EFFECTIVE MANAGEMENT OF COMPLEX STATE & LOCAL TAXES

A Strategic Guide for Architecture and Design Firms Doing Business Across State Lines

By Martin E. Prendergast, MBA
Gray, Gray & Gray, LLP

What You’ll Learn

• Why do architecture and design firms have greater SALT exposure than firms operating in only one state?
• How nexus is established and what triggers tax obligations in states where your firm has no physical presence
• The risks associated with economic nexus, project-based work, and traveling employees or subconsultants
• How states use audit programs to identify non-compliant firms and pursue back taxes, interest, and penalties
• What an active SALT strategy involves and how Gray, Gray & Gray helps architecture and design firms develop one
• How to use voluntary disclosure programs to resolve past exposure before state authorities initiate contact

The Multi-State Reality of Modern Practice

Architecture and design firms often pursue projects across multiple states. For example, a Boston-based firm may secure projects in Nashville, Philadelphia, and Denver within the same fiscal year. While this demonstrates a strong, competitive practice, it also exposes the firm to the complexities of U.S. tax laws.

State and local tax (SALT) is not a unified system. Instead, it consists of 50 state tax regimes, hundreds of local jurisdictions, and thousands of interacting rules. Crossing state lines to do business can create tax obligations that may go unnoticed. States, facing revenue pressures and using advanced data analytics, are actively identifying such firms for owners, managing principals, and financial managers of architecture and design firms who suspect their multi-state exposure may be greater than they realize, or who want to get ahead of an issue before it becomes a problem. The strategies described here represent how Gray, Gray & Gray, LLP approaches SALT planning for firms in the AED industry.

Nexus: The Word That Changes Everything

Nexus is the concept that creates a tax obligation in another state. Historically, nexus required a physical presence, such as an office, employee, or equipment. This threshold was manageable, allowing firms to plan accordingly.

This is no longer the case.

Following the U.S. Supreme Court’s 2018 ruling in South Dakota v. Wayfair, states gained the authority to impose economic nexus standards. Under economic nexus, a company can incur a tax obligation in a state simply by exceeding a certain revenue or transaction volume threshold there, even without any physical presence whatsoever. Although Wayfair specifically addressed sales tax, many states have increasingly adopted or enforced economic nexus standards for income and franchise taxes as well.

For architecture and design firms, this creates a complex challenge. Physical nexus triggers still apply. Sending a project manager to another state for site visits over several months likely creates nexus. In some jurisdictions, the activities of subcontractors or subconsultants operating in-state may contribute to nexus exposure. When combined with an economic nexus, the number of states where your firm may have tax obligations increases significantly.

A Common Scenario

A 30-person architecture firm based in Connecticut secures major projects in New Jersey and Virginia. Senior staff travel for site visits over 18 months, and contracts total $2.4 million in each state. In both cases, physical and economic nexus thresholds are likely met. Without a timely filing strategy, the firm may owe income and/or franchise taxes in both states, along with interest and penalties from the date nexus was established.   

Why Architectural Firms Face Particular Risk

Not all professional services firms face the same SALT complexity. Architecture and design firms encounter factors that significantly broaden their exposure. Unlike sellers of tangible goods that may qualify for limited federal protections under P.L. 86-272, architecture and design firms generally receive little protection from state income-tax nexus standards because their activities involve services rather than the solicitation of product sales.

Project-Based Revenue Creates Concentrated Exposure

Unlike companies that sell products across broad territories, architecture firms may generate most of their revenue in a state from a single large project. This concentration can push a firm over an economic nexus threshold in one quarter, creating obligations that may last for years. Extended project schedules and the physical presence of staff, consultants, and subcontractors further increase exposure.

Traveling Employees Create Phantom Nexus

Each state has its own rules regarding employee activity that triggers nexus. Some states use a strict day-count threshold, while others apply a subjective standard based on income-producing activities. For example, a principal spending two weeks on a site in Georgia or a designer traveling to Phoenix for client presentations may establish nexus, even if the firm has no other presence in those states.

Payroll tax is another consideration. When employees work in multiple states, the firm may have withholding obligations in each state. Mishandling this can create liability for both the firm and employees, whose personal tax returns may need to reflect income allocated across several states.

Subconsultants Complicate the Picture

Architecture firms often engage specialists such as mechanical or structural engineers and landscape architects who may be located in other states or perform work outside the firm’s home state. In some jurisdictions, using a subconsultant with in-state presence can create nexus for the hiring firm, even if it never operates directly in that state. This nuance often catches firms off guard.

