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As the number of private sector colleges and universities offering online programs grows, institutions need to understand their state tax compliance requirements for these programs.

Navigate the State Income Tax Requirements for Higher Education Online Programs

  • 11/11/2013

Navigate the State Tax Requirements for Higher Education Online Programs

by Wendi Boddy and Jennifer Rodriguez

As the number of private sector colleges and universities offering online programs grows and many states continue to broaden their tax laws to include businesses with no physical presence, it is increasingly important for institutions to understand their state tax compliance requirements.

What is nexus?

Each state’s right to tax revolves around nexus — the amount of activity required for a state to be able to tax a business’s income (or tuition revenue for higher education institutions). Historically, this was based on the business having a physical presence in the state. For instance, it is common for an online higher education program to hire professors across the country. This would result in the institution having a physical presence in each state where its professors come from, and would consequently trigger multiple state filing requirements.

However, many states have expanded their nexus provisions in the last several years to include “factor based” or “bright line” economic nexus standards. These say that businesses may be subject to state taxation if they have economic activity or presence in a state, even if there is no physical presence.

Online higher education programs may meet one of these economic nexus criteria. For example, the bright line standard in California says that even if you lack a physical campus in the state, a school is subject to state taxes if it exceeds any of the following thresholds:

  • $50,000 of property,
  • $50,000 of compensation paid to a state resident,
  • $500,000 of sales, or
  • 25 percent of its total property, compensation, or sales are in California.

Assessing exposure to economic nexus

Higher education institutions should ideally determine if they are subject to state taxes based on economic nexus before launching an online program. This should include a complete nexus analysis of each state that you expect to have a presence — whether it is physical or just economic. Calculating the tax liability for each state can help you determine where you may want to focus your campaigns for student enrollment. The nexus analysis may also help you determine what states you may want to target as a hiring ground for online professors, and those you may want to avoid.

If you have already launched an online program and have not had a complete analysis of state nexus standards, there may be additional filing requirements that should be addressed. Therefore, you should have a state tax professional assess your previous and/or current state tax law liabilities.

If you were previously subject to state tax laws (for instance, if you hired a professor in one state and the professor no longer works for you, but you never paid taxes for that state) you may be able to enter into a voluntary disclosure program. The program allows you to become compliant in a state and the penalties for compliance failure are waived.

Sourcing service revenues

Once you have determined your state tax filing requirements, you must assess how to source your service revenues (e.g., revenues generated from an on-line program) to comply with state laws.

State sourcing rules vary, but there are three general approaches:

  • Market based is the newest approach, and sources to the state where the benefit is being received. It is based on the location of the customer or location of the marketplace. Only 10 states have adopted this approach, but more are planning to move in this direction.
  • Cost of performance sources where the greatest proportion of the income-producing activity takes place based on cost of performance.
  • Pro-rata cost of performance is a hybrid between market based and cost of performance. It allocates receipts from services performed within the state and out of state based on a pro-rata calculation of cost/time or another reasonable method.

Economic nexus increase expected

Currently, only six states have expressly adopted an economic presence standard for income tax purposes, but this number is expected to increase. Nexus is an evolving area and must be continually monitored. Be sure to stay on top of the changing rules and how they apply to your institution.

Wendi A. Boddy, Principal, Higher Education
wendi.boddy@CLAconnect.com or 704-998-5286

Jennifer R. Rodriguez, Manager, Higher Education
jennifer.rodriguez@CLAconnect.com or 407-244-9335