Multistate Tax for Consultants: When a Client in Another State Means a Return There, and When It Doesn't

Consultants cross state lines constantly and file in one state habitually, and the gap between the two is the exposure. The federal backdrop: Public Law 86-272 prohibits a state from imposing a net income tax on a business whose only in-state activity is soliciting orders for sales of tangible personal property shipped from outside the state — a protection that, by its terms, does not extend to services; a consultant has no federal shield, and each state's own nexus rules govern. Nexus — when a state can tax the consultant's income. Physical presence: a consultant who works at a client's site in another state has physical presence there — an employee (or the owner) performing services in the state is the classic nexus trigger, and most states assert income tax nexus from the first day of in-state work (some have de minimis thresholds for a few days of presence); a consultant who never sets foot in the client's state and delivers the engagement remotely has no physical presence there. Economic nexus: a growing number of states assert income tax nexus on businesses with no physical presence but with in-state sales above a threshold ("factor presence" or economic nexus — commonly US$500,000 of in-state sales, or a fraction of the business's total sales or payroll or property, with the thresholds and formulas varying by state), so a remote consultant with a large client in an economic-nexus state may owe that state's income tax on the revenue sourced there without ever visiting. Sourcing — how much of the income each state taxes: once a state has nexus, it taxes the share of the business's income (net of the consultancy's deductions) apportioned to it, and for service revenue the apportionment turns on the state's sourcing rule — market-based sourcing (the revenue is sourced to the state where the client receives the benefit of the service — the majority approach now, and the one that puts a remote consultant's revenue in the client's state) or cost-of-performance sourcing (the revenue is sourced to the state where the service is performed — the older approach, which puts a remote consultant's revenue in the consultant's own state); the two rules can tax the same revenue in two states (the consultant's cost-of-performance home state and the client's market-based state) with no credit between them at the business level for a pass-through — the double-tax exposure the multistate consultant manages by knowing each state's rule. The owner's personal side: a pass-through consultancy's income flows to the owner, who files a nonresident return in each state where the business has nexus and apportioned income, pays that state's tax on the nonresident share, and claims a credit on the resident state's return for taxes paid to the nonresident states (the resident-state credit — the mechanism that prevents most double taxation at the individual level, subject to each state's credit rules and the mismatch when the nonresident state's sourcing puts more income there than the resident state's does); the states' pass-through entity tax elections (an entity-level tax that is federally deductible without the SALT cap, with a corresponding credit to the owners) add a layer — electing in a state where the business has nexus shifts the deduction to the entity, and the multistate consultant's election is made state by state with the credit mechanics in view. The convenience-of-the-employer and telecommuting rules: a few states (New York most prominently) source an employee's wages to the employer's location even when the employee works remotely from another state for their own convenience — a rule that reaches the consultancy's W-2 consultants working remotely for a firm based in such a state, and that doesn't apply to the owner's business income (which follows the business's sourcing rules) — the firm with a remote bench across states has payroll withholding in each consultant's work state and, in a convenience-rule state, in the firm's state too. Payroll and registration: a firm with W-2 consultants working in other states (at client sites for extended engagements, or remotely from their homes) has payroll withholding, unemployment insurance, and workers' compensation obligations in those states (the classification guide's placed-consultant scenario has a state dimension — a consultant on a nine-month engagement in another state is working there), and the firm's registration in those states for payroll purposes is also evidence of nexus for income tax. Sales tax on consulting services: most states do not tax consulting services (a few tax services broadly), so the sales tax question that dominates a coach's digital products (the digital products sales tax guide) rarely reaches a pure consultancy — but a consultancy that sells software, data products, or training materials into other states has the sales tax nexus question on those lines. The compliance system: a client-by-state matrix (for each client: the state; whether work was performed there and for how many days; the revenue; the state's nexus rule — physical, economic threshold; the state's sourcing rule — market or cost of performance); a days log for consultants working out of state (the physical presence and the de minimis thresholds); the nexus determination per state annually; the apportionment computation for each nexus state (the state's formula — single sales factor in most states now, with the sourcing rule applied to the service revenue); the nonresident returns for the owner (or the composite return the state allows the entity to file on the owners' behalf); the resident-state credit; the pass-through entity tax elections state by state; the payroll registrations for consultants working in other states; and the voluntary disclosure programs for states where past exposure exists (most states offer them — a limited look-back and penalty waiver for businesses that come forward before contact). The exposure, honestly: a consultant who has worked on site in three states for years and filed in one has back-year nonresident returns, tax, and interest in each — with the resident-state credit for those years available only within the resident state's amendment window (a consultant who pays a nonresident state for a closed resident-state year gets no credit — the double tax the voluntary disclosure timing should avoid); a remote consultant with clients in economic-nexus, market-sourcing states has a smaller but growing exposure as those states' data-matching improves (the 1099s clients issue show the client's state). The planning: know each state's rules before the engagement (the matrix at proposal time); price the state tax into engagements in high-tax, market-sourcing states; structure on-site work with the days thresholds in view where a state has them; register for payroll before a consultant's first day in a new state; make the pass-through entity tax elections where they help; and file the nonresident returns from the first year of nexus rather than the first year of a notice.