Sourcing Rules are Evolving

Over three-quarters of U.S. states that levy corporate income taxes use market-based sourcing to assign service revenue, meaning receipts are sourced to the location where the customer receives or uses the service. The remaining states primarily rely on the “cost of performance” rule, sourcing sales to the location where the service is performed. This significantly impacts architecture and design firms that may be completing project work at their primary home-state office. If nexus is established, and the state where the end project sits is a market-based sourced state, then all the revenue for the project is sourced to that state.

Sales Tax on Services Is Spreading

Professional services have historically been exempt from sales tax in most states, but this is changing. More states are considering or implementing taxes on certain professional services, including design and consulting work. Firms should not assume they are exempt from sales tax in every jurisdiction.

The Audit Environment Has Changed

States have historically struggled to identify non-resident businesses operating within their borders. That challenge has largely been solved. States previously struggled to identify non-resident businesses operating within their borders, but this is no longer the case. States now use third-party data, federal tax returns, construction permits, licensing records, and social media to identify firms doing business without filing returns. They typically identify records that the firm may not even realize are publicly available. They are not guessing. They often already have a detailed picture of what the firm has done in their state.

The consequences of an audit revealing years of unfiled returns are significant. Interest accrues from the due date, often at rates between 8 and 12 percent annually. Penalties for failure to file and pay can add 25-50 percent more. If the failure is deemed willful, responsible parties within the firm may face personal liability.

The Lookback Risk

Most states have a statute of limitations of three to four years for tax assessments. However, if a taxpayer has never filed a return in a state, the statute may not begin. A firm operating in a state for 10 years without filing could face 10 years of liability if audited, limited only to the state’s records.

What a Forward-Thinking SALT Strategy Looks Like

Firms that proactively address their SALT obligations are in a much stronger position than those that wait. Effective SALT planning involves several interconnected disciplines.

Nexus Mapping

The first step is to understand where your firm has exposure. This requires a systematic review of current and recent projects, employee travel, subconsultant arrangements, and revenue by state. Gray, Gray & Gray conducts detailed nexus analyses for architecture and design clients, mapping these factors against each state’s thresholds to provide a clear picture of obligations and potential risks.

Apportionment Planning

Once nexus is established, the firm must determine how much income is taxable in each state. Most states use an apportionment formula based on sales, payroll, and property. Many now use a single-sales-factor approach, making revenue sourcing critical. Sourcing rules vary: some states use the place where services are performed, others the place where the client receives the benefit. These differences can significantly affect taxable income. Proactive apportionment planning, including engagement documentation and cost allocation, can influence effective state tax rates.

Voluntary Disclosure Programs

For firms with past exposure, voluntary disclosure agreements are usually preferable to waiting for an audit. Most states offer VDA programs that allow businesses to disclose prior liability, receive a limited lookback period, and obtain penalty waivers. In exchange, firms pay tax and interest for a defined period, typically 3 to 4 years, rather than facing unlimited lookback and full penalties.

Gray, Gray & Gray has guided many architecture and design firms through the voluntary disclosure process, often across multiple states. Coordinating these efforts requires careful management of timing and disclosure terms to avoid issues in one jurisdiction while resolving them in another.

Active Compliance Management

Proactive SALT management is an ongoing process. Firms should integrate procedures to ensure that new projects trigger nexus reviews, employee travel is tracked for payroll tax compliance, and filing obligations are consistently met. For firms without dedicated tax staff, outsourcing to an advisor with industry expertise is often more effective than managing internally.

Why Industry Knowledge Matters in SALT

SALT is complex in any industry. However, the factors that determine a firm’s exposure, such as revenue sourcing, employee site visits, and subconsultant agreements, require a detailed understanding of how architecture and design firms operate.

Gray, Gray & Gray has decades of experience working with architecture, engineering, and design firms. We understand project lifecycles, fee structures, subconsultant engagement, and site-based work. This expertise allows us to identify exposures and opportunities that generalists may overlook.

Our SALT practice is integrated with our broader advisory services for the AEC industry. This integration is important because SALT decisions impact payroll taxes, income apportionment, and entity structure. Coordinating these elements in a unified strategy distinguishes effective planning from a piecemeal approach.

The Cost of Waiting

Firms often delay addressing SALT exposure, viewing it as a manageable issue for later. However, costs increase over time as interest accrues monthly. Audit selection is now more data-driven and targets professional services firms with multi-state projects. States are increasingly able to identify out-of-state firms.

The best-positioned firms treat SALT as a strategic business issue, not just a compliance task. At the scale where SALT exposure can reach six or seven figures in back taxes, interest, and penalties, it requires the same attention as project management, insurance, or talent retention.

Gray, Gray & Gray is prepared to help your firm assess its position and develop a tailored plan. The process begins with a confidential nexus review, which often reveals exposures even for firms confident in their compliance.