2026 state and local tax planning guide

State and local tax: Keeping track of your evolving footprint

For many middle market businesses, state and local tax planning opportunities and exposures emerge quietly, and sometimes without warning. New hiring patterns, changes in customer base or revenue streams, and evolving laws can quickly alter a taxpayer’s tax footprint and liability.

As federal tax law changes, state responses—whether conforming to the changes, decoupling from them or enacting new tax laws of their own—remain fragmented and often unpredictable.

Emerging digital services and technologies make it easier to expand your business across state lines, potentially creating taxable connections you may not have anticipated. Additionally, today's service-based sales activities are outgrowing sourcing methodologies designed for an economy that was predominantly goods-based for decades. As states modernize their tax regimes to better reflect current economic and business realities, they are also increasing audit activity to ensure compliance with frequently changing laws.

These developments affect more than compliance. They can influence cash flow, financial reporting, business expansion, capital investment, transaction planning and audit risk. An annual review can help you reevaluate assumptions that may no longer reflect how your business operates, uncover tax-saving opportunities and address historical exposure. RSM's state and local tax team has identified five major issues and key questions to ask your advisor to help you stay compliant as your business grows.

States have taken a broad and inconsistent approach to adopting the federal tax changes enacted in the One Big Beautiful Bill Act (OBBBA). As states balance revenue needs, budget pressures and economic policy objectives, many are selectively conforming to or decoupling from key business provisions.

State conformity with federal tax law can significantly affect a business’s tax liability, planning, multistate compliance, operations, potential expansions, tax savings and exposure. In particular, state tax outcomes may vary significantly depending not just on a company’s business operations but also on each state's conformity with:

• Section 174 research and development expensing
• Section 168(n) bonus depreciation for qualified production property used in manufacturing, production or refining
• Section 163(j) limitations on deductible business interest expense

A multistate conformity review can help not only with annual return compliance in the states where you operate, but also with making informed decisions about your multistate operations and expansion opportunities.

Since the South Dakota v. Wayfair Inc. decision, state tax nexus has remained a significant issue for middle market and growing businesses as they add property, employees, customers and revenue streams in new locations. The widespread adoption of economic nexus standards for sales and income taxes and the use of digital commerce and internet-based technologies in facilitating these expansions can create unnoticed and unanticipated filing obligations.

• Economic nexus: Many states impose economic nexus standards for sales and use taxes, income and franchise taxes or gross receipts taxes. The applicable thresholds, measurement periods and filing consequences can differ by state and tax type.
• Remote and hybrid employees: Employees working in another state may create business tax nexus, employer withholding obligations, unemployment insurance responsibilities and other payroll-related requirements.
• Affiliate and related-party activity: In some circumstances, the activities of an affiliate or related entity may affect a company’s nexus, combined-reporting obligations or filing position.
• Business expansion and transactions: Acquisitions, new facilities, inventory placement, third-party fulfillment arrangements and new service offerings may change the company’s filing footprint.
• P.L. 86-272: While this law is not directly related to nexus, states continue to examine the scope of federal protections against state income tax for certain solicitation activities, particularly when businesses engage in internet-based activities that extend beyond protected solicitation.

An annual nexus review can help determine whether your business is filing everywhere it should and only where it should. These reviews can identify potential filing obligations and planning opportunities, particularly for businesses experiencing growth, entering new markets, expanding their workforce or making significant capital investments.

For many multistate businesses, apportionment planning creates greater savings opportunities than tax rate changes.

Growth in services and other intangible business activities has made determining where receipts should be sourced more complex. States can apply different sourcing methods, such as market-based sourcing or cost-of-performance sourcing, but may interpret the same method differently. Services, particularly digital services and software as a service (SaaS), are especially difficult to source, but goods also present challenges when customer location data is incomplete or changes. States may even look through to the location of a business customer’s customer in cases when third parties may be direct or indirect recipients of a particular service.

Special apportionment, often called alternative apportionment, has also become a major issue in tax planning and a focus of litigation. When a standard state apportionment formula or sourcing methodology does not fairly represent a business’s activity in the state or produces an inappropriate result, taxpayers may be able to petition the state for permission to use an alternative method. Conversely, state taxing authorities may impose an alternative apportionment method during an audit.

Reviewing existing apportionment positions well before filing season begins can avoid unpleasant surprises close to the deadline. Businesses can reduce costly and time-consuming litigation by examining their activities, monitoring relevant litigation and obtaining support when seeking a different apportionment method or responding to state law changes.

State and local credits and incentives may enhance cash flow, offset investment costs and support growth initiatives. Potential opportunities can arise when a business expands a facility, adds employees, develops new products, invests in equipment, enters a new jurisdiction or undertakes a significant technology or infrastructure project.

It is important to distinguish between two broad categories:

• Statutory incentives are established by law and may be available when prescribed eligibility and filing requirements are satisfied.
• Discretionary incentives generally require an application, negotiation or approval process and may need to be secured before the business makes an investment, creates jobs, signs a lease or publicly commits to a project.

Key activities that may qualify for statutory or discretionary credits include:

• Research and development
• Manufacturing
• Energy and sustainability production or investments
• Hiring and workforce development programs
• Efforts related to artificial intelligence, such as data center construction and technology investment

In addition to seeking new incentives, businesses should review existing incentive agreements for compliance and clawback protection. A tax advisor can help you analyze and claim these benefits correctly to determine qualifying expenses, whether they can be prorated and when clawbacks apply. Tax and finance teams should evaluate new business initiatives before they are implemented or publicized to identify negotiated incentives that require advance planning to maximize their value.

States continue to increase sales tax audit activity to capitalize on the post-Wayfair nexus environment and to shore up revenue shortfalls. Audit programs increasingly rely on analytics and technology like AI to increase efficiency and broaden operations, and on frequent distribution of nexus questionnaires, information document requests or similar notices.

Businesses can best prepare for this increased scrutiny with robust documentation of positions taken on sourcing, nexus, credits and incentives, and federal tax conformity. State audits initiated within the statute of limitations can drag on for years, during which there could be changes in business operations, tax and finance personnel, or IT systems used to retain relevant documents. Taxpayers should contemporaneously document tax positions and supporting calculations to stay audit-ready.

Businesses may also want to take advantage of voluntary disclosure programs and other cleanup approaches to mitigate historical exposures and abate costly penalties.

If your business receives a state nexus questionnaire, information request or notice, consulting your tax advisor can help ensure you understand the request and avoid providing ill-informed responses that may be difficult to retract or correct.

Bonus topic: Digital economy and state tax base expansion

Newly emerging state taxes on software, social media, cryptocurrency and data storage signal that tax base expansion into new forms of digital activity is an important issue to follow. Some examples:

• California's taxation of SaaS and prewritten software
• Colorado’s removal of its exemption for downloaded software
• lllinois’ new cryptocurrency transfer and social media taxes

At the federal level, a proposal advancing through Congress indicates how lawmakers plan to treat digital assets on the national level, raising more questions about how and to what extent states may regulate digital assets like cryptocurrency in the future.

Frequently asked questions