Key takeaways

• No federal shield for services: Public Law 86-272 protects sellers of tangible goods, not consultants — each state's own nexus rules govern.
• Physical presence creates nexus from the first day of on-site work in most states (some have de minimis day thresholds); economic nexus reaches remote consultants above a state's sales threshold (commonly US$500,000, varying).
• Sourcing decides how much: market-based sourcing puts revenue in the client's state; cost-of-performance puts it in the consultant's — the same revenue can be sourced to both, with the owner's resident-state credit as the individual-level relief.
• The owner files nonresident returns in each nexus state and claims the resident-state credit; pass-through entity tax elections are made state by state with the credit mechanics in view.
• W-2 consultants working in other states create payroll withholding, unemployment, and workers' comp obligations there — and convenience-of-the-employer states source remote wages to the firm's state.
• Build the client-by-state matrix at proposal time, log out-of-state days, file from the first year of nexus, and use voluntary disclosure for the past before the resident-state credit window closes.

The multistate consultant's matrix

Per client: state; on-site days (log); revenue; the state's nexus rule (physical / economic threshold); the state's sourcing rule (market / cost of performance). Per nexus state: apportionment computed; nonresident return (or composite); pass-through entity tax election decision; payroll registration if consultants worked there. Resident state: the credit for taxes paid; the amendment window for past years. Past exposure: voluntary disclosure by state. Sales tax: any product or training lines sold into other states. The matrix is a page per year, and the days log is the input no one keeps until asked.

Worked example

A strategy consultancy (an S corporation, one owner, three W-2 consultants) based in a cost-of-performance home state bills US$1.4 million: US$600,000 from home-state clients, US$450,000 from a client in a market-sourcing state where the owner and a consultant spend about 60 days a year on site, US$250,000 from a fully remote client in an economic-nexus, market-sourcing state, and US$100,000 from a remote client in a state with neither economic nexus nor market sourcing. The matrix: the on-site state — physical presence nexus (60 days, above its de minimis), market sourcing puts US$450,000 there, the firm apportions and the owner files a nonresident return, and the two consultants who worked there triggered payroll withholding and unemployment registration in that state from their first engagement day; the remote economic-nexus state — US$250,000 is below its threshold this year (monitored; next year's growth may cross it); the fourth state — no nexus. Home state: the owner's resident return with the credit for the on-site state's tax; the home state's cost-of-performance rule sources the on-site state's US$450,000 to the home state too — the credit absorbs most of the double sourcing, and the residual is priced into next year's rate for that client. The pass-through entity tax election: made in the home state (the SALT cap sidestepped on the home state's tax), not in the on-site state (its credit mechanics didn't favor it). The past: the on-site engagement is in its third year and the firm had filed only at home — the on-site state's voluntary disclosure program takes the prior two years with penalties waived, and the home state's returns for those years are amended for the credit inside its window. The firm's competitor, with the same footprint and a notice from the on-site state after its client's 1099 data was matched: four years of nonresident returns, penalties, and a home-state credit available for only three of them.

Official sources

The Multistate Tax Commission's statement on Public Law 86-272 provides that "only the solicitation to sell personal property is afforded immunity under P.L. 86-272," and that "the sale or delivery and the solicitation for the sale or delivery of any type of service that is not either (1) ancillary to solicitation or (2) otherwise set forth as a protected activity ... is also not protected under Public Law 86-272 or this Statement." — Multistate Tax Commission, Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272, https://www.mtc.gov/wp-content/uploads/2023/02/StatementofInfoPublicLaw86-272.pdf

The IRS states that "S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes." Shareholder-employees who perform services must be paid reasonable compensation as wages before distributions, and the election is made on Form 2553. — Internal Revenue Service, S corporations, https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

Practitioner note

Consultants cross state lines constantly and file in one state habitually, and the federal protection that shields sellers of goods explicitly excludes services — so each client's state is its own nexus and sourcing question, answered at proposal time or in a notice. Our multistate files run a client-by-state matrix with a days log, file nonresident returns from the first year of nexus, make the pass-through entity tax elections state by state, and use voluntary disclosure for the past while the resident-state credit window is still open — because the double tax that can't be fixed is the nonresident year whose resident-state credit expired.

See also: For related guidance, see the consulting firm's entity structure and the QBI cap; and browse every small business tax guide, by situation.

Next step

Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles multistate compliance for consulting firms — client-by-state nexus and sourcing analysis, days logging, apportionment and nonresident returns with the resident-state credit, pass-through entity tax elections, payroll registrations for out-of-state consultants, and voluntary disclosure for past exposure. See pricing or book a call.