionment percentage, which can mean significant tax savings, particularly for C corporation manufacturers.

Common Sales and Use Tax Pitfalls

Sales tax always seems to be a hot topic, so I asked Rich about the common pitfalls he sees manufacturers run into. He explained that some of the biggest risks involve filing requirements and whether manufacturers have Nexus in multiple jurisdictions. As he says, he'll repeat it forever: physical presence creates Nexus in all cases, and economic nexus has that bright-line test we discussed.

The trickier part is that physical Nexus has some common traps for businesses that aren't thinking about them. Rich shared several examples:

• Holding inventory in third-party warehouses out of state, including staging inventory in another state to help with shipping costs.
• Sending service technicians across state lines.
• Having remote employees working in another state.
• Sending employees to trade shows in other states.

That last one surprised me. Manufacturers often send people to trade shows thinking that being there only a day or two shouldn't create Nexus, or they're not thinking about it at all. But Rich noted that one day can certainly create Nexus in some states. He's seen states like New York and Massachusetts, both higher income tax and sales and use tax states, assert Nexus in these situations. It's incumbent on businesses to understand that physical presence creates these risks for both sales and use tax and income tax.

The Manufacturing Exemption Opportunity

On the opportunity side, Rich highlighted manufacturing exemptions from sales and use tax as something businesses really need to be aware of. Virginia in particular has exemptions for machinery and equipment that's actually used in the production of a product. The complication, he explained, is determining what actually qualifies as machinery used in production. The machine itself is easy, but what about the parts attached to it, or the ancillary support equipment?

Most states apply what's called a direct use test, meaning the machinery must be an integral part of producing the product and not just supportive. It's a gray area that can result in either overpaying tax if you miss the exemption, or underpaying tax if you apply an exemption when you shouldn't. As Rich noted, that's exactly where Brown Edwards can come in to make sure the exemption is applied appropriately.

Don't Overlook Property Taxes

Property tax doesn't usually get as much attention, but it should. I shared with Rich that in my own past working at a coal company, we would scrub the fixed asset listing every year to make sure we weren't paying property tax on items that had been disposed of or were no longer there. Rich was glad to hear it, because a lot of businesses ignore that step, and that's where issues come into play.

Property tax is calculated on a base value, including furniture, fixtures, machinery, and equipment, with that value multiplied by the tax rate set by the local taxing authority. Companies can't really control the tax rate, other than through lobbying and elections, so the best way to manage the bill is to control the tax base, the value, and make sure it's as low as legitimately possible.

One of the biggest mistakes Rich sees is the misclassification of assets. It's important to evaluate the mix of business personal property to make sure items are in their proper categories, because different types of personal property carry different tax rates. For manufacturers in particular, machinery and equipment typically has a reduced tax rate, especially in Virginia. He also cautioned that inventory should be kept well away from personal property tax returns, since for the most part it's exempt.

Rich pointed to several other opportunities to reduce a property tax bill:

• Appealing assessments where it makes sense, rather than simply accepting them as many companies do.
• Checking that the original cost basis isn't incorrect.
• Scrubbing the asset list so that disposed assets aren't still being reported.
• Making sure you're not double counting assets or misapplying depreciation schedules.
• Reviewing the assessed value to confirm it doesn't exceed the fair market value of the assets.

As Rich reminded us, property tax can be one of the largest bills any company receives, manufacturers included, so there's real value in this work.

A Real Success Story: Saving a Client Over $90,000

Our listeners always love a good story, especially one where real dollars were saved, so I put Rich on the spot. He shared the example of a company that does a lot of lumber work and had a North Carolina sales and use tax issue. The company had Nexus in North Carolina but had never filed any North Carolina sales and use tax returns. Brown Edwards was able to get them into what's called a voluntary disclosure agreement with the state, saving them over $90,000 in penalties.

I asked Rich whether a voluntary disclosure agreement is essentially coming to the state humbly and saying this wasn't intentional, and he confirmed that's absolutely correct. With most states, you outline the facts of the case to the state anonymously, so you're not yet coming forward as the taxpayer. The state will either accept the facts or not. When they accept, they typically limit the number of years of filings to three or four years and abate any penalties associated with those years. From there, you start filing your sales and use tax returns prospectively going forward.

There's an important catch: to qualify for a voluntary disclosure agreement, the state can't have already contacted you through a notice or a Nexus questionnaire. States are willing to accept these agreements because they effectively didn't know about you, which is what makes the arrangement attractive. In this case, $90,000 in penalties was a big incentive to come forward and pay the tax that should have been paid all along.

What really drove the point home was the timeline. This company had been doing business in North Carolina for over fifteen years. As Rich explained, if you have never filed a tax return, there is no statute of limitations, so theoretically the state could go back the full fifteen years and assess penalties and interest on top of the tax. Being able to limit that exposure to three or four years is a very good outcome for the taxpayer, and coming clean when the state doesn't yet know about you is great for the state too.

How Brown Edwards Can Help

To close out our conversation, I asked Rich to walk our listeners through the services Brown Edwards offers that could help in situations like these. He outlined several:

• Nexus studies to help determine which states a business or manufacturer should be filing in, from both an income tax and a sales and use tax perspective.
• Voluntary disclosure agreements, which Brown Edwards can help prepare and file, assuming the state hasn't already contacted you about the liability they think you owe.
• Sales and use tax reviews to identify refund opportunities and ensure business systems are properly calculating sales tax and not missing out on use tax. Rich noted this often comes up with resale certificates, where companies buying products to resell sometimes end up using those products in their own business and fail to assess use tax, which can get them into trouble.
• State tax audit representation, particularly here in Virginia, which Rich described as pretty aggressive with sales and use tax audits. Brown Edwards can help mitigate any assessments the state might issue.

These reviews can identify where you're not paying enough tax as well as where you're paying too much and may be due a refund.

Final Thoughts

This is a topic I see every single day working with my manufacturing clients, and I'm grateful to Rich for sharing his expertise. State and local tax may be complex, but as this conversation showed, understanding Nexus, apportionment, exemptions, property tax, and tools like voluntary disclosure agreements can protect your cash flow and uncover real savings.

If you're interested in any of these services, both Rich's and my contact information is available on our website at www.becpas.com.

  • 25 min

Cash Flow Is King: Navigating State and Local Tax in Manufacturing

Manufacturing Minute

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